diff --git a/Source/NakedDesire/NPC/NPCAIController.cpp b/Source/NakedDesire/NPC/NPCAIController.cpp
index 30ba085b..b5e6bc20 100644
--- a/Source/NakedDesire/NPC/NPCAIController.cpp
+++ b/Source/NakedDesire/NPC/NPCAIController.cpp
@@ -8,8 +8,10 @@
 #include "AI/NavigationSystemBase.h"
 #include "BehaviorTree/BlackboardComponent.h"
 #include "Kismet/GameplayStatics.h"
+#include "Perception/AISense_Sight.h"
 #include "NakedDesire/Global/NakedDesireGameMode.h"
 #include "NakedDesire/Player/NakedDesireCharacter.h"
+#include "NakedDesire/Stats/StatsManager.h"
 
 void ANPCAIController::SetShouldReactToPlayer(const bool Value)
 {
@@ -19,7 +21,7 @@ void ANPCAIController::SetShouldReactToPlayer(const bool Value)
 void ANPCAIController::OnPossess(APawn* InPawn)
 {
 	Super::OnPossess(InPawn);
-	
+
 	NavigationSystem = FNavigationSystem::GetCurrent<UNavigationSystemV1>(GetWorld());
 	GameMode = Cast<ANakedDesireGameMode>(UGameplayStatics::GetGameMode(GetWorld()));
 
@@ -29,7 +31,7 @@ void ANPCAIController::OnPossess(APawn* InPawn)
 
 	TArray<AActor*> TargetActors;
 	UGameplayStatics::GetAllActorsOfClass(GetWorld(), ANPCTargetLocation::StaticClass(), TargetActors);
-	
+
 	const int RandomIndex = FMath::RandRange(0, TargetActors.Num() - 1);
 	Blackboard->SetValueAsVector("TargetLocation", TargetActors[RandomIndex]->GetActorLocation());
 	Blackboard->SetValueAsVector("SpawnLocation", SpawnLocation);
@@ -37,3 +39,30 @@ void ANPCAIController::OnPossess(APawn* InPawn)
 	PlayerCharacter = Cast<ANakedDesireCharacter>(UGameplayStatics::GetPlayerCharacter(GetWorld(), 0));
 	Blackboard->SetValueAsObject("Player", PlayerCharacter);
 }
+
+void ANPCAIController::OnUnpossess()
+{
+	if (bCurrentlyObserving && PlayerCharacter)
+	{
+		PlayerCharacter->StatsManager->SetObserved(false);
+		bCurrentlyObserving = false;
+	}
+	Super::OnUnpossess();
+}
+
+void ANPCAIController::OnTargetPerceptionUpdated(AActor* Actor, FAIStimulus Stimulus)
+{
+	Super::OnTargetPerceptionUpdated(Actor, Stimulus);
+
+	if (Actor != PlayerCharacter)
+		return;
+	if (Stimulus.Type != UAISense::GetSenseID<UAISense_Sight>())
+		return;
+
+	const bool bSensed = Stimulus.WasSuccessfullySensed();
+	if (bSensed == bCurrentlyObserving)
+		return;
+
+	bCurrentlyObserving = bSensed;
+	PlayerCharacter->StatsManager->SetObserved(bSensed);
+}
diff --git a/Source/NakedDesire/NPC/NPCAIController.h b/Source/NakedDesire/NPC/NPCAIController.h
index bbd96ef7..a39754fb 100644
--- a/Source/NakedDesire/NPC/NPCAIController.h
+++ b/Source/NakedDesire/NPC/NPCAIController.h
@@ -4,14 +4,13 @@
 
 #include "CoreMinimal.h"
 #include "DetourCrowdAIController.h"
+#include "Perception/AIPerceptionTypes.h"
 #include "NPCAIController.generated.h"
 
 class ANakedDesireGameMode;
 class UNavigationSystemV1;
 class ANakedDesireCharacter;
-/**
- * 
- */
+
 UCLASS()
 class NAKEDDESIRE_API ANPCAIController : public ADetourCrowdAIController
 {
@@ -19,7 +18,7 @@ class NAKEDDESIRE_API ANPCAIController : public ADetourCrowdAIController
 
