1. REPUTATION RISK
Also known as the Cinderella Asset!
Michel Rochette
May 9 2007
Enterprise Risk Advisory, LLC

2. Presenters
 Dr. Leslie Gaines-Ross, Chief Reputation Strategist at
Weber Shandwick in NY where she leads the firm’s
consulting services and proprietary thought leadership
in reputation risk management. She is the creator of
www.reputationRX.com, a web site dedicated to
reputation issues
 Mr. Scott C. NewQuist, Managing Director at
Perception Partners, which specializes in providing
advice on identifying and managing reputation risk,
corporate governance and reporting.
 Michel Rochette, an ERM consultant at Towers Perrin
in NY who specializes in ERM and the management of
non-tradeable risks!
©Enterprise Risk Advisory, LLC 2

3. Reputation Risk
 Context: Why is it important to financial institutions?
 What is reputation? Definitions and comparisons
 Value of reputation: Drivers and evaluation measures
 Reputation risk: Definitions
 Reputation risk: Qualitative and quantitative measures
 Examples of reputation risk
 Reputation risk: Management approaches
 Reputation risk: Framework
 Rating agencies and regulators’ points of views
 Case studies
 Questions.
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4. Citations by Warren Buffet & Goldman Sachs
―It takes twenty years to build a reputation
and five minutes to destroy it.‖ (W. Buffet)
―If you lose dollars for the firm, I will be
understanding. If you lose reputation, I will be
ruthless.‖ (W. Buffet)
―Our assets are our people, capital and
reputation. If any of these are ever
diminished, the last is the most difficult to
restore.‖ (Goldman Sachs Business
Principles)
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5. Importance of Reputation and Trust
 Information asymmetry
 Outsiders don’t know as much about a company as
insiders, so a good reputation alleviates and allow
customers to make a choice.
 Important for all companies but crucial and vital to
insurers as we sell distant promises.
 Important for insurers that have one global brand:
AIG, ING, Aegon, Met Life, Sun Life, Manu Life,
AXA, Allianz, Zurich, etc.
 In essence, we exchange money for a promise to
pay in the future. (Money for Paper!)
 More important in a period of rapid changes,
globalization, internet blogs, activism, mass media.
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6. Importance of Reputation to Stakeholders
 Employees: Are more loyal to a company with good
reputation. Help with recruiting
 Investors and business partners: Will take risk in a
company that they can thrust based upon its
reputation. (More than 90% think about reputation in
investment decisions: 40% care about reputation, 50%
care partially).
 Lawmakers and regulators: Reputation can help
lessen the legal burden on a company.
 Public at large: Preserve ―social license‖ to operate
 Customers and suppliers: Support loyalty to company
 Competition: Barrier to entry
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7. Reputation Risk: Number 1 Risk for CROs
Reputational Risk
(52)
Regulatory Risk
(40)
Human Capital Risk
(40)
IT RISK
(35)
Financial, Market, Credit and Insurance Risk
(30)
Crime, security, political, natural hazard, FX, Terrorism, Country Risk
(20)
Source: Economist Intelligence
Unit, 2005
Max Scale: 100
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8. Reputation and Financial Impact: Corporate
Reputation Watch by Harris Interactive
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9. Value of Reputation: National Corporate Survey
 Microsoft: 1st place
 Johnson and Johnson: 2nd
 Google: 4th
 Berkshire Hathaway Inc. 21st
 American Express Company: 34th
 Wells Fargo & Company: 36th
 State Farm Insurance: 42nd
 Allstate: 51st
 No Life companies included. Have your companies rated!
 Consult Fortune’s annual survey of America’s Most Admired
Companies.
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10. What is Reputation: General Definitions
 A corporate reputation is a collective representation of
a firm’s past actions and results that describe the
firms’ ability to deliver outcomes to multiple
stakeholders. It gauges a firms’ relative standing both
internally and externally. (Fombrun/Foss: Developing a
Reputation Quotient, 2000)
 Reputation is public information regarding a players’
trustworthiness. A players’ reputation reflects the
information that third parties have on how trustworthy
his behavior has been in the past. ( Ripperger 1998)
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11. Comparison of Reputation and Image
 Reputation:
 Corporate Actions and Conduct that
 Create Trust
 As Experienced by different Stakeholders.
 Serves as a reservoir of goodwill in time of crises.
 Image
 Belief and personal evaluation of a firm
 Tied to the firm directly, not to actions by the firm.
 If image is positive, reputation will improve
 However, reputation evolves more slowly than
image because it is tied to actions.
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12. Comparison of Reputation and Brand
 Brand:
 What differentiates us from the competition
 Marketing of the company including advertising and
publicity
 Refers to logos and names of companies
 Reputation:
 Cannot be enhanced by just a name change.
