Risk Management and Bookkeeping Systems

Risk Management

Risk management may be defined as the art and/or science of anticipating and controlling all elemental, inherent, and environmental hazards that could cause financial loss and determining the most efficient means of financing such loss. In establishing an effective Risk Management program, it is first necessary to be aware of the consequences that may result from the existence of loss-causing hazards. They are: 1) damage to or loss of property, 2) loss of income from damage to property or additional cost of alternative means to continue services, 3) money damages arising out of negligent acts resulting in bodily injury or damage to property of others, and 4) loss of service due to death or incapacity of key personnel.

Risk is uncertainty. The underlying theme of risk management is that any business enterprise faces the possibility of loss. While the particular loss and severity varies among types of organizations, each one faces loss-causing risks that can reduce income and/or destroy efficiency. Three fundamental rules of risk management are: 1) Don't risk more than you can afford to lose. 2) Don't risk a lot for a little. 3) Consider the odds.

An organization's governing principle should be to protect its assets from attrition due to fortuitous losses by: 1) eliminating risks wherever possible, 2) reducing the effects of risks which are economically unfeasible to eliminate entirely, 3) assuming or self-insuring (as a charge against operating expenses) losses from risks not considered significant in relation to cash flow, and 4) transferring risks to another party contractually, or purchasing insurance for risks not otherwise transferred. Of these methods, No. 4 (transferring risk by the purchase of insurance) is the most common. When risk is transferred to an insurance company, the buyer should receive from the insurance company not only loss-paying ability but also other services, such as loss prevention engineering and claims adjusting facilities.

Of the four methods involved in protecting assets from attrition, the best alternative should be chosen for each risk of loss. The key decision is to determine which risk management technique will contribute most to the Company's objectives.

The purchase of an insurance policy creates an immediate funding device for future losses. It is essential that the policies include coverage for all insurable losses. The goal of covering all insurable type losses depends on current market conditions.

In certain circumstances foreseeable losses may be of such small magnitude that no effort should be made to finance them. Deductibles are customarily utilized to avoid dollar-trading with insurance companies. Since the insurance company determines its ultimate premiums on the basis of class losses plus an overhead charge factor, the elimination of small inconsequential losses from insurance coverage reduces the cost of that insurance.

The use of deductibles is common in the property and time element areas. Generally speaking, deductibles are not used in the liability areas because it is essential that the insurance company be involved in a liability claim from the first dollar upward in order to control the defense of the case.

One recommendation is that all your insurance policies restrict the cancellation privilege of the insurance company by requiring at least 60 days (preferably 90 days) prior notice of cancellation or non-renewal. When risk is transferred to an insurance company, the buyer obtains loss paying ability as well as other services such as loss prevention engineering and claims adjusting facilities. The following four basic benefits should be expected from an insurance company:

• Respond promptly and adequately at time of loss. The ability of an insurance company to perform at time of loss depends on the coverage in the policy. The response is a contractual obligation and if the policy is adequate, the response will be adequate.

• Property conservation advisory services designed to prevent or limit the effect that inherent hazards may have on property, including its earning potential. In this regard the insurance company is considered to be an expert in prevention of loss. The value of prevented loss is inestimable.

• The transfer of the buyer's risk at a cost commensurate with the degree of loss potential and frequency thereof.

• Assurance that the insurance market will be available long into the future.

The relationship between an independent agent and the various insurance companies represented is complex. The agent attempts to maintain a balance with the various companies placing sufficient good business with each to keep each one happy, yet maintaining a market for the less attractive risks. The insurance buyer is rarely a part of this operation, but is substantially affected by it. An agent with a predominantly good book of business will be able to serve an insurance buyer better than an agent with a poor book of business. In effect, the agent is a customer of the insurance company and the insurance buyer is a customer of the agent.

This is not to imply that an insurance company operating through an agent does not pay specific attention to an individual buyer's needs. The insurance company assists the agent in helping the buyer and is most able to provide good coverage at nominal cost if the insurance agent maintains a good relationship with the insurance company. It goes without saying that no insurer will continue to provide insurance over a long period of time for a situation that shows signs of deterioration.

The relationship between an insurance company and an insurance buyer is tantamount to a joint venture. The śuccess of the joint venture centers on the ability of the insurance buyer, working with loss prevention personnel of an insurance company, to effectively control all preventable type losses.

There are no hard and fast rules to be applied in the selection of an insurance source. The relationship is a personal one and must fit the personalities of the parties involved. Of paramount importance are the insurance company's loss paying abilities, ancillary services offered, and contractual provisions within the policy.

Insurance Costs

Liability insurance premiums are influenced by individual loss experience modified by the impact of inflation as related to the cost of goods and services, as well as the claims consciousness of the American public, coupled with higher jury awards. When a large sum of money is awarded by a jury to an injured party, the out-of-court settlements of other claims have a tendency to rise proportionately. Thus, the total cost of claims increases.

Property insurance premiums have consistently been influenced by overall loss experience independent of the losses sustained by a specific insured.

Reinsurers in the world insurance marketplace influence primary insurance premiums drastically. There probably has been no other time in recent insurance history when the effect of reinsurance has been as visible. Reinsurance allows the primary insurance company to increase capacity and maintain availability. The " banking" aspect of reinsurance expects the primary insurance company to eventually reimburse the reinsurance company for all losses and expenses paid out.

The fall of 1984 became the visible turning point of insurance premium levels. Reinsurers began to demand higher premiums for their insurance and these costs were passed down to the primary insurance companies. As reinsurance treaties expired in 1985, some treaties were not renewed and others commanded reduced limits and increased premiums. In 1986 insurance costs are practically out of control and the amount of coverage drastically reduced. This general trend in curtailment of the insurance market has precipitated the premature termination of established insurance programs by companies that have decided to retire from certain classes of business (such as schools and governmental bodies).

It is anticipated that a shortage of insurance capacity will persist for the next eighteen months to two years. The change in capacity will result because of new investment moneys flowing into the insurance industry attracted by anticipated profits. This should stabilize insurance costs and may even precipitate another round of price reductions to the advantage of the buying public.

Bookkeeping Systems

Reasons to maintain accurate books and records are to:

• Keep track of transactions with others

• Supply potential lenders with accurate financial data

• Comply with government regulations

• Detail taxable income

The accounting and information needs of your business must be analyzed to determine the best bookkeeping system. The particular system you adopt should provide the following:

• Detailed operating statements

• Comparison of current results to budgets and prior periods (where and when available)

• Financial statements suitable for use by management and creditors

• Information for tax returns and reports to regulatory agencies

• Sufficient control to protect assets and detect errors

Components of a Good Bookkeeping System

Each business has special needs that must be considered when establishing a bookkeeping system. Factors you should take into account when determining the specific areas of operation in your bookkeeping system include: the form of business, the industry in which you are engaged, the number of employees, the number of product lines (services), the number of business locations, and the complexity of your business.

The company's accounting records should consist of the following:

• Chart of accounts

• General ledger

• Sales and cash receipts journal, detail accounts receivable cards and aged accounts receivable trial balance

• Cash disbursements journal

• Purchase journal and detail vendor payable cards

• Payroll journal

• General journal

• Fixed assets ledger

• Inventory stock record control

• Bank reconciliations, including deposit receipts

• Monthly financial statements