Risk Insider: Nir Kossovsky

Wells Fargo, Reputation and the Wisdom of Crowds

By: | October 24, 2016 • 3 min read
Nir Kossovsky is the Chief Executive Officer of Steel City Re. He has been developing solutions for measuring, managing, monetizing, and transferring risks to intangible assets since 1997. He is also a published author, and can be reached at [email protected]

My firm relies on prediction markets to inform indices of reputation that provide a quantitative measure of governance, risk and compliance as perceived by stakeholders. We call them reputational value metrics.

In mid-2014, Wells Fargo’s metrics were getting notably more volatile, indicating that members of the crowds of Wells Fargo stakeholders, in their wisdom, were worried.

Between June and December 2014, Wells was losing in the courts in a number of mortgage-related matters, including additional lawsuits from home lending practices thought to have been settled in 2012; new suits for “equity stripping;” discrimination against pregnant applicants; federal insurance fraud and newly discovered compliance failures.

While publicly there was no mention of the underlying issue of the current reputation crisis, which stems from Wells Fargo’s aggressive cross-selling program, it is fair to speculate that many stakeholders were both experiencing and signaling discomfort with it.

Now, with the benefit of hindsight, there are three pieces of evidence pointing to the inevitability of this crisis.

Wells Fargo lost track of the financial importance (and therefore risk) of cross-selling, misunderstood reputation risk, and mismanaged risk management at the board level.

Disclosed in unusual detail in Wells Fargo’s 10Ks of 2013 and 2014–but not 2015-was the operational risk of…

…’cross-selling’ efforts to increase the number of products our customers buy from us …[which] is a key part of our growth strategy… [with the risk being that] we might not attain our goal of selling an average of eight products to each customer.

Wells Fargo thought reputation risk and adverse publicity could impair cross-selling. It did not appreciate that cross-selling could give rise to reputation risk, notwithstanding a scathing LA Times expose in December 2013.

The company’s blindness to the risk resulted from the distribution of risk oversight among board committees.

Wells Fargo lost track of the financial importance (and therefore risk) of cross-selling, misunderstood reputation risk, and mismanaged risk management at the board level.

At Wells Fargo, Reputation Risk is under the purview of the Corporate Responsibility Committee; Enterprise Risk is under a separate Risk Committee to whom the Chief Risk Officer is also attached; Ethics/Business Conduct Risk is under the Audit Committee, and Compensation Risk is under the purview of Human Resources Committee.

This means that the reputational crisis that emerged from Wells Fargo’s cross-selling strategy with inherent compensation risk, ethical risks and operational risks sprouted and blossomed under the watchful eyes of at least four separate board committees.

The tipping point came in early September 2016 in a public disclosure that the Consumer Financial Protection Bureau (CFPB), the Los Angeles City Attorney and the Office of the Comptroller of the Currency (OCC) fined the bank $185 million.

The regulators alleged that as the result of perverse incentives, unethical behaviors and ineffective operational oversight, more than 2 million bank accounts or credit cards were opened or applied for without customers’ knowledge or permission between May 2011 and July 2015.

The classical manifestations of a reputational crisis then materialized, as customers broke off relations, employees sued, customers sued, investors sued, the stock price fell at least 7 percent, executives lost their heads and the regulators piled on.

One wonders how many Wells Fargo board members are concerned about finding themselves testifying before one of the legislative body’s many oversight committees.

One way to communicate authentic rehabilitation is to share with its competitors its strategy for mitigating this “industry-wide” risk.

While damage to the personal reputations of John Stumpf and others may be permanent, companies have a way of recovering. Wells Fargo has acknowledged the error and within a week of the September reveal, terminated the cross-selling program.

The last and most critical steps are still to come. First, the company must streamline its risk oversight process to account for the interplay between operational risks, liquidity risks, and reputational risks.

To capture the benefits of improved governance, Wells Fargo then needs to communicate its changes to the many stakeholders that now view the bank with a jaundiced eye. One way to communicate authentic rehabilitation is to share with its competitors its strategy for mitigating this “industry-wide” risk.

Another way is to communicate to those who look for vulnerabilities in governance (read, activists) that third parties are attesting — dare I say warrantying — the new improved governance processes at Wells Fargo.

Unfortunately, odds are that Wells Fargo will follow a time-honored tradition of putting the cart before the horse by first engaging in an expensive communications campaign while hiring an expensive law firm to discover what went wrong.

Time will tell.

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The Law

Legal Spotlight

A look at the latest legal cases impacting the industry.
By: | October 15, 2016 • 4 min read

Bodily Injury Definition at Crux of ‘Pill Mill’ Suit

In June 2012, West Virginia sued H.D. Smith and other pharmaceutical companies, accusing them of contributing to the state’s prescription drug abuse epidemic that costs it hundreds of millions of dollars each year. The state asked for a court order barring them from distributing controlled substances.


West Virginia accused H.D. Smith of distributing “huge quantities” of opioids and other drugs to “pill mills” — pharmacies that distributed the drugs “to fuel and profit from the citizens’ addictions,” according to court documents.

