Must it always be risky business? (risk management by insurance)(Cover Story)

Companies insure against property and casualty loss; why not against rogue trading, new product failure, and other business risks?

Business risk insurance should be thought of as a new and efficient source of capital

But banks and insurers will need to integrate and tailor products

Companies routinely take out property and casualty (P&C) insurance to protect themselves against the risk of damage caused by fire, theft, storm, or any of a number of accidents. But few have stopped to consider whether business risks - which may have a far greater impact on shareholder value - can be transferred to a third party in the same way. Failed product launches, rogue trading, and regulatory changes, to name but a few business risks, can seriously damage a company's profitability. Yet most companies still regard these as the inevitable, uninsurable perils of entrepreneurialism.

A handful of companies, both public and privately owned, take a different view. They use business risk insurance to preserve or even increase shareholder value in terms of return on equity (ROE) by protecting the cash flow, reducing the amount of capital tied up in the business, or improving their financing terms. In essence, they see business risk insurance as a new and efficient source of capital.

The instruments they use are radically different from most insurance products available today. Yet the concept remains the same: financial risk is transferred to a third party, for a certain price. What is being redefined is the boundary between transferable risk and the risk a company and its shareholders are expected to carry.

Rethinking risk management

The emergence of business risk insurance follows moves by many companies to rethink the way they manage their traditional P&C risks in order to enhance shareholder value.

US corporations, for example, set aside on average 1 to 3 percent of their total revenues to cover risk, most of it in the form of traditional insurance premiums. Yet many discover that premium payments made over the years are higher than any damage compensation they receive. As a cheaper alternative, some are retaining portions of their traditional insurance risk, particularly those risks for which it is possible to calculate the maximum possible loss. They do this either through self-insurance (by having no insurance, in other words the company simply meets costs with its own cash), or by setting up self-insurance vehicles such as captive or "rent a captive" companies that have access to cheaper wholesale insurance rates and whose profits belong to the parent company.

TYPICAL BUSINESS RISKS

External, one-off risks

Health/ecological/safety liabilities   Tobacco, electromagnetic
                                       smog, airlines

Consumer boycotts/strikes              Gene-manipulated food,
                                       salary negotiations

Technology                             Millennium IT risk,
                                       eurocurrency, computer
                                       viruses

Regulation/authorities/rating          Open skies, telecoms
                                       liberalization, agencies
                                       expropriation, change of
                                       accounting/fiscal standards

Patent infringement                    Software, bioengineering,
                                       high technology

Commercial discontinuities             End of product life cycle,
                                       loss of important contracts

Recurrent market risks

Demand/supply cyclicality              Pulp and paper, aluminum,
                                       oil, real estate, weather- …