Intangible assets are the most important generators of business wealth today but are rarely insured. The potential market for intellectual property insurance is enormous as Ernest Kay explains.
It is unusual for a scientist to be invited to write an article for this journal. Even more unusual when the scientist is neither a broker nor an underwriter but works closely with those areas of commerce and industry that depend for their very existence on something that until recently was seldom talked about.As a technologist and also a barrister, I have spent most of my life creating, protecting and exploiting what is now the most important single wealth generator in the world. What is that? I wonder how many involved in the practice of the commercial world would give the correct answer.The rights and assets associated with it are now appearing for the first time as an identifiable item on the balance sheet. It has been the reason for most mergers, acquisitions and take-overs that have occurred over the past 10-12 years. Major financial organisations, banks, venture capital corporations, have made - and lost - vast fortunes investing in it. But investment continues at an unprecedented rate despite the losses and irrespective of the uncertainty surrounding it.
What is this “it” which the world is now so dependant upon? In two words - intellectual property. Intellectual property is effectively the product of the human mind manifested in a form, such as a patent or registered trade mark, which gives legal ownership and rights to its use. Companies such as Pfizer, Shell, Cadbury Schweppes, Dyson, Microsoft, Sony, Motorola, to mention only a few, spent many millions of dollars each year creating it and almost as much protecting it and exploiting it.
The creative process is frequently long but the legally enforceable rights - intellectual property rights (IPR) - that result are usually the most valuable assets of a company. They confer a monopoly position on the company creating and owning the rights.
Take one of these rights - the patent right - and look at how it has proved to be such an important wealth generator. Viagra - the well known drug that corrects erectile dysfunction (better known as impotence) is currently highly newsworthy and is expected to reach a sales figure for this year of $2.1 billion. Pfizer invented and developed the drug as part of its research programme and succeeded in achieving a monopoly position because of its worldwide patent rights. Without enforceable patent rights, the drug could be manufactured by any other pharmaceutical company and financial returns to the inventing and investing company would be relatively low. In other words it would be difficult for Pfizer to recover the many billions of dollars spent on research. The incentive to invent and invest would disappear.
A similar picture emerges in the high risk biotechnology field. Remember the revolutionary nuclear transfer invention that led to the cloning of Dolly the sheep? Soon after the successful cloning, a major investment company, 3i plc, invested £6 million to help with development and commercial exploitation. This £6 million was invested on the back of the two patents that had been filed globally to protect the invention.
But in other areas of high technology, such as computer software, the intellectual property rights protecting the ideas is of such value that it cannot realistically be assessed. Take for example the IP associated with Microsoft - both copyright on the software and trademark on the name and logo. We are all aware of the legal battles that have been, and still are being, waged in this and related areas of videos, video games, digital technology etc. Millions of dollars are being spent to enforce intellectual property rights or defend against allegations of infringement in this technical area.
Acquiring intellectual property
Looking further afield we recall the spate of acquisitions in the 1980s and 1990s, most of which were driven by the intellectual property assets of the target company. An investment banker from a major New York investment firm recently stated that a company's brand names may, in some cases, represent as much as 80% of a company's value. One well known example is the Marlboro trademark for cigarettes which industry sources have valued at $40 billion worldwide. Owned by Philip Morris, whose portfolio also includes the well known Cheezwhiz, Maxwell House and Kraft trademarks, Marlboro cigarettes are said to be the world's most popular products.
Other examples include the $5.7 billion acquisition by Grand Metropolitan of the Pillsbury Company, owner of Burger King, Green Giant and Haagen Daz. Kohlberg, Kravis & Roberts (KKR) paid a premium of $21.7 billion above book value when it spent $25 billion for RJR Nabisco, a multiple of eight times. Philip Morris purchased Kraft for £12.9 billion, four times its book value. Nestlé acquired Rowntree, owner of the trademarks Smarties, Polo, KitKat, Black Magic, for $4.5 billion, which was five times its book value. In all these cases the premium was paid for the brand names or trademarks rather than for the physical assets.
And so the picture unfolds. The value of intangible assets, such as intellectual property rights, now far outweighs the value of the older, more conventional tangible assets, such as bricks and mortar. It is interesting for me, as a relative outsider in the field of insurance, to observe that many businesses and major companies have not appreciated this change in wealth location. If a factory is demolished by fire, insurance will cover the rebuilding costs. If a product causes harm to a person using that product, the insurance will pay the legal fees and damages. These not so-important tangible assets are automatically insured at considerable cost on a regular annual basis without question.
But the intellectual property rights of a company - the most valuable assets - are not insured. Infringement or copying can cause bankruptcy or insolvency, unless there are sufficient funds available for the legal battle. Few realise these legal costs can be well into the millions of dollars. Inventor James Dyson successfully defended his patent for his eponymous vacuum cleaner in the US. It cost him more than $4 million and that was more than three years ago. The product was his familiar small grey and yellow cyclone cleaner, the technology of which is relatively simple. Imagine what the cost would have been had the case involved the complexities of computer software or genetic engineering. If one includes damages as well as legal costs, and any financial loss suffered, one could be talking of at least $50 million.
Why are these situations and these high potential expenses to a company not covered by insurance?
In a survey of risk managers conducted by Lloyd's and the UK risk management association, AIRMIC, it appeared that their main concern was with the vulnerability of their corporate reputation, a key component of which is intellectual property. If this is correct why then do companies not take the insurance that is available?
There are various reasons. One of them is that many do not realise that insurance adequate for their needs may be available. There is a growing market in Lloyd's and among specialists insurers like AIG. New policies, for example, now offer cover for costs such as pursuit of an infringer of intellectual property, defence against allegations of infringement of a third party, a situation which frequently arises when a new product is manufactured and sold or an established product is introduced into new territories, and brand rehabilitation expenses after a reputation crisis.
Secondly, until very recently, the real value of intellectual property to a company was not fully realised. Thirdly, the older insurances in the field were not satisfactory for one reason or another, giving payments of perhaps £250,000 to £500,000 and excluding the United States. But a further reason is that very few brokers understand what intellectual property is about and its relevance to a company, so advice to industry was not as available and as sound as it ought to have been. A further reason may be that until quite recently very few underwriters were prepared to take the risk associated with intellectual property, especially that associated with the hi-tech areas.
I seldom make predictions as to how an industry will develop, but I hold the firm view that in five to seven years from now the image of intellectual property insurance will have reached a much greater level of importance than the other conventional insurances such as fire, theft, etc, of the present day. Coping with the demand for this insurance and with the rapidly increasing new technical developments is going to be a challenge to both brokers and underwriters alike but the rewards of rising to the challenge will be enormous.
Ernest Kay is legal and technical director of the intellectual property consulting firm. LBT Services Ltd. Tel: +44 (0) 171 962 2419; fax: +44 (0) 171 709 7999. He gratefully acknowledges the information Alexander Forbes has provided concerning intellectual property insurance at Lloyd's.