Risk Insider: Nir Kossovsky

D&O’s Weakened DNA

By: | July 1, 2015 • 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]

“Want to Attract Board Members? Manage Company Risk Better,” declared the headline of Tony Chapelle’s article in the Financial Times’ Agenda news service for corporate directors published June 15, 2015.

The feature (Paywall) helpfully warned board candidates “to perform due diligence before accepting a seat or risk loss of personal capital and reputation.”

“Directors want to work for honest, risk-aware companies, said Stephen Ferris, professor and senior associate dean at the University of Missouri — as quoted in Chapelle’s article —  “to reduce the likelihood of getting enmeshed in ligation over fraud, defective products or other situations that threaten their ability to properly discharge their duties. They’ll also be less exposed to losing their personal capital or their reputations, which could limit their opportunities for serving on other boards.”

The challenge for companies seeking the best board members is that governance, risk management, and compliance disclosures do not have great signaling gravitas or impact, nor are they as robust and convincing as talking money.

This is sound advice, of course, but we’ve seen this movie before.

In the late 1980s, corporations were finding it difficult to attract and retain qualified directors. At that time, at the height of complex transactions, directors were exposed to claims that they failed to exercise due care, and consequently, to potential personal liability both that was disproportionately large and rather unpredictable.

FORTUNE described the perceived risk in that era as being “so great that only madmen and lepers were expected to join corporate boards.”

That’s when directors who wanted to work for “honest, risk-aware companies,” sought out companies that had qualified for, and could afford, Directors & Officers liability insurance.

As Risk Insider Peter Taffae explained last year, “The intent then, and arguably today among experts, is to protect senior management and the insured’s board against litigation arising from their capacity as a director and/or officer, from third parties.”

The cover protected the personal capital of the director with one policy, which eventually became Side A of a common policy, and “bet” on the risk management culture of the company with a separate policy that evolved into Side B.

D&O coverage was available at rational prices to the better risks — its presence was a signal that the company had a strong risk management culture.

Only it was more than a signal. It was a warranty-like badge of honor where a third-party backed, with real money, the company’s claim of a strong risk management culture.

Money talks. But that was then.

Chapelle’s article and the experts quoted therein suggest that D&O insurance today merely whispers relative to the noise of 21st century threats — especially from social media, regulatory scrutiny, and investor activism — to directors’ “personal capital or their reputations.”

Today’s risk-aware director-prospect is advised to look beyond liability coverage to the underlying risk management practices, to study the 10-K Item 1A risk disclosures, and to validate that the company is providing appropriate risk mitigation strategies for all recognized threats.

The challenge for companies seeking the best board members is that governance, risk management, and compliance disclosures do not have great signaling gravitas or impact, nor are they as robust and convincing as talking money.

With D&O’s mojo gone, perhaps companies that have implemented world-class enterprise risk management programs could let prospective directors appreciate and value them with clear and credible signals like board performance bonds?

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Column: Roger's Soapbox

Know Your Limitations

By: | May 6, 2015 • 3 min read
Roger Crombie is a United Kingdom-based columnist for Risk & Insurance®. He can be reached at [email protected]

The insurance of directors and officers has been of the keenest interest to me since the mid-1990s. When I say “keenest interest,” don’t get me wrong: D&O is as dull as printing money can be. But I have followed the discipline since ACE arrived in Bermuda more than 20 years ago. They wrote it and I wrote about it.

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I know Side A when I see it. I’ve saved time by assuming that Side B covers what Side A does not.

Yes, I’ve met people who insist there is a Side C, at weird insurance conventions in places you’ve never heard of, but I prefer to think of D&O like a single from the 1960s (a song stamped on heavy plastic and played on … never mind). Side A was the hit single; Side B the filler. There were double A-sides, but I stray further from the subject with every passing word.

I mention D&O because I have lately become a director of the company that manages the managers of the apartment block I live in. The protection D&O coverage offers is now literally of the keenest interest. I’ll tell you straight: writing about D&O is less stressful than having D&O written for you.

I know Side A when I see it. I’ve saved time by assuming that Side B covers what Side A does not.

As the finest director never to draw a salary, I have suddenly become aware of the true value of D&O insurance to the insured.