H.D. Smith sought defense and indemnification from its general commercial liability insurer, Cincinnati Insurance Co., saying the policy was triggered “because of bodily injury” coverage.

The insurer sought a judicial determination that the policy did not cover the claim, and the U.S. District Court for the Central District of Illinois agreed, saying the state was seeking “economic damages” resulting from the drug epidemic.

On July 19, the U.S. 7th Circuit Court of Appeals, reversed the decision, ruling that West Virginia’s allegation that it spent money caring for drug-taking citizens who suffered bodily injury is no different than the claim of a mother seeking payment on a claim relating to her taking care of her son’s drug-induced injuries.

Pills Spilling From BottleThe state, it said, alleged that H.D. Smith “ ‘interfered with the right of West Virginians to be free from unwarranted injuries, addictions, diseases and sicknesses.’ H.D. Smith’s actions caused West Virginia to spend money ‘addressing and combating the prescription drug abuse epidemic.’ ”

Scorecard: Cincinnati Insurance must provide a defense to H.D. Smith on the state’s lawsuit.

Takeaway: The court said the policy’s phrase “because of bodily injury” provided broader coverage than if the policy covered damages “for bodily injury.”

Court: Broker Lied About Investigations

In 2014, executive professional insurance consultants (executive) was sued by AZ Air Time, an indoor trampoline park, after finding out it had no liability insurance following three personal injury lawsuits, although it had paid premiums for the coverage. Executive sought a defense from Admiral Insurance Co., which had issued a professional liability insurance policy.

The insurance company denied coverage, contending that Executive lied in its application when asked whether any agency personnel had been the “subject of complaints filed, investigations and/or disciplinary action by any insurance or other regulatory authority or convicted of criminal activity.”

In fact, Cynthia Rose-Martin, co-owner of the brokerage, voluntarily surrendered her license and was fired from another brokerage in 2010 after an Arizona Department of Insurance investigation on allegations of fraud and embezzlement. She was accused of enrolling clients in AFLAC supplemental coverages without their consent or knowledge, according to court documents.

In 2012, the DOI investigated another claim that Rose-Martin asked a client to provide a “blank check that could not include the word ‘void’ on the check.” She later agreed to a consent judgment that she engaged in “fraudulent, coercive or dishonest practices” as well as forged another’s name to a document relating to an insurance transaction. She was fined $2,500.

On Aug. 10, the U.S. District Court for the District of Arizona granted Admiral Insurance Co.’s request to rescind the policy for the firm, whose owners reportedly fled to Mexico after AZ Air Time filed suit against them.

Scorecard: Admiral Insurance does not have to provide a defense to the brokerage.

Takeaway: The policy to the brokerage would not have been issued if it had disclosed the Department of Insurance investigations.

Court Rules on Defective Product Coverage

In the spring of 2010, three customers of phibro animal health corp. reported to the company that its Aviax II feed additive, which was designed to prevent a parasitic disease in chickens, stunted the growth of their chickens. Phibro filed notice of a potential liability claim with Chartis Insurance Co., an affiliate of National Union Fire Insurance Co., which had issued commercial general liability and umbrella insurance policies. Phibro eventually settled the claims of the three customers.

Close-up of chicken eating grain from feederThe company filed a lawsuit seeking a judgment from the Superior Court of New Jersey in Bergan County after Chartis denied coverage.

On June 24, 2014, the court dismissed the case, concluding that the losses did not constitute “property damage” caused by an “occurrence,” because the chickens “were not physically injured and were subsequently sold for human consumption,” albeit at a lower price because of their smaller size.

The Superior Court’s appellate division reversed, in part, noting that “an accident” was part of the policy’s definition of “occurrence.”

“A manufacturer naturally would not have wanted to market this feed additive if it knew in advance its customers’ chickens would experience such an undesirable reaction,” the court ruled on July 14.


It rejected the insurer’s argument that the adverse side effects could have been foreseen and that the incident resulted in only economic losses. “The term ‘physical injury’ under the policies does not require that the property that is damaged be unsalable,” it said.

The court returned the case to the lower court to determine whether the chickens could have been “restored to use” if given more time before slaughter, which could exclude coverage under the “impaired property” clause.

Scorecard: Depending on additional proceedings, Phibro may be covered for losses associated with its feed additive.
Takeaway: The ruling casts doubt on the state’s prior rulings that a policyholder’s defective products are excluded from coverage. &

Anne Freedman is managing editor of Risk & Insurance. She can be reached at [email protected]
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Sponsored: Berkshire Hathaway Specialty Insurance

Why Marine Underwriters Should Master Modeling

Marine underwriters need better data, science and engineering to overcome modeling challenges.
By: | October 3, 2016 • 5 min read

Better understanding risk requires better exposure data and rigorous application of science and engineering. In addition, catastrophe models have grown in sophistication and become widely utilized by property insurers to assess the potential losses after a major event. Location level modeling also plays a role in helping both underwriters and buyers gain a better understanding of their exposure and sense of preparedness for the worst-case scenario. Yet, many underwriters in the marine sector don’t employ effective models.

