Marcus Schmalbach, RYSKEX
Google parent Alphabet’s recent power outage is a perfect example of how parametric insurance products could help companies insure risks related to their intangible assets, says Marcus Schmalbach of Ryskex.
Insurance markets are suffering from a huge protection gap, especially in the intangible assets world, principally because of issues related to knowledge, trust and price issues. Parametric insurance solutions address all of these concerns.
Recent events at Alphabet exemplify the opportunity: on December 14, at 3:47 am Pacific time, Google experienced an authentication system outage that lasted approximately 45 minutes. It was resolved at 4:32 am Pacific.
The system outage of one of the most important tech companies in the world lasted less than an hour, but made headlines around the world.
An insurance case?
I am not intimately familiar with Alphabet’s business, but traditional insurance looks ill-equipped in this particular instance, generally being subject to some interpretation which usually takes months to resolve.
Traditional insurance requires a number of questions to be addressed. What exactly would be insured? The “repair costs” or the loss of earnings? Are these costs truly significant for a listed company with a turnover of $162 billion in 2019? I have never had the pleasure of being the chief risk officer of such a company, but I suspect that the amount of compensation, if any, will hardly matter.
The impact approach: parametric risk trading
A company such as Alphabet thrives on reputation, users’ belief in its security and the non-capturability of the company. No-one merely “searches for something on the internet” any more: they “Google it”. What happens to users when the system is down? Do they lose faith, and migrate to other providers? How long and often can such an outage be tolerated without having a serious impact on reputation and user activity?
Holders of Alphabet shares, such as myself, were probably most concerned about how the market was reacting, and whether that 45-minute period was enough to shake confidence in the company.
“Indemnity solutions and the classic insurance concept are not designed for this. The claim settlement process would take far too long.”
In this instance the impact on the share price was relatively muted, but it clearly could have been much worse if the outage had lasted longer, or if they were to start happening with more frequency. It is easy to see how such events could lead to the loss of customers and advertising partners.
Is traditional indemnity insurance the appropriate solution for such a company? No: the focus must be on the intangible assets of the company. Today, intangible assets constitute as much as 90 percent of the S&P 500’s $28.94 trillion market value.
In 1975, 83 percent of the value of the S&P 500 was accounted for by tangible assets. This reversal means the actual protection gap is much larger than currently appreciated—and it will rise even more than currently projected.
This is where parametric solutions can help. If Alphabet had been hit really hard, the share price would have plummeted and the company would have needed cash quickly to cover the downward slide by buying shares. Indemnity solutions and the classic insurance concept are not designed for this. The claim settlement process would take far too long.
It is different with parametric solutions. As soon as the defined triggers were hit, the money would flow immediately. The defined triggers could have been set as “server down” for a given period of time, an article appearing in The Wall Street Journal, or a stock price drop of a given amount and for a given duration.
The benefits of parametric risk trading
The parametric concept is not just a simplification of the classic indemnity product. It has other advantages. The triggers can be varied depending on the risk affinity or aversity of the company.
The share price slump required to trigger the contract could be set at 1 percent, which would make the premium more expensive. Alternatively a decline of 7 percent could be required to trigger the payout, which would mean the premium would be lower.
The risk-taker does not need any significant insurance knowledge. The claim is so clearly defined that even non-traditional insurance market participants can get involved—you just have to make sure that you can actually pay in case of the margin call.
Institutional investors in the capital market who already own Alphabet shares or are short Alphabet shares could provide coverage, increasing the available capacity and making the current capacity bottlenecks a thing of the past. Large and well-known companies with an affiliated captive can participate in this development.
Ironically, the insurance market lacks capacity and shies away from acquiring intangible assets, while the capital markets are flooded with money looking for investments in high-yielding opportunities.
Although the Alphabet example could be categorised as a “storm in a teacup” and the scenarios shown have not come to pass, it can certainly be taken as a warning. The risk landscape is changing and intangible assets are becoming more and more important.
The traditional market continues to focus on the bread-and-butter business. For many exciting risks, a changing of the guard is in the offing—if one is not careful and sleeps through the market. The growing demand for parametric solutions will increasingly lead to risks no longer being insured but traded like an asset class—especially in the intangible assets spectrum.
If you want to learn more about this, I will be talking about it at the CICA Conference 2021 in Arizona on March 14-16.
Marcus Schmalbach is the founder and chief executive officer of RYSKEX. He can be contacted at: firstname.lastname@example.org
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