 Larger concept as it includes other elements as we
will see.
 Often referred as ―Emotional Capital‖ of the firm
 Thus, if capital, it is subject to risk.
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13. Value of Corporate Reputation: Drivers
Long-term
Financial Performance
Client Service
Corporate Governance
New products
Regulatory Compliance
New services
Pricing
Reputation
External factors
Communication
Social/Environmental
Disclosures
Responsibilities
Crisis Management
Pressure Groups
Human Capital/Talent
Culture
Corporate Ethical Values
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14. Value of Reputation to the Firm
 A good reputation encourages consumers to buy products and
services.
 Suppliers are willing to do business with you, thus expanding
opportunities.
 Top notch employees want to join and stay with your organization,
thus enhancing its innovation capabilities and value.
 Favorable outlook from regulators and rating agencies, thus
decreasing financing cost and increasing value.
 Investors want to hold shares, thus increasing value.
 Positive feedback from media and pressure groups increase
value.
 In a crisis mode, investors give the company the benefit of the
doubt, thus easing short-term decrease in value.
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15. Value of Reputation: Qualitative Measures
 It is the sum of how all constituencies view and
perceive the organization.
 National Corporate Reputation Survey by Harris
Interactive
 Specific company’s reputation survey: Ex. Swiss Re
does one every 2-3 years.
 Media evaluation of public opinions. Ex. Media
Tenor International reports, % of negative/positive
reports, Awareness Threshold of 3%( Below 3%
leads to higher risk), Value Reporting of company’s
value drivers.
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16. Value of Reputation: Quantitative Measures
 An Intangible asset which doesn’t show up in the balance sheet. It
is sometimes referred as ―Emotional Capital.‖
 It has a current value and influences future value of the firm.
 Best approach is by the Court of Financial Opinion: Stock Market!
 Estimated value of reputation = Market Value of Company -
Balance Sheet Value - Intellectual Property – Brands( Cos like
Brandz, Core Brand) – Copyrights - other Intangible Assets.
 Usually, reputation is the largest component of intangible assets.
 Reputation reflects the rise of the ―non-physical economy‖,
especially in the developed world. Some surveys have shown
ratios of market value to balance sheet value between 10 and
100.
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17. Reputation Risk: Regulatory Definitions
 FSA: The risk that the firm may be exposed to
negative publicity (Trust) about its business practices
or internal controls (Actions), which could have an
impact on the liquidity or capital of the firm or cause a
change in its credit rating. (Affecting its stakeholders).
 US Federal Reserve(2004): ―Reputation risk is the
potential loss that negative publicity regarding an
institution’s business practices, whether true or not, will
cause a decline in the customer base, costly litigation,
or revenue reductions (financial loss).
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18. Business Definitions of Reputation Risk
 US Federal Reserve(2004): ―Reputation risk is the
potential loss that negative publicity regarding an
institution’s business practices, whether true or not, will
cause a decline in the customer base, costly litigation,
or revenue reductions (financial loss).
 ADD other business elements:
 Loss value of key employees.
 Loss value of key suppliers.
 Increased cost of regulatory actions.
 Financial impact of rating agencies’ decisions.
 Financial impact of new products
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19. Reputational Risk: A Risk by Itself or a
Consequence (Second tier) of Other Risks?
 According to Economist Intelligence Unit(2005) survey,
―52% consider reputation risk as a risk by itself, while
48% consider it as a consequence of other risks‖ like
operational risk – people, process, systems and
external events – compliance and financial.
 Appears that if first risks are more quantitatively
analyzed – market, credit, operational … -
Reputational risk appears as a second tier risk –
mostly within financial institutions – while it appears as
a risk of its own in the corporate world – like Hilton,
Cruise companies where emphasis is on their
products/services -.
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20. Reputation Risk: Qualitative Measures
 Complaints by all stakeholders act as an early warning system:
Monitor and analyze trends.
 Identify and monitor your company’s HOT SPOTS in relation to all
your stakeholders’ interests, particularly in periods of rapid
change. Ex. Organizational changes, new products/services.
 Compliance/Audit functions. Are they proactively identifying and
following-up on issues?
 Assess flows of risk information in the institution.
 Assess the link between compensation programs and desired
behaviors.
 Is reputation risk part of the new product approval process?
 Is there a Code of Ethics? Reward ethical behavior? Penalize
misbehavior?
