With the recent rash of high-profile recalls by automakers, many suppliers of components are debating whether it makes sense to purchase product recall insurance. Here are some questions suppliers should ask about this relatively new insurance product.
Do I need product recall insurance?
You should seriously consider this insurance if you manufacture or distribute the types of components that, if defective, could lead to product recalls by your customer. As a rough rule of thumb, if you think you need products liability insurance you also should consider buying product recall insurance.
What losses are commonly incurred when a component supplier is subject to a product recall? Can I insure against all of those losses?
You can incur both direct and indirect losses when your customer’s product is recalled because it incorporates your faulty equipment or device. Most product recall policies allow you to select coverage for one or more of the following losses:
- The direct costs you incur to remove, re-install or destroy the recalled product.
- Injury to your reputation.
- Loss of your sales and other business.
- Loss of customers.
- Indemnity of downstream original equipment manufacturers (OEMs) or other customers.
- Costs of defending lawsuits (brought by your customer or by third parties).
- Recall losses incurred by third parties (e.g., your customer’s customers).
- What kinds of product recall insurance are currently on the market?
Many insurers have entered the product recall market. Most are offering “customized” products that allow customers to pick and choose among different kinds of policies and a wide variety of covered losses. Product recall policies can be purchased that cover only safety-related recall events, only non-safety related recall events (also referred to as “impaired property recalls”) or both types of events. You also may be able to purchase product recall coverage for a select number of your product lines.
What are the most important things you’ll want to include in your product recall policy?
Be sure that, at the very least, your recall policy provides for the following:
- Coverage for your replacement costs: Avoid recall policies that do not cover the costs you incur in replacing the defective products with non-defective ones.
- Coverage for your defense costs: Try to negotiate coverage for defense costs that do not erode your policy limits and allow you to select your preferred choice of defense counsel.
- Impaired property: Look for a policy that insures you for loss due to property becoming “impaired” because it incorporates your defective equipment.
- Coverage for government-mandated recalls: The definition of a “mandated recall” can vary between carriers, but most require that there be a reasonable possibility that the product will cause serious safety or health issues.
- Crisis consulting: This valuable service is offered by some insurers to provide recall contingency plans and assistance during a recall crisis.
- What policy exclusions and limitations should you try to avoid?
Some coverage exclusions and limitations are to be avoided if possible. These include:
- Overly broad definitions of an insured event: Under most product recall policies there must be an “insured event” before a loss from a product recall is covered. Try to avoid highly subjective limitations on what constitutes such an event. One product recall policy, for example, provides that an insured event triggers coverage only if, at the inception of the policy, “the insured was not aware of circumstances which could result in loss under this policy.” In a close case, the “aware of circumstances” qualifier may tempt an insurer to deny coverage.
- A broadly worded “pre-existing conditions” exclusion: Avoid policies that exclude coverage for “any condition, circumstance or situation” that caused or “could reasonably be expected to cause, lead to or result in” an insured event.
- An overly expansive “intentional acts” exclusion: Try to avoid product recall policies that exclude losses “from an intentional act or omission that the insured knew or should have known could reasonably lead to an insured event.”
- An exclusion for losses resulting from a decrease in your product sales following an insured event: A decrease in sales could be one of your biggest losses. Ask the insurer to delete this exclusion and add a policy endorsement that specifically provides coverage for “loss of gross profits.”
- An exclusion for fines and penalties. Avoid product recall policies that exclude coverage for fines or penalties imposed by third parties, courts or governmental organizations or agencies.
Product-recall coverage for component suppliers can vary widely from insurer to insurer. Shop around. Find an insurer willing to offer you a customized product recall policy that meets the particular needs of your company, at a cost you can afford.
Thomas Bick (above, left) is a Shareholder based in Butzel Long’s Washington, D.C., office. He is Chair of the firm’s Insurance Coverage Specialty Team. Bick specializes in litigation and client counseling relating to insurance coverage (representing policyholders).