All companies operating within the food and beverage industry, whether multinational in scale or independent local growers or food and beverage processors, are under constant risk of severe financial loss due to product contamination. This article provides some practical information about the risks, the heightened regulatory involvement, how traditional insurance may apply, a brief peek on what to expect in the event of a recall and options for effective protection through the utilization of Product Contamination & Recall insurance.
Two Key Areas of Focus
· How to transfer the financial risk of product contamination and product recall, and
· The critical necessity of integrating the insurance claim process within the recall event.
A One-Week Food Recall Snapshot
A snapshot of the U.S. Federal Food Safety website over a recent seven day span reveals food product recalls involving: Salmonella contaminated raw frozen fish, undeclared milk allergens in a Taco dinner product, Listeria contamination of pizza products, undeclared egg allergens in a sausage product, Listeria contamination of deli-sandwiches, mislabeling of a frozen pasta product, undeclared Sulfite allergens contained in a fruit preserve, undeclared peanut allergens in an almond snack, and of course, potential Salmonella contamination of fresh vegetable packaged salads. Most of these recalls affected independent private businesses and illustrate the vulnerability of all food and beverage businesses.
The Implications of the Food Safety Modernization Act (“FSMA”)
The potential effects of the FSMA with its passage into law on January 4, 2011, suggest that we can expect to realize more product recalls. Here are some key points to consider:
- Enhanced Record Keeping & Full Access by FDA
Food producers are required to maintain detailed records of food safety and security protocols, including manufacturing, packaging, and distribution process of every food product for a minimum period of two years.
- Registration, Inspection & Rejection of Imports
Food facilities must be registered,
Imports will be rejected when a foreign facility refuses inspection,
Increased inspections of U.S. and foreign food facilities
- FDA Authorized to Mandate a Product Recall
The FDA’s authority to effectuate a unilateral product recall product was previously limited to baby formula and could only previously recommend a product recall. Under the FSMA the FDA can unilaterally order a product recall.
- Whistleblower Protection
The FSMA provides protection to employees reporting regulatory violations.
The fact that the FDA can now unilaterally order product recalls and the codification of the protection afforded to employees reporting violations signals the need for heightened urgency on the part of the food and beverage industry enterprises to ensure that they are adequately protected against the devastating financial and reputational consequences caused by a product recall event.
How Can a Food or Beverage Enterprise Protect Itself?
Business Insurance 101
Every business owner has a varying degree of familiarity with a Business Owner’s Insurance Policy (“BOP”) which provides most smaller enterprises with two main forms of coverage: Commercial General Liability, Business Property, as well as a host of other ancillary coverage ranging from Business Automobile to Data Privacy Breach coverage. Some BOP policies also contain limited Employment Practices Liability and limited Employee Dishonesty coverage.
Unfortunately, many independent companies operating in this industry are operating under the misconception that their basic commercial insurance coverage will provide protection in the event of a product recall. Nothing could be further from the truth.
How Would a Commercial General Liability (CGL) Policy Respond?
For the limited purposes of this discussion, a CGL policy will provide defense and indemnification for claims of policy-defined “Bodily Injury or “Property Damage” brought by third-parties against the policyholder. Coverage under these policies is typically triggered by an “Occurrence” which is further defined as an “Accident.” CGL policies generally require that the “Bodily Injury” must have a physical manifestation to trigger coverage, rather than simply a claim of emotional distress. While specific policy language is always subject to the interpretation of a court, it is generally held that a physical bodily injury caused to a consumer arising from a contaminated product would be covered as a product liability claim under a CGL insurance policy.
While the associated bodily injury claims may be covered under a standard ISO CGL policy, those same policies also contain an exclusion typically entitled Recall of Products, Work or Impaired Property. That provision precludes coverage for any claims of damages associated with any loss, costs or expenses involving the policyholder’s product, work or impaired property if it involves a product recall or withdrawal because of a known or suspected defect.
The CGL – Product Recall Hybrid Policy
A recent entrant into the commercial insurance products arena provides limited coverage for some of the product recall expenses that would be otherwise uninsured under a standard CGL insurance policy. This type of combination policy provides coverage only for:
Customer notification costs of recalled product,
- Recalled product shipping and disposal costs,
- Refund, repair or replacement product costs
- Reimbursement for third-party expenses including defense costs
It should be noted that the above expenses represent only a portion of the overall expenses that a company would incur in the event of a product recall.
