We present a (speculative) scenario exploring the use of a hazard insurance agency to protect the funding agency+ from systemic risks. This goes beyond traditional D&O insurance in that it aims to insure the reputation of the funding agency.

The guidaticum was a safe-conduct pass (i.e., a passport) issued to travelers in the thirteenth century, extending protections and credentials to merchants entering a foreign territory to conduct business. Guidaticum were issued by anyone with the means, including barons, merchants, kings, lords and wealthy citizens. They extended the commercial reputation of a non-traveling merchant to the traveling merchant, and protected the traveling merchant while en route. The guidaticum often came with a guarantee from the issuer to be held legally liable in the local courts for the actions of the traveling merchant.

The local merchant could revoke the guidaticum if the traveling merchant attempted to deceive trading partners, significantly increasing the chance of the traveling merchant later being robbed or maimed. This was a powerful dis-incentive for the traveling merchant to engage in fraudulent activities. A guidaticum could be bought for a given period of time, or permanently with an annual fee.

We issue our funding managers a modern-day guidaticum. They have a safe-conduct pass for as long as they engage in honest trade. They purchase the pass with their reinvested winnings. Engage in misconduct and we reach into your past winnings to make right the wrong. Our guidaticum is issued by a hazard insurance company, who is held financially responsible for the actions of agency managers. Insurance covers financial reparations, but only after ensuring the responsible agency manager has been relieved of all past winnings (i.e., we don’t condone maiming).
The above safe conduct pass, written in the Tedesco language, is dated April 27, 1706, with the signature of Vittorio Amedeo II. This is a later reincarnation of the guidaticum.

Our guidaticum protects the funding agency+ from exposure to systemic risks. Systemic risks can bankrupt the agency even though daily operations in each investment are doing quite well. When our traveling merchants (agency management+) engage in mismanagement, fraud, misrepresentation, negligence or breach of fiduciary duties, this puts everyone in danger. These are sophisticated risks beyond the ken of most observers. So we engage experts who manage these risks for a living.

We purchase hazard insurance, bundled with hazard protection services. Our insurance premiums purchase a new, independent set of eyes to raise alarms at the first sign of trouble (and if necessary to raise premiums as an additional signal). We buy insurance to cover our reputation – a very intangible asset. Bad reputation spreads like a contagion. We need a partner who can stop this disease in its tracks, who knows how a confluence of seemingly minor transgressions can lead to a major breach.

We seek extraordinary levels of protection. An insurance policy for reputation may never before have been conceived. We achieve this level of protection by requiring insurers to put skin-in-the-game. They become part of our community. This means at the first hint of trouble they can decide to pay out damages. Better to pay first, contain the contagion, and recover payouts later, as appropriate. Our insurance agent needs to understand where to inject cash quickly to avoid even larger future liabilities.



A New Insurance Industry

Insurers take in premiums. But premiums often only pay the bills. An insurer’s profits come from its investment of premiums into stocks and bonds. Premiums are paid up front. We insist our premiums paid to the insurance agent be reinvested back into our funding agency. Your profits as insurer are intimately tied to our success, both in insurance liabilities and in investment profits. Our insurance agency will be deeply vested into making our funding agency a success, and not just helping it avoid failure. Insurers celebrate in our success and suffer in our failure.

Insurers are not kept alone with this high-risk financial exposure. We also self-insure by pledging agency management (and/or investee+) retained earnings. Systemic risks most often result from management actions, so we pledge an manager’s retained earnings as security for possible future damages for which they may be responsible. And we place management’s reparations first in line in the event of damages they cause.

We expect agency management to push the limits in their financial, legal and regulatory actions. Our funding agency is dedicated to bending the rules. We depend on the experience and gut-feel of agency management to carry out daily operations. We do not restrict managers in matters of business risk. We expect the insurer to provide guidance. But insurers do not make rules. We don’t want management to be overly cautious. We don’t want them reckless. We instead align financial (and reputational) incentives so best choices are made for the long term health and welfare of the funding agency.

Pay first, assign liability later

Key to making this insurance policy work is submission of all parties to the adjudication by our in-house (independent) judicial function. The judiciary decides who pays damages in the event of a breach. It’s not easy. One person’s mismanagement is another person’s prudence. The judiciary provides quick disbursements of cash in the event of an emergency (i.e., to stop a crisis in confidence in its tracks). Our in-house judiciary has an intimate understanding of the mechanics for reinvested winnings, something that would take years to sort out in a host government legal system. For matters of reputation we need fast action, and we get this by binding our insurance agent (and agency management) to exclusive arbitration by our independent judiciary.


Ours is a funding agency like none before. Our insurance agent must be one with us in their understanding of fund operations (e.g., bringing forward of future windfalls+, distaste for quantitative analysis, etc.). Our insurer does not depend on risk-sharing across several firms through diversification or volume (e.g., flood insurance, marine insurance). Our insurer will be, in effect, a provider of systemic risk prevention expertise, compensated with (retained) shares in our perpetual fund+, and at risk for damages not covered by self-insurance. The business for our insurance agent is high margin - high risk. The risks are controllable in that the insurer will know our business intimately, and these risks will lie squarely within their area of expertise and oversight.

This is not D&O insurance. This is hazard insurance. It provides the funding agency with access to outside hazard prevention expertise and extra financial clout in cases requiring extraordinary reparation. To the best of our ability we extract reparations from those most responsible for the damages. Insurance covers the rest.

Editor's Picks for September, 2011

Further Reading
Joined: 01/20/2010
We're already partially there!

Credit default swaps offer insurance against the default on loans to corporations by lending institutions. These insurance policies have already been structured to pay out in the event of a reduction in credit ratings by a corporation. Not quite the same as a loss of reputation, but headed in that direction.

Reba Tull
Joined: 03/30/2011
An insurance agent will cost you more than if you self-insured

Hard to see how any current hazard insurance agency would take up this challenge. Insurance agents look to bundle risks across several firms or industries. There is no bundling in this example and the insurance agent looks to be taking on the largest portion of the risks.

Investing into unpredictable R&D+ is a very risky business. You attract capital to this business by offering premium returns on that capital. You can’t reduce these premiums by sloughing off risks to another firm. The other firm will in essence charge you the same amount as if you kept the risks in-house. Maybe even more since they want to make a profit.