Assessing the Risks of Insuring Reputation Risk

• Author: Andreas Kolb,Joan T. Schmit,Nadine Gatzert
• DOI: http://doi.org/10.1111/jori.12065
• Published date: 01 September 2016
• Date: 01 September 2016

ASSESSING THE RISKS OF INSURING REPUTATION RISK

Nadine Gatzert

Joan T. Schmit

Andreas Kolb

ABSTRACT

Reputation risk is becoming increasingly important, especially with the

rapidly growing influenceof social media, heightenedscrutiny on reputation

risk by banking and insurance regulators, and reputation’s impact on

organizational value. Insurers have responded to this development only

recently by offering new reputation risk insurancesolutions. The aim of this

article is to present the first detailedacademic analysis of these new insurance

policies, including examination of the risks insurers face in offering such

coverage. We also offer a conceptualizationof reputation risk in an insurance

and risk management context with focus on exposures, perils, and hazards.

Our analysis indicates that loss identification and measurement generate the

greatest challenges to insurersin providing reputation risk coverage. Lack of

experience as well as the complexity of the chain of reputation risk events

related to reputation insurance coverage present insurers with significant

challenges in making this a viable line of business.

INTRODUCTION

With notable recent events such as the $59 billion in firm value lost to BP shareholders

from the reputational effects of the 2010 Gulf Coast oil spill (see Aon Oxford Metrica

Reputation Review, 2011) and the direct recognition of reputation risk bybanking and

insurance regulators, new emphasis is being given to reputation-damaging events.

An organization’s reputation generally is taken to derive from fundamental

organizational activities and is subject to a wide array of potentially damaging

events. In this sense, reputation risk is at the crux of organizational value. Insurers are

Nadine Gatzert is at the Friedrich-Alexander-University of Erlangen-Nuremberg, Chair of

Insurance Economics and Risk Management, Lange Gasse 20, Nuremberg, Germany, 90403.

Gatzert can be contacted via e-mail: nadine.gatzert@fau.de. Joan T. Schmit is at the University

of Wisconsin-Madison, The Distinguished American Family Insurance Chair in Risk

Management and Insurance, 975 University Avenue, Madison, WI 53706. Schmit can be

contacted via e-mail: jschmit@bus.wisc.edu. Andreas Kolb is at the Friedrich-Alexander-

University of Erlangen-Nuremberg, Insurance Economics and Risk Management, Nuremberg,

Germany. Kolb can be contacted via e-mail: andreas.kolb@fau.de. The authors would like to

thank an anonymous referee and Harris Schlesinger for valuable comments and suggestions on

an earlier version of this paper.

© 2015 The Journal of Risk and Insurance. Vol. 83, No. 3, 641–679 (2016).

DOI: 10.1111/jori.12065

641

responding to the importance of managing organizational reputation through

introduction of reputation-specific insurance policies.

1

The introduction of this new

product deserves attention, both because of the essential nature of organizational

reputation to ultimate success, as well as the difficulties of defining and measuring

reputation, and any resulting loss due to a reputation-damaging event. That is,

insurance is both of great value and difficult to offer effectively. In this article,

therefore, we provide the first presentation and evaluation of the current insurance

solutions, their coverage and provisions, and an analysis of the challenges and risks to

insurers associated with selling reputation risk insurance. We also offer a

conceptualization of reputation risk in an insurance and risk management context

with focus on exposures, perils, and hazards.

The majority of the academic literature on reputation has focused on developing a

consistent understanding of the meaning and manifestation of reputation as the

“perceptions” held by external observers of an organization, including how an

organization creates a reputation, and the effects (both positive and negative) of an

organization’s reputation (see, e.g., Rindova, Williamson, and Petkova, 2010; Lange,

Lee, and Dai, 2011). We therefore begin with a discussion of the definition and

conceptualization of reputation in the “Components of Reputation Risk” section,

where we present components of reputation risk: exposures, perils, and hazards. We

also briefly discuss the importance of reputational risk mitigation. In the “Insurance

Against Reputation Risks” section we detail specifics of the few reputation risk

policies currently available, taking into account the underlying elements of reputation

risk. An analysis of the significant risks and major challenges to insurers in providing

reputation risk coverage is presented in the “Challenges and Risks of Insuring

Reputational Risks” section, including concerns over accumulation and spillover risk,

loss estimation and pricing, and moral hazard. Conclusions and thoughts on future

research comprise the final section of the article.

COMPONENTS OF REPUTATION RISK

As depicted in Figure 1, the components of reputation risk are naturally comproed of

exposures, perils, and hazards. The intent of reputation risk management is to (1)

identify these components, (2) assess them in terms of likelihood and severity, and (3)

identify and implement the most effective risk management means to achieve

organizational objectives through risk control and risk financing techniques. To

begin, then, we must identify and understand the underlying exposures, perils, and

hazards.

2

In general, reputation risk exposures derive from underlying organizational

characteristics and representations. Perils are wide-ranging, often connected with

1

Note that in contrast to existing product recall coverage, the new reputation risk policies tend

to have far broader coverage triggers instead of protection solely against loss associated with

product recall.

2

Regan (2008) offers a valuable discussion of reputation risk management without

consideration of the insurance coverages, which we focus on in this article (see also the

section on reputation risk mitigation).

642 THE JOURNAL OF RISK AND INSURANCE

other loss exposures as well. Hazards tend to generate from organizational culture,

values, and governance. We discuss each below in far greater detail to understand the

relevance of insurance to manage this particular source of risk.

Underlying Reputation Exposure

Reputation Conceptualization. A large body of literature exists regarding reputation,

primarily in the management and marketing fields, with recent growing interest in

the financial domain as well, especially as an outgrowth of analysis of operational risk

events (see Perry and de Fontnouvelle, 2005; Cummins, Lewis, and Wei, 2006; Micocci

et al., 2009; Gillet, Hu

¨bner, and Plunus, 2010; Fiordelisi, Soana, and Schwizer, 2013,

2014; Sturm, 2013). Much of the existing literature on reputation can be categorized

as a debate about reputation’s meaning and measurement (see Rindova et al., 2005;

Clardy, 2012). In the following, we summarize key elements of the existing

knowledge, focusing especially on aspects affecting risk management and the

provision of insurance.

Charles Fombrun is at the center of most of the current literature on reputation. His

1996 book is referenced by nearly every researcher in the field, and his founding of the

journal Corporate Reputation Review (CRR) provides an outlet for significant amounts

of research. In the inaugural edition of the CRR, Fombrun and van Riel (1997) offer six

distinct interpretations of reputation from the perspective of six distinct academic

disciplines, which are shown in Table 1.

Although differences cont inue to exist in defining “reputation,” agreement on

some elements also has formed. In particular, general agreement exists that

reputation refers to social co gnitions, such as knowledge, impressions, perceptions,

or beliefs (see Rindova, William son, and Petkova, 2010) and that they reside in

the minds of external obser vers or stakeholders (see Rindova, Williamson, and

Petkova, 2010; Clardy, 2012). Th e distinction of “external o bservers” is relevant to

distinguish reputation fr om identity. Identity typ ically is considered to be t he

impressions held by internal stakeholders, primarily t he workforce (see Davies

et al., 2001).

FIGURE 1

Elements of Reputation Risk

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