The Commercial Property Policy
Commercial Property policies are available either with a more restrictive policy form only covering loss caused by policy-specified Perils (causes) or on an “All Risks” basis under which coverage is triggered from any cause or peril unless it is specifically excluded by the policy. Commercial Property policies provide coverage for, among other things, physical loss or damage to inventory and stock, which is pertinent to a discussion about product recall. Whether an affected product or stock has been actually physically injured by a covered peril is the initial determination that must be made in order to determine if the Commercial Property coverage will apply.
Additionally, Property policies contain a number of other provisions that may come into play to limit or exclude coverage in connection with a product recall event. One provision found in all Commercial Property policies is the Pollution Exclusion. This type of exclusion invariably contains the term “contaminant” which depending upon the particular Property policy and the legal jurisdiction that would interpret the Property policy’s coverage, may be held to apply to a contaminated product inventory or stock.
Product Contamination and Product Recall Insurance
The optimal way a food or beverage company can protect itself from the economic and reputational damages caused by a product recall is to transfer that risk through an insurance mechanism that is designed to specifically respond to a recall event.
Coverage under these policies are typically triggered by one or more of the following policy-defined events: Accidental Contamination, Malicious Contamination or Product Extortion.
First-Party Coverage responds to the policyholder’s:
• Business Income Loss,
• Recall Expenses,
• Product Rehabilitation expenses,
• Consultant and Advisor costs
• Extortion costs
Third-Party Coverage responds to the policyholder’s:
• Liability for claims brought by third-parties such as distributors, wholesalers, or supermarkets or other customers, for their economic loss and reputational damage in connection with a policyholder’s product recall.
This coverage is typically triggered when it is determined that consumption or use of the suspect product either has resulted in bodily injury or property damage or will result in bodily injury or property damage within 365 days of the product’s withdrawal.
Optional Coverage offered by at least one major Product Recall insurer includes:
• Product Refusal Coverage protects against economic loss caused by the refusal of an insured product during a scheduled delivery. The refusal must be caused due to a publication that the insured product will cause bodily injury and because bodily injury has been caused by a similar product.
• Intentionally Impaired Ingredients Coverage provides protection in the event of contamination or impairment of an insured product that results from an ingredient supplied to the policyholder and when the contamination or impairment was intentional and wrongful but not malicious.
Pre-Recall Consultative Services
Sophisticated Product Recall insurers will provide the policyholder with some limited of Pre-Recall Risk Management services as part of the protection afforded under the insurance policy.
These consultative services provided by external experts may include the analysis of one or more of a policyholder’s Crisis Management plan, its training & development processes, reviews of manufacturing and corporate systems and processes. There is little doubt that small to mid-sized companies without the benefit of dedicated risk management professionals can benefit from such analyses and advice. This process, which is voluntary, also benefits the insurance underwriters as it provides a deep view into the potential vulnerabilities of a policyholder to product contamination and recall, which if uncorrected to the satisfaction of the insurer, may result in less favorable terms and/or higher policy premium.
Complete Access & Cooperation
Unless a company has gone through the process of a product recall claim, most companies don’t realize their contractual obligations to fully cooperate with their Product Recall insurer. This means to immediately notify the insurer of a suspected event and to allow the insurer and their experts full access to records, product, company personnel and facilities. The insurer has the contractual right to complete access to the policyholder’s books and records and to inspect the policyholder’s property and operations at any time in relation to the subject matter of the Product Recall policy.
Coverage Determination- The Scientific Analyses Process
Upon notifying the insurer of a suspected or actual product contamination, in almost every instance the insurer will exercise its contractual right to perform a scientific analysis of the product to determine whether it has in fact been contaminated, and whether the contamination rises to the level that it will reasonably cause bodily harm to consumers.
Policyholders must be prepared to share their scientific analyses data with the product recall insurer to support their claim for coverage. Depending upon the nature of the contamination, triggering coverage for voluntary recalls can be contentious if the respective experts’ conclusions do not align. Therefore, identifying highly qualified external experts in advance of a product recall will afford the policyholder the ability to react quickly to obtain the required analyses in the event of a recall. Advance consultation with legal counsel experienced with food and beverage product recalls can be a useful process for identifying scientific experts that are qualified to serve as effective litigation experts.
