Is Your Company’s Insurance Recall-Ready?
October 27, 2014 - Kestrel Food Safety
Are you insured against a food recall? Should you be? Even plants with the best controls are at risk—human error, mechanical breakdowns, or sampling failures can happen at any time. No company is immune to a food product recall; in fact, it is safe to assume that they will one day have to deal with some type of recall situation.
The number and magnitude of product recalls has increased significantly in recent years. The FDA and USDA documented 1,275 class I and II food recalls in 2012, indicating that on average, 30 recalls occur every week in the U.S. As global supply chains grow in complexity, so do risk exposures. Food imports to the U.S. have grown by an average of 10% each year over the last seven years, according to the FDA.
The increased complexity and geographic reach of food distribution networks has dramatically increased the chances of accidental contamination. Beyond that, the Food Safety Modernization Act (FSMA) has granted the FDA substantial new powers to police and, for the first time, order the recall of a food.
Every company that deals with food or food products must be concerned with contamination in today’s world.
Product Contamination Consequences
A full-scale recall involving food products can be detrimental to a food manufacturer or retailer. In fact, 81% of companies polled by the Grocery Manufacturers’ Association consider the financial risk from recalls as significant to catastrophic.
There are three primary consequences of a major product contamination/recall event:
- Product recall expenses – product replacement costs, recall and redistribution expenses, product destruction costs, related crisis management consultation fees
- Business interruption – financial loss due to product unavailability, decontamination downtime, government action, brand damage, and loss of contracts
- Third-party liability – financial loss due to third-party property damage and bodily injury
In many cases, a recall event will result in decreased profits over the short run of 6-18 months. The long-term brand damage to an entire product category, if tarnished, can impact earnings over an even longer period of time. One form of protection from these economic and reputational damages can be to transfer risk through an insurance policy that is specifically designed to respond to a recall event.
Are You Covered?
Business Owner’s Insurance Policy “BOP” provides most enterprises with two main forms of coverage: Commercial General Liability (CGL) and Business Property. Many food and beverage companies operate under the misconception that basic CGL insurance coverage will provide protection in the event of a product recall.
In reality, a CGL policy will provide protection for claims of policy-defined bodily injury or property damage brought by third parties. These policies typically contain an exclusion (Recall of Products, Work or Impaired Property) that precludes coverage for any claims of damages associated with any loss, costs, or expenses involving the policyholder’s product, work, or impaired property if it involves a product recall or withdrawal because of a known or suspected defect.
Because most CGL policies do not cover recall-related losses, such as direct recall costs, business interruption losses, and lost profit claims from suppliers, companies should carefully assess their need for separate Product Recall, Business Interruption, or similar types of insurance.
Protecting Company Assets
Product Contamination/Recall policies provide an emerging level of coverage beyond GCL insurance. Companies can purchase either first-party or third-party Product Recall policies, or both.
First-party policies provide coverage for the insured’s own economic loss incurred as a result of a recall in the following areas:
- Business interruption
- Lost profit
- Recall expenses
- Rehabilitation expenses to respond to adverse publicity and rebuild a brand’s image
- Consultant and adviser costs
Third-party coverage applies to economic loss incurred by third parties (e.g., distributors, wholesalers, customers) and includes broad coverage for numerous costs associated with food recalls, including:
- Sweeping the supermarket shelves to remove the recalled product
- Transportation and disposal of the product
- Notification to third parties of the recall
- Additional personnel/overtime
- Cleaning equipment
- Laboratory analysis
Business Interruption insurance is another coverage that could be impacted by a recall situation and should also be considered. Business Interruption insurance may cover not only catastrophic losses, but also food recall events. If purchased, it is important to make sure that the Business Interruption coverage works hand-in-hand with Product Recall coverage.
What to Look for in a Policy
Product Recall insurance should be specifically tailored to meet the needs of a particular company—the value of the policy is in the details. What is covered in a policy is key to maintaining viability in a recall situation. Umbrella policies and product liability policies need to be checked and verified for possible recall applications.
Here are some things that a company should assess when purchasing or renewing a Product Recall/Contamination policy:
- Will the policy cover recalls where the likelihood of bodily injury is remote, such as a class II or class III recall? What if a recall is requested (vs. ordered) by the FDA or other agency?
- Will the policy cover loss from an FDA administrative detention?
- What happens if loss is incurred due to a recall or other event and it turns out that the facts underlying the recall are later determined to be incorrect?
- Does the policy exclude coverage if the recall or other loss was due to a problem with a competitor’s product?
- Does the policy exclude loss if the product breaches a warranty of fitness?
- Does the policy provide coverage for claims by third parties (e.g., customers)?
- Does the policy cover lost profits/revenue and how is the loss calculated?
- Does the policy cover the logistical and reparative measures associated with a recall (e.g., shipping and destruction, public relations, product replacement, and reputational repair costs)?
Managing a Recall Situation
The risk for all food companies of being affected by a recall is substantial. If a company has not yet faced a recall, chances are that it will. Managing that product recall claim is a complex process, which is why it is far better to insure that the company is recall-ready before a recall happens.
Working with a risk management partner with deep experience in this area can help companies avoid severe financial and reputation damage by helping them to:
- Better understand potential product contamination and exposure
- Analyze the potential insurance coverage vulnerabilities to product contamination and recall
- Understand the impact of retaining exposure on the balance sheet versus the risk transferred via insurance or other means
- Better manage third-party relationships by assessing contamination risks at the supplier or contract manufacturer level
Submitted by: Bill Bremer