Insuring the intangible
Valuable assets, indistinct risks
Whether it’s proprietary algorithms, massive data sets or intricate global supply chains, intangible assets are critically important sources of competitive advantage and profitability for many firms.
In fact, according to one study, intangible assets – including a company’s brand, intellectual property (IP) and data – accounted for more than 85 percent of the S&P 500’s overall value in 2015.
And just like physical assets, they need to be protected.
However, managing and mitigating the risks associated with intangible assets is complicated by the fact that they, by definition, are indistinct. Their value is subjective and often calculated using formula with assumptions about estimated future income. Moreover, their value can fluctuate widely even in the short-term, the threats aren’t always readily apparent, and the impacts often are hard to anticipate.
If a competitor replicated a retailer’s proprietary procurement system, for example, the firm could lose one of its most significant competitive advantages. But understanding how that ultimately translates into lower sales/profitability is not easy to estimate in advance.
Likewise, when a company’s systems are hacked and its data compromised, the magnitude of the loss can vary considerably. At a minimum, the damages could be limited to the ransom the hackers demand to unlock the data. However, it’s also possible that publicity about the attack could seriously undermine the company’s reputation and brand, leading to a steep drop in sales.
Flexible, adaptable and capital efficient
For a variety of reasons, the options for covering IP, data, brand and other intangible assets via traditional risk transfer solutions are often limited. Many insurers, for instance, are reluctant to cover contingent business interruption losses caused by a disruption in the supply chain.
That’s also why more and more captive owners are implementing increasingly innovative solutions for protecting their intangible assets against various threats. They recognize that captives offer a flexible, adaptable and capital efficient alternative for safeguarding their reputations, IP, data and related resources.
The risk transfer options for intangible assets are limited, at least in part, by a lack of historical data as well as the inherently unpredictable nature of the risks. A captive can overcome those obstacles by bundling volatile risks where there is limited data, like a supply chain disruption or the loss of valuable IP, along with other non- or lowly correlated exposures with stable loss histories.
That enables a challenging risk, when aggregated with other perils, to become insurable at appropriate attachment points. Also, reinsurers are often willing to cover these programs, particularly when they’re part of a multi-line/multi-year contract supported by structured reinsurance.
This approach offers several advantages.
First, the captive owner now has a mechanism for capturing better data about the particular risk. That data can be used to enhance its overall enterprise risk management efforts by highlighting vulnerabilities in, say, its procurement and logistics operations or its data protection systems. It also can help the captive manager and its fronting partner in refining the terms and conditions, as well as the attachment points and limits, for different risks.
Covering these risks within a captive also promotes faster, more effective responses. In many cases, when an intangible asset is at risk, speed is of the essence. That’s especially true, for instance, when the company’s reputation is at stake. Or as Warren Buffett famously noted, “It takes 20 years to build a reputation, and five minutes to ruin it.”
However, when something triggers a wave of negative publicity, having coverage within the captive enables the company to immediately dispatch crisis management experts to limit the magnitude and duration of the damages.
A final thought. In the face of new regulations and enhanced governance requirements, using a captive to cover just a few stable and predictable lines-of-business is becoming less and less attractive. At the same time, many parent companies are seeing their intangible resources grow in importance and value. Both developments suggest that captive managers will continue to pursue innovative solutions that enable them to protect previously exposed assets while reducing overall risk volatility and improving capital efficiencies.
About the author: Marine Charbonnier is Head of A.R.T. Integrated Solutions, AXA Corporate Solutions, AXA XL division. She has worked in the alternative risk transfer market since 1992. Since then, Marine has supported a wide range of clients in implementing tailored risk financing solutions to promote capital efficiencies and enhanced enterprise risk management. She is based in Paris and can be reached at firstname.lastname@example.org.
This article first appeared in Commercial Risk Europe.