Article published by Kyle Langan August 25th, 2023
For financial health and longevity, it is vital to understand the costs of risk and their impact on surplus or profitability. This article provides analysis on cash flow for a treatment provider. It may point out factors that typically go unmeasured at times of stress.
Learn How to Measure:
Risks are inherent in an entity’s operations, and risk brings cost.
Total Cost of Risk is money spent managing risks and incurring losses. It is the sum of all aspects of operations that relate to risk.  Costs usually include buying insurance. Policy types and claims history determine these costs. Other costs include retentions, uninsured losses, administrative work, risk control, and indirect costs. 
Losses set back cash flow, but with the right protection, most direct losses are covered by insurance. Indirect costs are unbudgeted expenses of events caused by business interruption or disruption. An indirect loss cost factor, specific to industry group and risk category, can help with the calculation.  With these indirect costs calculated, strategic opportunities arise to minimize Total Cost of Risk.
A litigated medical malpractice loss will incur significant costs, thereby increasing Total Cost of Risk for a treatment provider. This results from the losses in the settlement/judgement and attorney fees (direct costs). Separate, there are business disruptions, time for data gathering, strategy formation, and human capital expenditures (all indirect costs).
Scenario: Addiction Treatment Provider Faces Medical Malpractice Allegation
$50,000 = Cost of insurance purchased by Treatment Provider (Premiums, Taxes, Fees)
$250,000 = Medical Malpractice Loss
Insurance company provides a $250,000 payout and protection for the covered cause of loss as defined in the treatment provider’s human services professional liability policy.
$10,000 = Self-insured retention
Insurance company collects $10,000 from the treatment provider after the loss concludes, as it was the entity’s agreed portion of the loss, per the insurance contract.
An indirect loss cost factor measures wasted time, energy, and resources spent on a claim process and recovery from the loss.  Indirect losses erode cash flow.
A factor of 0.50 equals indirect losses totaling an additional $125,000
250,000 * (0.50) = 125,000
In conclusion, the Treatment Provider faces $125,000 of indirect costs, $240,000 in losses covered by insurance, and a $10,000 deductible.
$125,000 is the portion that may go unaccounted for on financial statements, unless it is quantified by the treatment provider’s risk manager or CFO.
Total Cost of Risk:
Indirect Costs = $125,000
Insurance Premium = $50,000
Self-insured retention = $10,000
Total Cost of Risk for the Treatment Provider this year = $185,000
This also illustrates the importance of insurance. Without the protection, Total Cost of Risk is $240,000 higher, totaling $425,000, plus interest expense, if the company used debt to finance the loss.
Cost of risk. Cost of Risk | Insurance Glossary Definition | IRMI.com. (n.d.). Retrieved February 28, 2022, from https://www.irmi.com/term/insurance-definitions/cost-of-risk
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Data-driven client outcomes for the insurance industry. TCORCalc. (2019, July 28). Retrieved February 28, 2022, from https://tcorcalc.com/