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A company's reputation may be intangible, but when it's damaged, the losses are real. Can insurance bridge the gap?
Roy Harris, CFO Magazine
August 1, 2004
When Martha Stewart was denied a new trial last month, shares of Martha Stewart Living Omnimedia Inc. took another dip, further illustrating the particular peril faced by companies closely identified with a "brand name." As many have learned lately, corporate reputations polished for decades to a high luster can be instantly tarnished by ineptitude, malfeasance, or plain bad luck. It may be a show-biz truism that there is no such thing as bad publicity, but employees and shareholders of companies as diverse as Royal Dutch/Shell Group, Carnival Cruise Lines, and Bridgestone/Firestone know too well that when the corporate name is sullied, the damage can be devastating.
"All you have to do is read the papers every day to see the challenges companies have had in this regard," says Bradley Wood, senior vice president of risk management at Washington, D.C.-based Marriott International Inc. "The exposure to reputational loss is greater than ever, and there's no insurance product to cover it."
Not yet, anyway. The insurance industry has been interested in offering such coverage for many years, but the difficulty in determining the value of a brand or reputation, and the cost of restoring same, has proven extremely challenging. Whatever the source of bad publicity — be it genuine tragedies that cost lives, the peccadilloes of management, or a host of things in between — the result can affect stock price, sales, and every other barometer of success.
For many years, insurers have offered piecemeal approaches that address certain facets of reputational damage but don't begin to approach comprehensive coverage. Liability insurance can pay for a legal defense, and additional coverage may address costs associated with a product recall or business interruption. Beyond that, about the only help toward restoring reputation or brand value comes in the form of limited crisis-communication coverage, a relatively new offering that covers some of the costs associated with public relations and advertising campaigns.
Wood is among a number of executives who have been pressing insurance companies to do more. He wants to see the industry design a product that would tie reputational coverage to corporate value lost in a crisis. Marriott's brands, including Ritz-Carlton and Ramada, are, he says, "among our most important assets, and protecting our reputation is a natural extension of our brand-management strategy."
The terrorist attacks of 2001 stalled nascent efforts to develop such coverage, but recently research has been conducted in both the United States and Europe into how to place some insurable value on brands and aid companies facing reputational damage. "I've been working on this for four or five years, and now we're at the stage of trying to get the pricing to work," says John Bugalla, San Francisco based managing director of the Aon Risk Services unit of risk-management giant Aon Corp. A product is probably still more than a year away, "but the market is opening up," according to Bugalla, as large companies express more interest in protecting against a catastrophic decline in shareholder value wrought by a damaged corporate reputation — including the potential impact of Sarbanes-Oxley violations.
What's a Brand Worth?
CFO interest in such insurance appears to be growing. At Dallas-based Brinker International — the parent company of several restaurant chains, including Chili's, Romano's Macaroni Grill, and Maggiano's Little Italy — CFO Charles Sonsteby immediately sees its appeal — if it is priced affordably. "Our job is to maintain shareholder value," he says, so if an insurance plan can provide a suitable level of protection at a reasonable price, "you would have to take a look at that."
But determining what would constitute a fair price is far from easy, in part because the value of a brand is difficult to quantify and the list of things that can harm it is long and varied. Even companies that value their brands highly, such as Marriott and Brinker, do not, as Sonsteby says, "actually put dollars and cents to [the value of the brand]." Where does that leave the insurance industry?
One admittedly rough way to measure that value is stock price, but the specter of compensating companies for steep declines in their shares doesn't excite insurers. "You can't just insure a stock price," says Robert Hartwig, chief economist at the Insurance Information Institute, in New York. "The damage could be anywhere from trivial to cataclysmic, and with larger corporations the loss could be so large it isn't coverable by any single insurance company."
In addition to the potential scope of such losses, carriers refrain from covering reductions to market capital because "it's a moving target," notes Bugalla. "If you're an insurance company, when would you know when to pay the loss" for a perceived reputational damage, since at any point the stock price could begin to recover? Yet another issue is that some CEOs may have greater skills in managing through a crisis, a quality that's difficult, if not impossible, to quantify. Would premiums vary based on the insurer's assessment of those abilities?
James Gregory, CEO of CoreBrand LLC, a brand-valuation consultancy in Stamford, Connecticut, has been talking with insurers about how to quantify reputational worth. He believes that valuations can be developed that satisfy insurance-company standards. "Our database tracks companies at risk, and we have all the bells and whistles to go with it," he says, alluding to CoreBrand's methodology of combining survey-based "favorability" ratings and financial analyses to estimate what part of market capitalization represents brand value. (On average, CoreBrand puts it at 5 to 7 percent.)
Bugalla cites work being led in the United Kingdom by Deborah Pretty, principal of Oxford Metrica, that quantifies both the value of a brand and the reputational impact of various events, and identifies corporate measures that can help mitigate the damage. Oxford Metrica has been particularly interested in the management qualities that mark a company as a likely "recoverer" from a crisis, as opposed to a "nonrecoverer" — which Pretty describes as one whose stock "suffers an immediate negative impact of over 10 percent and has yet to recover fully up to one year after the catastrophe."
