Preparing for the Unexpected with Product Recall Insurance
Companies often incur substantial costs implementing and responding to product recalls. A children's product recall might include any of the following costs, among others:
- Investigation expenses
- Public relations and crisis management costs
- Increased labor costs to remedy the product defect and respond to customer inquiries
- Cost of replacement products or parts
- Consumer refunds
- Shipping and transportation for recalled items and replacement products and parts
- Storage or disposal costs for recalled items
- Defense and settlement or judgment costs for any third party claims of bodily injury or property damage resulting from the defective product
- Marketing costs to rehabilitate the brand and product
A company will likely suffer a significant loss of profits following a recall. One of the many urgent questions a company will have when facing a recall is whether it has insurance coverage to offset these costs and losses.
Over time, the insurance market has evolved to respond to product recall risks. This evolution, however, has caused confusion over the scope of coverage available under different types of policies. The losses resulting from a recall could potentially implicate several types of insurance, but this article will focus on a common source of confusion in the product recall scenario: the differences between a typical commercial general liability (GL) policy and a policy specifically insuring for product recall.
While many large companies now carry product recall insurance, many others – particularly smaller businesses – still do not. This is sometimes due to misconceptions about the scope of available coverage under their GL policies. Even those businesses with product recall insurance may have narrower coverage than their exposures warrant. The continued expansion of the product recall insurance market in 2015-2016, including expansion to small businesses through lowered premiums and retentions, warrants a closer examination of every children's products supplier's insurance program to determine adequacy of coverage in the event of a recall or withdrawal of products from the marketplace.
Do You Have Coverage for Product Recalls Under Your General Liability Policy?
A company's GL policy may cover the costs associated with defending, settling and paying any judgment on claims of bodily injury or property damage to third parties resulting from a defective product. However, recalls and market withdrawals are preventative in nature, implemented to prevent future unknown but potential injury. Indeed, some products are recalled when there has not been any bodily injury or property damage, but the potential defect is nevertheless known. As a result, GL policies typically do not cover a company's out-of-pocket expenses incurred in implementing a recall, nor the company's lost profits and expenses in rehabilitating the brand and product following a recall.
GL policies also commonly contain exclusions pertaining to product recalls. A GL form used by the Insurance Services Offices, Inc. has an exclusion for "Recall of Products, Work or Impaired Property," also commonly called the "Sistership Exclusion" that excludes coverage for:
Damages claimed for any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of "Your product" . . . if such product . . . is withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, deficiency, inadequacy or dangerous condition in it.
Insurance Services Offices, Inc. Coverage Form (CG 00 01), Excl. n.
This exclusion may not preclude coverage for property damage or bodily injury caused by the defective product (before or after recall) but may preclude coverage for the company's recall costs, even though the recall is implemented to prevent future bodily injury or property damage. Similar exclusions may also preclude coverage for a company's out-of-pocket costs in implementing a recall. Some insurance carriers may also draft this Sistership Exclusion more broadly, seeking to apply it to any liability incurred by the insured on third party claims relating to recalled products.
Product Recall Insurance
While it may be possible to procure some product recall insurance by adding an endorsement to a GL policy, many insurance carriers now offer separate (and usually broader) policies specifically insuring product recall. Product recall insurance policies were first available primarily for products in the food and drug industries, but have now expanded significantly. Indeed, according to insurance broker Aon, the market capacity for product recall underwriting increased by approximately 25% in 2015 for food and non-food risks. In 2016, more insurance carriers expanded product recall insurance to the small business market by offering policies with lower retentions and premiums. In addition, more carriers have exhibited flexibility on key exclusions and definitions, including government recall requirements.
Product recall policies may provide coverage for the following types of losses: 1) the direct costs to implement a recall, 2) the profits lost by the company as a result of the recall; 3) costs to reestablish the company's reputation and market share; 4) crisis management costs; and 5) costs incurred in paying claims made against the insured by others in the distribution chain, including distributors, wholesalers and retailers (third party business interruption costs). The policy may be written to provide coverage only if the recall is necessitated by a particular event, or it may be written on an "all risks" basis, generally covering any type of recall except those specifically listed in the policy's exclusions. Ordinarily, the trigger for coverage is the company's knowledge that the product is or may be defective, and that use of the product could cause (or has caused) bodily injury or property damage.
Scope of Coverage Under a Product Recall Policy or Endorsement
Before purchasing or renewing a product recall policy or endorsement, it is imperative to understand any limitations or exclusions that might exist in the proposed language. For example, the definition of "recall" may differ between insurance carriers and policy forms in terms of the necessary timing of the recall. Some product recall insurance may respond only with respect to products recalled before sale, whereas others may respond also to products withdrawn after sale. Product recall policies may also provide coverage only for certain types of costs incurred during the recall. For example, some carriers offer coverage for recall notification expenses, increased labor costs and similar consequential losses associated with a recall, while excluding coverage for the costs to replace the defective product or refund customers. In addition, narrower product policy forms or endorsements may require a government-ordered recall, and thereby exclude coverage for voluntary recall. However, in 2015, an increased number of carriers began offering more flexible policy language in this regard, including forms eliminating the requirement of government-mandated recalls.
It is imperative for a company to assess its recall risks and exposures before a recall happens. Given the enormous financial impact a product recall will likely have on a company, the extent of government regulation over the children's product market and the substantial number of recalls impacting children's products, manufacturers should ensure that they have thoroughly reviewed their exposures and compared those exposures to their existing policies to determine the adequacy of coverage in the event of a product recall.
For additional questions, please contact Christina Arnone, or the Stinson Leonard Street attorney with whom you regularly work.