Wednesday, May 9 4:30 – 6 p.m. Session 1 Session Sponsor: Joint Risk Management Reputation Risk [PD] Moderator: Dr. Leslie Gaines-Ross* Presenters: Dr. Leslie Gaines-Ross*; Scott Newquist*; Michel Rochette, FSA Experts with practical experience managing operational risks will define reputation risk. What are its implications? How can reputation risk be measured and managed? You will hear about various predictive methods and obtain information about what methods are the most useful. The panel will also describe how reputation risk can be reported to management. As a result of attending this session, you will be ready to take the first steps in assessing your firm’s reputation risk and review protocols that are in place today for protecting its reputation using common industry terminology and practices. Targeted Value Ladder Stage: Employer/Client Coordinators: Anthony Dardis, FSA, FIA, MAAA; David T. Henderson, FSA, MAAA
Wednesday, May 9 4:30 – 6 p.m. Session 2 Session Sponsor: Investment Using Quantitative Analysis to Help Set and Monitor Investment Policy [PD] Moderator: Robert R. Reitano, FSA, MAAA Presenters: Malcolm P. Hamilton, FSA, FCIA; Robert R. Reitano, FSA, MAAA; Wing Fat Wong, FSA, MAAA Life and pension financial modeling experts will discuss information on calculations needed to help design investment policy. Learn how investment policy and investment management decisions can be modeled for risk management and ALM. You’ll gain an understanding of the concept of a notional portfolio and how it can be used. Targeted Value Ladder Stage: Task/Technical, Process Coordinators: Anthony Dardis, FSA, FIA, MAAA; Marc N. Altschull, FSA, MAAA
REPUTATION RISK Also known as the Cinderella Asset! Michel Rochette May 9 2007
Enterprise Risk Advisory, LLC
Presenters Dr. Leslie Gaines-Ross, Chief Reputation Strategist at
Weber Shandwick in NY where she leads the firm’s consulting services and proprietary thought leadership in reputation risk management. She is the creator of www.reputationRX.com, a web site dedicated to reputation issues
Mr. Scott C. NewQuist, Managing Director at
Perception Partners, which specializes in providing advice on identifying and managing reputation risk, corporate governance and reporting.
Michel Rochette, an ERM advisor at Enterprise Risk
Advisory who specializes in ERM and the management of non-tradeable risks!
©Enterprise Risk Advisory, LLC
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Reputation Risk Context: Why is it important to financial institutions? What is reputation? Definitions and comparisons Value of reputation: Drivers and evaluation measures Reputation risk: Definitions Reputation risk: Qualitative and quantitative measures Examples of reputation risk Reputation risk: Management approaches Reputation risk: Framework Rating agencies and regulators’ points of views Case studies Questions. ©Enterprise Risk Advisory, LLC
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Citations by Warren Buffet & Goldman Sachs
“It takes twenty years to build a reputation
and five minutes to destroy it.” (W. Buffet) “If you lose dollars for the firm, I will be
understanding. If you lose reputation, I will be ruthless.” (W. Buffet) “Our assets are our people, capital and
reputation. If any of these are ever diminished, the last is the most difficult to restore.” (Goldman Sachs Business Principles) ©Enterprise Risk Advisory, LLC
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Importance of Reputation and Trust Information asymmetry Outsiders don’t know as much about a company as
insiders, so a good reputation alleviates and allow customers to make a choice. Important for all companies but crucial and vital to insurers as we sell distant promises. Important for insurers that have one global brand: AIG, ING, Aegon, Met Life, Sun Life, Manu Life, AXA, Allianz, Zurich, etc. In essence, we exchange money for a promise to pay in the future. (Money for Paper!) More important in a period of rapid changes, globalization, internet blogs, activism, mass media.
©Enterprise Risk Advisory, LLC
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Importance of Reputation to Stakeholders Employees: Are more loyal to a company with good
reputation. Help with recruiting
Investors and business partners: Will take risk in a
company that they can thrust based upon its reputation. (More than 90% think about reputation in investment decisions: 40% care about reputation, 50% care partially).
Lawmakers and regulators: Reputation can help
lessen the legal burden on a company.
