Manage Expectations, Manage Reputation
The art of managing reputation risk really comes down to shaping the expectations of shareholders, customers, vendors, creditors and investors.
“Not an easy thing to do,” said Nir Kossovsky, chief executive officer, Steel City Re, speaking at the annual RIMS conference in San Diego on April 12.
“Managing expectations involves behavioral economics – shaping what people expect from you and then meeting those expectations.”
He said expectations typically revolve around six key areas: safety, ethics, quality, security, sustainability and innovation. Failing to meet any of those expectations creates vulnerability for a company, opening up an opportunity for shareholders or special interest activists to come after the board of directors as the culpable party.
Increasingly, directors and officers are the true casualties of reputation damage.
Dissatisfied customers or partners know that “the court of public opinion is much more effective than the court of law,” Kossovsky said, so they will bring allegations against the board and force a public response.
“Managing expectations involves behavioral economics – shaping what people expect from you and then meeting those expectations.” – Nir Kossovsky, chief executive officer, Steel City Re
The best way to mitigate reputation risk, then, is to proactively communicate the board’s awareness of a company’s exposures, and acknowledge its duties to deliver on expectations related to the six key areas.
“Communication is critical,” said Todd Marumoto, director of risk management, Mattel, Inc. “There needs to be some sense of a plan for how the board will respond to a reputation event.”
Without a quick response, the silence is filled by the white noise of unsubstantiated opinion, Kossovsky said. That weakens the board’s credibility.
“Facts are available without much of a down payment. Allegations brought against the board don’t necessarily have to be true and can’t always be validated.”
Conflicting expectations make reputation risk management even harder.
Customers expect, for example, near impossible standards of quality and customer service, while shareholders expect strong profit and growth, and creditors expect swift payment.
While many believe that marketing and press coverage can be the tool for the messaging needed to mold expectations through public perception, the most effective way to mitigate reputation risk is through enterprise risk management that strives for excellence, the speakers said.
In other words, expectations should be set by a company’s performance.
Kossovsky offered the example of BP, which claimed to be “beyond petroleum.”
Despite impressive initiatives to use cleaner energy, BP was still, in fact, heavily reliant on petroleum. The Deepwater Horizon spill of 2010 sparked so much anger because people expected BP to be above such environmentally dangerous accidents.
ExxonMobil, on the other hand, acknowledged to its shareholders that a spill was always a real threat, but demonstrated the steps it was taking to minimize the risk. Shareholders thus had more realistic expectations of the company and are harder to disappoint.
Presenting to the C-Suite
Risk managers can bring the importance of reputation risk to the C-suites’ attention by demonstrating its financial impact.
“Expenses could come from having to replace a vendor, from a government penalty, litigation and class action lawsuits, or having to implement a new management process,” Marumoto said.
Overall, costs associated with remediating a reputational event can be two to seven times higher than costs related to the operational failure that caused the reputation damage in the first place.
“With reputation risk, it’s not always about right or wrong, but about getting the right outcome to satisfy shareholders and customers.” — Todd Marumoto, director of risk management, Mattel, Inc.
“It affects every line item of the P&L,” Kossovsky said.
The impact on D&O effectiveness will also certainly grab senior management’s attention.
“A typical board member makes about $250,000 per year to sit on the board for a term usually of about three years, and he’s usually sitting on three different boards,” Kossovsky said.
“He’s looking at a personal loss of over $2 million” if a reputational hit leads to him being asked to step down from those boards.
According to Marumoto, risk managers can influence outcomes of a reputational event by working internally with investor relations and marketing to ensure the company is sending a consistent message, and to develop a coordinated response plan.
“Ultimately, you have to be responsible for all things that pass in front of you,” he said. “Partner with vendors you trust, be transparent in your efforts to mitigate risks, and develop relationships with government agencies.
“With reputation risk, it’s not always about right or wrong, but about getting the right outcome to satisfy shareholders and customers.”
Captives See Growth for Terrorism Risk
An advance look at the “2016 Marsh Captive Benchmark Review” revealed a substantial growth in the number of captives targeted to terrorism coverage.
In the last three years, nearly 40 captives by Marsh clients were created to cover risks excluded from conventional terrorism policies and/or to provide access to reinsurance to cover the potential gap under the Terrorism Risk Insurance Act, said Ellen Charnley, San Francisco-based managing director, captive solutions, during a RIMS luncheon session on April 12.
“That’s a big growth area,” she said.
In addition, more than 20 other captives were formed to address international terrorism risks, she said.
Typically excluded perils include nuclear, biological, chemical and radiological risks, as well as cyber terrorism, and the captives provide access to the government backstop.
Other non-traditional coverages that are seeing captive growth are medical stop loss, cyber, international employee benefits, political risk, supply chain and crime, she said.
“We see a continued growth in non-traditional coverages,” Charnley said.
Chris Lay, London-based president, Marsh captive solutions, said the brokerage is seeing “a lot of activity tailoring captive programs to address cyber risks.”
In addition to evolving cyber risks and terrorism, other top risks being addressed by captives were catastrophic earth/weather events, economic downturn and political unrest, Lay said.
The top industry sectors that form captives remain financial institutions; health care; auto/manufacturing; retail/wholesale; and communications, media and technology.
However, Charnley noted, if premium dollars were used to rank the industries, communications, media and technology companies would probably rank second, below financial institutions.
Top-ranked unique or emerging industries forming captives were construction; energy; real estate; education; and sports, entertainment and events, she said.