 Evaluation of media coverage of companies
 Monitor internet blogs
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21. Reputation risk: Indicators
 Rate your organization:
 Low if
— Management anticipates well changes in market and
regulatory nature
— Franchise value minimally exposed
 Moderate if
— Management adequately responds to changes in market
— Franchise value is controlled
 High if
— Management doesn’t anticipate reputation risk
— Weaknesses are present
— Franchise value substantially exposed to in litigation,
consumer complaints.
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22. Reputation Risk: Quantitative Measures
 Measured as the market value impact of an event which is above
the direct value of the event itself, the excess is qualified as the
reputational impact.
 Ex. Federal Reserve Bank of Boston measured Reputational
impacts of operational events:
 Internal Fraud: The market value impact was more than 6
times the value of the internal fraud itself, which is due to lack
of control by the company and lack of confidence in actual
management.
 Externally caused events: No reputational impact.
 Thus, seems to confirm the initial definition of reputation as
being based on ACTIONS by company.
 Fines account for less than 10% of total market value loss.
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23. Reputation Risk: Quantitative Measures
 Failures by companies that have a reputational impact have a
lasting financial effect on the market value of companies:
 1/3 of financial analysts say that their evaluation of a company
will take into account the impact of a failure in reputation up to
3 years after the event. (Hill/Knowlton 2006 survey)
 Companies take up to 3 years to recover from a crisis that
affected their reputation. (Burson/Marstelle Market research)
 Model developed by UK-Based OxFord Metrica called
ValueReaction Model: Analyze impact of reputation crisis on
company stock price. Will company recover from a crisis? If
management handles crisis badly, investors conclude that
management cannot handle unexpected events.
 Set up Loss Data Base of operational events and their
reputational impacts.
 Scenarios modeling of major threats using expert judgment
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24. Reputation Risk: Model Quantitative Financial
and non Financial Impacts of Damage: Factors
 Stock decline
 Run on the bank
 Spike in policy surrenders
 Outflow of assets under management
 Drop in sales, decline in market share
 Ratings downgrade
 Regulatory investigations, license withdrawal, fines
 Shareholders’ litigations and class-actions
 Political fall-out, discontent in communities
 Negative media coverage
 Pressure groups and public opinion
 Employees and contractors withdrawals.
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25. Reputational Risk: Importance of companies’
actions on Historical Reputation Events.
Long-term
Financial Performance
Client Service
Corporate Governance
New products
Regulatory Compliance
New services
66%
Pricing
47%
Reputation
External factors Communication
Social/Environmental Disclosures/Security Breaches
Responsibilities 57%
Pressure Groups Crisis Management
Human Capital/Talent
Culture
Source: Economist Intelligence
Corporate Ethical Values
Unit, 2005
58%
% of respondents.
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26. Examples: Non financial Sectors
 Catastrophe: Three Mile Island
 Safety Issue: Union Carbide chemical leak in Bhopal in 1984.
 Environmental issue: Home Depot promising to stop selling wood
from protected forests after Rainforest Group Action intervention,
Exxon Valdez
 Catastrophe: Concorde crash and impact on both Air France (less
impact ) and British Airways (larger impact due to slow response).
 Product Recall:
 Tylenol tampering scare in 1982 due to cyanide. Limited
impact due to Johnson and Johnson quick responses in the
end. In fact, Johnson and Johnson has been rated top in
reputation by Harris Interactive.
 Perrier suffered longer from toluene traces found in its waters
due to lack of crisis management.
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27. Examples: Financial Sectors
 Scandals/Fraud:
 Arthur Andersen co. fell almost entirely due to its
damage to its reputation after Enron’s scandal in
2002.
 Interesting case in the field of reputation. Similar to
Barings in the field of operational risk.
 One year earlier in 2001, the Chief Executive was
saying: ―There is extraordinary power in our name
because it stands for time-tested values, a unique
one-firm global operating approach and recognized
superior performance.‖
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28. Examples: Financial Sectors
 Fraud: KPMG paid 456 million dollars but escaped indictment that
could have crippled the firm.
 External events: SARS had huge impact on tourism both in
Toronto and China.
 Market Timing/Fraud in 2003/2004 at Putnam Investments
 Paid 4 million in fines.
 Fired top management of international funds.
 Lost 14 billion of assets under management in a week (5%).
 Assets under management from 272 billion (03) to 192 (07).
Never recovered from institutional clients.
 Putnam sold to Great-West Life in Feb. 07 ending a history
dating back to 1937.
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29. Examples: Financial Sectors
 Accounting Scandals at Fannie Mae:
 Direct impact: 400 million dollars in fine to SEC and
OFHEO.
 Indirect impact: Fannie Mae ordered to limit
mortgage holdings at 727 billion dollars. Thus,
company cannot grow anymore. This situation will
last until ― it has implemented internal controls and
risk management. We are talking years…‖
 Scandal at Marsh. Stock declined by 40%, Moody’s
downgraded company due to decline in reputation.