Public at large: Preserve “social license” to operate Customers and suppliers: Support loyalty to company Competition: Barrier to entry ©Enterprise Risk Advisory, LLC
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Reputation Risk: Number 1 Risk for CROs Reputational Risk (52)
Regulatory Risk (40)
Human Capital Risk (40)
IT RISK (35)
Financial, Market, Credit and Insurance Risk (30)
Crime, security, political, natural hazard, FX, Terrorism, Country Risk (20) Source: Economist Intelligence Unit, 2005 Max Scale: 100 ŠEnterprise Risk Advisory, LLC
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Reputation and Financial Impact: Corporate Reputation Watch by Harris Interactive
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Value of Reputation: National Corporate Survey Microsoft: 1st place Johnson and Johnson: 2nd Google: 4th Berkshire Hathaway Inc. 21st American Express Company: 34th Wells Fargo & Company: 36th State Farm Insurance: 42nd Allstate: 51st No Life companies included. Have your companies rated! Consult Fortune’s annual survey of America’s Most Admired
Companies. ©Enterprise Risk Advisory, LLC
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What is Reputation: General Definitions A corporate reputation is a collective representation of
a firm’s past actions and results that describe the firms’ ability to deliver outcomes to multiple stakeholders. It gauges a firms’ relative standing both internally and externally. (Fombrun/Foss: Developing a Reputation Quotient, 2000) Reputation is public information regarding a players’
trustworthiness. A players’ reputation reflects the information that third parties have on how trustworthy his behavior has been in the past. ( Ripperger 1998)
©Enterprise Risk Advisory, LLC
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Comparison of Reputation and Image Reputation: Corporate Actions and Conduct that Create Trust As Experienced by different Stakeholders. Serves as a reservoir of goodwill in time of crises. Image Belief and personal evaluation of a firm Tied to the firm directly, not to actions by the firm. If image is positive, reputation will improve However, reputation evolves more slowly than
image because it is tied to actions. ©Enterprise Risk Advisory, LLC
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Comparison of Reputation and Brand Brand: What differentiates us from the competition Marketing of the company including advertising and
publicity Refers to logos and names of companies Reputation: Cannot be enhanced by just a name change. Larger concept as it includes other elements as we
will see. Often referred as “Emotional Capital” of the firm Thus, if capital, it is subject to risk. ©Enterprise Risk Advisory, LLC
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Value of Corporate Reputation: Drivers Long-term Financial Performance
Client Service New products New services Pricing
Corporate Governance Regulatory Compliance
Reputation
External factors Social/Environmental Responsibilities Pressure Groups
Communication Disclosures Crisis Management
Human Capital/Talent Culture Corporate Ethical Values
ŠEnterprise Risk Advisory, LLC
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Value of Reputation to the Firm A good reputation encourages consumers to buy products and
services. Suppliers are willing to do business with you, thus expanding
opportunities. Top notch employees want to join and stay with your
organization, thus enhancing its innovation capabilities and value. Favorable outlook from regulators and rating agencies, thus
decreasing financing cost and increasing value. Investors want to hold shares, thus increasing value. Positive feedback from media and pressure groups increase
value. In a crisis mode, investors give the company the benefit of the
doubt, thus easing short-term decrease in value. ©Enterprise Risk Advisory, LLC
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Value of Reputation: Qualitative Measures It is the sum of how all constituencies view and
perceive the organization. National Corporate Reputation Survey by Harris Interactive Specific company’s reputation survey: Ex. Swiss Re does one every 2-3 years. Media evaluation of public opinions. Ex. Media Tenor International reports, % of negative/positive reports, Awareness Threshold of 3%( Below 3% leads to higher risk), Value Reporting of company’s value drivers.
©Enterprise Risk Advisory, LLC
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Value of Reputation: Quantitative Measures An Intangible asset which doesn’t show up in the balance sheet. It
is sometimes referred as “Emotional Capital.” It has a current value and influences future value of the firm. Best approach is by the Court of Financial Opinion: Stock
Market! Estimated value of reputation = Market Value of Company -
Balance Sheet Value - Intellectual Property – Brands( Cos like Brandz, Core Brand) – Copyrights - other Intangible Assets. Usually, reputation is the largest component of intangible assets. Reputation reflects the rise of the “non-physical economy”,
especially in the developed world. Some surveys have shown ratios of market value to balance sheet value between 10 and 100. ©Enterprise Risk Advisory, LLC
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Reputation Risk: Regulatory Definitions
FSA: The risk that the firm may be exposed to
negative publicity (Trust) about its business practices or internal controls (Actions), which could have an impact on the liquidity or capital of the firm or cause a change in its credit rating. (Affecting its stakeholders). US Federal Reserve(2004): “Reputation risk is the
potential loss that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions (financial loss).
©Enterprise Risk Advisory, LLC
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Business Definitions of Reputation Risk
US Federal Reserve(2004): “Reputation risk is the
potential loss that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions (financial loss).
