Total cost of risk (TCOR): what it includes and how to calculate it

Total cost of risk (TCOR) is everything a business spends in a year to manage its risk: the premiums, the losses it pays itself, what it spends to administer claims and prevent losses, and the internal time that goes into all of it. It is the right number for judging an insurance program, because a program with the lowest premium can easily cost more once the deductibles, fees and collateral are counted.

The calculation is simple addition. The discipline is in finding every item and measuring losses the same way each year. The Total cost of risk (TCOR) calculator does the arithmetic once you have the figures.

How the industry defines it

IRMI, the risk management reference publisher, defines cost of risk as "the total cost of managing risks and losses incurred by an organization," and says the total includes four things: losses the organization retains plus the expense of handling those claims, the cost of preventing or reducing losses, premiums and other costs of transferring risk, and the overhead of running the risk management function (IRMI).

The RIMS Benchmark Survey, the main benchmark for large buyers, reports TCOR as insurance costs, retained losses and the administrative cost of the risk management function. RIMS says its survey holds data on more than 5,000 insurance programs from 570 organizations, many of them Fortune 500 companies (RIMS). The most recent figure we could verify is from its 2019 edition: average TCOR of $9.95 per $1,000 of revenue in 2018, up from $9.75 in 2017 (RIMS, 2018 survey release; Insurance-Canada summary of the 2019 edition). Those are large-company numbers from a market that has changed since. Use them to understand the ratio, not as a target for a 30-person business.

What goes into the number

Two details trip people up. Collateral is counted at its cost, the fee on the letter of credit or the earnings you give up, and not as the whole amount posted. And retained losses must include the losses below the deductible that never reached the insurer, such as a $4,000 equipment repair you absorbed. Those do not appear on a loss run.

The formula and the ratios

TCOR = premiums + retained losses + claims administration + broker fees + loss control + taxes and fees + internal time + collateral cost.

Three ratios make it comparable over time:

• TCOR as a percent of revenue, or per $1,000 of revenue, which corrects for growth.
• Premiums as a share of TCOR. If premiums are 95% of the total you have retained very little, and your price is mostly the market. If they are 65%, the quality of your losses matters more.
• TCOR per employee or per vehicle for exposure-based trends.

A hypothetical comparison

Say a wholesale distributor with 120 employees, a warehouse and 18 delivery vehicles has $30 million in revenue. Its broker proposes raising property and auto deductibles to $25,000 for a premium reduction. The figures are invented to show the method.

The premium falls $62,000, yet TCOR rises $15,000, because the company would now keep an expected $57,000 more in losses, pay for administration and spend more on telematics and driver training to hold the line. The proposal wins only if the retained losses come in lower than expected: at $60,000 instead of $95,000, TCOR would be $479,000, or $20,000 below the current program. The decision therefore depends on the loss forecast, which brings you back to your loss runs: what they are and how to request them and to the deductible and retention break-even calculator, which finds the claim frequency where two options cost the same and shows a bad year.

Run the bad year as well. If the company has eight $25,000 auto and property claims in one year, it retains $200,000 even though the premium drops. Whether it can absorb that is a cash question, not an accounting one.

Gathering the data

1. Pick the period. Twelve months, usually the policy year.
2. Pull premiums for every line, including taxes and fees. Use a premium audit result if one has been issued, not the estimate. See premium audits: how they work and how to prepare.
3. Pull loss runs from every carrier, valued at the same date. Add the losses you paid yourself, inside deductibles and outside any claim.
4. Add the cost lines: fees, safety spending, collateral costs, assessments and your best estimate of staff hours at a loaded hourly cost.
5. Enter revenue, then compute the ratios and keep the file. The first year's value is the baseline.

Compare like with like. A claim valued at 12 months will usually develop upward as it ages, so adding one year valued at 12 months to another valued at 36 months misleads. Larger programs have an actuary estimate ultimate losses. A smaller one can simply value every year at the same age.

What TCOR leaves out

TCOR measures what you spend. It does not measure what is left uncovered, which is where the surprises live.

• Uninsured income loss. Business income below the waiting period, beyond the limit or outside the covered cause. The business income (interruption) limit calculator tests the limit.
• Indirect injury costs. OSHA's Safety Pays estimator treats the employer as always paying indirect costs of an injury, and uses the profit margin (3% by default) to show how much extra sales it takes to pay for it. OSHA notes that its estimates rest on NCCI average lost-time claim data for policy years 2015 to 2017 and are not a company-specific analysis.
• Lost customers, reputation and management distraction.
• The cost of capital tied up in a self-funded layer.

For those reasons a lower TCOR is not automatically a better program. It shows cost, not protection. Adequate limits, sound forms and insurer financial strength sit outside the number and belong in the broker conversation.

Using TCOR in decisions

• Retention choices. Test each deductible or self-insured retention option against the base; see risk transfer vs retention: avoid, reduce, transfer or retain and deductibles vs self-insured retentions: who pays first.
• Large-deductible and captive programs. These move cost from premium to retained losses and fees, so TCOR is the right yardstick. See large deductible workers' comp programs: how they work and what they cost and what is a captive insurance company and how does it work?.
• Safety investments. A $20,000 guarding program that cuts workers' comp claims shows up as a retained loss reduction and, later, a better experience mod.
• Board and lender reporting. A single TCOR trend line is easier to explain than ten renewals. It is a standard exhibit for Enterprise risk management (ERM) explained and for what a risk manager reports (what a risk manager does, and when a business needs one).

Common mistakes

• Comparing premium to premium and ignoring the retained layer.
• Leaving out claims administration and collateral.
• Treating one good loss year as a trend.
• Counting the same cost twice, such as a TPA fee that also sits inside a retained-loss figure.
• Changing the method every year so the trend means nothing.

Key takeaways

• TCOR = premiums + retained losses + administration + fees + loss control + taxes and fees + internal time + collateral cost.
• A lower premium does not mean a lower TCOR. Compare programs on the whole, and test a bad loss year as well as an average one.
• Count losses the same way every year, valued at the same age, and include small losses paid outside the insurer.
• RIMS's benchmark (2018 data: $9.95 per $1,000 of revenue) is a large-company reference. The better comparison for your business is your own trend.
• TCOR shows cost, not coverage. Uninsured income loss, indirect injury costs and reputation sit outside it.