This article focuses on the multiple and diverse challenges to the risk management of intangible assets given their structural differences compared to tangible assets.
Over the past decades, the value of intangible relative to tangible corporate assets has steadily increased. According to the Ocean Tomo Intangible Asset Market Study (2020), the relative aggregate value of intangible assets of corporations listed in the S&P 500 has continuously risen from 17% in 1975 to 90% in 2020. Man aging the risk exposure of intangible assets is therefore critical for shielding corporate value from threats.
This article focuses on the multiple and diverse challenges to the risk management of intangible assets given their structural differences compared to tangible assets. However, it must be emphasised that risk exposures of tangible assets have neither disappeared nor become less relevant. On the contrary, they might interact with and be superimposed by new types of threats in relation to intangible assets.
Tangible vs. intangible assets
Tangible assets, by definition, are physical and thus geographically confined, relatively easy to identify and value in contrast to intangible assets. Most intangible assets are not listed on the balance sheet of corporations. Their ownership is difficult to verify. Typical examples are reputation, goodwill, brand recognition, R&D investments in joint ventures, or confidential information about customers. Intangible assets and their value are likely to be globally interdependent across corporations, industries, and with the public sector due to, for example, supply chains, social media, cyber threats, and other forms of interconnection.
Above all, tangible assets often interact with intangible assets. Environmental contamination and damages can lead to substantial reputational losses of a corporation that, in turn, might critically reduce sales and profits. The loss or theft of confidential data can cause similar reciprocal effects that are at times hard to identify separately.
The rapid shift in public perception and judgement of corporate social and environmental responsibility exerts reputational and regulatory pressure on corporations to invest in, sometimes, premature technologies and products that involve risks that are difficult to anticipate. Social media plays a crucial role in amplifying those effects by its potential to spread news and information globally within a very short period of time.
Emerging risks threaten the value of both tangible and intangible assets. Their amplifying effect on risk exposures of intangible assets, however, is likely to be much larger due to their global interdependence. Emerging risks are difficult, if not impossible, to anticipate, to identify, and to value. The risk profiles of emerging risks change dynamically. There is little, if any, historical experience and data, and causal effects are hard to identify.
Emerging risks typically impact globally and affect many industries. The inter- action with emerging risks thereby increases the difficulty of identifying and valuing intangible assets.
Intangible assets in risk management
The challenges in identifying and valuing intangible assets directly translate into difficulties in the subsequent step of the risk management process: managing the risk exposure of corporations through risk avoidance, risk mitigation, and/ or risk transfer.
The functioning of risk transfer mechanisms through corporate insurance and derivatives contracts crucially depends on the feasibility of writing contracts that are enforceable by courts. As intangible assets are difficult to identify and to value, and their ownership is hard to verify, writing such contracts for the transferring of risk exposures is challenging, if not impossible. Ambiguity about the contract’s enforceability ex post impedes risk transfer and its value-added ex ante.
Global interdependence between intangible assets and thereby between their risk exposures constitute further challenges. These interdependencies can lead to strongly correlated and globally clustered risks. Consider, for example, cyber and pandemic risks. The capital costs to insure those clustered risks through private insurance markets at a reason- able solvency level might just be too high. Moreover, interdependencies are often the result of contagion effects between the risk exposures of multiple companies across industries, sometimes between the private and public sector. Contagion effects are inherent in supply chains, reputational risks, and cyber threats.
The challenges to the identification and verification of ownership of intangible assets in combination with external, contagion effects of their risk exposure pose difficulties for and reduce the willingness of corporations to commit to risk management strategies aimed at avoiding and/or mitigating their individual risk exposures. This commitment problem can lead to an inefficiently low level of investment in risk avoidance and/or mitigation.
The role of insurance brokers
What are possible responses and solutions to meet those challenges to managing risks of intangible
assets? If the capacity in the private insurance sector is too limited to insure highly clustered and interdependent risks, then the public sector with its authority to tax and possibility to issue government debt can expand the capacity and even transfer and share those risks across generations. The private insurance sector can contribute to this public and private partnership with its expertise in risk underwriting and claims handling.
Insurance brokers can play a leading role as risk experts and consult- ants in transforming emerging risks into insurable risks by developing knowledge about new threats and their underlying structure. This expertise enables the identification and valuation of risk exposures and the establishment of risk standards, which consequently facilitates risk avoidance, risk mitigation, and/or risk transfer.
However, even if insurance contracts are difficult to enforce ex post, brokers can expand insurance capacity for those risks by their power to move their book of business to a competing insurer. If this threat is credible, then insurance companies will settle reasonable claims, even if they are not legally bound to do so. In turn, insurance companies have in interest in equipping their brokers with such power as it enables them to charge the appropriate insurance premium ex ante for the voluntary but credibly enforced settlement of those claims.
Within a network of interdependent risks with contagion effects, insurance brokers can act as coordinators by demanding the commitment of associated companies to avoid risks and/or invest in risk mitigation. In addition, brokers can facilitate efficient insurance solutions based on those commitments. If the entire risk network is too complex and external effects too opaque, brokers can still focus on the closest “neighbours” of their client in the network, analyse the external effects on their client, develop and demand risk standards for their “neighbours”, and thereby increase insurability and insurance capacity.
The above serves to highlight the relevance for corporations to manage their risk exposures related to intan- gible assets, the structure of which differs in various dimensions from the one of tangible assets. These differences pose major challenges and raise many questions related to risk management. Future research is needed to develop innovative solutions for effectively shielding corporations against those threats.
Professor for Risk Management and Insurance Vienna University of Economics and Business
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