Crisis Management Coverage
Product Recall policies almost universally provide either a specified sub-limit as part of the policy’s aggregate limit or an additional separate limit to pay for the policyholder’s cost to retain a Crisis Management firm to handle public relations in connection with a product recall. This is an important aspect of coverage as it affords immediate access to expert assistance to restore a company’s reputation in the event of such a crisis. Most policies will require the policyholder to select from the insurer’s pre-approved list of qualified crisis management firms.
Insurer’s Right of Subrogation
As is the case with most insurance policies, upon payment of a covered Loss under a Product Recall policy, the insurer has the contractual right to seek recovery from a third-party that may have caused the loss, which includes bringing litigation in the name of the policyholder. This can become a delicate business issue when a policyholder’s key supplier would appear to be the source of the problem. While most insurers will not waive their right to subrogation (unless there is a corresponding higher premium paid at policy inception) it is a point that policyholders must keep in mind and may become a relevant aspect of the negotiation of the claim.
Other Key Considerations
The Directors’ & Officers’ Liability Policy – The Failure to Purchase Insurance Exclusion
Commercial insurance policies of every variety contain a standard exclusion to coverage that essentially states the policy will not apply if there is a claim alleging the failure to purchase insurance or adequate insurance that would have covered the loss against the company.
Food and beverage companies that have investors who may bring litigation against a company for financial damage caused to a company that was involved in an uninsured product recall may understandably think the purchase of a D&O or Management Liability policy would protect them from most investor claims alleging corporate mismanagement. However, in the event of an uninsured product recall event, the D&O policyholder may find they are without the protection from investor lawsuits they thought they had purchased under their Directors’ & Officers’ Liability policy because they chose to not purchase Product Recall insurance.
Some Practical Steps To Take
Every food and beverage company, large or small, must have a product recall crisis plan in place which identifies both internal and external management personnel and a process for managing the crisis event. The plan should be reviewed periodically and mock-tested with distribution chain partners to identify areas for improvement. This pro-active approach will favorably distinguish a potential Product Recall insurance applicant to insurers and result in more favorable premiums.
Some basic actions when a product contamination is suspected:
- Immediately notify legal counsel, and preferably retain coverage counsel.
- Immediately notify regulatory authorities.
- Immediately notify everyone in the suspected product’s distribution chain.
- Immediately notify your insurance broker and all potentially involved insurers in writing including Commercial General Liability, Commercial Property, Product Recall and Directors’ & Officers’ Liability insurers. Communications should be pre-approved by legal counsel.
- Immediately isolate and preserve all suspected contaminated product wherever located and do not destroy any contaminated product.
- Maintain accurate financial records of all costs associated with the product recall.
- With advice from legal counsel, retain qualified external experts to perform a scientific analysis of the suspected product and to determine causation of the contamination.
- Coordinate access to the suspected product, facilities, and records with the insurers’ claims representatives and experts through legal counsel and your insurance broker.
- Manage all external communications through a central point of contact.
The increased authority of the FDA to unilaterally order product recall under the Food Safety Modernization Act will likely increase the incidents of involuntary product recalls. FDA ordered recalls should lessen the potential contention between policyholders and Product Recall insurers with regard to the necessity of the product recall.
The extremely significant financial benefits of the coverage afforded by this catastrophic insurance product both in terms of first-party coverage for the policyholder as well as third-party liability coverage for loss to the policyholder’s distribution chain partners cannot be overstated.
Managing a product recall claim is a complex process requiring coordination between the policyholder’s senior financial and operations management, internal and external experts, legal counsel, insurers and their cadre of corresponding experts.
When selecting an insurance representative for this highly specialized insurance product, food and beverage companies should carefully consider the insurance professional’s demonstrated claims experience, their ability to work effectively with internal and external resources and with insurers to achieve a fair and equitable resolution of the associated claims. Careful selection is particularly vital for small to mid-sized companies without the dedicated internal risk management resources for coordinating the various aspects of the claim process.