Nir Kossovsky, Denise Williamee and Peter Gerken of Steel City Re discuss the development of reputational risk, including current trends, how a captive can provide cover, and the specific challenges in insuring this risk
Reputational risk management has evolved to a heightened importance in recent years owing to the advance of behavioural economics, which allows the financial services sector to more effectively quantify concepts such as behaviour, psychology, value and communications.
Peter Gerken, senior vice president, risk transfer agency and insurance, Steel City Re, describes reputational risk as “the threat of lost corporate value when emotionally-charged stakeholders abruptly cease anticipating a promised or positive future experience, benefit or performance”.
Gerken adds that this is a different type of risk compared to cyber, product recall or employment practices liability, for example, because it both weakens a company’s growth strategy and exposes the board of directors to scrutiny from regulators, litigators and social media.
Greater recognition of the non-physical damage sustained by behavioural economic perils has stemmed from social politics and social justice movements for companies to adhere to more ethical standards, particularly in the oil and fast fashion industries.
“Cultural friction enhanced by social media, including #MeToo and #BlackLivesMatter, diversity, equity and inclusion, environmental activism and social inflation, gave tangible proof that reputation is more than publicity,” notes Nir Kossovsky, CEO, Steel City Re.
A report by Willis Towers Watson, ‘Reputational crisis insurance for the retail industry’, found that recent years have seen systemic changes to the way in which ordinary people consume information and form opinions. The new reputational landscape is also informed by changing demographics, declining public trust, state and non-state manipulation of media, and changes to the quality and quantity of data, the report notes.
Similarly, a joint report by Aon and Pentland Analytics investigating reputational risk in the cyber age determined that the risk landscape is “fundamentally shifting as the digital and physical worlds continue to connect and converge”, particularly owing to the rising power of social media, which has enabled people with the environment and means to collect and circulate information (and misinformation) globally and instantly. As well as negative social media, reputational risk events can derive from product failure, cyberattacks, supply chain disruption and executive misconduct.
Amid this environment, Aon’s 2021 Global Risk Management Survey ranked reputational risk fifth (compared to second in 2019 and first in 2017), with environmental, social and corporate governance (ESG) as a particular driver of reputational damage. Denise Williamee, vice president, corporate services, Steel City Re, describes ESG issues as “the dominant source of reputation risk”.
The survey notes that reputational risk is ranked higher in North America (owing to a higher number of corporate reputational crises, such as financial fraud, neglect of employee health and inappropriate advertising) and in the public sector (owing to governments’ poor handling of the COVID-19 pandemic, political scandals and extreme partisan politics).
In particular, the COVID-19 pandemic has developed the idea of conceptual value among governance, legal and risk professionals, and how best to protect it through insurance and risk management strategies.
Therefore, it is crucial for companies to reconsider their existing risk management, assessment and financing programmes, as well as to invest in a form of reputational crisis insurance, as this provides real-time reputational intelligence, profit protection, crisis communications and brand reconstruction based on perceptions of transparency, honesty and social responsibility.
Willis Towers Watson’s 2021 Global Reputational Risk Management Survey Report highlights reputation as a compound risk that should be addressed as a company-wide strategic issue rather than the sole responsibility of risk management teams, with 79.5 per cent of survey respondents indicating a belief that the focus on reputational risk in their business will only increase over the next five years.
Using captives for reputational risk
As organisations explore innovative reputational risk insurance products that encompass media monitoring, benchmarking, big data tools, stakeholder surveys and management platforms, this greater demand for integrated risk management and governance solutions has seen alternative capital sources enter the reputational risk reinsurance market — including captives. Captives hold a significant strategic role in reputational risk management by dually creating a financial solution for reputational risk and an ‘arms length’ risk management practice to protect the value of the parent company’s reputation.
Kossovsky explains: “Captives are invaluable. They can tactically cover the costs of going-forward impaired cash flow — analogous to an umbrella or difference in conditions policy — and cover the basis risk inherent in commercial parametric reputation and ESG insurance policies.”
Captives simplify the conceptual value of ESG within the operational and governance systems that help companies mitigate risks to address their stakeholders’ ESG expectations by providing evidence of reliable measures of quantification — and use of a captive demonstrates that due diligence by a third-party has authenticated the company’s reputational risk management.
Gerken adds that this tactical coverage strategically indicates implementation of prudential risk management to the capital markets and other stakeholders. “No commercial solutions currently in play can offer this vital spectrum of both tactical and strategic protection. Just as directors and officers insurance discovered widespread need in the early 1980s when dutiful boards were sued for stock price drops, no company today can afford to proceed without a reputation/ESG solution, and captives should have a prominent role,” he notes.
Challenges in insuring reputational risk
The complexity of quantifying the intangible value associated with reputational risk naturally presents challenges in its measurement, management and monitoring.
Respondents in Willis Towers Watson’s 2021 Global Reputational Risk Management Survey indicated that major complications are a lack of clear methodology (59.5 per cent) and a lack of access to reliable data (51 per cent). Other named challenges include inadequate company tools and insufficient skills among current staff.
There exists further potential issues in implementing captives to cover reputational risk. For example, there is legacy organisational resistance within the captive industry to the notion of insuring and managing reputational risk because of the misconception that it is all about marketing, communications and public relations rather than genuine, or traditional, risk management.
In addition, there is a legacy organisational belief that reputational risk can be mitigated through traditional legal strategies — in fact, it is difficult to perform value-at-risk quantification outside of a parametric model.
However, Kossovsky remains confident that “a company with an astute board, risk-aware leadership and sophisticated risk management team will find placing reputation risk in a captive with a parametric policy straightforward within many receptive jurisdictions”.
Williamee points to Connecticut as a key example, where the insurance department recently wrote it “does not anticipate any issue for prospective captives to be domiciled in Connecticut to utilise Steel City Re’s behavioural economic underwriting, parametric policy and pricing services to insure reputation and ESG-related risk”.
Looking ahead, the evolution of the reputational risk landscape is certainly set to be interesting, with Gerken anticipating that all external environmental forces and social pressures that have impacted the frequency, severity and perilousness of reputational risk over the last 12 months will only increase and compound owing to the industry-wide focus on ESG.
“Boards must demand and implement upgrades to their firms’ enterprise reputation risk management apparatus or face the risk of being discounted by the capital markets and the subsequent ire of disappointed investors,” Kossovsky concludes.