 	UPROPERTY()
 	ANakedDesireCharacter* PlayerCharacter = nullptr;
-	
+
 	UPROPERTY()
 	const UNavigationSystemV1* NavigationSystem = nullptr;
 
@@ -29,10 +28,14 @@ class NAKEDDESIRE_API ANPCAIController : public ADetourCrowdAIController
 	UPROPERTY(EditDefaultsOnly)
 	UBehaviorTree* BehaviorTreeAsset = nullptr;
 
+	bool bCurrentlyObserving = false;
+
 public:
 	UFUNCTION(BlueprintCallable)
 	void SetShouldReactToPlayer(bool Value);
 
 protected:
 	virtual void OnPossess(APawn* InPawn) override;
+	virtual void OnUnpossess() override;
+	virtual void OnTargetPerceptionUpdated(AActor* Actor, FAIStimulus Stimulus) override;
 };
diff --git a/Source/NakedDesire/Stats/StatsManager.cpp b/Source/NakedDesire/Stats/StatsManager.cpp
index 42684e39..86bdd29d 100644
--- a/Source/NakedDesire/Stats/StatsManager.cpp
+++ b/Source/NakedDesire/Stats/StatsManager.cpp
@@ -24,7 +24,22 @@ void UStatsManager::TickComponent(float DeltaTime, enum ELevelTick TickType,
 	FActorComponentTickFunction* ThisTickFunction)
 {
 	DecreaseEnergy(0.9f);
-	DecreaseEmbarrassment(1.0f);
+
+	if (ObserverCount > 0)
+	{
+		// TODO (#05): replace 0.0f with ClothingManager->GetEffectiveCoverage() when that lands.
+		constexpr float CoverageWeight = 0.0f;
+		IncreaseEmbarrassment(EmbarrassmentGainRate * (1.0f - CoverageWeight) * DeltaTime);
+	}
+	else
+	{
+		DecreaseEmbarrassment(EmbarrassmentDecayRate * DeltaTime);
+	}
+}
+
+void UStatsManager::SetObserved(const bool bObserved, const float CoverageWeight)
+{
+	ObserverCount = FMath::Max(0, bObserved ? ObserverCount + 1 : ObserverCount - 1);
 }
 
 void UStatsManager::IncreaseEmbarrassment(const float Amount)
diff --git a/Source/NakedDesire/Stats/StatsManager.h b/Source/NakedDesire/Stats/StatsManager.h
index ce0c229c..6437a9c4 100644
--- a/Source/NakedDesire/Stats/StatsManager.h
+++ b/Source/NakedDesire/Stats/StatsManager.h
@@ -19,9 +19,17 @@ class NAKEDDESIRE_API UStatsManager : public UActorComponent
 	float Energy = 1000.0f;
 	float MaxEnergy = 1000.0f;
 
+	int32 ObserverCount = 0;
+
 public:
 	UStatsManager();
 
+	UPROPERTY(EditDefaultsOnly, Category = "Embarrassment")
+	float EmbarrassmentGainRate = 10.0f;
+
+	UPROPERTY(EditDefaultsOnly, Category = "Embarrassment")
+	float EmbarrassmentDecayRate = 1.0f;
+
 protected:
 	virtual void BeginPlay() override;
 	virtual void TickComponent(float DeltaTime, enum ELevelTick TickType, FActorComponentTickFunction* ThisTickFunction) override;
@@ -30,6 +38,10 @@ public:
 	float Stamina = 100.0f;
 	float MaxStamina = 100.0f;
 
+	// Called by NPCAIController when sight is gained or lost.
+	// CoverageWeight: fraction of body covered [0..1]; pass 0.0f until #05 (GetEffectiveCoverage) lands.
+	void SetObserved(bool bObserved, float CoverageWeight = 0.0f);
+
 	UFUNCTION(BlueprintCallable)
 	void IncreaseEmbarrassment(float Amount);
 	void DecreaseEmbarrassment(float Amount);