Originally published in the August 2009 issue of NationalUnderwriter's e-newsletter, E&S/Specialty Lines Extra.

CAUTION! A U.S. government agency has alerted consumers thatconsumption or use of this product may pose an unsafe, hazardous orpotentially harmful threat to users.

This type of announcement has become more commonplace in recentyears.

In the United States, the numbers of voluntary and involuntaryrecalls continue to hit higher levels than in the past–or at leastthey have played out more dramatically in the media.

In 2007, at a Capitol Hill news conference, the year was dubbed“The Year of the Recall.” This label was supported by statisticsthat there were 472 consumer product recalls during thisrecord-setting year.

In mid-2008, a spokesperson for the U.S. Consumer Product SafetyCommission in Washington said the number of recalls continued torise.

From peanuts to pistachios, much attention has been paid toproduct recalls in 2009 as well–particularly consumable productrecalls. The January 13 recall of peanut products, notorious forbeing one of the largest recalls in U.S. history, was just thestart of 2009's recall issues.

The peanut is unsurpassed in the number of businessesaffected–more than 2,100. In this case, microbial contamination hadan impact on a wide variety of products in the supply chainincluding cereals, health bars, crackers and ice cream. Given thatthis chain reaction affected a large number of other businesses,the peanut outbreak in total was also responsible for eight deathsand 575 illnesses throughout the United States, according to pressreports. (See, for example, Associated Press report, “PeanutProduct Recall Tops List of Bad Foods,” Feb. 5, 2009).

It's more than a few peanuts

Everyone is no doubt aware of the well-publicized recalls of petfood due to melamine poisoning, not to mention the contamination ofbeef, spinach, tomatoes, jalapeno peppers, pistachios and cookiedough in the past 24 months.

The 2007 recall of pet food, which turned out to be the largestrecall of pet food in history, impacted 1,177 products in total andcost the primary company involved more than $55 million inexpenses, plus an additional $30 million in litigation settlementcosts, according to various media reports.

But it's not just food items that are being affected. Outside ofconsumable products, numerous consumer goods and products have alsobeen recalled. As the United States continues to rely oninexpensive products manufactured in China, this reliance hasfueled
heightened interest in adherence to consumer safety standards.Interest in standards picked up after the 2007 recall of children'stoys due to lead paint and continues today with concerns associatedwith Chinese drywall mounting.

The U.S. government has cracked down in an effort to maintainpublic safety. Standards have continued to become more stringent aswe uncover more about consumer safety and what it takes to keep thepublic safe. Government agencies such as the Consumer ProductSafety Commission, the Food and Drug Administration, the U.S. Dept.of Agriculture and the Environmental Protection Agency are allgoverning authorities. Each entity has taken on a strong role ininsuring the safety of consumers.

The insurance community has also responded to catastrophicevents and product recalls by creating crisis management divisionsand brand protection products. These insurance vehicles affordbalance sheet protection and restoration of reputational integrityto companies that must take part in voluntary or involuntaryrecalls.

Product recall solutions

It is important to note that this insurance coverage ispurchased on a standalone basis. It is over and above the potentialcoverage provided by a commercial general liability program, whereunintentional bodily injury and property damage claims would findcoverage due to a negligent act, error or omission.

In the past, recall insurance programs were not readilyavailable or did not have the needed scope of coverage. Today,standalone coverage can be readily found from a number of domesticcarriers. More importantly, it is available to a wide array ofbusinesses–including those involved in the automotive supplysector, a typically hard-to-insure area.

Target industries for consumable products are food and beveragecompanies, pharmaceuticals, cosmetics and pet food companies. Forconsumer goods and products, target businesses are those involvedin manufacture or distribution of equipment, machinery andappliances, toys, sporting goods, furniture and jewelry, to name afew examples.

There is also coverage for component parts that can be a varietyof products that are manufactured, distributed, imported, exportedand sold as part of another manufacturers' product. These are thecritical and non-critical “ingredients” or “parts” of thethird-party product.

Product recall coverage generally has two parts: Coverage A,first-party expense coverage, and Coverage B, third-partyliability. While Coverage A will cover the direct expenses, i.e.recall expense, business interruption, consultant costs andrehabilitation associated with the recall, Coverage B will addressthe damages of a third party, potentially including the customer'sgross revenue, recall costs and customer product rehabilitationcosts.

