Critical audit matters coming into focus

By Russ Banham

Journal of Accountancy

As auditors prepare for a new auditing standard requiring the disclosure of critical audit matters (CAMs) in their reports, they are traveling in uncharted territory and contemplating new information that they will be providing to investors.

The new auditing standard AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, adopted by the PCAOB in 2017, is predicated on enhancing the relevance and usefulness of the auditor’s report. The first phase of implementation affects PCAOB audits of companies with fiscal years ending on or after Dec. 15, 2017, and includes disclosing auditor tenure and other changes to the form and content of the auditor’s report.

The second phase of implementation requires CAMs to be disclosed in the auditor’s report beginning with fiscal years ending on or after June 30, 2019, for audits of large accelerated filers, and for all other applicable companies for fiscal years ending on or after Dec. 15, 2020. The phased implementation date gives audit firms time to develop processes around determining which items they will disclose as CAMs, which are matters that:

  • Have been communicated to the audit committee;
  • Are related to accounts or disclosures that are material to the financial statements; and
  • Involved especially challenging, subjective, or complex auditor judgment.

At present, audit firms are developing processes to ensure all their engagement partners have a consistent method to identify CAMs.

“As with all changes in our audit methodology, we will distribute implementation guidance and tools for engagement teams to implement the new standard,” said Dave Sullivan, CPA, national managing partner for quality and professional practice at Deloitte & Touche LLP. “We also plan to design and implement controls to monitor the adoption of the CAM disclosures and assure that engagement teams have considered all the requirements of the new standard while applying it to their unique client situation.”


The standard is intended to provide investors with more comprehensive information for investment decisions and is an opportunity for auditors to provide more information of value during the audit. AS 3101 requires auditors to identify a CAM, describe the principal considerations that led to its selection as such, describe how the CAM was addressed in the audit, and refer to the relevant financial statement accounts or disclosures in making these determinations. While CAMs may be matters that were traditionally discussed with audit committees, they were not discussed in an auditor’s report.

Sullivan provided an example of a CAM that might not have been disclosed in past auditor reports. “Let’s say a company with a lot of goodwill on its books is struggling,” he said. “It’s going through the process of predicting future earnings to determine whether or not the goodwill will be impaired. The projections may involve revenue and expense calculations 10 years into the future. This would fit the definition of a critical audit matter, as it is material to the financial statement and could be subjective, complex, and involve auditor judgment.”

The new standard creates several challenges for auditors, audit committees, and preparers of financial statements. First, the PCAOB did not provide an all-inclusive list of what might constitute a CAM. Rather, it is the auditor’s responsibility to make this determination.

“The new framework is broad enough that on one level you might think that ‘goodwill impairment’ is a difficult judgment that would always be a CAM, yet this is not the case,” Sullivan said. “A company could be so profitable that this is not a difficult, complex, or subjective judgment. But if the company the next year has a truly bad year, then goodwill impairment could be a CAM.”

Other possible CAMs include a company’s valuations of hard-to-value securities and investments in nonliquid assets, assuming in both cases that they are material to the balance sheet, Sullivan said. “While the firm anticipates some effort in reporting the CAMs the first year of compliance, we’re very supportive of the new audit model and the goal of giving investors additional information to assist their valuations,” he added. “By separating out such issues for specific attention by investors, they’re better aware that this was a significant estimate by management and one of the most challenging areas in the audit for the auditor.”

A second challenge is how many CAMs an auditor must detail in the report. “Auditors will first look to the definition of a CAM in the auditing standard,” said Cindy Fornelli, executive director of the Center for Audit Quality (CAQ), which is affiliated with the AICPA. “A CAM is any matter arising from the audit of the financial statements that is communicated or required to be communicated to the audit committee, that relates to accounts or disclosures material to the financial statements, and that involved especially challenging, subjective, or complex auditor judgment. There is no set number for CAMs for the auditor to communicate.”

Boilerplate language is another area that will represent a challenge for auditors related to this standard. SEC Chairman Jay Clayton issued a warning of sorts when the new standard was issued. He said he would be disappointed if CAMs result in boilerplate communications that snuff out the potential for the new standard to deliver meaningful information toinvestors.

Fornelli shared that auditors may identify the same CAM from one year to the next. “Investors are looking for comparability. So as long as a CAM provides meaningful and accurate information about the audit, it may be OK to use similar language year after year,” she said.

Fornelli also said that investors must appreciate that the new PCAOB standard does not provide the same heightened degree of transparency called for in the United Kingdom’s auditor reporting standard issued in 2013 by the Financial Reporting Council (FRC). The FRC standard requires auditors to describe the most significant risks of material misstatement, disclose the levels of overall and performance materiality, and explain the scope of the audit.

“They’re different standards with different levels of transparency,” Fornelli said. “The other caveat I have for investors is that they should not expect the CAMs to be a proxy for the conversations they must still have with management, the audit committee, and the auditors. This is not the purpose of the standard. Nevertheless, investors will get insights into what the auditor has found to be challenging or complex, which is a big step forward.”


Given these various challenges, the good news is that the phased effective dates give auditors, audit committees, and preparers time to get ready. While other mandatory features of the new auditing standard, such as disclosure of an auditor’s tenure, were phased in on Dec. 15, 2017, the communication of critical audit matters for large accelerated filers is not required until audits of fiscal years ending on or after June 30, 2019, and for all other companies for audits of fiscal years ending on or after Dec. 15, 2020. “That’s a pretty good lead time,” Sullivan said.

In the meantime, Sullivan said engagement teams are endeavoring to consider all the matters that may be CAMs, to determine which ones will be disclosed as such in the auditor’s report. The firm’s internal implementation guidance and model workpapers are guiding engagement teams through the process of considering relevant items and documenting their conclusions as to whether or not each matter is, in fact, a CAM. “We’ll monitor the application of this guidance and tools as we prepare to implement this portion of the new standard,” he added.

The firm also expects to engage in frequent dialogues with the audit committee about what might constitute a CAM disclosure. “We will then take a dry run, going through the process of identifying the matters that could be CAMs and how they might look in a report,” Sullivan said. “Once that is done, we would bring everyone together to look at the draft and react to the disclosures.”

Sullivan recommended launching this audit planning process early in the fiscal year to discern the challenging, complex, and subjective areas of the audit and discuss them with the relevant parties. “As the year progresses, if circumstances change or something big happens like an acquisition, certain CAMs may drop off the list, but others will remain so there are no surprises two days before the filing,” he said.

Lastly, Sullivan advised that auditors exercise restraint in not trying to do too much, too soon. “You need to present important information, not duplicative information,” he said. “If there is a very good description of the [entity’s] critical estimates in the footnotes, in which the matter’s complexities and subjective judgment is detailed, I don’t think auditors need to repeat the same words [that are] in the body of the 10-K. They’re already voluminous and can be repetitive.”

About the author

Russ Banham is a Pulitzer-nominated business journalist and author who writes frequently about finance and accounting issues.

Beyond Digitization: The Road To Fully Digitalized Manufacturing

By Russ Banham


Digitization, digitalization and digital transformation: It’s easy to confuse them, but in fact, they’re very different, each describing a specific facet of a journey toward the development of new revenue-producing business concepts.

Phase one, digitization, is simply the process of transforming operating manuals, handbooks, documents, photographs and other informational resources into a digital format. That process represents a big leap forward in terms of efficiency, making it possible for computers to search, access, store, exchange and integrate all that data.

Most manufacturers have embraced digitization. But too many companies pause at this juncture, wondering which way next to turn next.

Digitalization—phase two—is about processes. It involves using digitized information to optimize production workflows, making them simpler, as well as more efficient and cost effective.

For example, in the manufacturing space, the use of “smart” factory equipment equipped with internet-connected sensors and semiconductors has the potential to change how businesses create their products. Smart machines can do what workers do—and they can do it more efficiently and more accurately, and for a lot less money. In effect, automating these processes—and training people up on how to work with technology—both frees up resources for businesses and makes room for employees to work in tandem with automated processes to produce even better results.

Intelligent systems can also be configured to make a company’s sales and aftermarket processes more efficient, such as by offering insights into asset utilization and maintenance needs, or integrating with other enterprise systems over the internet to more tightly coordinate manufacturing.

In addition, manufacturers can build digital bridges to supply chain partners, consumers, banks and other financial partners, government agencies and other third parties. Supply chains, for example, can be integrated with smart machines to reduce inventory and improve just-in-time manufacturing metrics.

When powerful computing technologies, such as big data analytics, AI and machine learning, are incorporated into this digital nexus, other benefits emerge. These include more transparent communications, more robust collaborations and better-streamlined transactions with partners, not to mention closer relationships with customers.

Once these phases are complete, digital transformation beckons on the horizon. True transformation blends the physical and cyber worlds by aligning manufacturing with internet-enabled data analytics and cognitive computing technologies such as artificial intelligence (AI) and machine learning.

 Leveraging advances with digital transformation

For manufacturers, going beyond digitization and digitalization toward a differentiated digital transformation offers opportunities to use data for expanding on new services and customizing current ones.

For instance, ideas for new services beyond routine repair and maintenance are now closer within reach for businesses, thanks to technologies that can predict when a product might need servicing or replacement well before it actually runs into trouble and breaks down.

The possibilities for product customization also show another example of the extrinsic value of digitization and digitalization. Based on customer data, a manufacturer can produce specialized products that address specific consumer needs and expectations. Whereas customization was inefficient in the past, given the need to stop production runs to gear up machines for different product batches, digitalization allows for a seamless switchover.

In one example of a product workflow, data linked to different customer demands can flow over the internet into a smart machine and might guide it to produce 10,000 traditional products followed by 10 specialized products in which the color or functionalities are different. With those specialized products, manufacturers can access previously underserved markets, increasing both customer satisfaction and revenues.

Yet another new income stream is data monetization—the transformation of manufacturing data into business intelligence that owners can sell to other entities via a subscription-based model. In this context, a manufacturer’s raw data becomes actionable information for other businesses. Using a data-as-a-service model, a truck tire manufacturer could embed sensors in its tires to capture interesting data relating to location, road conditions, speed, distance and other factors. That data might then interest buyers in government and industry.

Fast track ahead

With all three phases of digitalized manufacturing aligned, opportunities to drive growth abound. Manufacturers can seize additional market opportunities by digitalizing their products. A drywall manufacturer, for example, could embed internet-enabled sensors into its product to provide real time safety-related information on temperature and moisture conditions, thus creating a high-value product that it can sell at a premium.

Manufacturers can also price digitalized products variably, based on product usage data they obtain via internet-enabled sensors in a given item. This can lower prices for some consumers, widening both market share and profit margins. Additional revenue can also emerge from applying a manufacturer’s data-driven insights from the manufacture of one product to the manufacture of other products for both existing and new markets.

To realize these new business opportunities, it’s important for data and digital leaders in a digitally transformed organization to align with their sales and marketing teams. The latter can help the former figure out new ways to earn digital revenue. Together, they can explore the company’s range of digital assets through the lens of what they can offer in terms of new income opportunities.

The bottom line? Don’t get confused by the rhetoric when it comes to true digital transformation. Turning data into information is one thing. Turning it into dollars is where it counts.

Russ Banham is a Pulitzer-nominated financial journalist who writes about the intersection of business and technology.

Breaking Bad

By Russ Banham


Not every day does the CEO of a large public company contentedly smoke marijuana on a podcast (which was also recorded on video), shortly after tweeting he has secured funding to take the business private, blindsiding the board of directors. But this is Elon Musk after all, the Johnny Depp of CEOs.

Musk took Tesla’s institutional investors, shareholders, employees, and customers on quite a hair-raising ride in the second half of 2018. His abrupt tweet about having secured funding to take the company private culminated in a decision by the Securities and Exchange Commission to strip away his chairmanship, fine him and Tesla $20 million each, and mandate the appointment of an independent chairman and two independent board directors to oversee his communications.

