Companies in the food, auto, and consumer goods industries frequently integrate ingredients and components from a supply chain that can stretch around the world. The goal? To sell quality finished products from store shelves and internet sites. But when a product failure or contamination event triggers a recall, the financial impact and stress placed upon the global supply chain can quickly become a major problem and a financial nightmare for all involved.
We are seeing increased awareness by companies of the need for both product recall and product liability insurance coverage. In a recall situation, multiple lines of insurance may be asked to respond to address the financial damages incurred by a company. These insurance programs, often intended to work together, actually can lead to some friction. Knowing the roles and purposes of product contamination insurance coverage, product recall cover, and product liability coverage can have a significant impact on a company’s expectations when faced with a claim.
When a Recall Occurs
The financial impact of a recall is never easy to measure; it’s often a complex interplay of multiple parties, policies, and insurers. Each party in the supply chain will be impacted in a slightly different way.
Once an insurance claim is filed, insurers need to evaluate the scale and accuracy of the claimed financial damages before coverage can be determined and the claim paid. An investigation, review, and due diligence process must occur, often involving insurance claims professionals, relevant experts, forensic accountants, and other resources. And because multiple policies may need to respond, each insurer could have its own team of experts completing this process.
Critical is being able to document the cause of the loss, its impact and the resulting losses, and—a common challenge in product recall events—identifying who is responsible for paying each aspect of the documented loss.
Two Policies, Two Different Things
Merely having insurance coverage neither eliminates the potential for disputes and litigation in these cases, nor guarantees a swift settlement of a claim. The insurer’s goal in managing the claims review is to develop an accurate evaluation of the recoverable loss and its role and obligations in settling that claim.
Among the first steps claims professionals take is to analyze the claim against each potentially invoked policy and to segregate costs to the appropriate policies and coverage afforded by each.
Product contamination/recall policies typically are a first-party coverage product. This type of policy is intended to cover the insured party’s direct losses and costs, including the value of inventory destroyed, recall costs associated with locating and retrieving the product, extra expenses, brand rehabilitation, loss of profits suffered by the insured, and, perhaps, select consulting and legal costs. In general terms, the carrier providing a recall policy is working closely and directly with the insured to establish the losses, determine coverage, and measure the financial impact the insured has suffered.
Product liability is a third-party coverage product. In the context of production manufacturers, this policy is intended to protect the insured against claims filed by the insured’s customers, its customers’ customers, or other third parties for damage caused. This coverage most often is triggered when a product failure or contamination event causes bodily injury or property damage to a third party. The value of a third party’s damaged goods and losses is most often considered by the general liability policy, on behalf of the insured. The insured’s own products are typically excluded, as is recall expense, although some general liability policies offer some limited recall cover by endorsement.
These two policies seem fairly straightforward. But how a first-party product recall policy might interact with a third-party product liability policy can cause complications.
For instance, a complication can arise because both polices might provide cover for the same or similar elements of the claim, such as the inventory losses of the third party. An agreement may need to be reached as to which insurer will contribute what amounts to the value of damaged third-party inventory, which often is a large element of a recall claim. The carriers will need to reach an understanding, which can take time since it’s based on investigations into the cause of the loss.
Additionally, the third-party inventory loss includes costs and materials added to the product by the third party, as well as the insured’s own ingredient or component. The value of the insured’s product should be isolated, as this will be payable by the recall policy. The distinction between first- and third-party losses in such multi-component products takes some detailed accounting analysis.
From a claims management perspective, the practicalities of communication and the ability to obtain appropriate financial support for losses can be complex. In first-party losses, the carrier has the luxury of working directly with the policyholder. There likely is a good client relationship, and the insured often is comfortable providing information to support losses.
With third-party losses, the insured’s customers may be unwilling to provide support for their losses. The customers may feel that limited information is needed to support the loss, and that the insured simply is liable to pay the amounts demanded. This can make it challenging for the insured to support a claim for payment by his general liability carrier. This also is true for claims from a third party that may be covered by the recall carrier under a third-party endorsement. Successful claims management is more likely with early engagement and dialogue with third-party customers, which allow for documents and financial support to be gathered. It is critical to initiate those discussions early, while the third party is still interested in assisting in the claims process.
From a claims payment perspective, the recall policy acts as a reimbursement policy—the losses must be incurred, paid, and supported by the insured in order to be paid by the insurer. The general liability policy pays losses to third parties on behalf of the policyholder. Such payments may be negotiated, settled, and paid to the policyholder without the need for the policyholder to have made payments to the third party. Thus, payments may be feasible for the general liability carrier more quickly than the recall carrier.
Assumptions that these policies will respond, process, and pay claims in the same manner, and disconnects from one or all parties involved, can result in confusion, frustration, and tension in the claims process. Anticipating these disconnects and mitigating them through effective communication can help all parties navigate a recall and the related insurance claims more efficiently. Collaboration and understanding the nuances of these policies and their interaction are paramount in these situations. A solid claims team that is aware of these issues and is willing to discuss them openly will bring success in claims management.