ADD other business elements: Loss value of key employees. Loss value of key suppliers. Increased cost of regulatory actions. Financial impact of rating agencies’ decisions. Financial impact of new products ©Enterprise Risk Advisory, LLC
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Reputational Risk: A Risk by Itself or a Consequence (Second tier) of Other Risks? According to Economist Intelligence Unit(2005) survey,
“52% consider reputation risk as a risk by itself, while 48% consider it as a consequence of other risks” like operational risk – people, process, systems and external events – compliance and financial. Appears that if first risks are more quantitatively
analyzed – market, credit, operational … Reputational risk appears as a second tier risk – mostly within financial institutions – while it appears as a risk of its own in the corporate world – like Hilton, Cruise companies where emphasis is on their products/services -.
©Enterprise Risk Advisory, LLC
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Reputation Risk: Qualitative Measures Complaints by all stakeholders act as an early warning system:
Monitor and analyze trends.
Identify and monitor your company’s HOT SPOTS in relation to all
your stakeholders’ interests, particularly in periods of rapid change. Ex. Organizational changes, new products/services.
Compliance/Audit functions. Are they proactively identifying and
following-up on issues?
Assess flows of risk information in the institution. Assess the link between compensation programs and desired
behaviors.
Is reputation risk part of the new product approval process? Is there a Code of Ethics? Reward ethical behavior? Penalize
misbehavior?
Evaluation of media coverage of companies Monitor internet blogs ©Enterprise Risk Advisory, LLC
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Reputation risk: Indicators Rate your organization: Low if
— Management anticipates well changes in market and regulatory nature — Franchise value minimally exposed Moderate if — Management adequately responds to changes in market — Franchise value is controlled High if — Management doesn’t anticipate reputation risk — Weaknesses are present — Franchise value substantially exposed to in litigation, consumer complaints.
©Enterprise Risk Advisory, LLC
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Reputation Risk: Quantitative Measures Measured as the market value impact of an event which is above
the direct value of the event itself, the excess is qualified as the reputational impact. Ex. Federal Reserve Bank of Boston measured Reputational
impacts of operational events: Internal Fraud: The market value impact was more than 6 times the value of the internal fraud itself, which is due to lack of control by the company and lack of confidence in actual management. Externally caused events: No reputational impact. Thus, seems to confirm the initial definition of reputation as being based on ACTIONS by company. Fines account for less than 10% of total market value loss.
©Enterprise Risk Advisory, LLC
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Reputation Risk: Quantitative Measures Failures by companies that have a reputational impact have a
lasting financial effect on the market value of companies: 1/3 of financial analysts say that their evaluation of a company will take into account the impact of a failure in reputation up to 3 years after the event. (Hill/Knowlton 2006 survey) Companies take up to 3 years to recover from a crisis that affected their reputation. (Burson/Marstelle Market research)
Model developed by UK-Based OxFord Metrica called
ValueReaction Model: Analyze impact of reputation crisis on company stock price. Will company recover from a crisis? If management handles crisis badly, investors conclude that management cannot handle unexpected events.
Set up Loss Data Base of operational events and their
reputational impacts.
Scenarios modeling of major threats using expert judgment
©Enterprise Risk Advisory, LLC
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Reputation Risk: Model Quantitative Financial and non Financial Impacts of Damage: Factors
Stock decline Run on the bank Spike in policy surrenders Outflow of assets under management Drop in sales, decline in market share Ratings downgrade Regulatory investigations, license withdrawal, fines Shareholders’ litigations and class-actions Political fall-out, discontent in communities Negative media coverage Pressure groups and public opinion Employees and contractors withdrawals.
©Enterprise Risk Advisory, LLC
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Reputational Risk: Importance of companies’ actions on Historical Reputation Events. Long-term Financial Performance
Client Service New products New services Pricing 47%
Corporate Governance Regulatory Compliance 66%
Reputation
External factors Social/Environmental Responsibilities Pressure Groups
Communication Disclosures/Security Breaches 57% Crisis Management Human Capital/Talent Culture Corporate Ethical Values 58%
Source: Economist Intelligence Unit, 2005 % of respondents.
ŠEnterprise Risk Advisory, LLC
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Examples: Non financial Sectors Catastrophe: Three Mile Island Safety Issue: Union Carbide chemical leak in Bhopal in 1984. Environmental issue: Home Depot promising to stop selling wood
from protected forests after Rainforest Group Action intervention, Exxon Valdez
Catastrophe: Concorde crash and impact on both Air France (less
impact ) and British Airways (larger impact due to slow response).