The swashbuckling billionaire CEO isn’t the only person running a public company whose bizarre or inappropriate actions have been in the spotlight. Much worse than Musk’s cryptic tweets are accusations of sexual harassment against 273 business, media, and broadcasting executives, according to Temin and Company’s #MeToo Index. Among them are former CEOs Leslie Moonves (CBS) and Steve Wynn (Wynn Resorts).

In this age of 24/7 social media feeds, chief executives and other high-ranking corporate officers — the public faces of their companies —have never been more public. Careless comments, thoughtless actions, and criminal conduct go viral quicker than you can say “resignation,” damaging a company’s reputation and all the businesses and people that rely on the organization for their livelihoods.

“Today, a CEO of a large company gets out of bed and walks across the street and it’s public information,” says Stephen Kasnet, vice chair and lead director of the board at both Granite Point Mortgage Trust and Two Harbors Investment. “It’s so easy for others to know what they’re doing and thinking.”

Some CEOs curry the attention. Nothing wrong with that if their statements and deeds enhance their organization’s long-term financial performance and their social media quips don’t violate securities laws governing material misstatements. The ability to transform a CEO’s fame into corporate and product brand-building is a positive, but there is a downside if their fame is used carelessly or inappropriately. A CEO’s (or any other corporate officer’s) unguarded comments or conduct can unmoor the corporate ship and attract government investigators.

They can also affect how people within the organization treat their subordinates. “The CEO sets the tone and the culture of the organization; if they raise their voices, use profanity, or express certain beliefs, others in the company may infer these behaviors and beliefs are OK,” says Ron Shah, CFO of Hodges-Mace, a provider of employee benefits services.

All of those alarming possibilities are putting institutional investors on guard. “Executive misconduct is a really big focus this proxy season, especially in relation to the #MeToo movement and issues surrounding human capital management,” says Courteney Keatinge, director of environmental, social, and governance research at proxy advisory firm Glass Lewis & Co. “Corporate culture and governance are at the top of the list of investor concerns for boards to supervise.”

Big Mouths

Is executive misbehavior new? To be fair, today’s captains of industry are not much different from their peers of yesteryear. When they’re used to people hanging on their every utterance, some CEOs become imperious know-it-alls. Take Henry Ford, founder and president of Ford Motor. In the 1920s, Ford fumed about a “Jewish conspiracy” in a series of op-eds in his hometown newspaper, the Dearborn Independent. The series’ title said it all: “The International Jew: The World’s Problem.”

Bear in mind that Ford, a brilliant mechanic and businessman, dropped out of high school after ninth grade to work on the family farm. His geopolitical expertise was formative, at best. [Editor’s note: Russ Banham is the author of the book, “The Ford Century.”] Ford’s fulminations ended when Jews boycotted the company’s motorcars. With sales slumping, he retracted his anti-Semitic comments.

In the decades that followed, most CEOs kept their opinions to themselves. If they exhibited certain behaviors like using profanity or drinking to excess during their two-martini lunches, they had enough power over employees’ careers and means of support to keep them quiet. And what happened in the office tended to stay in the office. Apple co-founder and CEO Steve Jobs is remembered for his sharp outbursts nearly as much as his visionary ideas. But as Jobs’ biographer, Walter Isaacson, wrote, many years later, there was the “good Steve” and the “bad Steve.”

Even in the era of the personal computer’s invention, a video recorder wasn’t in the hands of every consumer to document boorish acts, and the Internet wasn’t around to disseminate sordid video clips instantly. No longer is this the case.

Travis Kalanick, the founder and former CEO of Uber, allegedly tolerated a workplace culture that included sexual harassment and discrimination. He also famously berated an Uber driver from the back seat of the driver’s car while the dashboard camera filmed the flareup. The ill-fated trip was the last straw for shareholders, who mounted a successful revolt to remove Kalanick as chief executive.

If YouTube and other video-sharing sites aren’t pushing transparency enough, anonymous employee feedback sites like Glassdoor and Indeed provide an anonymous forum for people to lift the veil on their bosses’ transgressions. A recent exposé published on LinkedIn, for instance, disclosed the conduct of the CEO of a Seattle-based government agency, who “looked women up and down” and pitched temper tantrums, on one occasion kicking an office chair across the room.

Cult of Celebrity

Many companies have made great strides in setting employee conduct policies, and at large multinationals these highly designed, magazine-like documents can run 30 to 40 pages, even guiding workers about what to do in sticky situations. (The Starbucks code of conduct tells baristas how to handle an inappropriate email from a co-worker.) Presumably, these codes of conduct apply to everyone from the CEO on down.

But in many organizations, the rules are elastic when it comes to the head honcho. The problem is that many boards hire CEOs who, by nature, are overconfident individuals. Smart CEOs say dumb things for a variety of reasons, chief among them raging overconfidence. When the weighty crown of celebrity is placed upon such big heads, it creates a compulsion to engage followers on social media with the brilliance of their beliefs on most every subject.

“Combine a smart guy with a huge ego and give them a bully pulpit, and at the end of the day their ego can destroy the organization,” says Kasnet. “The more power someone gets, the more it justifies their ‘genius.’”

Musk apparently was given leeway to do whatever he wanted by his handpicked board because of his wildly creative and obsessive ways. “Most CEOs filmed smoking pot in an interview would be gone the next day,” says Stephen Horowitz, CFO of CareCentrix, a national provider of post-acute home-care services.

But even smoking marijuana on a podcast seems to pale in comparison with the flood of sexual harassment accusations being levied at CEOs and other corporate executives. In those cases, directors can no longer look the other way.

“There cannot be a double standard just because it’s the CEO,” says Peter Cappelli, the George W. Taylor Professor of Management at The Wharton School. “Nobody should be let off the hook for something like sexual harassment. This is what organizational culture is all about. People are watching to see who gets punished and who gets rewarded.”

Others share his perspective. “Boards must have zero tolerance when it comes to issues like sexual harassment,” says Ken Stillwell, CFO of Pega, a provider of customer-engagement software. “I don’t care if the person is the world’s best CEO; you can’t barter away sexual harassment without compromising your integrity. Some things are non-negotiable.”

Boards that fail in this regard have only themselves to blame. “An organization’s reputational risk is a pressing governance challenge, yet few boards give it the attention it deserves,” says Chuck Saia, CEO of Deloitte risk and financial advisory and previously the firm’s chief risk, reputation, and crisis officer. “It’s not hard for the board to sit down with the CEO to document the organization’s shared beliefs. What’s harder is to ensure the CEO lives by them and is held accountable for them.”

Ego Management

To be fair, many CEOs are aware of the impact their words carry. “When I communicate, I always do my best to exercise caution,” says Therese Tucker, founder and CEO of publicly traded BlackLine, a provider of finance and accounting software. She takes this responsibility to heart. “Words are so powerful. How something is phrased can come across in ways that the speaker or writer did not intend.”

Indeed, many corporate officers lead their organizations with humility and empathy. According to psychological studies, humble CEOs are more self-aware of their strengths and limitations and are more open to others’ ideas. Research also indicates that empathetic CEOs more deeply appreciate employees’ need to engage in meaningful work and value their contributions more fully.

So, is there a way to balance the visionary genius of a Jobs, Kalanick, or Elon Musk with their eccentricities? Certainly, directors should not stifle a CEO’s creative impulses, despite their seeming eccentricity. But there are ways to keep these rogue entrepreneurs in check. Sensitivity training — making people more aware of behaviors that may inadvertently cause offense to others — is a good start. At the very least, it might guide CEOs to curate what they say before they say it.

Some CEO behaviors and comments can be partly chalked up to youthful immaturity — the case with such wunderkinds as Bill Gates, Jobs, Marc Zuckerberg, and Musk, all of them business founders and CEOs in their 20s. A young business leader with a big ego is bound to push the limits of respectability. “Some CEOs gain credibility by being the ‘wild one,’ which fits the brand of the company they’re leading,” says Tucker. “That’s OK, as long as the company has a set of values everyone [including the CEO] ascribes to — values like treating all people fairly and giving them the opportunity to bring their authentic selves to work.”

Bosses who fail to follow these behavioral standards may be outed, whatever their age. But Saia says companies can also build their own anonymous feedback sites to ferret out indications of a problem before it blows up into a scandal. He also advises the use of real-time technology tools that take the pulse of a company’s reputation.

“Using machine learning, data analytics, and image-recognition software, you can ferret out and monitor what people are saying about your products, services, and workplace culture to nip things in the bud,” he says.

Unseasoned CEOs can be provided a mentor drawn from the board, such as the lead director or board chair. History suggests there is merit in this concept. Apple’s board forced 30-year-old Jobs to resign in 1985 for being overly demanding and difficult to work with. Eleven years later, the board chair, Edgar Woolard, brought him back to lead the foundering company. “Most important was that Woolard served a vital role as Jobs’ sounding board, confidante, and critic, helping to keep him in line and put Apple back on track,” says Sheila Hooda, CEO of Alpha Advisory Partners and a member of two boards (Virtus Investment Partners and Mutual of Omaha).

The Right Thing

Certainly, the risk of CEO misconduct cannot be tabled by the board when bad behavior goes public. If a board becomes privy to a CEO’s misconduct and simply hopes it will fade away, it won’t. Employees in the know will report the situation on social media or leak it to traditional media. “It comes down to the board,” Kasnet says. He once served on a board of directors whose CEO’s judgment was overridden by his “ego-driven self-aggrandizement,” he says. “When we realized this, we made a change. Was it tough to do? Sure, but it was the right thing to do.”

Says Hooda: “The board has a fiduciary responsibility for the organization’s culture, reputation and long-term financial performance — all of which rest upon the CEO’s ethics and integrity as the culture champion of the organization. No CEO is irreplaceable.” To underline this fact, she suggests an organization should always have a succession plan in place for the person’s immediate replacement if need dictates.

Another way to tame a CEO’s animal brain is money. “For years, boards were concerned that clawback policies, by not having clearly defined terms, would lead to litigation and other legal implications,” Keatinge says. “That’s changing, with more progressive companies retaining outside counsel to create clawback provisions that won’t cause legal troubles down the line.”

Depending on the violation, the CEO could retain a role in the organization in return for forfeiting part or all of his or her incentive-based compensation. In cases of serious offenses, the executive could be pink-slipped along with the monetary forfeiture.

“If the CEO is going the wrong way, then put a leash on the CEO—sooner than later,” says Kasnet. “Too often the board waits until the eleventh hour, and by then it’s too late.”

Stillwell agrees. “There is no return on investment worth CEO misconduct,” he says. “Not just shareholders suffer the bad behavior—an extended ecosystem of employees, customers, business partners, suppliers, vendors, and communities also suffers.”

Boards of directors also have to be careful of the context in which they let executives go. Sexual harassment allegations by six women against Moonves led to his resignation in September. CBS is now on the hot seat for the former CEO’s severance package — a whopping $184 million exit payout, unless it is determined he was “fired for cause.” Two independent investigations are underway to figure out whether the allegations legally provide the means to give Moonves nothing.

Were he to receive the full amount, it could cause a public backlash against CBS. “Amply rewarding a guy who has been fired for the sexual harassment and intimidation of women will not sit well with many people,” says Keatinge from Glass Lewis. “What kind of message does that send to employees in the organization? How can they feel respected, appreciated, and safe in knowing their allegations matter?”

Likewise, Sergey Brin, president of Google’s parent company Alphabet, reportedly gave a “hero’s farewell” and a $90 million severance package to Andy Rubin, creator of the company’s Android operating system, upon the latter’s resignation in 2014. What was not revealed at the time was why Rubin resigned — he’d been accused of coercing another employee into a sexual act. According to The New York Times, Rubin is one of three former Google executives accused of sexual misconduct who received substantial exit packages, all shielded by the company.

