Quantifying Return
Even without going into a significant level of detail, an organization can come to understand the trade-offs in expected costs and returns arising from different interventions and programs aimed at altering an organization’s risk profile. Rather than attempting to evaluate the absolute cost of any particular scenario, it is only necessary to consider incremental change, such as what will the increase/decrease in costs be if a particular approach is taken.
With the preceding as background, the focus now shifts to an examination of how employees impact, directly and indirectly, the risk profile and associated costs. As mentioned earlier, most of the risk attributable to employees falls into two categories: strategic risk and operational risk. A number of subcomponents relevant to strategic risk hinge upon an organization’s ability to attract and retain qualified employees in order to fulfill its strategic objectives. While the employee impact on strategic risk is critical, the focus here will be on operational risk, in particular two subcategories: worker safety risk and service provision related liability risk. A third area of employee related risk not covered in this discussion is product shrinkage or loss.
Worker Safety Related Risk. In virtually any operation involving employees, there are accidents. The consequence of these accidents is manifested in a variety of ways. An employee who is injured on the job causes the organization to incur costs ranging from payments made for treatment and missed time to the costs of additional overtime necessary to cover production for a missing worker.
Risk Transfer Costs. Worker’s Compensation Insurance, a mandatory program for virtually all business firms in the United States, allows an organization to transfer some of the risks associated with workplace accidents to a third party. This third party then makes some of the payments that the firm would otherwise be directly obligated to pay. Worker’s Compensation Insurance is a complex subject in and of itself and the discussion here is not inclusive but touches on a few key points relating to costs. As with other forms of insurance, there are costs associated with this risk transfer in the form of premium payments. The cost of transferring worker safety risk depends on the loss experience of the organization. In 1995 there were more than 3.6 million disabling accidents in the U.S. workplace. In that year, firms paid more than $30 billion in Worker’s Compensation premiums, representing the largest component of the $131 billion in commercial liability premiums paid (Lencsis 1998, 1). Two companies, otherwise identical, will pay different premiums based on the rate of claims over the past several years. Claims rate experience from the previous four years (three years of actual rates with a one year lag to compensate for open claims) is a common approach for setting the rates differentially from a baseline for a given industry. Logically, companies that have experienced higher rates of claims must pay a higher cost to transfer the risk associated with potential future claims. Because of the lag in resetting rates based on experience, firms that reduce their claims rates generally must wait a year or more before they start to see reduced premiums for Worker’s Compensation Insurance.
Loss Costs. When a worker is injured on the job, there are a variety of directly and indirectly associated costs not covered by insurance payouts. It may be necessary to increase overtime for remaining employees in order to cover for absent employees. This is especially true in environments where there is little spare capacity, which is common with the current drive toward efficient staffing and in environments where there is a lack of qualified employees. Product or service quality may suffer due to the absence of an employee. Production schedules may slip. Organizations that are part of a supply chain can see effects ripple throughout the system. Costs associated with simply processing and following up on claims can accumulate to surprising levels. Employees who are injured, but still on the job, require additional management resources. Many of the indirect loss costs are difficult to accurately quantify, but it is useful for an organization to enumerate them and explore their potential impact.
Risk Mitigation Costs. Organizations employ a variety of approaches in attempts to reduce workplace accidents, ranging from system safety (making sure that the equipment and processes in place are optimized from the point of view of safe operations with cost constraints) to employee selection and training.
As there are costs associated with any mitigation efforts, it is critical to prioritize those likely to have the most impact. Job Safety Analysis (JSA) provides a high level description of the work environment from the point of view of discovering causes of accidents. People, processes, and equipment interact in a complex system that can and does lead to accidents. The process and equipment components can lead to unsafe conditions, whereas the people (employees) engage in unsafe acts. Ultimately the intersection of unsafe acts and unsafe conditions is where accidents can occur (Wert and Bryan 2001, 45). In some environments, such as manufacturing, a great deal of work has been done to reduce the impact of unsafe conditions. In a recent study, DuPont found that only 4 percent of accidents were due to faulty equipment or other technical issues. The other 96 percent could be attributed to unsafe acts by employees (Olin 2003). Much of this study was based on data from manufacturing environments where firms like DuPont have a long history of aggressively improving safety issues related to physical systems technology. This would suggest that mitigation efforts may best be effectively leveraged when they are structured around employees, in particular the selection of new employees.
Service Liability Risk Related. Liability risk, within operational risk, covers a range of issues. Here the concentration is upon liability risk associated with the provision of service. In environments where there is direct or indirect interaction between the firm’s employees and its customers, there is the potential for adverse impact on the customer, and this impact can often be traced to a particular incident, which can itself be related to the actions of employees. For example, a shopper in a grocery store slips and falls on a recently mopped floor where no caution sign was displayed to warn the customers. The shopper is injured and the store faces a potential liability claim. Some service environments have much larger liability risk potential than others. Healthcare is an excellent example, where the costs of shifting liability risks to third parties as well as the costs of losses are very high (Carroll 2004).
Healthcare liability issues as they relate to the nation’s medical liability system are a prominent issue today both economically and politically. Patient safety issues can be, to a significant extent, attributed to actions of the employees of the healthcare firms. The Joint Commission on Accreditation of Healthcare Organizations (JCAHO), one of several oversight groups in a complex system, is responsible for accrediting healthcare organizations and ensuring high quality patient care and patient safety. The JCAHO recognizes the link between patient safety, liability costs (both loss and risk transfer costs), and healthcare organization employees (JCAHO, 2005)
Risk Transfer Costs. Liability insurance is the most common form of risk transfer. Premium rates are dependent upon the type of business and the previous loss experience, which is considered to be a predictor of future risk potential. The liability insurance market has seen a significant hardening in recent years due to a generally perceived increase in risk across nearly all sectors of business, coupled with a recent increase in estimated hazard risks. The health-care industry, in particular, has seen a dramatic rise in the costs of transferring risk; The industry is at the point where the costs of doing this may become so prohibitive that it is not possible to continue operations. These spiraling costs threaten to cripple the industry (Joint Commission on Accreditation of Healthcare Organizations 2005a and b).
Loss Costs. In the context of liability related losses, costs are incurred to pay for the portion of risk not transferred (deductibles being a good example) as well as other indirect loss costs. Liability related lawsuits for wrongful damages incurred by customers are becoming more and more prevalent in most business sectors, and firms assume significant risk of loss not covered by their liability policies. Liability issues also impose a variety of indirect costs. A firm’s reputation may be diminished in the case of extreme liability issues (Firestone Tire being a prime example), which has an effect on future revenue potentials. In some cases there exist complex indirect causality relationships. Again in healthcare, the JCAHO accredits healthcare organizations based on a complex set of rules and guidelines. The consequence of failing the accreditation process can be drastic, as eligibility for a variety of payment systems like Medicare and participation in healthcare insurance networks are tied to continued accreditation. Healthcare organizations that experience patient safety issues consequently face higher risk transfer costs in the future, higher current loss costs in the present, and an increased probability of a catastrophic loss of accreditation. The loss of accreditation is an example of a very low frequency occurrence but with very high consequences, which is in turn driven by an aggregation of higher frequency individual incidents, each with lower direct consequences.
Risk Mitigation Costs. As with worker safety related risks, firms engage in a wide variety of efforts in an attempt to mitigate liability risk. In service oriented environments, the most cost effective programs will be those that focus on the employee, through training of current employees and selection of future employees.