Pretty says that the idea of the research is "to assess reputational impact in financial and strategic terms that resonate with the CEO's agenda." As part of this, Oxford Metrica uses cash-flow analyses, brand-strength evaluations, and a determination of managerial expertise to help create a metric for "reputation equity" that can be tapped in a crisis — and can be ranked by an insurance company in its attempt to determine a price for coverage. Its calculations also attempt to capture what Pretty calls "a clean measurement of reputational impact for a given event," which can aid corporate managers in strategic planning and resource allocation.
The need to blend all this into one system hints at the complexity of insuring a reputation. But beyond the factors addressed by those formulas, the potential for management errors to destroy value still has insurers stumped. For example, says Pretty, "think of Shell, where the situation — the downgrade of reserves — was definitely made worse by the fact that the chairman didn't deliver the message to analysts himself."
If a system is ever to be devised to insure against reputational damage, it is almost certain to spread the risk between insurer and client. "One way to make brand impairment insurable," says Bugalla, "is through a blended finite risk program." Such an approach would, for starters, establish a prefunded amount of coverage — say $10 million — so that the risk to the insurer is limited. The "blending" would also require the insured party to self-fund over time a large portion of the potential claim amount — more than half, in fact. And while it would cover incidents such as the sabotage behind the Johnson & Johnson/Tylenol poisoning cases in the 1980s, or injury of an accidental nature (as with airline crashes), or managerial malfeasance, it would not cover illegal corporate activity — an admittedly murky dividing line that often requires negotiation between insurer and client.
The CFO Makes the Call
As work progresses, companies are left to pick and choose among more-limited coverages, and address reputational risk through operations, not insurance. Brinker, for example, systematically assesses a number of risks, such as physical safety hazards at its sites, and like most restaurant chains, pays particular attention to food quality. In the industry, memories of the decade-old case of Foodmaker Inc.'s Jack in the Box — in which a fatality from tainted hamburgers threatened the very existence of the fast-food chain — remain vivid. Brinker aggressively monitors operational risks, both in-house at each restaurant and via an outside firm that performs food-quality inspections.
What help would Brinker get from insurance if some type of crisis hit? Susan Sieker, vice president and treasurer, says the company has a general liability policy with Arch Insurance Group as well as coverage of food-borne-illness damages from Lloyd's. The Lloyd's policy allows claims for business interruption, and provides some public-relations and advertising funds to help restore customer confidence and win business back — coverage the insurance industry calls "restoration." At Brinker, "a situation would have to be somewhat catastrophic for insurance to kick in," notes Sieker. "Up to $1 million to $1.5 million, we're self-insured." And, of course, there's no insurance for the loss of shareholder value in the event that a problem keeps customers or investors away.
Both product-recall (aimed at manufacturers) and food-borne-illness coverage are part of what Bernhard Steves, vice president at the Swett & Crawford insurance-brokerage unit of Chicago-based Aon, says is a limited insurance market served primarily by American International Group (AIG) and Lloyd's. And it is expensive. For food-borne-illness annual premiums, "you're usually looking at a minimum of $25,000, and a larger company can pay several million," says Steves.
Responding to interest among middle-market clients, some insurers offer a directors' and officers' product that addresses crisis communication. For coverage to pay out, AIG requires the CFO of the insured entity to make what it calls a "good-faith decision that a covered event may have an immediate and material effect on the company's stock price." Among the negative events it covers: recalls, hostile-takeover bids, loss of a major customer, and potential delisting.
Zurich Financial Services offers similar protection, quickly remitting up to $100,000 to "help control about-to-be-released bad news," according to Bruce Hayes, executive vice president, Management Solutions Group. The coverage lets a company work through one of four preselected media firms, a potential boon for small-company CFOs who may need outside expertise. Larger-scale coverage from AIG has failed to catch on, most likely because those companies consider in-house resources sufficient.
One day, however, spin control may not be the only response to reputational damage. If the insurance industry can put a value on brand, and a reasonable price on coverage, CFOs may have more substantive recourse when they confront bad news.
Roy Harris is senior editor at CFO.
What's in a Name?
As the case unfolded against Martha Stewart for her sale of ImClone shares, the stock price of her company, Martha Stewart Living Omnimedia Inc., eroded, often in lockstep with news events (see below).
June 2002: In its examination of ImClone trading, the House Energy and Commerce Committee says that it is looking into Martha Stewart's sale of almost 4,000 shares. ImClone founder Samuel D. Waksal is arrested. Stewart denies trading on "improper information."
October 2002: An assistant to Stewart's stockbroker pleads guilty and agrees to testify against Stewart. Stewart resigns from the NYSE board. Waksal pleads guilty. MSO reports 42% drop in third-quarter profits.
March 2003: MSO reports first-ever quarterly loss.
June 2003: Stewart and stockbroker Peter Bacanovic are indicted. One day later, Stewart takes out a full-page ad in USA Today proclaiming her innocence, and launches a Website devoted to same.
November 2003: Stewart defends herself to Barbara Walters on "20/20" and says her case does not compare with corporate fraud at Enron and WorldCom.
January 2004: Stewart trial begins; she pleads not guilty to all five charges.
February 2004: The most serious charge against Stewart is thrown out.
March 2004: Stewart found guilty of the remaining charges.
July 2004: Stewart sentenced to five months in jail, two years of probation, and a fine.
Source: Associated Press