Who in an organization can prevent such blatant errors in judgment? While boards of directors play a critical role in taming CEOs’ behavior, there may be a role for the CFO as well.

“My fiduciary responsibility as the CFO of a public company is to protect shareholders,” says Stillwell. “In certain states, this responsibility extends to other stakeholders like vendors and suppliers. That’s my job, but I’m also a human being. I would never abide behavior I consider intolerable. Would I bring evidence of a CEO’s sexual harassment of an employee to the board? In a heartbeat.”

But Stillwell hopes that day will never come. “Great business leaders understand that the company is much more than themselves,” he says. “They know there are many livelihoods depending on them to do the right thing.”

Out of Office

Workers’ off-duty acts may be protected by state laws.

In this hyperpolitical, tense social climate, it’s not just CEOs whose actions are under a microscope. Many workers, professional and otherwise, have been caught on a smartphone camera outisde of work behaving, shall we say, shamefully. Others have been dismissed after posting inexcusable offensive comments on social media. In the world of at-will employment, companies often don’t hesitate to let workers go. But in some states, there are specific off-duty behaviors for which you can’t fire someone. The following are some examples.

Arizona — Employers may not threaten or intimidate employees in ways that would influence political opinions, views, or actions; enclose written or printed political propaganda in pay envelopes; or post political notices or threats should a particular candidate be elected.

Connecticut — Employers may not subject an employee to discipline or termination based on his or her exercise of First Amendment rights. However, an employer may discipline an employee if the exercise of those rights interferes with job performance or the working relationship between the employee and employer.

Colorado — Political activities and some off-duty behaviors protected. Employees can’t be prevented from participating in politics, running for public office, or being elected to public office. Nor can they be terminated for engaging in lawful activities during nonworking hours, unless the behavior is “rationally related to a particular employee’s responsibilities or is necessary to avoid a conflict of interest.”

Massachusetts — Employers may not threaten or attempt to influence an employee to vote or to withhold a vote. They also may not threaten or attempt to influence an employee to give or withhold a political contribution.

New Jersey — Employers may not terminate an employee or take any adverse action against any employee based on smoking or use of other tobacco products. May do so “if the employer has a rational basis for action that is reasonably related to employment, including the current or prospective employee’s responsibilities.”

New York — Protects political activities, recreational activities, union activities, and legal use of consumable products outside of working hours and off of the employer’s premises. Off-duty activities can be restricted if they create a material conflict of interest related to the business.

Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.

5 Roles AI Will Play In The Corporate Governance Of Tomorrow

By Russ Banham

Corporate governance is in the crosshairs, with institutional investors broadcasting their concerns over the financial impact on companies of such social issues as the #MeToo movement, climate change, diversity and inclusion, and board gender composition.

Businesses with all-male boards, for instance, are now perceived as sending a message of gender inequity, while those whose CEOs or board members deny the existence of climate change are increasingly viewed as misinformed. Among other things, these assessments can affect a company’s stock performance.

Cognizant of this possibility, institutional investors are sounding alarms. A June 2018 survey of 223 institutional investors by consulting firm Aon indicates that 68% have concerns over board gender diversity in their proxy voting. And a 2018 survey of 60 institutional investors by audit firm EY states that nearly 8 in 10 (79%) consider climate change to be a significant risk, with 48% commenting that enhanced reporting of climate risks is a high priority.

“People have the ability to exchange their opinions and ideas more freely and easily in this era of constant information availability and accessibility,” said Sapna Nagaraj, director of machine learning and data science at BlackLine, a publicly traded provider of financial and accounting software automation solutions. “This is leading society as a whole to become more socially aware and conscious of such issues as human rights, gender equality and climate change, insofar as how businesses view these subjects.”

What You Say Impacts What You Do

Nagaraj makes an excellent point. Most people have a social conscience and many feel some degree of pressure to express their opinions in their social media accounts—and that includes high-profile people such as business leaders and board members. When their followers and others become privy to these individuals’ opinions on different social issues, that knowledge can positively or negatively affect public perception of the company’s brand and products.

“Companies are being judged not just by their business profitability, but by their operating principles,” Nagaraj noted. “Brands will be labeled as being socially conscious or not, creating long-lasting implications for the organization’s profitability, recruitment and retention of skill sets, and survival.”

Some businesses may undeservedly incur these challenges, given the propagation of fake news. Others may be unaware of how the organization is being examined and rebranded, learning about it after the fact on LinkedIn or on anonymous employee-feedback sites such as Glassdoor and Indeed.

“Whereas companies previously controlled the projection of their social branding, this is now being driven externally,” Nagaraj explained. “Consequently, it is incumbent upon businesses to be aware of this unfolding narrative in its earliest iterations to regain control of their story.”

Recapturing The Narrative

AI can help speed up the capture and analysis of truly useful information, turning this data into knowledge that can be used to track and assess impact on corporate profitability. Here are five ways in which the use of AI and other technologies can help businesses in the quest to drive their own stories.

1. Know thyself.

Just as a researcher can discern the gender diversity of a workforce, or an environmental group can discover if a company creates environmental hazards or sells products with potentially harmful components, an organization can find ways to monitor its own performance in key areas.

“There are software applications that can analyze the safety of the ingredients in your products and access public information on the organization’s environmental footprint, such as the volume of fossil fuel it burns or trees it cuts down,” Nagaraj said.

2. Turn the tables.

While companies such as Glassdoor and Indeed provide an external forum for disgruntled or unfulfilled employees to express their dismay, companies can create internal space for employees to be heard. The HR department can pull together an AI or analytics team to survey employees about their levels of engagement and create algorithms to make sense of this information, nipping burgeoning workforce problems in the bud.

3. Get a better look.

Many companies are unaware of how their products, services and brands are being represented in social media. Now, thanks to a combination of object-image recognition software and deep learning technology, they can determine if their products are being viewed on social media, how many times and the related context.

Basically, an algorithm is created to find the image, calculate the number of people viewing it and discern these individuals’ impressions. Based on the findings, a business can take actions to reframe the context.

4. Get ahead of trends.

While the #MeToo movement ignited after allegations of sexual impropriety against Harvey Weinstein, inferences of where things were headed could have been gleaned well in advance. Certainly, Hollywood’s “casting couch” was not a new phenomenon, and accusations of sexual harassment in the technology industry were front-page news for years.

“AI can track the rate of emerging sociocultural trends and compare them to specific business outcomes,” said Nagaraj. “An algorithm can find interesting correlations—good, bad and otherwise.”

5. Be the first on the block.

Down the line, Nagaraj predicts, an organization along the lines of the Better Business Bureau will be developed to assess and rate a company’s social consciousness. This barometer will entail a simple score that defines a company’s position on different social issues, such as board composition, diversity and inclusion, and climate change.

“It’s only a matter of time before consumers, institutional investors and the stock market factor in a company’s social conscience when buying products or shares in a publicly traded company,” she said. “By creating a specialized AI and analytics team, businesses can create their own social consciousness rating, seizing the narrative before others tell it their way.”

All in all, there is ample evidence to indicate that more companies than ever before are being held accountable for their actions and workforce composition, as well as leaders’ social media statements. Deploying AI to optimize these factors will be integral to future corporate advances: In this age of flourishing social consciousness, corporate governance is no longer just about business.

Russ Banham is a Pulitzer-nominated financial journalist and author who writes frequently about the intersection of business and technology.

Hiring America’s Heroes: What Four Companies Are Doing To Hire Veterans

By Russ Banham

Chief Executive

Earlier this year, Chief Executive, in partnership with the Thayer Leader Development Group (TLDG) at West Point, launched our inaugural Patriots in Business Awards to honor the Best Companies with Veteran & Military Initiatives. The award recognizes outstanding businesses that lead our nation in supporting active duty military members, veterans and their families and exemplify the values of Duty, Honor and Country through their business practices and throughout their community and industry.

“Chief Executive and TLDG created this award to recognize the innovative and dedicated initiatives of companies big and small to support America’s veteran and military families,” says Marshall Cooper, CEO of Chief Executive Group. “In doing so, we hope to inspire more CEOs to improve or begin their own efforts.”

“The winners distinguished themselves by consistently improving their military support each year, and going beyond just focusing on hiring efforts,” notes Dan Rice, cofounder and president of TLDG. “Once a veteran or military spouse is hired, their support continued through mentoring, training, volunteerism, outreach, networking and more.”

Both organizations extend their thanks to the judges in this first Patriots in Business Awards: Nicholas Pinchuk, chairman and CEO of Snap-on Incorporated; Gen. Herbert J. “Hawk” Carlisle (ret.), president and CEO of National Defense Industrial Association; Michael Linnington, CEO of the Wounded Warrior Project; David Kim, founder and president of the Children of Fallen Patriots Foundation.

Large Enterprise: Comcast NBCUniversal

Led by retired U.S. Army Brigadier General Carol Eggert, Comcast NBCUniversal’s Military and Veteran Affairs team is a fully-staffed organization focused on recruiting, hiring and cultivating veteran and military spouse talent. The team pursues this mission via a holistic, end-to-end approach that ensures that its branding, community impact and partnership efforts on behalf of the military community are aligned across the business.

Key features of the company’s wide-ranging veteran programs include 15 days paid time off each year for active duty employees on deployment for military training, in addition to regular paid time off. The employees’ benefits continue without change, safeguarding their families’ financial protection.

Comcast supports a relocation assistance program for military spouses, guaranteeing them a job interview when transferring to a location within the company’s geographic footprint. Outside these areas, spouses are referred to recruiters from partner companies. A generous transition package also is provided. Comcast also supports the U.S. Chamber of Commerce’s “Hiring Our Heroes” corporate fellowship program, which provides service members the opportunity to gain corporate experiences before transitioning into the civilian sector. In 2015, the company committed to hiring 10,000 veterans, National Guard and Reserve members, and military spouses through the end of 2017. To get the word out about this ambitious hiring agenda, the company hosted an Employee Military Awareness Week each year, supported by a national communications effort. The hiring goal was met and exceeded. Since 2010, more than 15,000 members of the military community have joined its workforce. “We continue to hire and support this incredible community, as well as develop new partnerships to help us do so,” said Eggert.

Medium-Sized Business: Academy Securities

Founded by former U.S. Naval Officer and Naval Academy graduate Chance Mims, Academy Securities is the nation’s first and only post-9/11 disabled veteran-owned broker-dealer. More than half the ownership (58 percent) of Academy Services consists of military, combat and/or disabled veterans. Eighty percent of management ranks and 41 percent of employees also are veterans. All are encouraged to engage other veterans to apply for employment. The firm’s 2018 target for veterans as a percentage of total hires is 50 percent.

Academy Securities’ management team reviews all veteran employment applications. Many candidates are given training to take the FINRA Series 7 examination to become general securities representatives. After completing the program, they are eligible to become full-time hires. If job positions are unavailable, the firm assists applicants with interview preparation skills, internships and/or industry mentoring. It also encourages applicants to apply for jobs through its partner networks like the New York City Veterans Advisory Board, Veteran’s on Wall Street and the Veteran Mentor Network.

“We understand that the financial industry is first and foremost a service industry, but we also recognize the strength of military values and culture and continue to maintain them in our firm’s core values of teamwork, loyalty, and integrity,” says Mims, Academy Services’ CEO. “We want to be consistently recognized for our unwavering adherence to our core values and fellow veterans, as well as exceptional client service.”

America’s military veterans are some of the most skilled people on the planet, able to lead a project team through extraordinary challenges or deliver superior outcomes on mission-driven tasks. More than one million veterans will exit the U.S. Armed Forces over the next five years. This diverse talent pool has highly sought-after competencies, including discipline, flexibility, planning, technical, communications and problem-solving skills. And that’s the short list.

