The risk of faulty products

If the saying no publicity is bad publicity holds true, Cadbury must be having a field day. Just about everyone seems to be aware of the salmonella scare and, most recently, incorrectly-labelled Easter eggs. More importantly, for businesses, they can suffer significant financial loss if they have to succumb to a product recall.

The net direct costs of Cadbury's first recall in the UK comprised £5m of customer returns, £10m of stock destroyed, £17m remediation costs and £5m of increased media spend.

Cadbury estimated that the adverse impact on revenue was between £30m and £35m and between £5m and £10m on profit (net of £7m insurance recovery).

But that's just a snapshot of what is happenning in the fast-growing product recall world, which now enjoys a capacity of $50m in primary risks, up from last year's $30m. The current additional capacity is $120m.

The number of recalls has increased in the past 12 months. Ian Harrison, executive director of the global casualty team at Lockton, says: "There has been a real upsurge in interest in the EU, especially in the UK, due to regulations as well as the Cadbury incidents which raised awareness that all companies can suffer significant financial losses."

The product recall market is divided into food and non-food consumer products. These are governed by the General Product Safety Directive (GPSD) which came into force in the UK on 1 October 2005.

The European Commission's rapid alert system for food and feed has recorded an increase in the number of alert notifications (which end in the recall of a product) since the Commission began issuing reports in 2002, rising from 454 in 2003 to 691 (2004) and 956 (2005).

Food and drink has seen an upward trend in the number of recalls but was slightly down in 2006 partly due to the Sudan 1 food dye contamination issue which caused a spike in the 2005 figures.

"The majority of recalls in the UK are driven by incorrect allergen labelling, demonstrating how companies can fall foul of legislation," says Ed Mitchell, senior underwriter at XL Insurance.

The European Commission rapid alert system for non-food consumer products, which shares information about dangerous non-food consumer products, has also charted rises in the number of serious risk notifications, with 119 reported in January 2007, 107 in February and 109 in March.

Statistics show that toys are now chalking up the highest number of serious risk notifications, forming 24.3%, 31.8% and 32.1% of total notifications in January, February and March respectively.

"Toys present an interesting issue, because many toys are made in China. The financial risk tends to end with the importer because the Chinese manufacturers will not pay. This is exactly why the importer should buy product recall insurance," argues Harrison.

“There has been a real upsurge in interest in the EU, especially in the UK, due to regulations as well as the Cadbury incidents which raised awareness that all companies can suffer significant financial losses

Ian Harrison, executive director of the global casualty team at Lockton

Coming in a close second are motor vehicle notifications, which have reported fairly major recalls, predominantly due to the risk of injury.

Law firm Reynolds Porter Chamberlain has noted an increase of between 5% and 10% in the automotive sector recently, which partner Mark Kendall attributed to either cars possibly being fitted with more sophisticated technology or simply that more people are buying cars.

Graeme Berry, director of insurance claims at PricewaterhouseCoopers, says: "The general trend remains the same, as increased awareness and stiffer penalties have resulted in the number of notifications rising steadily. However, the rate of increase seems to be slowing down compared to 2005.

"The message continues to be that regulations brought in have improved and raised the profile of risk, which is great for the consumer," he adds.

With almost regular appearances in the headlines by a number of high profile companies in the past year, followed by the high cost of a product recall exercise, it is a wonder then that there are still businesses out there that go without product recall cover.

Kendall says: "The challenge for us and our clients is to determine whether a defective product is unsafe. It is easy to determine so in the case of unlabelled food which may contain allergens or if safety belts are defective. But there are other areas that are not so clear-cut and we have to ask whether it is going to be safety critical."

Negative publicity

He also explained that there is difficulty ensuring regulators that all action that can be taken has been taken and whether the alert system and the trading standards office should be notified, as there is a certain amount of negative publicity tied to this.

In the past it was mostly large companies that bought product recall insurance, simply because it was so expensive for smaller ones.

This product is now more affordable compared to a decade ago. Medium-sized companies are finding the product more accessible, more so now that insurers are selling tailor-made contracts to suit their needs.

Ed Mitchell says: "While I've noticed an increase in awareness of product recall insurance, I've not seen an increase in the number of people buying the product.

"Within a small specialist market, people ask why companies are reticent to come forward and buy cover. It's because of insufficient knowledge of the broking community on what the benefits of taking on this type of cover."

“Statistics show that toys are now chalking up the highest number of serious risk notifications, forming 24.3%, 31.8% and 32.1% of total notifications in January, February and March respectively.

One of the frustrations a broker faces is that product recall is often viewed as an add-on to public liability.

Lockton's Harrison says: "They don't recognise that the cost of a product recall could cost more than public liability. And because product recalls don't happen often and companies are not obliged to buy cover, they may not."

The news is not all bad though; as the take-up rate of product recall cover is improving. "The hit ratio is getting towards one in five where it used to be one in 10 five years ago," Harrison says.

Commenting on the food and drink sector, Mitchell says that a very small percentage of food and drink companies buy insurance at the moment.

"It [recall insurance] is seen as a luxury product. [Nonetheless] we have received a rise of 200% in enquiries between 2005 and 2006. New buyers form 20% of the business XL Insurance has written since January," he says.

The food and drink market is estimated to write an annual gross written premium (GWP) of £150m, and enjoys a growth rate between 20% and 30%.

Mitchell believes that a lot of companies are now looking to the market. "The introduction of the regulations had an immediate impact on the responsibility of the companies, creating awareness that they had to change the way they operated in relation to product recalls.

"There is now a traceability plan in place, competent authority in the Food and Standards Agency, specific obligation to collaborate with authority and consumer and media interest in healthy food and food scares," says Mitchell.

But are insurers ready to market this particular product in a more attractive package?

PricewaterhouseCoopers' Berry suggests a convergence in cover. "Eventually companies will buy less wide cover and self-insure, therefore making it more affordable.

"What we have in the UK now is widely drawn contracts that cost a lot of money. If the risk of product recall is better managed, then insurance could be cheaper and more readily available."

He forecasts that insurers will be better able to rate risk better, owing to economies of scale, which will lead to cheaper cover. Which can only be good news for everyone. IT