Product Recall Insurance is a special form of insurance, typically purchased by manufacturers and distributors to safeguard against the costs associated with withdrawing a defective, dangerous, or contaminated product from the marketplace. Coverage is underwritten by a handful of insurers who often provide specialized risk control and consulting services as part of their coverage offering.
The financial costs of a recall can be staggering, yet many small and medium manufacturers and distributors do not purchase coverage due to misconceptions and a general lack of understanding around how recall coverage and liability coverages work, which I’ll describe in a moment.
Who should consider Product Recall Insurance?
As mentioned, manufacturers and distributors of products as a broad class of businesses should be considering coverage. More specifically:
- Consumable products; such as food and beverage manufacturers, co-packers, importers, distributors, processors, exporters, and wholesalers.
- Consumer Goods – Manufacturers, importers, distributors, exporters, and wholesalers of appliances, electronics, clothing, furniture, children’s products, outdoor and sports products.
- Component Parts manufacturers, importers, distributors, wholesalers, exporters of parts used in general manufacturing (nuts, bolts, screws, metal parts), automotive, aviation, and medical devices.
What does Product Recall Insurance cover?
In its most basic sense Product Recall protection covers the costs associated with withdrawing a product from its distribution stream. Coverage is often structured as a “reimbursement” type policy and is broken into 3 parts:
- Part One covers direct expenses associated with the recall of a product. Things such as notifying customers, retailers, and distributors of a recall, the costs of physically collecting the product from store shelves or the distribution chain, shipping the products back to a warehouse and disposing of them, and the overtime/extra personnel costs incurred to perform a recall.
- Part Two covers the same types of expenses that a third party incurs and charges back to the insured when the insured’s faulty product is a component within that third party’s product. This coverage part will also include the potential loss of income and other expenses associated with their recall.
- Part Three is the optional endorsements which can be added to a policy to cover the lost profits, the replacement cost of the goods destroyed, rehabilitation of the insured’s brand, crisis management costs, PR costs, etc.
Now you may be saying: aren’t these types of claims covered by a product liability policy? Unfortunately, no, the products liability section of a general liability policy will not respond to claims covered/described above and is one of the leading misconceptions about this risk/exposure, and why business owners don’t purchase coverage.
What causes a recall?
Recalls can come from three major sources:
- Unsafe Products – which could be the result of imperfection, deficiency, or defect that creates an unsafe product that may cause a bodily injury or property damage. Here’s an example: The discovery of a faulty switch on an electronic device that could result in electrocution or fire. Here, the switch is a component of and incorporated into a larger device which may pose a serious or severe risk of bodily injury and property damage to others. Removing this product from the distribution stream is critical to avoid potentially serious claims for both bodily injury (electrocution) and property damage (fire which results in loss of real or personal property of others.)
- Defects in manufacturing – Here’s an example: The manufacturer of ice makers that are installed aftermarket in home refrigerators accidentally omits the right proper gasket in the device which results in numerous water leaks after installation. Here, the defective product creates hundreds of nuisance type claims for the manufacturer resulting from property damage to the homeowner’s kitchen floors and the food inside a refrigerator. It’s a less “serious” claim, yet one that will continue to spawn damage to the manufacturer’s brand and ongoing problems, so recalling and replacing the units is necessary.
- Adulteration – Adulteration affects consumable products and can result from microbiological, chemical, allergen, or physical hazards being incorporated into the product. Mislabeling of products can also trigger coverage. We have a client who manufactures food products and was notified by one of their spice distributors that a random test of a certain spice the client had purchased was processed in a facility that also processed peanuts and that peanut allergen could be in the batches of product they were sold. Unlabeled or mislabeled allergens is now one of the most significant reasons for a product recall. Our client had only manufactured a small batch of product which incorporated this contaminated spice, so the required recall was limited. Fortunately, they did have coverage and the insurer paid about $85,000 in costs associated with pulling the product off the shelves.
What are the common misconceptions about product recall insurance?
Business owners will often think that if a product needs to be recalled from the market that their product liability insurance will pay for it, unfortunately, this is not the case. Product liability insurance pays those sums an insured is legally obligated to pay due to one of their products causing bodily injury or property damage to a third party (a claimant). Product recall coverage does not cover bodily injury or property damage claims of others but instead uses this as a “trigger” which we’ll discuss in a moment.
Manufacturers, importers, and distributors often give the reason for not buying coverage as “I’ve never had a problem before, why do I need coverage?” I hear this a lot when we make different coverage recommendations like Cyber, D&O, Employment Practices, and others. Look, I get it, no one wants to expand their insurance budget, but the financial impact of a recall can be tremendous, and the risks are present, so a cost/benefit calculation should be done before dismissing coverage. Just because a client hasn’t had a problem in the past, doesn’t mean they won’t in the future.
Also, it doesn’t matter how well a firm screens its suppliers, or how strong their quality control program is, or how well run an operation is. Defects or errors are by their very nature anomalies – if they occurred with frequency or regularity a business couldn’t survive. It’s the anomalies that will destroy a company and its enterprise value and that’s the key reason why recall coverage should be considered.
What is the trigger for coverage?
The coverage trigger can change from one insurer to the next, so understanding what triggers coverage is critically important. One important footnote is that all policies will confine coverage to products that pose a threat of bodily injury or property damage. A policy will NOT respond or recall products that are poorly made or don’t work if there is no threat to injury or damages.
In terms of triggers there are two different types of coverage triggers:
- Voluntary – here the insured believes that there is a problem with a product and fears that it can lead to bodily injury or property damage to others and wants it out of the distribution stream before a problem arises.
- Involuntary – here, coverage is only triggered when a government agency; such as the Consumer Safety Products Commission, or an insured’s wholesalers or retailers mandate a recall due to a serious problem, again where there’s the threat of injury or property damage.
One final note.
Many general liability policies sold to manufacturers, distributors, and wholesalers will include an endorsement for recall expenses. This is not the same as a full-blown products recall policy. These endorsements are “good” but not great as they usually limit the scope of coverage to certain expenses as well as how much protection can be purchased.
To find out more about product recall insurance, and how it would fit into your risk portfolio why not give us a call to start a conversation.