Yet, more than one million U.S. veterans remain unemployed, somehow slipping through the recruitment net. Research suggests companies struggle to access this talent pool, despite recognition of its potential. In a recent study by Chief Executive and the State of Indiana of nearly 300 U.S.-based CEOs, 57 percent reported that their company considered hiring veterans, yet only 17 percent had implemented a program to support those efforts.

The good news? A growing number of U.S. companies are creating initiatives to more closely align military training experiences with employment openings and business needs. And the efforts are paying off. “Veterans are disciplined and accountable; they take ownership of their work, are very proactive in finding solutions to varied challenges, and don’t make excuses,” says Larry Hughes, vice president of training and diversity at 7-Eleven and a former Army officer who commanded two company units as a field artillery officer during his five-year service. “They also have advanced technical training and strong cross-cultural experiences. And they’re team builders who know how to resolve conflicts, motivate people and get the best out of them.”

On the pages that follow, we share some practical tips from companies and CEOs making a difference in the lives of veterans—while also making the most of a great opportunity.

Getting Started

Kevin Ryan founded the Service Brewing Company, a small brewery with a taproom in Savanna, Georgia, in 2014. Of the company’s 24 investors, 20 are veterans; and the majority of its 13 employees are also veterans. One is currently deployed in the National Guard and another is a former military spouse. “We’re always looking for veterans to add to our team,” says Ryan, a 1996 West Point graduate who subsequently served as an Army infantry officer.

In recruiting, Ryan aligned with two local military bases (Ft. Stewart and Hunter AAF) and Georgia Tech’s Veteran Education Program. He also reaches out to student veterans at Georgia Southern, as well as at the Association of the U.S. Army, the Military Officers Association of America, the Mighty Eighth Air Force Museum and many other organizations. “Soldiers don’t often get to go to job fairs or have the ability to network successfully, so we need to get out in front of them,” he says.

Other companies employ a similar strategy. At 7-Eleven, field personnel nurture close relationships with military base transition office staff members. “We advise on-base soldiers on resumé building and job interview tactics, host entrepreneurial boot camps and invite exiting service members to attend our seminars on franchising opportunities,” says Hughes. “We’re also a regular presence at military hiring fairs.”

The company has hired more than 300 veterans and military spouses as field consultants in the past year, tripling the number of these hires since 2014. The position is a gateway to other jobs in the organization.

Companies interested in hiring military veterans and spouses can draw on a wealth of resources geared toward assisting veterans. Local Veteran Service Organizations, Student Veterans of America chapters at colleges and universities and web sites like Hero 2 Hired, Veterans Job Bank or are all great ways of proactively recruiting ex-military men and women. Companies can also seek out career fairs focused on veteran recruitment and programs like Google’s “Jobs for Veterans” initiative.

Once hired, veterans and military spouses are given the special treatment they need and deserve to make the best of their talents. La Quintawelcomes military hires with a special veteran or military spouse pin for them to wear on their uniforms or business attire. Through the hotel’s guest loyalty program, five million points were donated to several veteran-focused organizations like Operation Homefront and Armed Services YMCA. “Putting people first is embedded in our culture, and those who have a passion for people and service fall in line with these core values,” says Derek Blake, La Quinta vice president of marketing and military programs.

Starbucks provides veterans with a unique benefit—to gift their Starbucks College Achievement Plan to a child or spouse. The program funds tuition for an online bachelor’s degree at Arizona State University in 150 various degree programs. Starbucks also offers veteran-employees what are called Military Mondays, a program developed with the William and Mary Law School to provide free legal counseling to service members at its stores. “Military Mondays is now scaling nationally and growing to include other critical services such as financial literacy training and investment counseling,” says Christopher Miller, Starbucks veterans and military affairs manager.

 Citi, in partnership with Bring Them Homes, has been instrumental in providing transitional, supportive, temporary, and permanent housing for veterans and their families. “To date, the program has supported the creation of more than 3,500 affordable housing units,” says Ruth Christopherson, a Citi senior vice president and retired colonel, U.S. Air National Guard.

Matching Skills

7-Eleven, which joined other U.S. companies in a 2012 pledge to hire one million veterans by 2020, is well on its way toward achieving the goal. The company has hired more than 300 veterans and military spouses in the past four years alone. To align the resumes of veterans with needed business skill sets, the company has created a presentation called “Military 101” that translates military assignments into corresponding business tasks.

“It ensures our recruiting team has a firm understanding of how military experiences and skill sets translate into roles within our team, and enables our transitioning veterans to be set up for success,” says Dave Strachan, chief of staff and a former Army officer. 7-Eleven CEO Joseph DePinto also is a former Army field artillery officer and West Point graduate.

Other companies tout the extraordinary range of abilities that soldiers attain over their own military careers. “People don’t think of veterans as having finance, operations, HR, IT or project management skills in a business context,” says retired U.S. Army Brigadier General Carol Eggert, a recipient of the Legion of Merit, a Bronze Star and a Purple Heart and head of Comcast NBCUniversal’s eight-person Military and Veteran Affairs organization (see sidebar). She says that misconception is fueled by a lack of understanding of the breadth and scope of leadership positions in the military.

Many companies are doing just that, creating an array of programs designed to match military community skill sets with business needs.For example, Citi, cofounder of the Veterans on Wall Street recruitment initiative and corporate sponsor of’s mobile app, launched Citi Salutes to centralize its 17 military veteran employee networks under the oversight of an executive steering committee. The firm also created a Veterans Recruiting Toolbox for recruiters.

Dow Chemical implemented a program where four or more years of military service meet the company’s minimum job requirements. The company also is running a pilot Military Engagement Program, in which a current employee-veteran coaches service members and military spouses through its hiring process.

Many companies, including 7-Eleven, Starbucks and Comcast, are corporate partners in the Hiring Our Heroes fellowship program. The 12-week operations management internship is designed to provide the skills needed to succeed in the civilian workforce. “We make an offer of employment to fellows who complete the program,” says Strachan, citing 7-Eleven’s recent hiring of a dozen graduates.

Smoothing Transitions

For many veterans, their first job in the private sector can be dislocating. The management structure is different, the vocabulary of business is arcane and the processes are atypical. Easing the transition of this talented group of employees improves the chances of retaining them. A 2016 survey by the U.S. Chamber of Commerce Foundation found that 44 percent of veterans left their first post-military job within a year.

Job vacancies at the Black Knight, a fast-growing company of 5,000 employees, are being filled with veterans at a 10 percent rate. For good reasons, too, since the company pledges full-wage continuation and medical and dental benefits to employees called up for active duty in the Reserves or National Guard. Returning employees are placed in the same position, or another position they might have attained had they remained continuously employed. “We’re ensuring their career paths remain productive and promising,” Circelli says. “You need to make hiring veterans a priority and then have the dedication to fulfill that commitment.”

At construction giant. Cushman and Wakefield, a military transition roadmap helops veterans acclimate to the corporate environment. Deloittesponsors the Career Opportunity Redefinition and Exploration Leadership Program, helping veterans and active duty service members identify their unique strengths to better direct their careers. Every Deloitte business has a partner, principal or managing director as a Champion for Military and Veterans. GE partnered with the U.S. Army Reserve Medical Command in a pioneering externship program providing eight months of biomed and imaging training to Army Reserve biomedical technicians.

Another Opportunity

According to research compiled by Blue Star Families (BSF), 43 percent of military spouses are unemployed, compared to 25.5 percent of civilian spouses. Eggert suggests employers shun this talent pool for outdated reasons. “Employers know they often need to relocate,” Eggert explains. “This makes no sense in an era where Millennials are job-hopping every three or four years.” Comcast not only proactively recruits military spouses, but also helps those forced to relocate find jobs elsewhere in the organization or with other employers through its partnerships with different veterans coalitions.

Booz Allen Hamilton welcomes military spouse employees with personal emails from other military spouses at the vice president level and has developed a specialized handbook for their use. And Starbucks is a member of the Defense Department’s Military Spouse Employment Partnership program, composed of more than 360 employers vetted and recognized by the Defense Department as portable career options.

Certainly, companies looking for skilled, hard-working and motivated employees would benefit from giving more thought and effort to hiring veterans and military spouses. “Every branch of service espouses specific core values like loyalty, dedication, respect and integrity,” says Eggert. “Military personnel live by these values, forging people with remarkable character, self-reliance, tenacity to get the job done and leadership.”

Service Brewing’s Kevin Ryan is certainly happy he’s hired so many vets. “One of the first things the military teaches you is to take orders—you’re given a task and you do it,” says Ryan. “Working in a brewery is a physically demanding job. You’re pulling and pushing and shoveling all day long, and then putting on your best face to pour a draft for a customer. I’ve never heard a single complaint.”

Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.

Industry 2050: How Clean Manufacturing Is A Win-Win Proposition

By Russ Banham


Now that more companies are realizing the financial and environmental benefits of investing in production methods and technologies that take the dirty work out of making stuff, clean manufacturing is no longer an oxymoron.

An industry that has long been an ecological disappointment is poised to become an exemplar of eco-friendly practices, creating products the negative environmental impacts of which have been significantly reduced. While this shift toward sustainable practices is great news for people and the planet, it’s also a boon for companies’ bottom lines – reducing expenses, maximizing profits and boosting reputations to generate more sales.

The overarching goal of clean manufacturing is to make things using economically sound processes that minimize negative environmental consequences while conserving energy and natural resources. In pursuit of this objective, an increasing number of manufacturers have implemented a wide range of initiatives that minimize waste, energy usage and harmful emissions; improve manufacturing efficiencies and output; embrace Internet-enabled automated technologies; and involve the use of less harmful and more economical composite materials.

This momentum contrasts sharply with practices in the early 2000s, when pioneering companies embracing green initiatives were few and far between. According to the Environmental Protection Agency, what once was a “small niche” now includes many major manufacturers that are “building long-term business viability and success” from their clean manufacturing programs.

Clean And Smart Manufacturing

While the positive experiences of these larger companies demonstrate that environmental improvements and profit-making go hand-in-hand, most midsize and smaller manufacturers across the world have yet to seize upon such opportunities.

“They may be struggling with their short-term survival, or cost pressure from clients, or lack of knowledge and resources to invest in environmental improvement,” stated Andrew Wyckoff, director of the Science, Technology and Industry Directorate at the Organization for Economic Cooperation and Development (OECD).

Overcoming such struggles may well be worth it. A dollar invested two decades ago in a select portfolio of public companies focused exclusively on growing their businesses would be worth about $14 today, according to a study by the Harvard Business School. But if that dollar had instead been invested in a portfolio of companies that focused on important environmental and social issues – along with growing their businesses – it would now be worth more than $28.

What explains such outsized gains? The latter companies focused on sustainable measures that trimmed manufacturing costs and improved equipment efficiency, which benefited both the environment and the bottom line. In other words, by doing good, these businesses also did well.

Such measures can be attributed in part to so-called smart manufacturing. Machines that are embedded with Internet-enabled semiconductors and sensors can report on looming maintenance needs. And by integrating lessons that the sensor-outputted data from equipment on the factory floor have to teach, products can be manufactured to customer demand, thereby limiting energy usage, production excess and inventory warehousing costs.

Leaner methods of production are also being attained through the increasing use of robotics, 3D printing of parts and engineered composite materials that present the means to make stronger, more durable, lighter-weight products with unique properties such as thermal and electrical conductivity. Composite materials have at least two constituent parts, being typically blends of different types of resins, polymers, ceramics and natural fibers. The end result is a product that uses less metal, reducing the environmental degradation caused by mining.

Burnishing The Brand 

These various activities also have significant reputational value. A report by McKinsey & Company notes that environmental sustainability is now a strategic and integral part of many businesses, given its positive effect on corporate reputation. A Nielsen study of 30,000 consumers across the world indicates that 73 percent of Millennials are willing to pay extra for sustainable goods.

