As universities invest more and more money in college sports, it makes sense that their athletic departments explore creative ways to hedge these investments.  But in doing so, athletic departments should remember that a hedge is only as valuable as the risk it covers.

Simply stated, a hedge is any investment that insures another investment.  For example, a football coach that has already recruited a 5-star quarterback would be prudent to also sign a 3-star or 4-star quarterback to hedge against an injury to the investment in the 5-star.  Likewise, an athletic department that sponsors a golf outing fundraiser that includes a new car as a prize for whoever can make a hole in one on a par 3 should buy an insurance policy on the contest that will pay for the vehicle in case somebody actually makes a hole in one.

In 2012, the University of Oregon thought it was hedging its exposure to paying incentive bonuses to Chip Kelly and his staff.  Oregon paid a $490,000 premium to insure its exposure to the bonuses.  However—after Oregon went 11-1 and won the Fiesta Bowl and Kelly and his staff earned $688,000 in bonuses—the insurer refused to pay claiming the insurance only covered the bonuses derived from accomplishments Oregon did not achieve:  a 12-win season, a Pac-12 title, a No. 1 end-of-season ranking and a berth in the national championship game.

In response, Oregon sued the two insurance brokers involved in the transaction and settled its claims for a payment of $240,000, which essentially was an agreement to split the loss of the premium payment.  When the litigation dust settled, a hedge that should have saved Oregon $198,000 ended up costing Oregon $250,000 more than the bonuses the Oregon coaches earned.  That’s a $448,000 hit when the lost savings and the added payment are combined.

When hedging is done right, it is a terrific strategy for athletic departments to reduce risk and cost.  But, as can be seen from Oregon’s experience, a flawed hedge can increase an athletic department’s exposure to the liability.

For these reasons, it is important to remember that the act of hedging is a hybrid act in that hedging is both an economic transaction and a legal act.  Thus, every athletic department that is considering purchasing an insurance policy or any other hedge will benefit from reviewing the transaction and the contract documents with an attorney who is knowledgeable about hedging and insurance coverage.