Product Recall: Tylenol tampering scare in 1982 due to cyanide. Limited
impact due to Johnson and Johnson quick responses in the end. In fact, Johnson and Johnson has been rated top in reputation by Harris Interactive. Perrier suffered longer from toluene traces found in its waters due to lack of crisis management.
©Enterprise Risk Advisory, LLC
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Examples: Financial Sectors Scandals/Fraud: Arthur Andersen co. fell almost entirely due to its
damage to its reputation after Enron’s scandal in 2002. Interesting case in the field of reputation. Similar to Barings in the field of operational risk. One year earlier in 2001, the Chief Executive was saying: “There is extraordinary power in our name because it stands for time-tested values, a unique one-firm global operating approach and recognized superior performance.”
©Enterprise Risk Advisory, LLC
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Examples: Financial Sectors Fraud: KPMG paid 456 million dollars but escaped indictment that
could have crippled the firm. External events: SARS had huge impact on tourism both in
Toronto and China. Market Timing/Fraud in 2003/2004 at Putnam Investments Paid 4 million in fines. Fired top management of international funds. Lost 14 billion of assets under management in a week (5%). Assets under management from 272 billion (03) to 192 (07).
Never recovered from institutional clients. Putnam sold to Great-West Life in Feb. 07 ending a history dating back to 1937.
©Enterprise Risk Advisory, LLC
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Examples: Financial Sectors Accounting Scandals at Fannie Mae: Direct impact: 400 million dollars in fine to SEC and
OFHEO. Indirect impact: Fannie Mae ordered to limit mortgage holdings at 727 billion dollars. Thus, company cannot grow anymore. This situation will last until “ it has implemented internal controls and risk management. We are talking years…” Scandal at Marsh. Stock declined by 40%, Moody’s
downgraded company due to decline in reputation.
©Enterprise Risk Advisory, LLC
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Example in the insurance industry: AIG Following investigations in a finite reinsurance, investigations led
to other investigations in accounting and fraud.. starting in March 2005 Result: Paid 1.6 billion in fines in February 2006 Share decline by 10 billion dollars in absolute terms when
investigations began. Relative share value destruction of 40 billion dollars considering the insurance sector performance between March 2005 and February 2006 when settlement occurred. Share price still hasn’t recovered in spite of increased profitability. Will take time to get back the reputation of the “world’s leading, rock solid insurance company.” AIG didn’t have a reputation recovery plan in place. ©Enterprise Risk Advisory, LLC
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Example in the insurance industry: AFLAC Japan Situation: Following investigations by the Japanese Regulator
about non payment of valid supplemental medical claims over 5 years– 10 cos. - Aflac and others had to review claims processes. Clearly an operational risk event. 90% of companies on Tokyo Stock Exchange offer Aflac
products! Continuous media coverage of the investigations. Operational impact on Alfac: Process and IT events: 19 169 errors Direct additional cost: 16 million dollars in additional claims. Represented .45% of all benefit payments, .01$ per share Possible fine by the FSA Costs to investigate, correct situations, publicize results.
©Enterprise Risk Advisory, LLC
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Example in the insurance industry: AFLAC Japan Reputation impact on Alfac: New sales dropped by 5% and 10%. Slow recovery Share price drop in early March 07:
©Enterprise Risk Advisory, LLC
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Management of Reputation Risk: Align with Risk Drivers Crisis Management (80%) Unplanned events but not necessarily unexpected. Mismanagement of crisis can seriously damage a reputation.
Media attention is high. Crisis team made of Board and technical people. Different from business continuity planning. Need to make strategic decision with little information. Ex. Katrina was a crisis mismanaged by all from President, FEMA to insurance companies. September 11 was better handled by former NYC mayor. His reputation was enhanced. Quote from Madeleine Albright: “ ..Being prepared for a crisis is never a waste of time.” Source: Economist Intelligence Unit, 2005
©Enterprise Risk Advisory, LLC
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Management of Reputation Risk Develop Corporate Social Responsibility programs: Build “goodwill” vis-à-vis stakeholders. Enhance internal ethical programs. (61%). Establish Code of Conduct by employees. AXA established a Sustainable Development Department in
2001 to coordinate a variety of environmental, community, educational and charitable programs. Integrate environmental impact studies in investment decisions and publicize.
Monitor external perceptions of company by all stakeholders
(61%)
Proactively monitor external threats. (56%). Ex. Sales practices,
bid rigging, failure of insurers, regulatory investigations, market timing on competitors and determine our possible reactions to them. Reactive or proactive and how to face the issue?