“Consumer brands that haven’t embraced sustainability are at risk on many fronts,” warned Carol Gstalder, Nielsen’s senior vice president of reputation and public relations solutions. “Social responsibility is a critical part of proactive reputation management. And companies with strong reputations outperform others when it comes to attracting top talent, investors, community partners and, importantly, consumers.”

Added up, the economic and eco-friendly benefits of sustainable manufacturing are compelling. By engaging in sustainable manufacturing, companies may also be eligible to receive government tax credits, grants and other incentives at the federal and state level. The reason for this largesse is the economic payback: The National Association of Manufacturers found that for every dollar spent in manufacturing, another $1.89 accrues to U.S. gross domestic product (GDP).

Unfortunately, approximately 31 percent of companies are unaware that such government incentives even exist.

The Next Industrial Revolution

Certainly, many midsize and smaller companies need to first understand that there is demonstrable business value in sustainable practices. The challenge, in Wyckoff’s view, is that these manufacturers “simply do not know where to start.”

To flatten this learning curve, the OECD has created a sustainable manufacturing toolkit for use by businesses of all sizes and types. The toolkit offers technical advice and best practices, in addition to measurement methods for calculating the return on an investment.

Sustainable improvements in manufacturing really have no downside. Consumers want products that are good for them and for the planet. In the decades to come, such products will be an increasingly possible, profitable reality. The great hope is that clean manufacturing will become a business-as-usual practice across industry – to the benefit of companies and the world at large.

Russ Banham is a Los Angeles-based financial journalist and author.

Dark Angel: The insurance industry as political tool for politicians

By Russ Banham

Leader’s Edge

First there was pressure from New York Gov. Andrew Cuomo and Maria Vullo, New York’s financial services superintendent, on the industry to dump the National Rifle Association as a client—even fining brokerage Lockton Affinity and insurer Chubb for selling and underwriting an NRA insurance policy.

Now, insurers are being asked to take sides on the climate change debate. It began with an epiphany, the realization that all fossil fuel companies shared a common feature—they bought property and casualty insurance. What if their insurers could be pressured to no longer underwrite the companies’ risk exposures or invest in their securities? The answer was obvious—the companies would flounder.

It was a brilliant concept, one that its originator—The Sunshine Project—has since set in motion. In July, the San Francisco Board of Supervisors became the first municipal body in the United States to call upon insurers to stop insuring and investing in the coal, oil and tar sands industries. The board also urged the city and county of San Francisco to screen insurers’ underwriting of and investments in these industries and to formally cut ties with those carriers that did not comply with its wishes.

“Cities have nothing to gain from collaborating with insurance companies that prioritize dirty energy companies over communities,” said Aaron Peskin, a San Francisco supervisor, in announcing the decision.

The decision was a major early victory for The Sunrise Project, the Australia-based organization that devised the idea of using the insurance industry as a battering ram to clear the world of harmful emissions produced by oil, coal and other fossil fuel businesses. “Pretty much any business in the world, if they don’t have insurance, they can’t operate,” says Ross Hammond, Sunrise Project’s senior campaign advisor in the United States.

For people fretting that humanity is at the brink of extinction from global warming, the modus operandi of The Sunshine Project is a stroke of pure genius, and it has arrived just in time. For insurance leaders, even those who support a transition away from fossil fuels, there is concern that using the industry as a blunt instrument to achieve political aims sets a potentially dangerous precedent. “It is not the role of insurance to steer politics,” says Jochen Körner, the executive managing director of specialist insurance brokerage Ecclesia Group, headquartered in Germany.

Nevertheless, Körner concedes he is conflicted on the subject. “On the one hand, I endorse the aims of the San Francisco resolution because we brokers and insurers can be enablers [of The Sunshine Project’s goals] by shutting down the support system for fossil fuel companies,” he says. “This can be a quicker way to ban coal and tar sands than through politics.”

On the other hand, Körner adds, “If insurers are the means to a political end, where does it stop? Who decides what is right and what is wrong?”

Körner is not alone. “The burning of fossil fuels is a concerning issue, but requiring property and liability insurers to abandon a multibillion-dollar business like the energy industry and to limit the diversification of their investment portfolios is bad public policy,” says Robert Hartwig, a professor of finance and co-director of the Risk and Uncertainty Management Center at the University of South Carolina.

In Hartwig’s view, if the Sunshine Project’s approach were taken to its extreme, the insurance industry could be compelled not to insure or invest in other industries deemed socially unacceptable. “There are people opposed to logging companies, pharmaceutical companies, tobacco companies, businesses that make pesticides and herbicides, airlines that produce high emissions, and cars that do the same,” Hartwig says. “Do we ban insurers from insuring or investing in these companies, too?”

Governing Issues

It’s possible, of course. According to the Environmental Protection Agency, the U.S. transportation sector produces more greenhouse gas emissions than the burning of fossil fuels for utilities. If insurers can be politically compelled to forsake the energy industry, automakers and airlines may be next.

Hammond has a different opinion. “Scaling a social movement that results in a healthier planet is a very good thing,” he said. “Insurance companies are investing in and insuring the very industries which are making climate change worse. If insurance companies want to protect us from catastrophic risk, they must break ties with the fossil fuel industry.”

In other words, insurers and reinsurers that continue to underwrite and invest in fossil fuel companies are directly contributing to a future in which they will experience more severe property catastrophe losses. Dump them, and losses will eventually moderate.

That might be a pretty enticing argument if the decision were left up to individual insurers. For years, organizations like the American Sustainable Business Council have advocated that companies voluntarily divest from fossil fuels and invest instead in low-carbon alternatives. The Business Council’s DirectInvest campaign asks companies to sign a pledge to this effect and lists the names of the top 200 oil, gas and coal companies.

But that decision belongs to the companies themselves. In San Francisco, government is calling the shots.

The Sunrise Project sees nothing wrong with this scenario. “Insurance companies are supposed to protect us from catastrophic risks,” the organization states. “Yet when it comes to the largest threat to humanity—climate change—many insurers are fueling a dangerous future through their investments in and underwriting of fossil fuels.”

In their corner is California’s insurance commissioner, Dave Jones, who wants insurers to voluntarily divest from thermal coal investments. Jones’s position is that these investments will experience a precipitous decline in value as the world shifts to renewable sources of energy. Jones has directed that the state insurance department maintain a searchable database of insurers that have invested in oil, gas and coal companies. This is all part of his Climate Risk Carbon Initiative, which was designed to provide the public with information on potential financial risks caused by climate change that California insurance companies face as a result of their exposure to investments in fossil fuel.

Not surprisingly, the initiative was met with virulent opposition in coal- and oil-producing states such as Oklahoma and Kentucky. In June 2017, nearly a dozen state attorneys general threatened to sue Jones for violating the Commerce Clause of the U.S. Constitution, arguing that by targeting energy companies, employment in their states will suffer. (One in four Oklahomans works in the energy industry.) “This initiative is misguided as a matter of policy, questionable as a matter of law, and inconsistent with the principle of comity among the United States,” the group maintains, promising legal action unless Jones relents.

Jones subsequently replied in a statement that he was “undeterred.” In May 2018, as the litigation threats from the 12 state attorneys general hovered above the department, Jones launched the nation’s first-ever stress test of climate-change risks on insurer investments in fossil fuels. Initial findings indicate that insurers in the state have more than $500 billion in fossil fuel related securities issued by power and energy companies, including $10.5 billion invested in thermal coal enterprises.

The California Insurance Department did not reply to requests for an interview with Jones. Leader’s Edge also reached out to the National Association of Insurance Commissioners, the organization representing state insurance departments, for its perspective on the subject. Spokesperson Erin Yang replied, “Unfortunately, it is not an insurance regulatory issue that the NAIC has taken up.”

Hartwig calls this position untenable. “Regulators are required to ensure the financial solvency of insurance companies,” he said. “The industry is one of the largest institutional investors on the planet. By limiting their ability to invest in the energy industry, this reduces the diversification of their investment portfolios. A less diverse portfolio is a risker one. … Ultimately, this will lead to higher insurance rates for people and businesses.”

Although Jones has called for insurers to voluntarily divest from coal and other fossil fuel companies—he’s issued no such mandate—industry groups like the Property Casualty Insurers Association of America (PCI) likened Jones’s position to calls for a boycott. “Politicians have every right to express their desires and set their own policy,” says David Kodama, a PCI assistant vice president. “It’s our role to inform them about the potential ramifications of their decisions.”

Like other insurance industry participants and watchers, Kodama believes the ramifications of San Francisco’s efforts could be precarious. “Our concern is that the Board of Supervisors’ decision will become a template to push a social agenda against companies in businesses that groups of people dislike,” he explained. “It could be used as the model to fight against companies that make certain chemicals, tobacco and e-cigarettes. I could see it used against marijuana businesses, abortion clinics, casinos and adult entertainment enterprises. All of these businesses buy insurance.”

He also disapproves of limiting insurer investments. “The inference is that insurers should invest in green companies providing sustainable and renewable energy instead of oil and coal companies,” Kodama says.

“But what if these investments are less secure and more speculative in nature? That would jeopardize the stability of insurers’ investment returns, to the detriment of their policyholders.”

Hartwig agrees. “Some environmental advocates believe the future will involve the massive storage of energy in industrial batteries, but the environmental consequences of these activities are becoming clearer,” he says. “Could this result in insurer prohibitions from investing in companies that make electric cars? What about other zero carbon energy technologies like hydroelectric dams that impact fish and wildlife or wind turbines that kill birds? Once you go off in this direction, there is no end in sight.”

His point is obvious: under such a scenario, insurers would be required to restrict their investments solely to politically correct companies. Körner provides another unsettling scenario. “If insurers and reinsurers don’t assume coal mining and coal plant risks, the government may need to provide insurance,” he says. “However, no government is equipped to underwrite coal-related risks. If losses exceed premiums, taxpayers will be on the hook. … The government is never a good risk-taker.”

One need look no further than the federal government’s National Flood Insurance Program for an example of how not to underwrite U.S. flooding risks; the program has been in the red since Hurricane Katrina struck the Gulf Coast in 2005.

Taking the Pledge

Despite these concerns over government overreach, many of the world’s largest European insurers and reinsurers are doing what The Sunshine Project, Commissioner Jones and the San Francisco Board of Supervisors have urged. Swiss Re, Zurich, Allianz, Aviva and Axa have decided to no longer underwrite and to divest from coal companies, according to a recent report by an organization called Unfriend Coal. In August 2018, Munich Re joined them. Altogether, the insurers have divested about $23 billion from coal companies.

“Climate change generates enormous economic and social risks,” says Oliver Bäte, CEO of Allianz. “It is already harming millions of people today. As a leading insurer and investor, we want to promote the transition to a climate-friendly economy.”

And the insurer doesn’t see the move as detrimental to its bottom line. “We are convinced that our approach will further improve the risk/return profile of our portfolio in the long term and that we will strengthen our position as a forward-looking investor,” says Günther Thallinger, a member of the board of management of Allianz who is responsible for investments and environmental, social and governance criteria. “As a long-term investor, we want to shape the change to a climate-friendly economy together with our clients. We will thus also strategically develop our investment opportunities in new technologies.

“It is important to limit global warming as quickly as possible. This will only succeed if business and politics pull in the same direction.”

It is not clear if these commitments by the foreign insurers and reinsurers also apply to their business in the United States, Hammond says. However, last summer Swiss Re announced it would no longer provide reinsurance to insurers with more than 30% thermal coal exposure.

No U.S. insurer has made such commitments. “The big gaping hole is the United States,” Hammond says. “Even though the coal industry is pretty much in a terminal decline, there are still plenty of coal-fired plants in the U.S. and plenty of proposals in the Powder River Basin and in Appalachia for more coal mining. Our goal is to get U.S. insurers to do what European insurers have done and are doing.”

