New Structures, Technology, Captives May Help Cover Intangible Assets

Though intangible assets are becoming an ever-growing part of many companies' value, there are significant disconnects between the way many organizations approach coverage of their tangible and intangible assets.

Addressing those growing exposures could be a function of parametric coverage designs, new technology, and captive insurance structures, according to panelists in a new Captive Insurance Companies Association (CICA) webinar.

"Intangibles are a growing proportion of corporate balance sheets, particularly in the [United States]," said John Donald, special cyber adviser to AXIS Capital. Speaking as part of a webinar titled "Beyond Digital Transformation—Benefits of Blockchain Tech" as part of CICA's 2020 "Building on the Best" webinar series, Mr. Donald noted that more than 80 percent of the value of S&P 500 companies is in intangible assets.

"The preponderance of assets on corporate balance sheets are actually intangible and not tangible," said Mr. Donald, including such assets as intellectual property, brands, and goodwill.

He noted that brands weren't even recognized by accountants as balance sheet assets until the 1990s, but their value has seen dramatic growth in recent decades. The value of goodwill has been driven higher by the recent level of merger and acquisition activity, he said, while share buybacks also distort the value of intangible assets versus tangible assets on balance sheets.

"All of those things have driven the rise of intangible assets on balance sheets, but it's not matched by insurance," Mr. Donald said. "The only area where it has been matched recently is in cyber insurance." He cited the phrase "data is the new oil," adding, "When we think of data or data protection, that leads us basically to cyber insurance."

With the number and cost of data breaches on the rise, the cyber-insurance market "is probably the strongest growing part of all the insurance market at the moment," Mr. Donald said.

Not only are companies increasingly connected online and handling growing amounts of data, criminal hackers have been able to condense their skills and share them online in tools that other cyber criminals can purchase relatively cheaply. "Anyone who wants to do you ill can do you ill, because tools can be purchased cheaply on the dark web," Mr. Donald said.

Covering the exposure presents challenges, however. In the world of tangible assets, the likelihood of buildings collapsing in New York, Tokyo, and London simultaneously is zero. But in the world of cyber risk, the connectivity between systems makes the risk of multiple companies' systems being shut down simultaneously in various spots around the world a very real threat.

Organizations need to consider the balance between protection and insurance, Mr. Donald said. On the property side, the amount spent on protection like sprinklers and insurance is typically about a 50-50 proposition. But with cyber risk, about $120 billion is spent yearly on protection and only about $6 billion on insurance.

There are three possible reasons—knowledge, trust, or price—why the cyber market isn't bigger, Mr. Donald said.

In that context, "The solution to this problem of the huge uninsured intangibles market is parametric insurance," he said. Parametric coverages are based on very straightforward if/then terms and are very clear, contributing to trust in the coverage. "But the most important factor is price," he said. Because they don't have many of the overhead costs of traditional insurance such as extensive claims processing or underwriting, parametric policies can reduce costs 45 percent, Mr. Donald said.

"The problem, of course, with parametric is trying to make sure your parametric index is matching properly with the risk you're trying to insure against," Mr. Donald said. And, for regulatory reasons, it's critical to pick the right markets for these products, since they might be viewed as derivatives rather than insurance.

For a captive insurance company, these coverages could provide a possible profit center, Mr. Donald said, with direct access to capital markets providing an opportunity to offer those markets interesting yield opportunities.

Marcus Schmalbach, CEO of RYSKEX GmbH, noted that his firm worked with AXIS to develop a parametric cyber-insurance coverage that links to distributed ledger technology blockchain and artificial intelligence. "At the end of the day, it's a new way of risk transfer," he said.

Illustrating how the coverage might work, Mr. Schmalbach used the example of a department store chain that was hacked at the holiday season, possibly affecting customer shopping due to the reputational damage.

A parametric insurance policy covering the event would be based on specific triggers. In this case, one trigger might be an article about the breach appearing in a major newspaper. Another could be a 10 percent drop in the company's share price on a specified exchange for more than a week. If both events occur, the department store company can file a claim and collect on the policy.

Payments, clearing, etc., are all done on a blockchain platform, adding efficiency to the process.

With parametric coverages, policyholders can negotiate the appropriate triggers individually, Mr. Schmalbach noted, with the policies' price determined by the amount of risk transferred. "No hard and soft market cycles," he said. "It's just you and the market itself."

David Thelander, special counsel at the Gravel & Shea law firm and a board member of the Distributed Ledger Governance Association, said that Vermont has been a leading domicile in supporting blockchain captive insurance innovation.

The state has been actively working to leverage its reputation in supporting captive insurance innovation to support other innovative technologies, particularly as they might apply to captives, he said.

More information about CICA's "Building on the Best" webinar series can be found on the CICA website.