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"A Recall Won’t Happen to Me, We Are Extremely Careful and Test All The Time."
From airbags to pharmaceuticals to food products, what might risk managers learn from news and social media coverage of product recalls? For Pet Food and Treat manufacturers, they might serve as a wake-up call to the potential impact of a product recall event and a lesson in what should be done immediately to prepare for potential exposures.
In February of 2018 alone, there were 10 dog and cat food recalls listed on the FDA website and in the past 6 months the agency has seen everything from Salmonella, to Pentobarbital and even elevated levels of bovine thyroid hormone.
As FSMA regulations continue to roll out in the various stages and consumers continue to increase their social media presence, one can expect voluntary and mandated recalls to increase in frequency and quickly become brand altering events. Costs from a product recall or contamination event can easily range from hundreds of thousands to millions of dollars depending on how wide spread your products are distributed. In addition to the physical expense of a recall, falling sales due to poor consumer confidence, brand rehabilitation expenses and potential lawsuits may also contribute to long-term losses and even the closure of your business.
Despite an increase in pet food company recall frequency and the potential for extraordinary costs, most manufacturers do not adequately plan, prepare and practice for—or buy insurance to protect against—product recall events. In addition to proper insurance coverages, careful planning is essential in managing the risk of a recall.
First Party vs. Third Party
There are two categories of exposure for a company faced with a product recall incident: first-party operational losses to the company and third-party liability losses to injured persons or companies.
Unlike third-party losses, first-party losses are often overlooked including “Dependent Property”. In addition to initial recall expenses, the potential long-term losses from the damage to a company’s reputation and loss of sales may continue for months or even years.
Product Recall vs. General Liability
It is a common misconception that product recall is covered under a general or product liability policy. In some limited cases, the General Liability policy will include a limited coverage sometimes referred to as “Withdrawal Expense”. While this coverage does help you to physically move the recalled product back to your facility, it does not contemplate the true expenses of a recall event. General and Product Liability coverages do a good job of covering Bodily Injury and Property Damage but generally exclude contamination and recall events.
The addition of a product contamination or product recall policy protects your bottom line by covering the direct costs of recall but transferring the risk is only one part of closing the recall exposure gap.
Regardless of size, every pet food and treat manufacturer should establish solid product risk management policies and procedures for handling a recall.
Five Point Model
Think of your risk management plan as a 5 point plan that outlines a series of defenses to counter the threat of a product incident. The first point of defense is total commitment to quality and represents actions that can be taken to eliminate the majority of threats. Any threat that escapes being eliminated by the first point should be addressed by the second, and so on. As you progress, the plan becomes more specific and more effective at isolating and eliminating product incident threats.
- Point 1 - Total commitment to quality.
- Point 2 - Prepare with a contingency plan.
- Point 3 - Focus with training.
- Point 4 - Respond with expertise and decisiveness.
- Point 5 - Transfer risk where possible.
Product Recall Insurance
Insurance for first-party losses caused by product tampering and contamination incidents are broadly labeled as product recall insurance. Product Recall policies help cover the additional costs associated with a recall, including product loss, costs to withdraw the product from market, product disposal, product testing, overtime wages and crisis management—costs that can be devastating because they arise at a time when a company’s revenues are typically hardest hit.
There are several coverage forms, each designed to isolate some component of First-Party product exposure:
- Recall expense. This out-of-pocket expense is associated with executing a product withdrawal. It includes costs like extra temporary employees, overtime, public safety messages, special testing and handling, destruction and disposal costs and crisis management and/or Public Relations consulting fees.
- Replacement cost. As the name implies, this is the cost of replacing any product that has to be destroyed. This includes the cost of materials, labor and overhead directly associated with producing the product.
- Lost profits. This indemnifies the insured for profits which would have been earned on the withdrawn products and also for profits that would have been earned on future product sales but which were not earned because of resultant future sales declines. Indemnification is usually limited to a specified time period.
- Brand rehabilitation expense. Underwriters can also indemnify the insured for necessary rehabilitation of the recalled product’s consumer image. This includes costs like extra advertising, extra expense to rush a new product to market and special promotions to rebuild public trust in the manufacturer and its products.
In addition to transferring risk, thorough risk management practices are essential to minimize the exposure and the cost of a recall event. The Product Recall insurance marketplace is highly specialized and working with a partner who understands the complexities of this coverage is vital.
Talk with Marsh & McLennan
Marsh & McLennan Agency helps our customers determine how to best construct a Product Recall policy tailored to the needs of your company.