From peanuts to pet food

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

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

This type of announcement has become more commonplace in recent years.

In the United States, the numbers of voluntary and involuntary recalls continue to hit higher levels than in the past–or at least they 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 statistics that there were 472 consumer product recalls during this record-setting year.

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 13 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, the Food and Drug Administration, the U.S. Dept. of Agriculture and the Environmental Protection Agency are all governing authorities. Each entity has taken on a strong role in insuring the safety of consumers.

The insurance community has also 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.

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 Corp. 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 of an endorsement to a CGL program, which generally only covers the notification, shipping and disposal costs surrounding a recall event.

Recall Costs and Management

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.

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.

Tainted food recalls create widespread risk

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

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

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

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

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

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

Following closely on the heels of the PCA recall was the more recent Setton Farms pistachio recall. Companies that used Setton Farm's pistachios in manufacturing their products will also have to conduct voluntary recalls.

In addition, like the PCA fiasco, the Setton Farms recall is also international in scope, since potentially contaminated products were exported to other countries.

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

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

Unfortunately for some companies dealing with potentially tainted food products, it will be their last recall because they will use all their financial resources in dealing with such a crisis.

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

There are many potential reasons for the increase in food-related product recalls and the expanded scope of their impact on the local, national and global food supply chain. It's no wonder local food producers are experiencing business and profitability challenges.

Given the globalization and complexity associated with the food supply chain, the centralization of food manufacturing and distribution processes, and the increased appetite for processed and raw foods, small businesses have a particularly difficult time navigating the food system.

Even with the resources that larger companies have, there are many hurdles and challenges to consider–such as the presence of pharmaceuticals in the water, global warming and evolved pathogens.

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

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

Another related cost to the food industry is product liability litigation. Indeed, over the past several years, there has been a steady increase in the number and variety of product liability lawsuits.

The risk of such lawsuits is present not only for companies involved in the food industry but also for firms that source and supply goods within the United States and around the world. In today's global economy, products purchased by Americans are often fully supplied or contain components grown, packaged or manufactured in locations around the world.

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

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

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

o Planning and strategy (proactive preparation)

o Contracts, enforceability by jurisdiction, records retention and documentation

o Recall process (a formal written plan, widely disseminated)

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 the quality-control process should consider establishing a cross-functional team, including individuals with specialized expertise and a range of responsibilities.

These individuals should include representatives from the following corporate functions: product procurement, distribution management, legal, risk management, treasury, human resources and accounting, as well as corporate communications.

Members of the cross-functional team should be positioned to discuss exposures, required controls, standards, regulatory/compliance, available resources and contractual protections.

A key aspect of the proactive risk management of product liabilities is the management of contractual relationships and purchasing appropriate levels of insurance coverage and capacity.

Understanding and verifying contractual obligations between suppliers, distributors and end users can be confusing for an organization. The ability to verify the certification of adequate and appropriate insurance coverage can often be achieved with U.S.-based companies, but foreign firms may be challenged and often struggle to meet these standards.

Vendors or additional insured coverage grants are often unavailable. Indemnification agreement language varies widely and often is unenforceable in many jurisdictions.

Most often the strongest contractual protection available is simply securing the insurance coverage.

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

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

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

The breadth of insurance coverage available in the market today varies greatly from one insurance carrier to the next. Companies should seek to understand this diversity and partner with insurance carriers with strong underwriting, claims and risk control expertise.

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

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

An important next step for those companies interested in transferring the risk is to wisely select the insurance broker and carrier that can best meet their needs.