Potential claims loom on every horizon. A director oversaw something imperfectly done? He failed to oversee or foresee something imperfectly done? Something happened while he was on vacation in Mexico? The poor so-and-so is liable every time.

We have a leaseholder who sends incomprehensible writs against us that he has drafted himself, claiming money he hasn’t lost and distress he hasn’t suffered.

Another leaseholder wants it to be Florida in the corridor while the ice piles up outside. One especially nutty fellow is on his fifth Jaguar of the year. Curiously, he doesn’t drive.

As a director, I’m liable for all their woes, errors, crimes and misdemeanors.

A press release issued last month reported that directors are often unaware of the terms and conditions applicable to their coverage. They have little clue, it seems, about basic stuff, such as term and limits.

Poor fools, I thought. Then it struck me: I also have no clue what the terms and limits of my D&O policy might be.

Clint Eastwood, that great director (and, as ‘Dirty’ Harry Callahan, officer), once said: “A man’s got to know his limitations.” Coverage-wise, I don’t know mine. I know the premium has been paid and the policy is in force, but beyond that I can’t tell my Side A from my Hepatitis B.

How many insureds, I wonder, cruise along, thinking that our bottoms are covered, without ever bothering to read the small print, or even the large? We insureds aren’t too bright, apparently.

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But here’s the thing, which you probably know if you work in insurance: We insureds don’t want to know the details. It’s not that we’re big-picture people. We’re more like Batman with his cowl on backwards.

For sake of argument, let’s say I’m protected by a three-year policy with a limit of $1 million for covered behavior. Knowing that, I would have to worry about what happens that might take place in four years’ time or cost more than a million bucks. The writs guy could have finished law school by then (and be putting on the writs).

To be honest — and I speak for insureds everywhere — not knowing is a much smoother experience for all of us.

Ignorance really is bliss.

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Sponsored: Lexington Insurance

Pathogens, Allergens and Globalization – Oh My!

Allergens and global supply chain increases risk to food manufacturers. But new analytical approaches help quantify potential contamination exposure.
By: | June 1, 2015 • 6 min read
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In 2014, a particular brand of cumin was used by dozens of food manufacturers to produce everything from spice mixes, hummus and bread crumbs to seasoned beef, poultry and pork products.

Yet, unbeknownst to these manufacturers, a potentially deadly contaminant was lurking…

Peanuts.

What followed was the largest allergy-related recall since the U.S. Food Allergen Labeling and Consumer Protection Act became law in 2006. Retailers pulled 600,000 pounds of meat off the market, as well as hundreds of other products. As of May 2015, reports of peanut contaminated cumin were still being posted by FDA.

Food manufacturing executives have long known that a product contamination event is a looming risk to their business. While pathogens remain a threat, the dramatic increase in food allergen recalls coupled with distant, global supply chains creates an even more unpredictable and perilous exposure.

Recently peanut, an allergen in cumin, has joined the increasing list of unlikely contaminants, taking its place among a growing list that includes melamine, mineral oil, Sudan red and others.

Lex_BrandedContent“I have seen bacterial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant.”

— Nicky Alexandru, global head of Crisis Management at AIG

“An event such as the cumin contamination has a domino effect in the supply chain,” said Nicky Alexandru, global head of Crisis Management at AIG, which was the first company to provide contaminated product coverage almost 30 years ago. “With an ingredient like the cumin being used in hundreds of products, the third party damages add up quickly and may bankrupt the supplier. This leaves manufacturers with no ability to recoup their losses.”

“The result is that a single contaminated ingredient may cause damage on a global scale,” added Robert Nevin, vice president at Lexington Insurance Company, an AIG company.

Quality and food safety professionals are able to drive product safety in their own manufacturing operations utilizing processes like kill steps and foreign material detection. But such measures are ineffective against an unexpected contaminant. “Food and beverage manufacturers are constantly challenged to anticipate and foresee unlikely sources of potential contamination leading to product recall,” said Alexandru. “They understandably have more control over their own manufacturing environment but can’t always predict a distant supply chain failure.”