“To improve underwriting and better serve customers, we have to ask ourselves if the knowledge around location level modeling is where it needs to be in the marine market space. We as an industry have progress to make,” said John Evans, Head of U.S. Marine, Berkshire Hathaway Specialty Insurance.

CAT Modeling Limitations

The primary reason marine underwriters forgo location level models is because marine risk often fluctuates, making it difficult to develop models that most accurately reflect a project or a location’s true exposure.

Take for example builder’s risk, an inland marine static risk whose value changes throughout the life of the project. The value of a building will increase as it nears completion, so its risk profile will evolve as work progresses. In property underwriting, sophisticated models are developed more easily because the values are fixed.

“If you know your building is worth $10 million today, you have a firm baseline to work with,” Evans said. The best way to effectively model builder’s risk, on the other hand, may be to take the worst-case scenario — or when the project is about 99 percent complete and at peak value (although this can overstate the catastrophe exposure early in the project’s lifecycle).

Warehouse storage also poses modeling challenges for similar reasons. For example, the value of stored goods can fluctuate substantially depending on the time of year. Toys and electronics shipped into the U.S. during August and September in preparation for the holiday season, for example, will decrease drastically in value come February and March. So do you model based on the average value or peak value?

“In order to produce useful models of these risks, underwriters need to ask additional questions and gather as much detail about the insured’s location and operations as possible,” Evans said. “That is necessary to determine when exposure is greatest and how large the impact of a catastrophe could be. Improved exposure data is critical.”

To assess warehouse legal liability exposure, this means finding out not only the fluctuations in the values, but what type of goods are being stored, how they’re being stored, whether the warehouse is built to local standards for wind, earthquake and flood, and whether or not the warehouse owner has implemented any other risk mitigation measures, such as alarm or sprinkler systems.

“Since most models treat all warehouses equally, even if a location doesn’t model well initially, specific measures taken to protect stored goods from damage could yield a substantially different expected loss, which then translates into a very different premium,” Evans said.

Market Impact

That extra information gathering requires additional time but the effort is worth it in the long run.

“Better understanding of an exposure is key to strong underwriting — and strong underwriting is key to longevity and stability in the marketplace,” Evans said.

“If a risk is not properly understood and priced, a customer can find themselves non-renewed after a catastrophe results in major losses — or be paying two or three times their original premium,” he said. Brokers have the job of educating clients about the long-term viability of their relationship with their carrier, and the value of thorough underwriting assessment.


The Model to Follow

So the question becomes: How can insurers begin to elevate location level modeling in the marine space? By taking a cue from their property counterparts and better understanding the exposure using better data, science and engineering.

For stored goods coverage, the process starts with an overview of each site’s risk based on location, the construction of the warehouse, and the type of contents stored. After analyzing a location, underwriters ascertain its average values and maximum values, which can be used to create a preliminary model. That model’s output may indicate where additional location specific information could fill in the blanks and produce a more site-specific model.

“We look at factors like the existence of a catastrophe plan, and the damage-ability of both the warehouse and the contents stored inside it,” Evans said. “This is where the expertise of our engineering team comes into play. They can get a much clearer idea of how certain structures and products will stand up to different forces.”

From there, engineers may develop a proprietary model that fits those specific details. The results may determine the exposure to be lower than originally believed — or buyers could potentially end up with higher pricing if the new model shows their risk to be greater. On the other hand, it may also alert the insured that higher limits may be required to better suit their true exposure to catastrophe losses.

Then when the worst does happen, insureds can rest assured that their carrier not only has the capacity to cover the loss, but the ability to both manage the volatility caused by the event and be in a position to offer reasonable terms when renewal rolls around.

For more information about Berkshire Hathaway Specialty Insurance’s Marine services, visit https://bhspecialty.com/us-products/us-marine/.

Berkshire Hathaway Specialty Insurance (www.bhspecialty.com) provides commercial property, casualty, healthcare professional liability, executive and professional lines, surety, travel, programs, medical stop loss and homeowners insurance. The actual and final terms of coverage for all product lines may vary. It underwrites on the paper of Berkshire Hathaway’s National Indemnity group of insurance companies, which hold financial strength ratings of A++ from AM Best and AA+ from Standard & Poor’s. Based in Boston, Berkshire Hathaway Specialty Insurance has offices in Atlanta, Boston, Chicago, Houston, Los Angeles, New York, San Francisco, San Ramon, Stevens Point, Auckland, Brisbane, Hong Kong, Melbourne, Singapore, Sydney and Toronto. For more information, contact [email protected].

The information contained herein is for general informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any product or service. Any description set forth herein does not include all policy terms, conditions and exclusions. Please refer to the actual policy 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 Berkshire Hathaway Specialty Insurance. The editorial staff of Risk & Insurance had no role in its preparation.

Berkshire Hathaway Specialty Insurance (www.bhspecialty.com) provides commercial property, casualty, healthcare professional liability, executive and professional lines, surety, travel, programs, medical stop loss and homeowners insurance.
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