From Peanuts To Pet Food: Coverage Available For Rising Recall Exposures

In mid-2008, a spokesperson for the U.S. Consumer Product Safety Commission in Washington said the number of recalls continued to rise.

From peanuts to pistachios, much attention has been paid to product recalls in 2009 as well–particularly consumable product recalls. The January 13th recall of peanut products, notorious for being one of the largest recalls in U.S. history, was just the start of 2009′s recall issues.

The peanut is unsurpassed in the number of businesses affected–more than 2,100. In this case, microbial contamination had an impact on a wide variety of products in the supply chain including cereals, health bars, crackers and ice cream. Given that this chain reaction affected a large number of other businesses, the peanut outbreak in total was also responsible for eight deaths and 575 illnesses throughout the United States, according to press reports. (See, for example, Associated Press report, "Peanut Product 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 pet food due to melamine poisoning, not to mention the contamination of beef, spinach, tomatoes, jalapeno peppers, pistachios and cookie dough in the past 24 months.

The 2007 recall of pet food, which turned out to be the largest recall of pet food in history, impacted 1,177 products in total and cost the primary company involved more than $55 million in expenses, plus an additional $30 million in litigation settlement costs, according to various media reports.

But it's not just food items that are being affected. Outside of consumable products, numerous consumer goods and products have also been recalled. As the United States continues to rely on inexpensive products manufactured in China, this reliance has fueled heightened interest in adherence to consumer safety standards. Interest in standards picked up after the 2007 recall of children's toys due to lead paint and continues today with concerns associated with Chinese drywall mounting.

The U.S. government has cracked down in an effort to maintain public safety. Standards have continued to become more stringent as we uncover more about consumer safety and what it takes to keep the public safe. Government agencies such as the Consumer Product Safety Commission (CPSC), the Food and Drug Administration (FDA), the U.S. Department of Agriculture (USDA) and the Environmental Protection Agency (EPA) are all governing authorities. Each entity has taken on a strong role in insuring the safety of consumers.

The insurance community has also stepped up and responded to catastrophic events and product recalls by creating crisis management divisions and brand protection products. These insurance vehicles afford balance sheet protection and restoration of reputational integrity to companies that must take part in voluntary or involuntary recalls.

Product Recall Solutions

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

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

Target industries for consumable products are food and beverage companies, pharmaceuticals, cosmetics and pet food companies. For consumer goods and products, target businesses are those involved in manufacture or distribution of equipment, machinery and appliances, toys, sporting goods, furniture and jewelry, to name a few examples.

There is also coverage for component parts that can be a variety of products that are manufactured, distributed, imported, exported and sold as part of another manufacturers' product. These are the critical and non-critical "ingredients" or "parts" of the third-party product.

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

More specifically, Coverage B comes into play when a third-party uses the insured's product as part of its product. For example, the recall of peanuts and peanut products distributed by the Lynchburg, Va.-based Peanut Corporation of America (now in bankruptcy) affected third-party businesses that manufacture crackers and ice cream using PCA's peanut butter paste. PCA sold peanut butter in bulk packaging in containers ranging in size from five to 1,700 pounds and paste in 35-pound packages to tanker containers.

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

A standalone coverage form for product recall can be tailored to meet the individualized needs of an insured. It is able to affect better and broader coverage than that that of an endorsement to a CGL program, which generally only covers the notification, shipping and disposal costs surrounding a recall event.

Costs and Management of a Recall

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

(Editor's Note: An earlier article written by three crisis management experts in 2003 references the same recall costs figures, also attributing them to WSU and describing the $540,000 recall cost as the total personnel cost for a product recall at that time.

Professor Barbara Rasco, a researcher at the WSU department of food science, could not confirm the earlier figures, but reported to National Underwriter in an e-mail earlier this month that the direct costs of a recall are roughly 10 percent of the total costs. (See related infographic for direct and indirect cost breakdowns.)

An insurance program can work to minimize the occurrence and possible toll of a recall on a business. Upfront, a recall program can educate the insured on how to manage potential exposure. The carrier or third-party provider can assist the insured in formulating a plan of prevention as well as an emergency crisis response plan of notification.

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

Experts brought in to manage the crises and respond to media scrutiny are invaluable resources for the insured. The recovery of the affected business will often depend heavily on the ability to restore consumer confidence and insurance recall products are vital in satisfying this need.

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

Patricia Roth is senior vice president for large commercial property, casualty & environmental at S. H. Smith & Co., Inc. in Hartford, Conn. She may be reached at patricia_roth@shsmith.com.