Source: Economist Intelligence Unit, 2005
©Enterprise Risk Advisory, LLC
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Management of Reputation Risk Establish Group Issue Processes. Ex. Swiss Re Establish an internal whistle blowing approach. A crisis
or an attack on reputation never come at a surprise. Someone knew something within the organization. Integrate communications strategies: right message,
delivered by right people to right audiences via a mix of channels is critical. Economic capital: Integrate reputation impacts into the
calculations of other risks, in particular operational risks. In financial industry, 30% feel that they can’t quantify while 66% feel that they can quantify in the energy sector. ©Enterprise Risk Advisory, LLC
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Framework for Governance of Reputational Risk Is reputation risk part of the overall risk policy? “Traditional Approach”: CEO is in charge (84%) Reflects focus on crisis management only, reactive Reputation is focused only on organization's own
operations. Dedicated personnel or dedicated task force CRO, head of business units, communications
manager (42%). Reputation risk management is more than PR. External parties expect dedicated resources like for the
other risks. ©Enterprise Risk Advisory, LLC
Source: Economist Intelligence U 2005
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External Views Rating agencies AM Best bases it evaluation on 3 criteria:
— Balance Sheet Strength — Operating Performance — Business Profile: Affected by reputation now and in the future. Affected by all reputation risk drivers. — Bases its rating on trust in management, enhanced by strong reputation, which is intrinsically linked to its capacity to manage its risk profile. Insurance regulators Reputation is a strategic asset of insurers. Each institution should
manage it proactively involving the Board and senior management as part of its overall ERM framework.
US Banking regulators OCC expects that reputation risk management will not be done in
isolation but will involve CRO, Board, Audit, Compliance, Customer complaint, HR OCC expects that compensation programs will support desired behaviors
©Enterprise Risk Advisory, LLC
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SOCIETY OF ACTUARIES Life Spring Meeting (May 2007) Session Topic:
Reputation Risk
Value Ladder
Employer/ Client
Overall Rating
All Sessions
1
Expected Attendance
2,690
22
Actual Attendance
2,238
24
All Sessions
Number of responses
998
9
Return rate (# of resp./actual att.)
45%
38%
Overall rating of this session
3.78
4.00
4.00 3.78
Provided you with practical technical information
3.97
3.44
3.44 3.97
3.83
3.78
3.78 3.83
Prepared you to impact industry-wide changes
3.64
3.33
Knowledge of Subject
4.28
4.56
Effectiveness of Delivery
3.79
4.13
1
Learning Experience
2
Indicate your level of Will enable you to make better business agreement with the following. This session: decisions
Leslie Gaines-Ross
Presenter Effectiveness1
This Session
Number of participants indicating presenter included commercial promotion in presentation
Scott Newquist
0
Knowledge of Subject
4.28
4.75
Effectiveness of Delivery
3.79
4.38
Number of participants indicating presenter included commercial promotion in presentation
Michel Rochette
0
Knowledge of Subject
4.28
3.63
Effectiveness of Delivery
3.79
3.50
Number of participants indicating presenter included commercial promotion in presentation
Moderator Effectiveness 1 : Rate the moderator's skills in managing this session
0 3.80
3.33 3.64 4.56 4.28 4.13 3.79 0 4.75 4.28 4.38 3.79 0 3.63 4.28 3.50 3.79 0
4.00
1
The rating scale used: Excellent (5), Very Good (4), Good (3), Fair (2), Poor (1), and N/A (no value).
2
The rating scale used: Strongly Agree (5), Agree (4), Neither Agree nor Disagree (3), Disagree (2), Strongly Disagree (1), and N/A (no value).
4.00 3.80
Evaluation Tips to keep in mind when reviewing the responses: Numerical evaluations tend to give you a pretty good feeling for how well the attendees responded to the session as a whole. Scores in the range of 3 to 5 are considered successful programs. Written comments come from people who may have a strong opinion, therefore they tend to be very good or very bad. Repetitive comments that point to the same theme could be an indication of an area you may want to capitalize on in the future or work on for future presentations.
Perception Solutions, Inc.
www.perceptionsolutions.com
7/17/2007
SOCIETY OF ACTUARIES Life Spring Meeting (May 2007) Session Evaluation (Participants' Comments) Session
Value Ladder
1
Employer/ Client
Perception Solutions, Inc.
Overall Comments Regarding This Session
Very interesting.
www.perceptionsolutions.com 7/18/2007
Comments- 1