Earnings insurance - mission impossible?

• Author: Scherzer, Martin H.
• Position: Earnings insurance for financial services companies - Column

Wall Street and its analysts aren't very tolerant of companies that fail to meet earnings targets. Thus, it's no surprise companies seek ways to avoid their wrath. Add the growing percentage of senior management compensation tied to share price and there's more incentive to look for every possible edge. In this context, both buyers and sellers have been seeking the financial "Holy Grail" - a way to insure meeting earnings targets.

While the insurance industry is not, and probably never will be, in a position to actually insure such a thing, the tools and techniques it's developing to pursue it are benefiting many companies. The greatest growth is in expanding globalization of business; advances in technology; convergence of the financial markets; and development of enterprise risk management.

It's A Small World

Globalization offers advantages as it creates new risk categories. Consider the hazards of setting up shop in countries that didn't exist a few years ago, or of trying to anticipate the effects a single European currency might have.

Mergers and acquisitions also create new risks. As firms consolidate, they have to rely on fewer suppliers, upping the odds of a supply chain breakdown.

Then there's the movement to more consistent financial reporting standards. This creates a more level playing field, but eliminates some of the historic benefits available to companies able to establish contingency reserves on their financial statements.

Firms are examining their traditional business practices to find efficient ways to mitigate or transfer such risks. Two increasingly prevalent tools include forming joint-venture companies or using hedging products. Companies that traditionally "did it all on their own," or those that found hedging too difficult or complex, are reviewing their stand.

The insurance industry is responding with new and redesiged products. Political risk coverage, for example, has existed for years. But increased capacity and broader definitions of loss enhance its value. And business interruption insurance, a mainstay of the standard property policy, can protect against supply chain disruptions.

Information Equality

While globalization has a macro effect on the way companies do business, technology has both macro and micro effects. More powerful computers, web search tools, e-mail and shared databases let virtually anyone in a firm's risk management, corporate finance and treasury departments retrieve previously unavailable...