Hammond is confident The Sunrise Project will prevail. In July, the group sent a letter to 22 insurers asking them to voluntarily stop underwriting and investing in fossil fuel companies. Among the companies receiving the letter are such large insurers as AIG, Liberty Mutual, Berkshire Hathaway, Chubb, Nationwide and The Travelers Companies. “We need a U.S. company to get out in front of this,” Hammond says. “Axa apparently got a lot of pressure from the French government to do something on climate change, given the Paris Accord. We’d love to see a big company like AIG take the lead on this here.

“This is an extraordinary opportunity for the industry to make a huge difference—a chance to make a mark when nothing positive is going to happen at the federal level,” he says.

At present, Hammond is doing outreach in other U.S. municipalities to consider initiatives similar to the one issued in San Francisco. He also recently visited Silicon Valley to discuss The Sunrise Project’s goals with large technology companies.

“We’re hoping that companies like Google and Facebook that already have done quite a bit on climate change will start a dialogue with their insurers—if they want to keep their business, they’ll need to distance themselves from the fossil fuel industry,” Hammond says. “Changing insurance companies is not a big deal.”

He’s also targeted the cities of New York and Los Angeles as likely to follow San Francisco’s lead in breaking ties with insurers of coal, oil and tar sands companies. “Both cities that have already taken actions on climate change,” he explains. “We want them to put their insurers on notice that these are their expectations going forward.”

Crossing the Line

Certainly, the overarching ambition of The Sunrise Project is clear. It wants coal, tar sands and other fossil fuel companies to fold up their tents for good, by whatever means necessary. Without insurance and insurer investments, the organization figures the companies cannot survive, and it’s probably right.

Some would agree this is a good thing. The question is whether the property and casualty insurance industry should be the means to such an end.

It’s a Solomon-like determination. As Körner says, “I have nothing against requiring insurers to demonstrate how they are individually reducing their carbon footprint, but to require them all to stop writing the risks of an industry that is doing nothing illegal crosses a line.”

Once a line is crossed, there is no going back.

Russ Banham is a Pulitzer Prize-nominated financial journalist and author who writes frequently for Leader’s Edge.

Lessons on Auditing from Carillion’s Collapse

By Russ Banham

CFO magazine

If past is prologue, U.K. accounting regulators may want to take a hard look at the great American business tragedy known as Enron.

In 2002, the scandalous collapse of the energy company caused the demise of one of the Big Five audit firms, Arthur Andersen, resulting in the Sarbanes-Oxley Act’s stern reforms. The now Big Four are in the crosshairs of U.K. regulators, following the spectacularly speedy collapse in January 2018 of Carillion, one of Britain’s largest construction firms. It was the largest insolvency in U.K. history, jeopardizing some 20,000 jobs and countless pensions. The company went into liquidation with liabilities of $9 billion and only a few million dollars in the bank.

All four auditing giants were connected to Carillion in some capacity, with KPMG its external auditor. A House of Commons report says KPMG failed to challenge management on “highly questionable assumptions” about construction contract revenue and accumulated goodwill from acquisitions. As with Enron, this roiling hurricane has whipped up urgent calls in the U.K. for auditing reform. Some want Parliament to separate the audit work of the Big Four from their prized consulting services; others suggest shattering them into multiple firms. While the first has been done in the United States, some here are still calling for the second.

The United States is ahead of the United Kingdom with respect to regulating auditing, but no one would say America has perfected the approach. An effective framework of accountability for auditors doesn’t presently exist. So, could a downfall of Shakespearean proportions like Carillion’s happen here? And is there a solution to making sure it doesn’t?

Applying Judgment

When considering the accountability of auditors in a sizable corporate meltdown like Carillion’s, or MF Global’s, or even that of Lehman Brothers, accounting experts underline the imposing task audit firms face. In every engagement, they issue an opinion on the fairness and accuracy of a company’s financial statements based on a statistical sampling of its financial data.

The key word here is “sampling.” No auditor of a large public company could possibly dig through every single transaction to guarantee its financial integrity. Consequently, there is always the risk of issuing an opinion that may be ambiguous or flat-out wrong. That is why it is called an “opinion,” a “judgment not necessarily based on fact or knowledge.” And why an “audit” is just another word for a “survey” or “check.”

“A lot of what audit firms do is a legitimate judgment call,” says Erik Gordon, a professor in the University of Michigan’s Ross School of Business. “Here in the United States, judgments are based on [generally accepted accounting principles], but they’re still judgments.”

The problems occur when the client pushes back, disputing the auditor’s judgment. The auditor may decode comments such as “I’m not sure you really understand our business” or “I don’t think you appreciate what is special about our industry” as “implying that the company will curtail the high-priced consulting services provided by the firm,” says Gordon. “That’s when the auditor’s objectivity can become strained.”

The U.S. Stage

Audit firms in the United Kingdom can still provide consulting services to the same client (unlike in the United States), resulting in a blatant conflict of interest. That and other circumstances of the Carillion case are an old tune in the U.S., which confronted similar issues post-Enron until Congress passed the Sarbanes-Oxley Act of 2002 (SOX). SOX prohibits firms from providing non-audit services to audit clients like internal audit outsourcing and large-scale, large-fee information systems design and implementation. The law also requires publicly held companies to disclose the fees paid to auditors.

Three of the Big Four firms pulled out of consulting after SOX came into effect, eventually returning to the business by committing not to provide audit and consulting services to the same company. For the most part, this accommodation has eased worries over another Enron. But does that make the Carillion calamity a case of “it can’t happen here?”

The list of mistakes that the U.K. parliament accuses Carillion’s auditor, KPMG, of making sound pretty similar to errors that U.S. auditors have made since SOX, especially during and after the 2008 financial crisis: questionable assumptions about revenue recognition and the goodwill value on corporate balance sheets, for example, and a lack of professional skepticism toward aggressive accounting judgments:

  • In 2014, the Public Company Accounting Oversight Board (PCAOB) banned a PricewaterhouseCoopers partner for overlooking improper revenue recognition by a medical device firm. The practices missed included unusual pricing and payment terms, quarter-end sales spikes, and a scheme by which the company funded a distributor’s purchases.
  • A U.S. district court recently found PwC guilty of giving Colonial BancGroup a clean audit for years before it emerged that huge chunks of Colonial’s loans to a mortgage originator were secured against assets that did not exist.
  • The PCAOB charged Deloitte with violating PCAOB rules and auditing standards in audits of software firm Jack Henry. The PCAOB said none of the engagement personnel had the knowledge to properly evaluate and audit the firm’s accounting for software license revenue.

In addition, criticisms of the U.K.’s accounting watchdog, the Financial Reporting Council, are similar to those leveled at the PCAOB: that the regulating entity is too close to the firms it oversees.

Two of the current five members of the PCAOB, for example, spent significant time at Big Four firms, and an April 2018 academic study found that an increasing number of PCAOB employees leave the regulator for senior-level positions at large audit firms.

Robust Regulation?

The Big Four declined to be interviewed for this story, referring the subject to the Center for Audit Quality (CAQ), which represents the interests of public company auditors. CAQ issued a statement to CFO maintaining that “robust independent regulation and oversight” is firmly in place in the United States “to safeguard auditor independence.”

“Auditing has become much more rigorous in the past 15 years,” says Owen Ryan, one-time CEO and managing partner of Deloitte’s advisory business and a member of its global executive committee. Financial restatements and large bankruptcies without forewarning by auditors have fallen significantly, he says. “Lawmakers and regulators like the [PCAOB] deserve credit for putting pressure on audit firms to be independent and to continually improve practices.”

Like all sweeping business regulations that are passed, SOX was initially greeted by companies as unnecessarily burdensome. But it has changed corporate behaviors for the better, restoring needed investor confidence in the accuracy and completeness of financial statements, says Robert Hartwig, a professor of finance at the University of South Carolina’s Darla Moore School of Business.

The statement bears repeating, as the White House and Congress are questioning the effectiveness of many capital markets regulations. A current bill in the House of Representatives, for example, would allow small broker-dealers to hire audit firms that are not registered with the PCAOB.

“The U.S. took a hard step in adding another layer of regulation. But the result has been greater financial transparency and corporate governance,” says Hartwig.

And the PCAOB is still refining its approach. As of June 30, 2019, auditors have to include in their reports a discussion of critical audit matters (CAMs) that have been communicated to the audit committee. CAMs are matters related to disclosures that are material to the financial statements and involve “especially challenging, subjective, or complex auditor judgment.”

Another factor involving the difference in oversight here and in the U.K. is a wide disparity in funding, points out Patrick Villanova, a former lead audit senior manager at PwC. The PCAOB’s $250 million annual budget is pretty much double the funding of the FRC and regulators in the Netherlands, Ireland, France, Germany, and South Africa — combined.

Breaking Up

In the United Kingdom, Parliament has remedies in mind in the wake of the Carillion collapse, some of which have also been contemplated in the United States. The two principal ones are (1) fragmenting the Big Four into smaller firms, and (2) detaching their audit arms from their consulting services arms, which generally offer strategy, legal, and merger-and-acquisition advice.

The first solution would encourage competition in the audit market, say U.K. lawmakers, limiting the potential for audit firms and clients to nurture long-term, cozy relationships. The Big Four check the books of nearly all (98%) of the U.K.’s 350 leading public companies. “The veiled threat [by regulators] is that if you don’t do it, we’ll do it,” says Gordon.

More competition would break the Big Four’s stranglehold. Other suggestions being proposed in the U.K. would cap these firms’ market share of public company auditing or limit the number of audit clients any one firm can have.

But is an oligopoly of four top-tier firms a bad thing, either in the U.S. or the U.K., given that there are tiers of other audit firms right below it? “More competitors usually leads to more competition,” says Gordon. “But I know people at all four firms, and in a sort of semi-genteel way they really do compete for business. Would a ‘Big Six’ be more competitive, giving a CFO more places to shop? Maybe, but I’m not sure it would result in higher audit quality.”

Jian Zhou, a professor of accounting at the University of Hawaii’s Shidler College of Business, would rather see a market solution. He notes that the second tier’s market share is growing in the United States. “We may soon have a Big Six, without the need to break up the Big Four to spur competition,” Zhou says. “Audit committee members need to have more of an open mind toward appointing second-tier audit firms like BDO, Grant Thornton, and Crowe Horwath.”

Villanova, now vice president and corporate controller at BlackLine, is doubtful about the prospect of breaking up the Big Four. “The second-tier firms readily admit they currently don’t have the national office resources, technical expertise, or the global networks of the Big Four,” he says.

He is not alone in that position.

“The Big Four are the ‘A-team’ for a reason — they’ve hired the cream of the crop,” says Tom Wheelwright, a former tax specialist in Ernst & Young’s national office and CEO of WealthAbility, a provider of tax and accounting educational tools. “No one goes to a second-tier firm if they have the opportunity to work for the Big Four … [because] their resources aren’t nearly as good. You’ll get better audit prices, but not better audits.”

Core Conflicts

The provision of both audit and consulting services by a Big Four firm is the other chief complaint of U.K. lawmakers. Their arguments are driven by an enhanced potential for conflicts of interest, since audit firms are both an advocate and a public protector of a company on behalf of shareholders and investors. And the job of advocate, in the form of advisory work, pays more.

The Big Four counter that added services like tax and legal consulting are useful from an expertise standpoint, allowing for higher-quality audits. They also say the added revenue stream of consulting services income helps subsidize clients’ audits. “If you remove the ability to offer these services, audit prices would be considerably more expensive, as much as double,” Wheelwright claims.

Nonetheless, these factors do little to offset the possibility of a serious conflict of interest. “If there are no disputes on the audit side with the client, no issues over asset impairments or how revenue and expenses should be booked, then no problem — the conflict of interest is hypothetical,” says Gordon. “But if the auditor is questioning these things while the firm also provides profitable services to the client” then the auditor may turn a blind eye.

