How product recall insurance works to protect your company Featured

8:00pm EDT October 26, 2010

Although product recalls such as those at Toyota have recently received a lot of media attention, recalls are nothing new.

“As far as consumer safety goes, whether it is consumer products or food products, there is certainly a much higher profile and increased number of recalls just because of the environment we’re in right now,” says Bernie Steves, managing director of Aon Risk Solutions Crisis Management Practice. “Clients are being faced with heightened risk and exposure. Fortunately, the insurance marketplace has learned over the years to respond in a more affordable fashion and with a broader scope of coverage than it has been able to in the past.”

Smart Business spoke with Steves about how product recall insurance can help your company should you find yourself facing a recall.

How often do product recalls happen?

There have been many high-profile recalls, particularly in the automotive area, over the last 12 months. From a media standpoint, a lot of that relates to the Toyota recall. There has been a lot of attention focused on it and a lot of concern, but it is something that has been occurring all along.

In reality, there have been more than 390 million car, truck or bus recalls since the National Traffic and Motor Vehicle Safety Act was passed in 1966. There are an awful lot of recalled automotive products out there, whether they are cars or component parts. Generally, those are all safety related defects, or they don’t meet federal safety standards.

What should companies know about product recall insurance?

The biggest change is that, in the past, it’s been a specialized type of insurance. It continues to be specialized, but the insurance marketplace has gained considerable knowledge in the last 10 years since it has been offering this type of coverage. The market has really homed in on what the exposures are and how it is underwritten. So the program now is much more affordable for smaller and midsized companies.

In past years, you were looking at minimum premiums and minimum retentions from six figures on up. That really limited those companies that could afford to purchase the coverage.

Today, with minimum premiums as low as $25,000 and deductibles starting at $50,000, it is applicable to a much larger range of businesses.

How do these policies work?

The recall of a product triggers the policies. The ultimate vehicle manufacturer is responsible for initiating the recall, but the source of the problem could come from any level of supplier — the guy that makes the screw or an integrated system provider to the OEM.

Generally speaking, there does have to be potential for bodily injury or property damage to occur because of the product in question. One thing that has changed is the availability to include ‘impaired property’ in the coverage.

Impaired property is an extension to these programs that extends the trigger beyond the bodily injury aspect, so that your product is making the end product less useful because it incorporates your product that is known to be defective. In other words, you get beyond that bodily injury aspect. So if the window doesn’t go up and down on a car, it’s not really a safety issue, but there is certainly an impairment issue.

While these policies were initially designed to respond only to those instances where there was potential for bodily injury, with the addition of this impaired property coverage, it can be extended to include situations where the end product is simply less useful.

How does product recall insurance respond to a claim?

There are a few ways these policies can respond. We generally look at either first- or third-party losses under these policies.

First-party losses are segregated into the losses that the insured themselves incur. For instance, take a component part manufacturer that incurs expenses to recall the product, such as notification, shipping and pulling stock back from its customers. Those expenses would be considered a first-party recall expense; they can be covered under the policy.

The policy also can cover the repairing, replacing or refunding of those products if they can’t be reused.

The flip side of that is the third-party expenses covered by these policies. For example, the insured is making widgets and sends those off to the customer, who comes back to it looking to be reimbursed for its own recall expenses. Depending on the actual carrier, third-party coverage can include third-party recall expenses. The same types of expenses are covered as for first-party expenses, and they are also extended to various other elements of third-party financial loss, such as loss of profits, extra expense or rehabilitation expense, again, depending on the carrier.

One other aspect that these policies provide is defense costs. So if the insured doesn’t believe that it is at fault for the problem, the policy will defend it against its customer.

If moving forward with a product recall, what can a company do to ensure it is getting the right amount of coverage for its needs?

The No. 1 thing to do is make sure you’re working with a broker that is familiar with the marketplace. It is a very specialized coverage, and a specialized number of carriers provide this coverage. It’s important that insureds are working with brokerage companies that have the expertise globally and have access to the various markets that can put these programs together.

Bernie Steves is managing director of Aon Risk Solutions Crisis Management Practice. Reach him at bernie.steves@aon.com or (312) 381-4145. In Detroit, contact managing director Mike Stankard at (248) 936-5353.