From vehicles to pharmaceuticals to food products, what might risk managers
learn from mass media coverage of product recalls? For manufacturers of all
types of consumer goods, 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. According to data from
the U.S. Consumer Product Safety Commission (CPSC), there are an average of
35,000 consumer product-related injuries every year.
Costs from a product recall or contamination can easily become many
millions of dollars. In addition to the physical expense of a recall,
falling sales due to poor consumer confidence, brand rehabilitation
expenses and potential shareholder lawsuits may also contribute to
Despite recall frequency and the potential for extraordinary costs, most
companies don’t 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.
Types of Exposure
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.
Unlike third-party losses, first-party loss is often overlooked. 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. Since these losses can be catastrophic, this article
focuses on ways to manage first-party incident exposures.
Misconceptions and Considerations
It is a common misconception that product recall is covered under a general
or product liability policy. Those 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
Regardless of size, every company offering consumer products—and sometimes
those that offer products intended for commercial and industrial use—should
establish solid product risk management policies and procedures for
handling a recall or contamination event.
Understanding Three Basic Perils
It’s helpful to understand the three basic contamination perils when
designing a risk management program that provides the best protection for
the least cost.
- Malicious tampering (intentional contamination) is prone to publicity, so
it may seem common. In reality, malicious tampering is rare, but when it
strikes, it tends to be a very severe loss. Managing this risk exposure can
be difficult, as motives vary widely.
- Accidental contamination is an unintentional error in the manufacturing,
packaging or storage of a product. This includes mislabeling of
ingredients, contamination by a foreign object or chemical, etc. This peril
is the most common, but the majority of incidents are discovered prior to
shipment. Therefore, these events receive very little publicity. As opposed
to malicious tampering, this peril has very high frequency but usually
relatively low severity. While most accidental contaminations are small
events, historically the largest losses have been due to accidental
- Product extortion is the most difficult peril to characterize. Its
frequency is between that of malicious tampering and accidental
contamination. Its severity, however, is more difficult to quantify. Most
extortions are amateurish hoaxes but may evolve into outright tampering
cases, which can be very costly.
Think of your risk management plan as a pyramid that outlines a series of
defenses to counter the threat of a product incident. The first line of
defense is the base of the pyramid. What actions can be taken to eliminate
the majority of threats, such as unwanted bacteria, disgruntled employees,
malfunctioning equipment, sloppy suppliers or lax testing? Put that in the
first tier (bottom) of the pyramid. Any threats that escape being
eliminated by the first tier should be addressed by the second, and so on.
As the pyramid rises, the plan becomes more specific and more effective at
isolating and eliminating product incident threats.
- Tier 1 - Total commitment to quality. The good news is that most of what
can be done to protect against a product incident occurs in the area of
product quality assurance and control. Commitment to turning out the
highest quality products day after day is the best countermeasure to the
threat of a product recall crisis. This dedication to quality should be
evident in every aspect of business, from manufacturing to marketing. The
logic is simple: If the product can’t leave the plant in a contaminated
state and the packaging is designed so that tampering is difficult to
accomplish or obvious once done, the odds of experiencing a major incident
are considerably reduced.
- Tier 2 - Prepare with a contingency plan. It is essential to have a plan
in place before a crisis arises. Research indicates that the first 48 hours
of a major product incident are more crucial than the next 48 days. Every
company should have a workable product recall and crisis management plan.
- Tier 3 - Focus with training. Contingency plans aren’t of much use if
they haven’t been tested and honed under simulated conditions to ensure the
- Tier 4 - Respond with expertise and decisiveness. Even with a good team
and a good plan, there is a place in a recall crisis for professional
- Tier 5 - Transfer risk where possible. Even the best companies who are
prepared for a recall can suffer substantial financial losses. In spite of
all precautions, a large-scale public recall may cost millions of dollars
in extra expense, lost profits, lost inventory, lost shelf space and lost
market share. If it comes to this, the last line of defense is a solid
product recall insurance program—one that indemnifies for the host of extra
expenses and losses in revenue that come with product withdrawals.
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 to cover the additional costs of 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. Work with Robertson Insurance & Risk
Management to ensure your product recall policy provides indemnity for:
- Recall expense. This out-of-pocket expense is associated with executing a
large-scale 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 PR consulting
- Replacement cost. As the name implies, this is the cost of replacing any
product that had 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. This is usually limited to a specified
- Brand rehabilitation expense. Most underwriters will 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. Our team of
experts can help secure the coverage you need and collaborate with you
develop a business contingency plan that meets your specific needs. Contact
Robertson Insurance and Risk Management today at (717)625-3770.