Coverage B comes into play when a third party uses the insured'sproduct as part of its product. For example, the recall of peanutsand peanut products distributed by the Lynchburg, Va.-based PeanutCorp. of America (now in bankruptcy) affected third-partybusinesses that manufacture crackers and ice cream using PCA'speanut butter paste. PCA sold peanut butter in bulk packaging incontainers ranging in size from five to 1,700 pounds and paste in35-pound packages to tanker containers.

Carriers are also able to address additional losses as a resultof a recall. The impaired-property expense endorsement responds inthe event that a third party's product cannot be used or is lessuseful because the ingredient or component has impaired theproduct's usefulness.

A standalone coverage form for product recall can be tailored tomeet the individualized needs of an insured. It is able to affectbetter and broader coverage than that of an endorsement to a CGLprogram, which generally only covers the notification, shipping anddisposal costs surrounding a recall event.

Recall Costs and Management

The cost of a recall and the reputational damage associated witha recall can devastate a business. A 2006 article (by LevickStrategic Communications, a crisis communications firm) referencesa Washington State University study putting the average cost of arecall at $540,000–about twice that of an average productlitigation settlement ($217,000). In August 2005, Horsham,Pa.-based Jury Verdict Research reported a similar figure as themedian jury award in product liability lawsuits involving consumerproducts like food and household appliances ($216,300), althoughJVR said the overall median for all categories of products was $1million, with transportation, medical and farm products driving upthe overall figure.

An insurance program can work to minimize the occurrence andpossible toll of a recall on a business. Upfront, a recall programcan educate the insured on how to manage potential exposure. Thecarrier or third-party provider can assist the insured informulating a plan of prevention as well as an emergency crisisresponse plan of notification.

Once a threat is encountered, carrier-assigned crisis managementconsultants work swiftly to respond in the event of a crisis,providing 24/7 assistance and communication. Early and promptmitigation is the most critical component in saving a situation aswell as a brand.

Experts brought in to manage the crises and respond to mediascrutiny are invaluable resources for the insured. The recovery ofthe affected business will often depend heavily on the ability torestore consumer confidence and insurance recall products are vitalin satisfying this need.

It is important to note that balance sheet protection and brandintegrity do not have to be an overwhelming expense. Recall programpremiums can start as low as $5,000 with deductibles beginning at$25,000. This is an expense that many businesses cannot afford tolive without.

Tainted food recalls create widespread risk

By Joseph Bermudez, attorney, Cozen O'Connor
and Mitchell Schmidt, senior vice president, custom casualty, ACEUSA

Originally published in the Aug. 31, 2009, issue of NationalUnderwriter P&C.

If a Hollywood screenwriter was shopping around a script called“Eating Dangerously in America,” you might associate it with a newreality TV show. Sadly, however, that title can be used toillustrate a new reality for many businesses feeling the effects ofthe massive international recall of peanuts last year.

The result was one of the largest food recalls this country hasever experienced–prompted by the discovery of salmonella linked toproducts from Peanut Corp. of America. Those peanuts are alleged tohave sickened more than 690 people in 46 states, killed nine, andresulted in the recall of nearly 3,900 peanut products.

While the enormity of this recall is striking in terms of thewidespread effect it had on people and businesses, even more so isthe fact that PCA supplied a mere 1 percent of the nation's peanutproducts. Conservative estimates place recall costs for the foodindustry at well over $1 billion.

While the damage caused by these tainted products sickenedpeople and wreaked havoc on the nation's food supply system, italso had detrimental effects on global food supply chains.

Following closely on the heels of the PCA recall was the morerecent Setton Farms pistachio recall. Companies that used SettonFarm's pistachios in manufacturing their products will also have toconduct voluntary recalls.

In addition, like the PCA fiasco, the Setton Farms recall isalso international in scope, since potentially contaminatedproducts were exported to other countries.

It's important to understand that a recall affects far moreproducts than it might seem at first glance. There are thousands ofpeanut-related products, many of which are staples in the diets ofaverage Americans.

Big companies are not the only ones troubled by these recalls,as companies in food-related industries of all sizes risk grievousharm to their reputation, brand equity and their bottom line.

Unfortunately for some companies dealing with potentiallytainted food products, it will be their last recall because theywill use all their financial resources in dealing with such acrisis.

