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July 16, 2015 Articles

Insurance for Product Recall Expenses

By Syed Ahmad, Kyle Sampson, and Patrick McDermott

The risk of product recalls is a fact of life for many businesses. Recalls entail numerous expenses and disruptions to business operations. Obtaining insurance coverage for those expenses and related exposures is critical for businesses that may face the unwelcome prospect of recalling a company product.

Recalls can reach into nearly every corner of the economy, from food, drugs, and medical devices to motor vehicles, child safety seats, toys, and household chemicals. In the United States, numerous federal agencies—including the Food and Drug Administration, the Consumer Product Safety Commission, and the National Highway Traffic Safety Administration—have authority either to formally order a mandatory recall of products that violate regulatory standards or to informally “recommend” that regulated firms launch a voluntary recall. Recent examples include a recall of tens of millions of vehicles with defective safety equipment and the massive recall of ice cream products due to listeria contamination.

Not surprisingly, the potential costs associated with recalls can be enormous. They include amounts spent to carry out the recall, including publicizing the recall, retrieving the recalled product, and disposing of the product. They also include lost sales, both for the product that was in fact recalled and in additional future sales due to possible damage to goodwill and brand name. And, of course, every recall raises the specter of lawsuits. These amounts can add up quickly. For example, according to the Wall Street Journal, one safety equipment manufacturer had posted hundreds of millions of dollars in recall-related charges in the last three years.

In light of the myriad of potential costs, insurance is an important vehicle for mitigating losses associated with a recall and related litigation. While a variety of insurance products may cover such losses, companies with significant recall exposures often purchase policies specifically designed to cover losses associated with recalls. Subject to the particular terms, product recall policies typically cover things like costs to recall a product, lost profits resulting from the recall, and any potential reputational damage. These specialized coverages can also provide access to, and reimbursement for, crisis management services.

Product recall policies can be industry-specific and even specific to the underlying cause of the recall. For example, AIG offers “celebrity endorsement” recall insurance to cover costs of recalls resulting from public disgrace of a celebrity endorser. So, when considering a product recall policy, companies should be aware of the costs that the specific policy covers and of the availability of specialty policies that may meet any unique needs they may have.

If a company finds itself facing a potential recall, it should examine all of its insurance policies that may provide coverage to identify all available sources for reimbursement for the costs and exposure associated with the potential recall. In addition to the product recall policies described above, other insurance policies such as general liability, property, business interruption, errors and omissions, and crime policies may provide coverage for certain costs associated with a recall. Policyholders should review these other coverages closely because they may exclude coverage for damages incurred in recalls. However, even policies with such exclusions may cover certain categories of damages arising from a recall.

Identifying applicable insurance quickly is important because the coverage may apply to a variety of pre-litigation costs, such as those incurred in investigating the root cause of the incident that led to the recall, publicizing the actual recall, and undertaking public relations campaigns in response to a recall. The costs incurred before any litigation can be substantial, and companies will benefit from identifying all applicable policies early in the process.

After identifying potentially available coverage, policyholders should provide timely notice to the insurance companies. Without timely notice, insurers may argue that potential coverage has been forfeited. Timely notice also allows policyholders to obtain benefits available under certain policies, such as the crisis management services available under some product recall policies.

Record keeping is another important step in obtaining coverage for recall costs. Businesses should keep detailed records of all costs associated with a recall and of losses incurred because of the recall. These records will prove vital in seeking recoveries under the applicable insurance policies. For example, as described above, insurance may cover many pre-litigation costs. Without documenting the costs associated with, for instance, the investigation of what caused the food contamination or product malfunction that resulted in a recall, the policyholder may be unable to sufficiently substantiate the costs that may be covered and subject to reimbursement.

A recall may also affect the availability and the cost of new insurance coverage for the company. Therefore, when the potential for a recall arises, an aspect of insurance known as an “extended reporting period” becomes a significant consideration. When insurance is provided on a claims-made basis—meaning that it covers claims made against the policyholder and reported to the insurer during the policy period—there can be an option to pay an additional premium to extend the time period in which to report claims to the insurer. This way, the policy will cover claims reported during the extended period that the policy would not otherwise cover. For example, take a claims-made policy that covers claims made and reported between July 1, 2014, and July 1, 2015, with a provision that allows the policyholder to extend the reporting period to July 1, 2016, in exchange for an additional premium. If the policyholder recalls a product in December 2014, it may face claims that it cannot report until after July 1, 2015. The policyholder’s claims-made policy may not cover those claims, and because of the recall, the policyholder may find it difficult to obtain a new policy to cover those claims. In this scenario, the policyholder will likely find it beneficial to purchase the extended reporting period so that the policy will also cover claims that are made before July 1, 2015, but that are not reported to the insurer until after that date. Premiums for extended reporting periods can be significant, but an extended reporting period is an option worth considering, especially in light of the potential hurdles to obtaining new coverage in the aftermath of a recall.

In sum, costs associated with recalls can be wide-ranging and significant. Insurance is an essential way businesses can alleviate those costs. To protect insurance recoveries when the potential for a recall arises, companies should carefully consider available insurance coverage, provide notice under any applicable policies, document all relevant costs and losses, and evaluate the potential impact of the recall on insurance the company will need to purchase in the future.

Keywords: mass torts litigation, insurance, product recall, claims made

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