For construction, the increased number is probably the result of improved economic conditions, she said.
For education, it’s more likely the reason is to seek access to reinsurance programs, said Art Koritzinsky, managing director, captive solutions, in New York.
He said Marsh expects to see continued growth in the number of 831(b) small captives, which have increased by 35 percent.
“That’s where a lot of the growth [in the captive market] is,” Koritzinsky said.
In December, the IRS rules regulating 831(b) captives increased the limit on direct premium from $1.2 million to $2.2 million and removed the ability of such captives to be used for estate planning, among other changes.
As for predictions, Marsh anticipates increased growth of captives for international employee benefits; terrorism, small captives; non-traditional risk; and in emerging markets such as Latin America and Asia Pacific.
They also anticipate companies beginning to use cash surpluses in captives for sophisticated investment strategies.
Marsh manages about 1,250 captives worldwide, with about $42 billion in premium. About 1,000 captive owners participated in the benchmark survey. Final results will be released in May.
Helping Investment Advisers Hurdle New “Customer First” Government Regulation
This spring, the Department of Labor (DOL) rolled out a set of rule changes likely to raise issues for advisers managing their customers’ retirement investment accounts. In an already challenging compliance environment, the new regulation will push financial advisory firms to adapt their business models to adhere to a higher standard while staying profitable.
The new proposal mandates a fiduciary standard that requires advisers to place a client’s best interests before their own when recommending investments, rather than adhering to a more lenient suitability standard. In addition to increasing compliance costs, this standard also ups the liability risk for advisers.
The rule changes will also disrupt the traditional broker-dealer model by pressuring firms to do away with commissions and move instead to fee-based compensation. Fee-based models remove the incentive to recommend high-cost investments to clients when less expensive, comparable options exist.
“Broker-dealers currently follow a sales distribution model, and the concern driving this shift in compensation structure is that IRAs have been suffering because of the commission factor,” said Richard Haran, who oversees the Financial Institutions book of business for Liberty International Underwriters. “Overall, the fiduciary standard is more difficult to comply with than a suitability standard, and the fee-based model could make it harder to do so in an economical way. Broker dealers may have to change the way they do business.”
As a consequence of the new DOL regulation, the Securities and Exchange Commission (SEC) will be forced to respond with its own fiduciary standard which will tighten up their regulations to even the playing field and create consistency for customers seeking investment management.
Because the SEC relies on securities law while the DOL takes guidance from ERISA, there will undoubtedly be nuances between the two new standards, creating compliance confusion for both Registered Investment Advisors (RIAs)and broker-dealers.
To ensure they adhere to the new structure, “we could see more broker-dealers become RIAs or get dually registered, since advisers already follow a fee-based compensation model,” Haran said. “The result is that there will be likely more RIAs after the regulation passes.”
But RIAs have their own set of challenges awaiting them. The SEC announced it would beef up oversight of investment advisors with more frequent examinations, which historically were few and far between.
“Examiners will focus on individual investments deemed very risky,” said Melanie Rivera, Financial Institutions Underwriter for LIU. “They’ll also be looking more closely at cyber security, as RIAs control private customer information like Social Security numbers and account numbers.”
Demand for Cover
In the face of regulatory uncertainty and increased scrutiny from the SEC, investment managers will need to be sure they have coverage to safeguard them from any oversight or failure to comply exactly with the new standards.
In collaboration with claims experts, underwriters, legal counsel and outside brokers, Liberty International Underwriters revamped older forms for investment adviser professional liability and condensed them into a single form that addresses emerging compliance needs.
The new form for investment management solutions pulls together seven coverages:
- Investment Adviser E&O, including a cyber sub-limit
- Investment Advisers D&O
- Mutual Funds D&O and E&O
- Hedge Fund D&O and E&O
- Employment Practices Liability
- Fiduciary Liability
- Service Providers D&O
“A comprehensive solution, like the revamped form provides, will help advisers navigate the new regulatory environment,” Rivera said. “It’s a one-stop shop, allowing clients to bind coverage more efficiently and provide peace of mind.”
Ahead of the Curve
The new form demonstrates how LIU’s best-in class expertise lends itself to the collaborative and innovative approach necessary to anticipate trends and address emerging needs in the marketplace.
“Seeing the pending regulation, we worked internally to assess what the effect would be on our adviser clients, and how we could respond to make the transition as easy as possible,” Haran said. “We believe the new form will not only meet the increased demand for coverage, but actually creates a better product with the introduction of cyber sublimits, which are built into the investment adviser E&O policy.”
The combined form also considers another potential need: cost of correction coverage. Complying with a fiduciary standard could increase the need for this type of cover, which is not currently offered on a consistent basis. LIU’s form will offer cost of correction coverage on a sublimited basis by endorsement.
“We’ve tried to cross product lines and not stay siloed,” Haran said. “Our clients are facing new risks, in a new regulatory environment, and they need a tailored approach. LIU’s history of collaboration and innovation demonstrates that we can provide unique solutions to meet their needs.”
For more information about Liberty International Underwriters’ products for investment managers, visit www.LIU-USA.com.
Liberty International Underwriters is the marketing name for the broker-distributed specialty lines business operations of Liberty Mutual Insurance. Certain coverage may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds. This literature is a summary only and does not include all terms, conditions, or exclusions of the coverage described. Please refer to the actual policy issued for complete details of coverage and exclusions.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.