However, whether a company dealing with the recall is a nationalproducer of food products or a local caterer, each is at risk inthe context of the global food supply chain.

There are many potential reasons for the increase infood-related product recalls and the expanded scope of their impacton the local, national and global food supply chain. It's no wonderlocal food producers are experiencing business and profitabilitychallenges.

Given the globalization and complexity associated with the foodsupply chain, the centralization of food manufacturing anddistribution processes, and the increased appetite for processedand raw foods, small businesses have a particularly difficult timenavigating the food system.

Even with the resources that larger companies have, there aremany hurdles and challenges to consider–such as the presence ofpharmaceuticals in the water, global warming and evolvedpathogens.

Companies large and small find these challenges and theirfinancial impact particularly difficult to swallow.

The costs involved in cases of food-borne contamination, forexample, are staggering. Food-borne diseases cause an estimated 76million illnesses, 325,000 hospitalizations and 5,000 deaths eachyear in the United States. The U.S. Dept. of Agriculture's EconomicResearch Service estimates the annual cost due to food-bornepathogens is in the range of $6.6 to $37.1 billion.

Another related cost to the food industry is product liabilitylitigation. Indeed, over the past several years, there has been asteady increase in the number and variety of product liabilitylawsuits.

The risk of such lawsuits is present not only for companiesinvolved in the food industry but also for firms that source andsupply goods within the United States and around the world. Intoday's global economy, products purchased by Americans are oftenfully supplied or contain components grown, packaged ormanufactured in locations around the world.

And the inherent risks and quality controls required to manageglobal supply chains are numerous. Fully identifying these risksand understanding how they impact a company's supply chain controlsshould be a top priority of management and include feedback andbuy-in from all levels of the organization.

While risk profiles vary greatly, based upon a company's overallproduct mix, distribution channels and strategies, all companiesneed to put quality control procedures in place.

Some key factors to consider when establishing an effectivequality control process include:

o Planning and strategy (proactive preparation)

o Contracts, enforceability by jurisdiction, records retentionand documentation

o Recall process (a formal written plan, widelydisseminated)

o Incident investigation

o Crisis response and process management

o Media communication

o Employee communication

o Regulatory notification

o Broad and tailored insurance coverage.

Companies that develop and implement various aspects of thequality-control process should consider establishing across-functional team, including individuals with specializedexpertise and a range of responsibilities.

These individuals should include representatives from thefollowing corporate functions: product procurement, distributionmanagement, legal, risk management, treasury, human resources andaccounting, as well as corporate communications.

Members of the cross-functional team should be positioned todiscuss exposures, required controls, standards,regulatory/compliance, available resources and contractualprotections.

A key aspect of the proactive risk management of productliabilities is the management of contractual relationships andpurchasing appropriate levels of insurance coverage andcapacity.

Understanding and verifying contractual obligations betweensuppliers, distributors and end users can be confusing for anorganization. The ability to verify the certification of adequateand appropriate insurance coverage can often be achieved withU.S.-based companies, but foreign firms may be challenged and oftenstruggle to meet these standards.

Vendors or additional insured coverage grants are oftenunavailable. Indemnification agreement language varies widely andoften is unenforceable in many jurisdictions.

Most often the strongest contractual protection available issimply securing the insurance coverage.

However, it is important to recognize that not all insurancepolicies and insurance companies are created equal. An importantconsideration is the financial stability of the insurance providerand partners in the supply chain.

Product liability claims can arise over a broad period oftime–therefore the long-term financial strength of the insurancecarrier is critical.

Standard general liability contracts include coverage for thefirst named insured's product liability exposures. It is important,however, to understand the level of coverage provided and wherepotential gaps in coverage may exist, based on a company's internalassessment of risk factors.

The breadth of insurance coverage available in the market todayvaries greatly from one insurance carrier to the next. Companiesshould seek to understand this diversity and partner with insurancecarriers with strong underwriting, claims and risk controlexpertise.

In conclusion, the continued expansion of the global economy andsupply chain requires all companies, whether large or small, toremain vigilant in their efforts to understand their exposures torisk and proactively manage it.

There are many activities companies can undertake to minimizeand mitigate these risks. For risks that cannot be fully mitigated,the risk must be assumed or transferred by way of insurancecoverage.

An important next step for those companies interested intransferring the risk is to wisely select the insurance broker andcarrier that can best meet their needs.