Ready, Set … Recall!!!

Protecting the consumer is the number one priority in a product recall. The challenge is, can you do so without crippling your business?

For consumer goods manufacturers and distributors, recalls can cost millions of dollars in product losses and operational delays, not to mention the potential long term damage to a company’s reputation and customer confidence in the safety of their products. Although a company may have an understanding of the various aspects of a recall, such as how to notify government officials and regulators and how to isolate the suspect product, they may not have a logistical plan for reputation-saving efforts. Companies must be prepared to deal with a recall from several angles, including financial protection, logistical planning and communication with the public and media.

Financial protection through product recall or contamination insurance is only part of the solution. Insurance products should be supplemented by a crisis management component that assists companies both with logistics and communications considerations, as well as real-time crisis support to safeguard the insured’s reputation.

Accidental contamination
The most common cause of product recalls in 2005 came from “mislabeling.” This type of “accidental contamination” may occur for several reasons, including misprinting of ingredients or simply applying a similar, but incorrect label to the product. Although the pro-duct itself may not be contaminated, the product’s mislabeling could lead to bodily injury through allergic reaction.

More commonly, accidental contamination is an unintentional contamination by an external source or substance. This would include contamination by a foreign object (glass, metal, stones), chemicals (oil, cleaning solvents), as well as a biological contaminant (listeria, salmonella, Ecoli). These contaminations generally occur either through contaminated ingredients obtained from suppliers and having made their way through incoming quality control, or through faulty machinery or facility maintenance. A light bulb breaking over a batch; metal shavings from a conveyor belt or improperly sanitized equipment are a few real life examples of accidental contaminations.

Oversight of product recalls in the U. S. is overseen by several agencies. The U. S. Food and Drug Administration is responsible for over 80 percent of food and beverage products with the remaining 20 percent administered by the U. S. Department of Agriculture. Non-food recalls are regulated primarily by the Consumer Product Safety Commission, but other governmental agencies regulating non-food recalls include the National Highway Traffic Safety Administration (automobile and related), the U.S. Coast Guard (watercraft), and the U. S. Environmental Protection Agency (pesticides).

Malicious product tampering
A less common, but potentially more destructive risk comes from deliberate or intentional contamination. The motives for product tampering vary widely, making controlling or managing the exposure very difficult. Moti-vations can be financially driven, as is the case in product extortion incidents and although uncommon in the U.S., countries such as Germany, Canada, the United Kingdom and Australia have a long history of these types of events. Disgruntled employees or customers are another potential tampering threat that seeks to “punish” a company for either real or perceived mistreatment.

The possibility of a biological, chemical or radiological attack on the food supply continues to be a major concern for consumers, manufacturers and the government alike. The events of Sept. 11, 2001, reinforced the need to enhance the security of the U. S. Political, terrorist or extremist groups may target companies due to a country affiliation or controversial product. The Animal Liberation Front, terrorist groups and other special interest groups have all demonstrated their ability to carry out damaging campaigns.

First party, third party and contractual
Losses resulting from a product recall are generally classified as either first party or third party losses. First party losses are those that may be directly incurred or suffered by the insured. Third party losses are those suffered by customers of the insured and for which the insured may be legally obligated to reimburse the customer. Third party “recall” liability losses should not be confused with general liability or product liability.

The obvious and initial first party financial exposure lies in the logistics of the recall itself and the notification expenses incurred in properly and promptly notifying the public of a safety issue and recall. Communications, warehousing, testing, transportation, employee overtime and clean up are some of the extraordinary costs that may be incurred. However, the potential long term losses from the damage to a company’s reputation and loss sales are of far greater concern. Unlike the expense of the physical recall, the loss of profits and brand rehabilitation expense may continue for months or even years.

Third party exposure to recall can be more difficult to quantify as these are largely outside the company’s control. Third party losses typically include losses suffered by customers as a result of a recall caused by your product. Third party recall losses are not limited to recall expenses alone. They can include your customer’s loss of profits and extra expenses incurred not only to the affected product, but also to other products your customer may sell. Companies providing component parts or ingredients, as well as contract manufacturers, have the greatest exposure to third party recall losses. The contamination of an ingredient, however small or insignificant, will affect the entire product rendering it useless.

Companies that use subcontractors or co-packers face a unique exposure that can be difficult to control. In most cases, these companies use stringent qualifying criteria prior to selecting a co-packer and require that co-packers abide by quality assurance standards at least equal to their own standards. However, should a co-packer precipitate a recall, they may not have the financial capabilities to respond to their customer’s losses.

While requiring the co-packer to carry recall insurance may provide some level of protection, it is difficult to monitor and often the benefit accrues to the co-packer and not the customer. As it is the company’s brand and reputation at stake, these exposures are best addressed through their own insurance program.

Risk management and transfer options
No amount of insurance can replace customer confidence lost due to the ineffective execution of a company’s recall strategy. Once an incident becomes known to the media, a company can expect difficult questions from a range of interested parties. Customers will want a clear understanding of the potential danger and measures the company is taking to minimize or eliminate the danger. Likewise, governmental agencies, employees, suppliers, distributors and other parties will have questions.

Every company should have a well documented and practiced crisis management plan. The crisis management plan coordinates all aspects of the crisis including procedures designed to quickly and efficiently identify, locate and recover any suspected products. The plan defines the crisis management team and their respective roles in responding to the crisis. All members need to be reachable at a moment’s notice. In many instances, the crisis team is supplemented by outside members that may include public relations and crisis management consultants.

Mistakenly, many companies believe they are protected for product recalls under their general or products liability policy. While these policies do provide coverage for liability from bodily injury, they do not provide coverage for product recalls. In fact, standard ISO forms specifically exclude “damages claimed for any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of your product, your work or impaired property. …” Although some liability carriers may provide an extension for product recall losses, these are usually subject to a minimal sublimit and are limited to first party recall expenses only. These extensions do not cover any first party loss of income, profits or extra expense, nor do they provide crisis support.

Product recalls are a threat to the short and long term profitability of companies in a wide range of industries. Properly analyzing the exposure is the first step in preparing an effective response. An appropriate response includes analyzing the exposure and developing not only the appropriate insurance program response, but also minimizing long term damage through pre-incident planning and effective timely response. The product recall insurance marketplace is a specialized market dominated by a handful of insurers. Aligning the insured with the proper insurance coverage, preparedness and crisis support will be key in how well a company weathers the recall storm.

Bernie Steves is a senior vice president in Colemont Insurance Brokers’ Chicago office.