The conflict of interest argument has also arisen in the United States, where many wonder if it makes sense anymore for the issuer being audited to be the one paying the auditor. After all, why do auditors continue to make big, costly mistakes that result in lawsuits? Could it be the pressure to keep the audit client happy?

Big Four alumni say the overwhelming majority of auditors are not being negligent. As Villanova explains, an auditor is often trying to figure out some “newfangled, ingenious thing that some banker came up with” while the “clock ticks toward the quarterly earnings report.” The company makes a best estimate based on the available information, and the auditor scrutinizes the company’s key assumptions to the best of his or her ability.

A potential solution to the problem of long-term auditor-client relationships, says Villanova, is having another firm come in and check the assumptions.

There is no law or accounting rule requiring the use of peer reviews, in the U.K. or the U.S. Not only would a “referee” weaken the conflict-of-interest charge — auditor would know its work would be evaluated by a competitor — it would spread the wealth among a greater number of firms, addressing the oligopoly assertion.

“It could result in a new practice, whereby a group of firms specializes in scrutinizing the financial data that another firm has already scrutinized,” Villanova said. That already happens when a company goes through a major acquisition or divestiture — one Big Four firm gets hired to give the company a valuation report and another audits the assumptions and models used in the valuation.

What Now?

The Big Four would hardly relish having other audit firms peering over their shoulders at their workpapers. In addition, issuers and investors might not put up with longer lead times between the closing of books and the auditor giving its imprimatur to the financial statements.

One thing auditors can do to head off any new rules is to ensure new auditors are trained to appropriately challenge the client on accounting and disclosure matters. Audit committees on boards of directors can also play a part. They must keep auditor independence intact and identify for auditors the transactions and accounting issues from which misstatements are likely to arise.

Still, audits will miss things, given that auditors need to form an opinion drawn from only a small wedge of the client’s financial data. “The public sees an audit as assurance that everything is perfect in a company, which is not what an audit is,” said Wheelwright. “It’s a testing process to see if what a company is doing is reasonable.”

Lawmakers in the U.K. might be off base — “looking for precise answers to improve a science that is inherently gray,” as Villanova puts it. But that doesn’t mean the quality of audits can’t be improved. For certain, if the Big Four firms don’t join the discussion about how to make incidents like Carillion less likely, they may not be happy with what regulators impose as a solution.

Russ Banham is a Los Angeles-based financial journalist and author.

Can We Bear the Cost: The Planet Is Warming. How Can We Prepare?

By Russ Banham

Leader’s Edge

It’s one thing to read about raging wildfires in California and quite another to experience the possibility of such a catastrophe. In early August, our secondary home in Idyllwild, a small town nestled in the San Jacinto mountains, was imperiled by the Cranston fire, just one of the many wildfires burning throughout the state.

The blaze was started by an arsonist, and all 3,000 residents of Idyllwild were evacuated.

For five nail-biting days, we waited, fearing mostly for our neighbors’ primary homes and their pets left stranded when the roads to the town were closed. A friend in the California Highway Patrol snapped a picture of a giant plume of smoke from our front fence line. It was a half-mile away. Winds blew westerly, not a good sign.

And then our prayers were answered. The ground and aerial firefighters who arrived by the hundreds to battle the blaze finally got it under control. Although the fire consumed more than 13,000 acres, the town and all but a half-dozen homes were spared. Other municipalities throughout California have not been so fortunate. The largest wildfire in state history burned for more than a month and encompassed more than 400,000 acres.

The costs of such natural disasters are borne by all of us—in our taxes and our insurance premiums. That cost was made clear in 2017. A study by the Swiss Re Institute found the economic damage caused by natural disasters last year totaled $337 billion, the second highest on record—of which $144 billion was insured, the highest on record. Three hurricanes that year—Harvey, Irma and Maria—ranked among the five worst hurricanes in history, in terms of financial costs. Insured losses from all wildfires in the world totaled $14 billion in 2017, the highest ever in a single year. In the United States alone, more than 9.8 million acres burned in 2017, costing $18 billion—triple the annual wildfire season record. Among these wildfires was the Thomas fire, California’s worst fire in history at the time in terms of acreage burned.

For businesses, natural disasters represent a serious risk management issue. Many surveys of large and midsize companies rank natural catastrophes among their top three risks. For small companies, such disasters are an even greater threat.

In the years ahead, diverse structures in regions vulnerable to natural disasters are bound to experience substantial property damage and destruction. Large companies will endure significant supply-chain disruptions, delays in business operations and reduced revenues. Many smaller businesses will fail.

What is being done to prepare for this dystopian possibility? The paradoxical answer is: quite a bit but not enough.

For example, in ZIP codes designated by the Federal Emergency Management Agency as susceptible to natural catastrophes, 40% of small companies experienced natural-disaster related losses that curtailed business operations.

Only 17% of them had business interruption insurance, according to a 2017 study by the Federal Reserve.

Leaving aside potential causes, more than 97% of climate scientists in peer-reviewed studies in notable scientific journals concur that the planet is warming. And more than 80% of climate scientists in studies conducted by groups supported by the oil and gas industry affirm that climate change is happening.

“The evidence is unequivocal that the planet is warming, with literally thousands of studies using all sorts of evidence to draw what are pretty rock-solid conclusions,” says Richard Black, director of the Energy and Climate Intelligence Unit, a U.K.-based nonprofit that publishes on energy and climate change issues.

What does this mean for natural disasters? It depends. Among the scientific community, some potential effects are generally agreed upon, while others have less consensus.

Hurricane Flooding

As the planet warms, ocean levels rise for two reasons: thermal expansion (water expands as it warms) and the flowing of melting land-based ice like glaciers into seas. “We can measure sea levels year by year and have seen gradual increases that may accelerate in the future,” said Robert Muir-Wood, chief research officer at catastrophe risk modeling firm RMS.

When hurricanes form, they create an additional abnormal rise in sea level—called a storm surge. The greater the rise in sea levels, the higher the risk of extreme flooding along coastal areas, given the expanded volume of water.

“There’s no doubt that hurricanes will inflict heavier damage due to rising sea levels caused by climate change,” says Michael Oppenheimer, a climate scientist and professor of geosciences at Princeton University. “That’s a no-brainer. The flooding will be greater and will extend more inland from coastlines.” That said, 90% of Harvey’s insured property losses derived from inland flooding and not hurricane wind intensity.

Climate change also is a factor in higher precipitation events, such as the 60 inches of rain that engulfed the greater Houston area during Hurricane Harvey. “As temperatures rise to warm oceans, water evaporates [faster] and produces more moisture content,” Oppenheimer explains. “On that, we climate scientists can agree.”

Muir-Wood shares this opinion. “There’s pretty good evidence to suggest we will have more intense rainfall resulting in extreme flooding events like we saw with Harvey,” he says.

Another factor in hurricane flooding is duration of the storm. Hurricane Harvey lasted 16 days—from August 17 through September 2. According to the journal Nature, climate change affects what scientists call “translation speed”—the speed at which a hurricane travels forward. This speed is slowing, indicating that storms may linger longer in a particular geographic area, increasing the risk of flooding.

“There’s a theory that shows a warming planet stalls atmospheric circulation patterns like trade winds and the jet stream, stalling storms in one place for longer periods,” Oppenheimer says. “But there is no scientific consensus yet that this is explicitly caused by climate change.”

The changing climate might also explain why scientists expect more Category 4 (130 mph to 156 mph winds) and Category 5 (157 mph or higher) hurricanes. That’s because hotter oceans provide more energy, fueling wind intensity.

“We may even need to create a new Category 6 to take into account more intense winds,” Oppenheimer says. “But most scientists are not willing yet to say that the observed change in wind intensity is due explicitly to climate change. Again, we’re not at a point yet to nail this down.”

If there is a silver lining in these dark clouds it is this: more frequent hurricanes generally are not anticipated, with some climate experts predicting a potential decrease in the overall number of future hurricanes, based on models involving warming temperatures. According to the National Oceanic and Atmospheric Administration’s Geophysical Fluid Dynamics Laboratory, three or four small hurricanes might merge into a single large hurricane, although the organization acknowledges uncertainty on this subject.

Droughts and Wildfires

Last year was the second-worst year on record for wildfires in the past 60 years, with 10 million acres burned, exceeded only by 2015, when about 10.1 million acres went up in flames. This year is well on track to break the record. (See sidebar: A Terrible Tally.)

Prior to the 1970s, wildfires in the United States received little attention from the government and the public, as they were generally smaller and sporadic and occurred in mountain regions with scant habitation. Then all hell broke loose. According to the Union of Concerned Scientists, between 1986 and 2003, wildfires burned more than six times the land area, occurred nearly four times as often and lasted almost five times as long as wildfires reported between 1970 and 1986.

More recent statistics indicate that wildfire seasons were 84 days longer on average from 2003 to 2012 than they were from 1973 to 1982. Large wildfires also are taking more time to contain, burning an average of more than 50 days between 2003 and 2012, compared to six days between 1973 and 1982.

Is climate change the cause of all this misery? “It’s a complicated peril, with a lot of actors in play,” Muir-Wood says. “You must take into account the previous history of drought and extreme heat waves.”

He’s referring to the fact that our world has seen weather like this before. Ancient Egypt was lost to one of history’s most withering droughts, and the United States’ most protracted drought occurred during the Dust Bowl years from the 1930s to the 1950s.

However, we do know that the increase in air temperatures due to climate change does cause drier conditions, such as decreased soil moisture and increased evaporation of water from lakes, rivers and other bodies of water—all of which can exacerbate drought conditions.

“Another factor is natural weather occurrences like El Niño events that cause year-by-year variability in drought potential,” Oppenheimer says. “What we do know is that future conditions will be progressively more favorable to these kinds of fires in many areas. The reasons are complicated, but the science is getting close to nailing it down.”

The Human Factor

While climate change can be blamed in part for the recent scourge of natural disasters, human folly contributes to much of the economic impact. First, too many people (myself included) continue to live in coastal areas and mountain towns, regardless of the known dangers. Second, those of us living in these regions downplay the risks and do little to reduce their impact.

“Despite all we have learned about the impact of hurricanes, wildfires and other natural disasters and how to protect ourselves and our businesses from their impact, we’ve actually done very little to reduce the material losses from these events,” says Howard Kunreuther, a professor of decision sciences and public policy and co-director of the Center for Risk Management and Decision Processes at the University of Pennsylvania’s Wharton School.

In his book (written with Robert Meyer) The Ostrich Paradox, Kunreuther contrasts human behavior negatively with the behavior of an ostrich presumed to bury its head in the sand when danger approaches. “The reality is that ostriches stick only their beaks in the sand, but their eyes see everything around them,” Kunreuther says. “People have their entire heads in the sand. The uncertainty associated with future sea level rise and the nature of hurricanes often leads us to hope for the best rather than fear the worst.”

He attributes this reaction to myopia, amnesia, optimism and inertia, which combine to make us always expect the best, even when bad things are blatantly obvious. “People have a tendency to think when they move to coastal areas in a hurricane-prone region that the worst won’t happen to them, despite all evidence to the contrary,” Kunreuther says.

Muir-Wood expressed a similar sentiment. “In most cases, the risks of a hurricane or wildfire are greater than how people perceive them,” he says.

Given all we know, scientifically and economically, about natural catastrophes, the related costs continue to rise, in large part because of our collective tendency to downplay their significance. “Following a wildfire or a hurricane that interferes with people’s lives, little if anything is done to prepare for the possibility of it occurring again,” Kunreuther says. “The thinking is that we will be spared next time around. We have very short memories when bad stuff happens.”

