The Trickle-Down Effect of Reputational Risk: What Will Become of VW’s Suppliers?

Damage Control

Jetta enthusiasts, hippies, Audi lovers—people who swore by the ethical standards of the Volkswagen Corporation are reeling. The world was stunned after news broke that the German automaker used software (dubbed “defeat devices”) in 11 million of its vehicles in an effort to cheat on U.S. emissions testing. The software controls vehicles’ diesel engines, so they run with maximum anti-pollution controls when emissions tests are in progress.

As angry and embarrassed as Volkswagen’s consumers might be from the discovery, the residual effects of reputational risk is likely to be felt by workers at every level in the organization. Within the confines of its main operations, the leadership team is on the front lines, taking the brunt of the financial burden and making tough decisions about how to conduct damage control. For example, Martin Winterkorn, chief executive of Volkswagen, stepped down as an initial step in taking responsibility for the corporation’s actions.

Reputational Risk - Captive Insurance Tailored Risk CoverageBut the people who do the work—the people who support these operations both internally and externally, might also feel the effects of a tarnished corporate reputation. Manufacturers and distributors of car parts, steel, nuts, bolts, gears, and wipers—what will become of these companies and the people who’ve helped position Volkswagen as a leader in automobile craftsmanship? What can owners of closely-held businesses learn about mitigating risks when they are positioned as a support entity to a larger corporation?


Mitigating and Funding Reputational Risks

Under the U.S. Clean Air Act, Volkswagen could face as much as $18 billion in fines for using the cheat software. On the surface, the fines are a blip in the road; a minor setback as the German company actually surpassed Toyota to become the world's largest automaker in July 2015. Additionally, new models of their flagship automobiles were revealed at the International Trade Fair for Mobility (IAA) in Frankfurt. But all this good press isn’t drowning out the discussion of a larger problem about Volkswagen’s future, namely, the fate of its diesel engines. Experts are focusing on parts of the exhaust system that which are designed to reduce emissions of nitrogen oxide, a pollutant that can cause emphysema, bronchitis, and other respiratory diseases (Source: NY Times: How Volkswagen Got Away with Diesel Deception). The uncertainty surrounding Volkswagen’s next move is likely to result in slumped sales and long-term effects from negative public opinion of what the company stands for. Restoring confidence in its consumer base will take time and a concerted effort by its global entities. In the meantime, the fallout will undoubtedly hurt third-party suppliers and partners if their contracts aren’t renewed. Volkswagen employs 274,000 people at 29 German factories, and it is already struggling with high labor costs (Source: NY Times: German Pride Takes Blow Amid VW Emissions Scandal).

Captive Insurance Risk Coverage - Reputational RisksMitigating reputational risks requires a solid risk management plan, regardless of business size. By taking an assessment of all risks, making decisions about transferring or retaining them, and establishing procedures for funding losses, closely-held companies have a substantial advantage in remaining operational and solvent in the event of a loss. Without the security of investors, private businesses must make a serious effort to combat the trickle-down effects of reputational risks had by the larger corporations they support. For example, concrete producers working with commercial construction partners might need to assess market fluctuations in their region, as the need for concrete might slump during winter months or when the economy slows. Middle market oil producers and rig operators might feel the effects of a decrease in oil prices.

Opting for commercial coverages might address more immediate risks, but what about indirect risks that have very real and tangible financial repercussions to a business?

Accounting for potential risks, including business interruption, market changes, loss of a major customer or a loss of a key employee could be covered comprehensively by forming your own captive insurance company. Tailored coverages, not seen in conventional markets, can fund losses and essentially protect your business from the serious financial blows of slowed or halted operations. Some other coverages may include:

  • Directors and officers liability – Coverage for loss exposures related to alleged executive liability and indemnification of risks arising from wrongful acts, which may include breach of duty, neglect, error, misstatements, misleading statements, omissions, or other action wrongfully taken or attempted
  • Employment practices liability – Coverage for a broad set of employment-related risk exposures including employment discrimination, sexual harassment, wrongful termination, breach of employment contracts, wrongful discipline, and more
  • Special risk: Commercial crime gap – Expands the insured’s commercial crime coverage by buying back certain coverages that are excluded from or limited by the insured’s currently underlying insurance policies

From Jared Fogle and the Subway Corporation to Dr. Palmer, the disgraced dentist who came under fire for his hunting exploits, there has been a host of highly publicized accounts of unethical missteps in the way of reputational risk. And of course, consumers around the globe are trying to make sense of Volkswagen’s dishonesty with the EPA and the California Air Resources Board. If there is anything to be learned, it is that risk can come in many forms and can have unforeseen consequences, especially those that trickle down from parent companies, partners, affiliates, and any other companies that work together to build strong brands. Combatting these effects requires a solid support system; a team of experts that can help navigate the specific perils of your business or industry. Realizing this need is the first step toward mitigating them.

Captives are a proven planning strategy that more mid-market business owners are adopting. To learn more about captives and their benefits, please contact Capstone Associated at WEB_TEL.