Lee Coppack reports on how shareholder value can be increased by insuring contingent liabilities
Transferring contingent liabilities to reinsurers can substantially improve business value for investors, Deborah Pretty, co-founder and principal of independent strategic advisor Oxford Metrica, told the conference.
She said this was because it freed capital and management time.
Pretty said that investors were risk averse, and so tended to penalise companies that had significant unquantifiable or latent liabilities, such as potential claims for environmental pollution.
An analysis of 250 firms, including 100 of the largest businesses in the US and the UK, showed that companies without such exposures tended to outperform those with large contingent liabilities by 10% to 15%, after market factors had been stripped out.
This shows that where such risks were sufficiently close and material that they had to be disclosed and provision made on the balance sheet, they were "value destroying", she said.
Shareholders wanted the capital they had invested to be used in the creation of value and not to fund such provisions. They wanted management to develop the business and not to be distracted by these old issues.
Insurance solutions had been instrumental on many occasions, particularly in mergers and acquisitions, in eliminating or capping contingent liabilities and creating value.
But Pretty said: "Understanding of the risk and robust insurer security are crucial to a successful deal."
She quoted several examples. UK company Hanson released $110m (£70m) of provisions made to cover US environmental liabilities incurred in the acquisition of a subsidiary.
The managers of T&N, formerly Turner and Newall, believed the market was undervaluing its shares and used insurance to cap its provisions for asbestos liabilities.
Saab wanted to limit the impact of the regional aircraft market on residual values. In each case, there was a correlated and substantial improvement in the stock's performance.
Key drivers for such deals included merger or acquisition, equity restructuring, introduction of foreign investors and pressure from third parties such as regulators, rating agencies and banks.
Disincentives included the complexity of such deals. They were time consuming and expensive, so they were rare.
Another problem was that it was impossible to guarantee that the limits of cover would be adequate, as Pretty said: "Half the battle is quantifying the exposures."
T&N appeared to have capped its asbestos exposures. This gave US company Federal Mogul the confidence to acquire T&N. Four years later, disaster struck. The limits of the cover turned out to be inadequate for the growing asbestos bill that T&N was facing in the US, along with many other companies.
