Being Prepared for a Product Recall
Mass media attention of product recalls brings to light important reminders for risk managers. Producers and manufacturers of all industries need to keep in mind the potential impact of a product recall event. Each reminder should serve as a lesson in what needs to be done to prepare for potential exposures.
Costs from a product recall can easily cascade into the millions. In addition to the physical expense of a recall, reduced sales due to poor consumer confidence, brand rehabilitation expense and potential shareholder legal actions may also contribute to long-term losses.
Despite recall frequency and the potential for extraordinary costs, most companies don’t adequately plan, prepare or buy insurance against product recall events. In addition to proper insurance covers, careful planning is essential in managing the risk of a recall.
Differences in Exposures
There are two categories of exposure to loss for a company faced with a product recall incident: first-party operational losses to the company and third-party liability losses to injured persons.
Unlike third-party losses, first-party losses are often overlooked. In addition to the initial recall expenses, the potential long-term losses from the damage to a company’s reputation and loss of sales may continue for months or even years. Since these losses can be catastrophic, this article focuses on ways to manage first-party incident exposures.
A Dangerous Misconception
It is a common misconception that product recall is covered under a general or product liability policy. Those covers do a good job of covering bodily injury and property damage but generally exclude contamination and recall events. The addition of a product contamination or product recall policy protects a company’s bottom line by covering the direct costs of recall, but transferring the risk is only one part of closing the recall exposure gap.
Every technology company with products on the market, regardless of size, should establish solid product risk management policies and procedures for handling a recall or contamination event.
Three Types of Contamination Perils
It’s helpful to understand the three basic contamination perils when designing a risk management programme that provides the best protection for the least cost.
- Malicious tampering (intentional contamination) is prone to publicity, so it may seem common. Malicious tampering is rare, but when it strikes, it tends to be a very severe loss. Managing this risk exposure can be difficult, as motives vary widely.
- Accidental contamination is an unintentional error in the manufacturing, packaging or storage of a product. This includes mislabelling, contamination by a foreign object or chemical, etc. This peril is the most common, but the majority of incidents are discovered prior to shipment. Therefore, these events receive very little publicity. As opposed to malicious tampering, this peril has very high frequency but relatively low severity. While most accidental contaminations are small events, historically the largest losses have been due to accidental contaminations.
- Product extortion is the most difficult peril to characterise. Its frequency is between that of malicious tampering and accidental contamination. Its severity, however, is more difficult to quantify. Most extortions are amateurish hoaxes, but may evolve into outright tampering cases, which can be very costly.
Transferring the Risk
Insurance for first-party losses caused by product tampering and contamination incidents are broadly labelled as product recall insurance. Product recall policies help to cover the additional costs of a recall, including product loss, costs to withdraw the product from market, product disposal, product testing, overtime wages and crisis management — costs that can be devastating because they arise at a time when a company’s revenues are typically hardest hit.
There are several cover forms, each designed to isolate some component of first party product exposure. Work with Hayes Parsons Insurance Brokers to ensure your product recall policy provides indemnity for:
- Recall expense. This out-of-pocket expense is associated with executing a large-scale product withdrawal. It includes costs like extra temporary employees, overtime, public safety messages, special testing and handling, destruction and disposal costs and crisis management and/or PR consulting fees.
- Replacement cost. As the name implies, this is the cost of replacing any product that had to be destroyed. This includes the cost of materials, labour and overhead directly associated with producing the product.
- Lost profits. This indemnifies the insured for profits which would have been earned on the withdrawn products and also for profits which would have been earned on future product sales, but which were not earned because of resultant future sales declines. This is usually limited to a specified time period.
- Brand rehabilitation expense. Most underwriters will also indemnify the insured for necessary rehabilitation of the recalled product’s consumer image. This includes costs like extra advertising, increased expenditure to rush a new product to market and special promotions to rebuild public trust in the manufacturer and its products.
In addition to transferring risk, thorough risk management practices are essential to minimise the exposure and the cost of a recall event. The product recall insurance marketplace is highly specialised. Our team of experts can help secure the cover you need and collaborate with you develop a business continuity plan that meets your specific needs. Contact us today.