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30. Example in the insurance industry: AIG
 Following investigations in a finite reinsurance, investigations led
to other investigations in accounting and fraud.. starting in March
2005
 Result:
 Paid 1.6 billion in fines in February 2006
 Share decline by 10 billion dollars in absolute terms when
investigations began.
 Relative share value destruction of 40 billion dollars
considering the insurance sector performance between March
2005 and February 2006 when settlement occurred.
 Share price still hasn’t recovered in spite of increased
profitability. Will take time to get back the reputation of the
―world’s leading, rock solid insurance company.‖
 AIG didn’t have a reputation recovery plan in place.
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31. Example in the insurance industry: AFLAC
Japan
 Situation: Following investigations by the Japanese Regulator
about non payment of valid supplemental medical claims over 5
years– 10 cos. - Aflac and others had to review claims processes.
Clearly an operational risk event.
 90% of companies on Tokyo Stock Exchange offer Aflac products!
 Continuous media coverage of the investigations.
 Operational impact on Alfac:
 Process and IT events: 19 169 errors
 Direct additional cost: 16 million dollars in additional claims.
 Represented .45% of all benefit payments, .01$ per share
 Possible fine by the FSA
 Costs to investigate, correct situations, publicize results.
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32. Example in the insurance industry: AFLAC
Japan
 Reputation impact on Alfac:
 New sales dropped by 5% and 10%.
 Slow recovery
 Share price drop in early March 07:
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33. Management of Reputation Risk: Align with
Risk Drivers
 Crisis Management (80%)
 Unplanned events but not necessarily unexpected.
 Mismanagement of crisis can seriously damage a reputation.
Media attention is high.
 Crisis team made of Board and technical people.
 Different from business continuity planning.
 Need to make strategic decision with little information.
 Ex. Katrina was a crisis mismanaged by all from President,
FEMA to insurance companies. September 11 was better
handled by former NYC mayor. His reputation was enhanced.
 Quote from Madeleine Albright: ― ..Being prepared for a crisis
is never a waste of time.‖
Source: Economist Intelligence
Unit, 2005
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34. Management of Reputation Risk
 Develop Corporate Social Responsibility programs:
 Build ―goodwill‖ vis-à-vis stakeholders.
 Enhance internal ethical programs. (61%).
 Establish Code of Conduct by employees.
 AXA established a Sustainable Development Department in
2001 to coordinate a variety of environmental, community,
educational and charitable programs.
 Integrate environmental impact studies in investment decisions
and publicize.
 Monitor external perceptions of company by all stakeholders
(61%)
 Proactively monitor external threats. (56%). Ex. Sales practices,
bid rigging, failure of insurers, regulatory investigations, market
timing on competitors and determine our possible reactions to
them. Reactive or proactive and how to face the issue?
Source: Economist Intelligence
Unit, 2005
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35. Management of Reputation Risk
 Establish Group Issue Processes. Ex. Swiss Re
 Establish an internal whistle blowing approach. A crisis
or an attack on reputation never come at a surprise.
Someone knew something within the organization.
 Integrate communications strategies: right message,
delivered by right people to right audiences via a mix
of channels is critical.
 Economic capital: Integrate reputation impacts into the
calculations of other risks, in particular operational
risks. In financial industry, 30% feel that they can’t
quantify while 66% feel that they can quantify in the
energy sector.
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36. Framework for Governance of Reputational
Risk
 Is reputation risk part of the overall risk policy?
 ―Traditional Approach‖: CEO is in charge (84%)
 Reflects focus on crisis management only, reactive
 Reputation is focused only on organization's own
operations.
 Dedicated personnel or dedicated task force
 CRO, head of business units, communications
manager (42%). Reputation risk management is
more than PR.
 External parties expect dedicated resources like for the
other risks. Source: Economist Intelligence
Unit, 2005
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37. External Views
 Rating agencies
 AM Best bases it evaluation on 3 criteria:
— Balance Sheet Strength
— Operating Performance
— Business Profile: Affected by reputation now and in the future.
Affected by all reputation risk drivers.
— Bases its rating on trust in management, enhanced by strong
reputation, which is intrinsically linked to its capacity to manage
its risk profile.
 Insurance regulators
 Reputation is a strategic asset of insurers. Each institution should
manage it proactively involving the Board and senior management as
part of its overall ERM framework.
 US Banking regulators
 OCC expects that reputation risk management will not be done in
isolation but will involve CRO, Board, Audit, Compliance, Customer
complaint, HR
 OCC expects that compensation programs will support desired
behaviors
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