And while companies of various sizes are impacted by a contamination, small to medium size manufacturers are at particular risk. With less of a capital cushion, many of these companies could be forced out of business.

Historically, manufacturing executives were hindered in their risk mitigation efforts by a perceived inability to quantify the exposure. After all, one can’t manage what one can’t measure. But AIG has developed a new approach to calculate the monetary exposure for the individual analysis of the three major elements of a product contamination event: product recall and replacement, restoring a safe manufacturing environment and loss of market. With this more precise cost calculation in hand, risk managers and brokers can pursue more successful risk mitigation and management strategies.


Product Recall and Replacement

Lex_BrandedContentWhether the contamination is a microorganism or an allergen, the immediate steps are always the same. The affected products are identified, recalled and destroyed. New product has to be manufactured and shipped to fill the void created by the recall.

The recall and replacement element can be estimated using company data or models, such as NOVI. Most companies can estimate the maximum amount of product available in the stream of commerce at any point in time. NOVI, a free online tool provided by AIG, estimates the recall exposures associated with a contamination event.


Restore a Safe Manufacturing Environment

Once the recall is underway, concurrent resources are focused on removing the contamination from the manufacturing process, and restarting production.

“Unfortunately, this phase often results in shell-shocked managers,” said Nevin. “Most contingency planning focuses on the costs associated with the recall but fail to adequately plan for cleanup and downtime.”

“The losses associated with this phase can be similar to a fire or other property loss that causes the operation to shut down. The consequential financial loss is the same whether the plant is shut down due to a fire or a pathogen contamination.” added Alexandru. “And then you have to factor in the clean-up costs.”

Lex_BrandedContentLocating the source of pathogen contamination can make disinfecting a plant after a contamination event more difficult. A single microorganism living in a pipe or in a crevice can create an ongoing contamination.

“I have seen microbial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant,” observed Alexandru.

Handling an allergen contamination can be more straightforward because it may be restricted to a single batch. That is, unless there is ingredient used across multiple batches and products that contains an unknown allergen, like peanut residual in cumin.

Supply chain investigation and testing associated with identifying a cross-contaminated ingredient is complicated, costly and time consuming. Again, the supplier can be rendered bankrupt leaving them unable to provide financial reimbursement to client manufacturers.

Lex_BrandedContent“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet. Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”

— Robert Nevin, vice president at Lexington Insurance, an AIG company


Loss of Market

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While the manufacturer is focused on recall and cleanup, the world of commerce continues without them. Customers shift to new suppliers or brands, often resulting in permanent damage to the manufacturer’s market share.

For manufacturers providing private label products to large retailers or grocers, the loss of a single client can be catastrophic.

“Often the customer will deem continuing the relationship as too risky and will switch to another supplier, or redistribute the business to existing suppliers” said Alexandru. “The manufacturer simply cannot find a replacement client; after all, there are a limited number of national retailers.”

On the consumer front, buyers may decide to switch brands based on the negative publicity or simply shift allegiance to another product. Given the competitiveness of the food business, it’s very difficult and costly to get consumers to come back.

“It’s a sad fact that by the time a manufacturer completes a recall, cleans up the plant and gets the product back on the shelf, some people may be hesitant to buy it.” said Nevin.

A complicating factor not always planned for by small and mid-sized companies, is publicity.

The recent incident surrounding a serious ice cream contamination forced both regulatory agencies and the manufacturer to be aggressive in remedial actions. The details of this incident and other contamination events were swiftly and highly publicized. This can be as damaging as the contamination itself and may exacerbate any or all of the three elements discussed above.


Estimating the Financial Risk May Save Your Company

“In our experience, most companies retain product contamination losses within their own balance sheet.” Nevin said. “But in reality, they rarely do a thorough evaluation of the financial risk and sometimes the company simply cannot absorb the financial consequences of a contamination. Potential for loss is much greater when factoring in all three components of a contamination event.”

This brief video provides a concise overview of the three elements of the product contamination event and the NOVI tool and benefits:

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“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet,” he said. “Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”

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This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Lexington Insurance. The editorial staff of Risk & Insurance had no role in its preparation.




Lexington Insurance Company, an AIG Company, is the leading U.S.-based surplus lines insurer.
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