By doing little if anything to reduce the potential impact of a natural disaster, when the next one arrives the aggregate damage losses are higher than they otherwise could have been. A study by insurer FM Global affirms this connection. The multinational property insurer/property loss prevention specialist company evaluated its losses from Hurricanes Irma and Maria, comparing the data of clients that had taken loss prevention actions based on its recommendations with those that hadn’t taken these actions.

“We were surprised to learn that the companies that took these actions experienced losses five times lower than those that didn’t,” says Katherine Klosowski, FM Global’s vice president of special projects. “We had expected a difference but not that magnitude.”

This is good news, indicating that losses can be contained. Such losses run a gamut wider than just property damage to homes and buildings. “There are arrows that go from climate change to things like food security, geopolitical stability and economic growth, all of which create risk management implications for companies,” Kunreuther says.

In fact, according to one study, as much as 95% of fresh produce is perceived to be at risk because of climate change. Livestock health is also at risk, as warming temperatures cause heat stress and increased demands for water that may not be as readily accessible.

“More needs to be done to assess these risk interdependencies,” Kunreuther says. “And insurers are in a prime position to undertake these assessments.”

Fortunately, there are many smart ideas circulating on how homeowners and businesses can reduce their risks of property damage, including water runoff systems like dikes to contain flooding, spraying homes with fire retardant prior to a wildfire and hurricane-resistant doors and windows. For more information, check out FEMA’s online hurricane preparedness and wildlife planning toolkits.

Government Action

When people fail to take actions to limit their exposure to property damage, governments generally don’t intervene on their behalf. “We’ve seen a perpetuation of poor public policy decisions, in which people and businesses are allowed to locate anywhere they want in structures that are inappropriate given the climate risks,” says Will Dove, CEO and chairman of new reinsurer Extraordinary Re. “This guarantees that catastrophe claims frequency and severity will only get worse.”

“We need the political will of the federal government to say that it will no longer encourage risky zoning and land-use rulemaking on the part of local governments, since it is local government that authorizes permits for construction activities in climate-vulnerable areas. Local building codes must reflect the actual risks, which are well understood.”

Princeton’s Oppenheimer also took local municipalities to task for not upgrading their building codes. “They need to get them up to modern standards that reflect reality and then enforce them stringently,” he says. “And the federal government flood insurance program must follow through with rates that are sound but also sensitive to the investments that people make to protect their property.”

If this were the case, more homeowners might buy flood insurance. Only two in 10 homeowners had either private or federally provided flood insurance to absorb losses from Hurricane Harvey, according to an estimate by the Consumer Federation of America. “People without insurance expect the government to bail them out, which is often the case,” Dove says. “In effect, the government bailout takes away the financial responsibility from the individuals affected. When this occurs, the taxpayer ends up footing part of the bill.”

Part of the problem is the National Flood Insurance Program, which is deeply in debt and nearly insolvent, in part due to repetitive claims for property damage by the same homeowners. “NFIP is in need of reforms,” Dove says.

“FEMA flood maps are outdated and don’t reflect current reality. There are no incentives to rebuild structures to accommodate the actual risks, resulting in repetitive loss properties. Coverage limits are stripped down in many cases, with no business interruption insurance for small businesses out of commission for longer than a month.”

Congress is now studying common-sense reforms to NFIP, like improved flood mapping and the identification of properties filing repetitive damage claims. But even with such enhancements, unless flood insurance is mandatory in vulnerable regions, not everyone will buy the insurance. Kunreuther proposed the idea of offering all homeowners and businesses financial incentives, like lower premiums and affordable loans, for structural improvements they undertake to reduce storm-related damage risks.

“A reason why people don’t invest in mitigation measures is because they perceive the cost as too high relative to the benefit,” he explains. “But if the government offers them long-term loans at affordable rates, there’s a better chance they’ll see value in making needed improvements. And if their insurance carrier simultaneously reduces its premiums for taking out the loan, the incentive for the business or the individual is even greater.”

Private Market

It’s not just a government problem, though, and there is a lot the private insurance market and other businesses can do to help encourage mitigation. And the private insurance market is growing for flood. Several reinsurers like Swiss Re are partnering with primary carriers to offer the coverage. Altogether, carriers wrote more than $623 million in business in 2017, a 51.2% increase in premiums over the previous year. Nevertheless, this is a pittance compared to the NFIP’s $3.5 billion in 2017 premiums.

As far as encouraging mitigation goes, Oppenheimer has some ideas. “Frankly, the U.S. insurance industry could do a lot more to fulfill its social responsibility by making sure people properly manage the risks to their properties,” he says. “A rate structure that gives people credit for building and maintaining resilient homes and premium rebates when someone does something good to make the property more resistant to damage are big steps in the right direction.”

Lenders also can do their part. “Banks can require businesses and homeowners in vulnerable areas to buy flood insurance as a condition of loans and mortgages,” Dove, of Extraordinary Re, says. “Many lenders already do this if the region is in a one-in-100-year flood zone. But the flood maps that define many areas are very dated and have not been updated to reflect current climate conditions. Certainly, no one expected that Hurricane Harvey could produce 60 inches of rain in a matter of days. Some regions that were not perceived as a one-in-100-year flood zones in the past may very well fall into this category now.”

Insurance brokers also can help tip the scales. “Too many policyholders are confused about what is and isn’t covered when a natural disaster strikes and are surprised when something they thought was covered wasn’t,” says atmospheric scientist Marla Schwartz, from reinsurer Swiss Re.

An example is mudslide damage and destruction. A few months after the Thomas fire was finally contained, heavy rainfall in the affected region resulted in massive and deadly mudslides that destroyed multiple homes. Although property insurance policyholders did not have mudslide insurance, which is unavailable in California, the state’s insurance commissioner instructed insurers to honor claims for mudslide damage, commenting that the fire was the “proximate cause.”

The decision was contentious, but Schwartz says, “It’s a good sign that regulators are up to date on links between fires and mudslides. But it would be better for insurers to recognize this link in their policies and reflect the risks accordingly in their premiums.”

Taking the Lead

Some believe the global property and casualty insurance industry can play a more influential role in understanding, managing and insuring future natural disasters. “There is no single set of people other than the actuaries at insurers and reinsurers who are better at understanding these risks and calculating their frequency and severity,” Black, of the Energy and Climate Intelligence Unit, says. “Companies like Swiss Re and Munich Re are just brilliant at this for obvious reasons—they’re bearing a good part of the cost. They and others should have louder voices in informing the public and policymakers of what is really going on and what needs to be done as a result.”

An unambiguous “voice” may well be needed. Every time the United States suffers a shocking disaster like Hurricane Katrina, Superstorm Sandy or the California wildfires, the inevitable hue and cry that follows eventually subsides—until the next big disaster arrives.

“The challenge in the future will not be lack of risk-bearing capital to absorb catastrophic losses,” Muir-Wood says, “but whether insurers are allowed to charge for the underlying cost of risk based on their technical arguments.” If they can’t charge for the actual cost of risk, he says, insurers might need to pull back coverage or pull out of markets entirely.

“Certainly, the world is not helped by a U.S. administration that doesn’t accept climate change as a reality, making the chances of support for infrastructure and building adaptions at the federal level currently nonexistent,” Black says.

“But insurers and reinsurers accept reality. They can be expected to tell it like it is.”

Oppenheimer contends time is of the essence. “Human beings have done a pretty good job saving more lives from natural disasters,” he says. “Fewer people die worldwide from hurricanes and wildfires than in the past. But on the property and business interruption side of things, the record stinks.”

Banham is a Pulitzer Prize-nominated financial journalist and author.

This Deep Learning Technology Is Redefining Ad Integrity

By Russ Banham


In the pre-social media era, marketers had a good idea about how many times consumers saw their corporate logo and other brand images. Then, around 2010, after social media sites took off, millions of people could see a company’s logo, unbeknownst to the organization. That was both good and bad news.

While exposing people to a company’s logo could, in theory, make them more familiar with the brand, products, and services, there was also the possibility the image could be put into a negative context and go viral. Until recently, marketers had no way to monitor the use of their advertising images by third parties.

Today, deep learning makes this possible. Computer vision, a subset of deep learning technology, gives marketers insights into how many people have viewed a logo or other brand images, in addition to their context.

“The use of computer vision for marketing purposes is becoming an increasingly common application of deep learning technology,” said Clement Chung, director of machine learning at Wave Financial, a provider of integrated software and tools for small businesses. “Companies can see just how they are being represented in online images, both positively and negatively.”

Ad Impact, Across Mediums

Deep learning is a subset of machine learning, itself a subset of artificial intelligence, in which computers are instructed to learn by example. For instance, in self-driving cars, the car’s computer is instructed to stop at a red light. Once the car is programmed to do so, the machine will know to stop at all red lights.

Computer vision technology, then, uses object recognition software to tabulate how many times an ad or logo has been viewed in social or traditional media, and the context in which the image appeared.

“The technique involves two parts—the development of an algorithm to train the computer to find the image, and then the use of object recognition to determine the context of the image,” said Chung.

This has to two positive effects for marketers. To begin, it helps them identify how many times an ad was viewed outside of its original distribution campaign. If we were to consider a Dodgers Stadium beer ad, for example, computer vision technology could provide a way to calculate how many times the billboard at the game was seen both on social media and traditional media. If the game is televised, chances are local and even national news stations may also carry images of the event in which the billboard ad is visible.

Detecting viewership can help marketing teams decide where to put ad dollars. “What if the ratings on the televised event have dropped significantly, meaning fewer people are seeing it at home?” Brian Kim, senior vice president of product at GumGum, a leading computer vision company,said. “This might convince the marketer to put its spend elsewhere.”

Using computer vision, companies can calculate if more people saw the image on social media or other media than the TV ratings indicate. “That’s a far better determinant of the advertisement’s value,” Kim noted.

Chung agreed, stating that a marketer may also discover things like a billboard placed behind the catcher was seen by more people than one situated in left field. “The goal in all cases is to get a bigger bang for your advertising dollar,” he said.

An Opportunity Algorithm

The technology also identifies missed opportunities and flags necessary damage control. If the context is positive, the company has the opportunity to push the advertised image toward becoming viral.

However, there is also the risk that an image of the brand or its logo could become a “meme of the worst kind, used for satirical purposes,” said Chung. “In such cases, the product’s brand value can quickly erode, especially if the marketer is unaware of the negative associations and is too late to do anything about it.”

Computer vision offers a way to be notified in real time about insulting brand imagery. “An algorithm can be created to spot the use of certain offensive words that accompany the image on social media,” Chung pointed out. One obvious example, he noted: “This product sucks!”

With the emerging technology, marketers have the ability to counter the offense. “There have been memes created by overworked millennials and teenagers fed up with too much homework where they’ve snapped a picture of themselves ‘drinking’ a household cleaning product—the ‘my fake suicide’ kind of thing,” said Kim. “With computer vision tools, brand managers have instant access to what is now a negative trend to quickly adjust the conversation in a more positive direction.”

Of course, computer vision can also help spot and seize marketing opportunities. For instance, GumGum has created a way for marketers to run an advertisement at opportune—often fleeting—moments in social media.

“We’ve developed a contextual relevance algorithm using object recognition software that can pinpoint, for example, when happy images involving humans and cats appear on social media,” said Kim. “Say this image appeared on CNN. We now have the opportunity to stick a banner ad for a national pet store chain into the image in real time. We would receive income from the pet store chain to display the advertisement and arrange for CNN to be paid a portion of the earnings.”

The technology is also able to train the algorithm to find a context in which a brand should appear in certain images, but doesn’t. With the beer company example, this might include adding logos to images of people photographed at parties, restaurants, or taverns where they know the beer is served.

“Computer vision can find images that fit the marketer’s desired demographic, and if the brand is not evident in these images, the information is nonetheless insightful for marketing purposes,” Chung said. “The company now has better intelligence on where to put its marketing spend.”

Russ Banham is a Pulitzer-nominated journalist and author who writes frequently about marketing technologies.