Taking it Back

Recalls, advisories, and safety alerts involving consumer products, vehicles, food, and health products have been on the rise in recent years. Recalls can be costly and even devastating to a business, but product recall insurance is increasingly available to help companies mitigate this risk. Adjusters who deal with manufacturing-related claims will need to understand how product recall insurance fits into the commercial landscape.

Product recalls can be mandated by a government regulatory agency operating under a specific statute or regulation. Recalls can also be initiated voluntarily if a manufacturer discovers a problem with a product – a step that can save money and help limit the damage to a manufacturer’s reputation.

As recall incidents have increased over the last few years, so have the number of insurers offering product recall coverage. Recall insurance can be relatively expensive, but it can make commercial sense for manufacturers that face exposure to recall but cannot afford to self-insure.

Recall vs. liability insurance

Product liability insurance and product recall insurance are sometimes confused. Product liability insurance is coverage for third-party liability claims for physical damage or injury arising from defects or problems related to products. This coverage is typically part of an insured’s commercial general liability (CGL) policy. Extensions to cover product recall are sometimes available on product liability policies, but they cover only recall expenses.

Comprehensive product recall insurance, on the other hand, is separate, first-party coverage for the insured’s economic losses resulting from product recalls. Comprehensive recall policies also cover third-party liability related to financial loss resulting from recall of the product.

Though each product recall insurance policy is unique and tailored to the specific insured’s business, there are three basic elements of comprehensive product recall insurance policies:

1. Indemnification for recall costs

2. Lost revenue

3. Crisis management services

Recall cost indemnification

The costs related to a recall can vary depending on factors such as the type of product involved, how widely the products are distributed, the ease or difficulty of pinpointing the problem that led to the recall, what it takes to remedy the problem, the time it takes to manufacture and restock replacement product, and so on. An automotive product recall, for example, can cost several times more than the original distribution of the product.

Direct recall costs that may be covered under comprehensive recall insurance policies include the following:

•costs of determining the scope of the recall and tracing the products

•transportation costs to remove recalled products and distribute replacement products

• costs of investigating the problem that led to the recall

• costs of fixing the problem – for example, cleaning contaminated production facilities

• costs of repairing or replacing recalled products

• temporary additional labour costs – for example, to staff consumer phone lines

• costs of additional regulatory burdens – for example, if products have to be re-inspected

• costs for legal and other professional advice

• advertising and promotion costs to help restore reputation and brand value

In addition to the obvious direct costs, recalls involve significant indirect costs. These are harder to quantify, and they can impact a business long after the recall is completed. For example, distributors may refuse to continue carrying the company’s products; the company may face increased borrowing costs because of damage to its reputation; and the company may lose market share to competitors while a product is off the market.

Lost revenue

As for a business interruption claim, determining the amount of revenue lost as a result of a recall is done mainly through forensic accounting. For example, loss calculations will require a projection of the sales that would have been possible if the recall had not occurred. For this part of the claim, gathering appropriate financial records is critical: recent operating statements, budget forecasts, sales and production records, and so on.

Crisis management

One of the reasons recalls can be catastrophic is because of the negative impact on the company’s brand and reputation. To mitigate the risk, timely and effective crisis management is key. A company usually does not have internal crisis management expertise, so the coverage provided under recall insurance fills an important gap. Crisis managers can help organize the logistics, including determining the scale of the recall, notifying others in the supply chain, overseeing public relations efforts, and so forth.

Company choice

Product recall policies have a deductible, which can be high, and the coverage itself can be fairly expensive. Whether or not a given manufacturer or supplier chooses to use product recall insurance will depend on a number of factors. One is whether or not it’s likely that the company will be subject to a recall. In general, the more components or ingredients there are in a product, the more chance there can be for exposure to recall risk – and the recall risk may extend to the suppliers of individual components or ingredients.

Another consideration is whether the company can self-insure the risk. Very large companies may prefer to spread the risk across different lines of business rather than purchasing product recall insurance.

For companies that are not large enough to self-insure, the decision may come down to whether or not the company could cope with a recall event. If a recall could potentially wipe out the company, recall insurance should be considered.

As in any claims situation, an adjuster dealing with a product liability event involving a recall will need a clear understanding of the coverage that’s in place. The adjuster will also need to understand both the nature of the loss and the specifics of the business before determining how to document the loss. W

This article is based on excerpts from ADVANTAGE Monthly, a series of topical papers on emerging trends and issues provided to members of the CIP Society. The Chartered Insurance Professionals’ (CIP) Society is the professional organization representing more than 15,000 graduates of the Insurance Institute’s Fellow Chartered Insurance Professional (FCIP) and Chartered Insurance Professional (CIP) programs.