Insuring recalls of unsafe products

Significant loss potential requires close attention of manufacturers, distributors

By Phil Zinkewicz

About 25 years ago, three people in the Chicago area died from cyanide introduced into Extra-Strength Tylenol capsules. The link between the deaths and the tainted capsules was discovered quickly and authorities notified the manufacturer, Johnson & Johnson. The final death total was seven. The firm moved into crisis mode because the product, a leading pain reliever, accounted for almost 18% of the company’s income.

The U.S. Food and Drug Administration issued a warning not to take Tylenol but did not order the product recalled. Johnson & Johnson decided to bite the bullet on their own. The company voluntarily recalled the product from the shelves of retailers all over the country. J&J’s decision was commendable as it put public safety ahead of the recall costs involved. And the costs were significant—more than $100 million. What’s more, the company’s insurance didn’t cover the loss.

The situation gave rise to a new coverage in the insurance business—product recall insurance, not to be confused with product liability insurance. Over the years, there have been other headline-making product recall events, such as in the pharmaceutical industry when arthritis painkillers Vioxx and Celebrex fell into disrepute. (Celebrex is still on the market, but Merck voluntarily removed Vioxx from pharmacy shelves.)

Lou Lubrano, senior vice president for crisis management at AIG WorldSource, a subsidiary of American International Group and considered to be the architect of product recall insurance coverages, reports other costly incidents of products recalled:

• A snack food manufacturer’s operations included the co-packaging of a name brand cookie. Despite the manufacturer’s superior scores from a well-known third-party auditor, human error led to the mislabeling of a batch of the cookies—the batch was not labeled as containing nuts. Mislabeling of an allergen runs the risk of imminent bodily injury, so the company recalled the batch. The insurer paid approximately $700,000 including the company’s recall expenses and loss of income.

• A manufacturer and marketer of over-the-counter medication recalled more than 500,000 tubes of a topical cream because the tubes were not adequately coated by the tube manufacturer. Without adequate coating, the tubes were porous and permitted air to enter, causing the topical cream to become extremely potent. Losses paid by the insurer exceeded $350,000.

• A fish and food processor expected to spend about $35 million to cover costs associated with a recall of chili sauce and other products out of a U.S. unit because of a botulism scare. The costs included product recall, destruction, effectiveness checks, quality inspections, consumer reimbursement, professional services, factory shutdown and startup costs. The company’s chief executive anticipated monthly distribution to resume six months after the incident.

More recently, the product recall problem has become global in nature, with products imported from China being recalled from retailers’ shelves. WorldNetDaily reports that imports from China were recalled by the U.S. Consumer Product Safety Commission twice as often as products made everywhere else in the world, including the United States. The Internet Daily reports that, of the 152 product recalls announced by the commission since January 2007, 104 have been products made in China. They include: portable baby swings, swimming pool ladders, faulty baby carriers, Easy-Bake Ovens, oscillating tower fans, exploding air pumps, oil-filled electric heaters, notebook computer batteries and circular saws, among others. Certain pet foods and human foods from China have also been taken off the market.

“In the past few years, there has been a noticeable increase in product recalls, and the media attention to them, across the globe,” says Lubrano. “Whether it is a manufacturer of finished goods or an importer of consumer commercial or industrial products, the threat of a recall cannot be ignored.”

Lubrano says that his company’s product recall insurance, AIG WorldSource RecallResponse, includes coverage for the insured’s product recall expenses and liability to third parties for both finished and component goods. “Whether the recall is voluntary or involuntary, costs may include notifying customers, the cost of shipping and disposal of the product, extra warehouse expenses and the cost of extra personnel required to conduct the recall,” he says. “There are also the costs to refund, repair or replace and ship the product back to the customer to be considered.”

Among the types of operations that the coverage is suited for are: machining, stamping, assembly and heat treating operations; metal and plastic component manufacturing; food and beverage; consumer product manufacturing; electronic component manufacturing and equipment; packaging and bottling operations; medical products; children’s products; pharma-ceuticals; and distributors of foreign goods in the United States.

“Take auto parts manufacturers out of the equation,” says Lubrano. “There is very little insurance market anywhere for product recall for auto parts manufacturers because there are so many recalls in that industry,” he points out.

Lubrano says that, with the relatively new global commercial environment, it is important for product recall underwriters to understand “the chain”—where is the product made, where is it packaged, how is it distributed? “Government controls in foreign countries are often different than they are in the U.S.,” he says. “If an underwriter doesn’t know where the product is coming from and through what channels it passes, then that underwriter is not doing a proper job.”

Richard Reed, vice president of Global E&O product manager for Chubb, says that product recall is a coverage designed for manufacturers and distributors of products. “Those who have had adverse loss experience or who have come close to adverse experience should have product recall insurance. Sometimes, the insured is under a contractual relationship which mandates the purchase of product recall insurance. In fact, U.S., European and Canadian companies are pushing to force evidence of recall insurance into contracts, especially when products are imported from other countries where laws are different from the United States and Canada.”

Reed says there are three catalysts that trigger product recall: 1) voluntary recall when a manufacturer itself discovers there is something wrong with its product; 2) when safety becomes an issue because there has been injury or damage; and 3) when there is a regulatory requirement for a recall.

In situations where a vendor puts its brand on a product manufactured overseas, that vendor should act in a “prudent and responsible” manner in terms of the people they are dealing with and whether they have product recall insurance so that they are not brought into a quagmire of litigation, Reed says. They should make certain that they are indemnified, he says.

Reed adds that there are three ways to cover a loss as the result of a defective product. “If people are hurt by that product, then it’s a product liability claim,” says Reed. “If the product needs to be repaired or replaced, then it’s product recall. And, if the vendor or retailer suffers a financial loss, that’s errors and omissions insurance.”

In any case, both Lubrano and Reed say that brokers and under-writers should take special care when providing coverage for insureds that are depending upon foreign manufacturers, packagers or distributors. *