The best approach to reduce the likelihood of a recall is to have and enforce rigorous and consistent product safety standards and testing, in excess of regulatory requirements. Even with such practices, events can occur that are not preventable. These events can be mitigated using insurance. Product recall coverage can reduce the financial impact of a recall to a manufacturer and, as importantly, provide resources to recover from the loss with its reputation intact. For companies that provide food or other consumer products, product recall insurance is an important part of a well structured insurance program.

What can cause a product recall?

• Mislabeling issues which can range from strict legal compliance (failing to show a required date) to an error that could cause injury to customers
• Accidental contamination of the product
• Malicious tampering by others, including the creation of adverse publicity so that consumers think the product is unsafe

The recall can be initiated by the company’s own testing program or by an outside agency.

How does an insurance policy respond?

Product recall policies generally have three possible triggers for coverage:

• Accidental contamination
• Malicious tampering; such as the infamous Tylenol contamination
• Extortion; a demand for money to prevent product tampering

As with most insurance, the coverage is designed to address those events that occur despite your best efforts. Businesses still need to establish effective quality control and consumer safety practices - including a recall plan - so there is a proven procedure to evaluate and respond to a potential situation. Insurance exists as a backstop when the testing and checking are not sufficient or external forces create an exposure.

A critical factor in triggering insurance coverage is the potential for bodily injury or property damage as a result of a defect in the product. It is important to note that the actual liability arising out of the bodily injury or property damage would be covered under product liability and umbrella policies.

"What is covered by Product Recall insurance?

There are several types of expenses that can be covered:

• Recall expenses: including such items as communication costs, transportation costs, additional labor, and space for stored product. Recall expenses can also include the cost of replacing the products and delivering them to the customers.
• Third party recall expenses: when your product is incorporated in to another product, the customer’s costs to recall their product can be covered.
• Loss of gross profit or business income: this includes the profit from the contaminated product, subject to a deduction for expenses, etc.
• Rehabilitation expenses: the cost of rebuilding the brand after a loss.
• Increased cost of working: the additional costs incurred to repair a damaged piece of equipment, or to clean a process after a contamination.
• Product extortion: the policy can cover the actual extortion demand.
• Crisis response: all stand alone policies include crisis management consulting, so that a company has access to experienced help in dealing with the press and other communications issues, and can mitigate the loss through appropriate public relations and crisis control.

Are all policies the same?

There is basic coverage that may be available from an underwriter that will reimburse for the product recall expenses you incur – including notification, overtime to recover the product, transportation costs, etc.

Broader coverage will pay for those direct costs, but will also pay the claims of customers for the product that they needed to destroy, or recall, in the event of an incident. It will also pay for the costs of destroying the inventory that may have been contaminated. Coverage may also be available to replace the product.

Finally, the broadest coverage pays for the replacement of the customer’s product, including the transportation costs to the customer. Custom or “stand alone” policies include broader coverage grants, including third party recall (when your product is incorporated in to another, and the third product is recalled), your loss of profits in the event of a loss, the actual cost of an extortion demand, and crisis management. These “stand alone” policies have similar but not identical coverage definitions and the forms, terms and premiums must be evaluated in the decision process.

How is coverage available?

The least expensive, but more limited coverage can be obtained from a company’s standard insurer. Product recall expense coverage is considered a first party coverage, similar to property insurance. Depending on the jurisdiction, there may be liability coverage available to pay for the costs incurred by customers. This approach usually does not cover the cost of replacing the product. Also, the limits offered are fairly low, between $25,000 to $500,000.

For larger or more complex exposures, there are “stand alone” product recall policies which incorporate the loss costs above, including product replacement for both customers and the company, loss of profits, extortion claims and crisis management. These policies require a specific application and documentation clearly identifying the company’s quality control practices, testing plans, compliance tracking, and recall notification procedures. They also require information about the company’s product recall experience, even if it is minor. Premiums are based on the type of product, the distribution and the quality of the risk management processes in place, and, of course, the limit of insurance required. There may be loss control service available for the company to improve its procedures.

Which carriers write this insurance?

Product recall insurance is a very specialized insurance product written by relatively few carriers. Lloyds of London is an important market with a broad form provided by different syndicates including Catlin, XL Capital and others. In addition, AIG provides a stand-alone product. All of the policies are “non-admitted” which means that the policy forms can be customized, and there is no “standard” language. The policy form is very important and ERP will analyze those terms and conditions in addition to the premium to determine the best policy for your company. All product recall policies have a self-insured retention and often have a co-insurance requirement, so the client shares in the total cost of the loss. The level of the retention and co-insurance are part of the premium determination.

Crisis Management

A key benefit to a “stand alone” policy is the inclusion of Crisis Management services. Most policies contain a requirement that the crisis management firm be notified as soon as possible after an event, so that they can get involved and work with the client to minimize any adverse publicity. Prompt, appropriate communications after an event can make a huge difference in the ultimate cost of the recall to the company

Product recall is a significant exposure which can be transferred in the commercial insurance market. If your portfolio company has the exposure, we will assist in evaluating the options to reduce the risk.

For more information, please contact Joan Spiegel (415-874-7135, jspiegel@equityrisk.com)
or your Equity Risk Partners professional.