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Today, though, it is my work horse. It serves me daily at work as I practice the ancient art of gazing into a crystal to foretell the future.

Throughout history, the crystal ball played a key role in the decision-making of many influential leaders, so why not me? I no longer need actuarial studies or data logs. By means of a self-induced trance, I now gaze deeply into the reflections of my crystal ball and guide work colleagues as to what will transpire in the future.

When we review contracts, most think we possess some mystical ability to predict the severity, timing and probability of the risk embedded within. Recently, my clairvoyant desktop tool was called upon when I was performing risk assessments of contracts that may contain contingent liabilities created by contractual indemnities.

Liabilities, Indemnities

When a contract is not explicit as to how liabilities shall be allocated between parties, any incurred liability is distributed based on the facts of each event. In this case, the law decides who is culpable and who should pay for damage.

To provide clarity or to deliberately shift liability from one party to another, some specify in a contract an obligation to pay money if a specified event occurs. This promise is called an indemnity and creates contingent liability.

Some consider using indemnities as a quicker and simpler mechanism of getting payment if you suffer a loss. There is opportunity in taking on such contingent liability, but with it, comes risk.

Governments routinely take on contingent liabilities through guarantee programs such as loans, mortgage insurance and rate guarantees. With the recent financial crisis, a series of contingent liabilities were triggered straining the financial position of the US government, resulting in the further build-up of public debt. In fact, history is full of examples where governments were faced with these sorts of budget "surprises."

We should not be shocked to hear that our recent crisis has forced governments to rethink the ways they quantify their fiscal burdens, and better monitor and assess risks that could be born from contingent liabilities.

Problem is, even with my crystal ball, contingent liabilities are not so easy to assess and the standards to measure them are ever evolving.

Many challenges exist, such as knowing how to consistently predict and log the timing, magnitude and likelihood of liabilities. In addition, what is the best process for fairly disclosing contingent liabilities? Should we try to recognize contingent liabilities on balance sheets in the accounting domain?

There is no question that attempts should be made to heighten consciousness and the transparency in how governments allocate, transfer or share risks with the private sector. But maybe the simplest solution is not a new solution.

Maybe we should simply charge a fee to anyone who receives a guarantee from the government and force the benefactor to pay the government for the ultimate cost of any given guarantee -- which is no different than procuring a good ol' insurance policy.

JOANNA MAKOMASKI is a specialist in innovative enterprise risk management methods and implementation techniques. She can be reached at riskletters@lrp.com.

December 18, 2012

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