The Cost of Certainty
Philosopher GK Chesterton famously wondered whether a man can be certain of anything at all. And that’s a fair question in a world that keeps throwing us curveballs. But assuming certainty is possible, another more interesting question is: What is certainty worth?
This came up in deal negotiations with a company that had history going back decades and lots of products out in the market. We had agreed on major terms and were now focused on details, including future liability. While the company had a very good safety record, one of their requests was that we assume all future liability for anything in the market, new or old (successor liability).
This is not a standard deal term!
Yet we always seek to understand where people are coming from so asked why that was a request. The answer was that the seller wanted peace of mind. In other words, out of the business, he didn’t want the business to ever come back to bite him.
I get that. But when we priced out what it would cost to carry forward that potential liability on insurance, the answer was about $100,000 per year. Assuming 3% annual escalators (and insurance rates have broadly been way higher than that), a 10% discount rate, and a 30-year hold, that’s a $1.2M ask. In other words, it surpasses our materiality threshold. Further, when you take into account that a claim could make our new company uninsurable for reasons that were entirely outside of our control, it’s an open-ended risk that we simply can’t be in the business of taking.
When we pointed this out, we were told that the likelihood of a claim was microscopic because of the company’s safety record. We asked that if that was the case, then why couldn’t they retain the risk? Again, the answer was peace of mind. And we get it, zero is a very different number from a number greater than zero. How different? Well, that depends on how likely it is you can be certain of something.
So can we be certain of anything? When it comes to offloading risk, the answer is yes, but there has to be a buyer and what’s more, it’ll cost you. Have a great weekend.
– By Tim Hanson
