“When billions of dollars are spent on creating brands and total quality management to maintain the integrity of products, many companies hope that they have managed the risk of a product recall.”
— Graeme Berry
PricewaterhouseCoopers
Product recall insurance
Recent problems with pharmaceuticals
have pushed this coverage into the spotlight
Phil Zinkewicz
|
“When billions of dollars are spent on creating brands and total quality management to maintain the integrity of products, many companies hope that they have managed the risk of a product recall.” — Graeme Berry |
In one episode of the BBC production of I Claudius, starring Dereck Jacobi and a host of British actors of the highest caliber, Emperor Caligula, played by John Hurt, is annoyed by his nephew’s constant cough. In an attempt to ease the boy’s cough and his own annoyance, the insane tyrant orders that the boy’s head be cut off. It worked. The boy’s coughing ceased, but it was surely a case of the cure being worse than the ailment. In modern terms, we might say that the boy’s demise was a “dangerous side effect” of the cure.
With all of the publicity that has surrounded some of the possible side effects of today’s pain killers—Vioxx®, Celebrex®, Bextra® and Aleve®—not to mention the controversy over the drug Prozac® and questions as to whether it can result in suicidal or violent behavior in some patients, the pharmaceutical industry today is suffering some dangerous side effects of its own. The industry’s elaborate advertising campaigns in recent years—campaigns generally aimed at arthritis sufferers who have long awaited a “magic bullet” to relieve their pains—had, at first, resulted in very favorable bottom-line results. But recent studies and reports that say the use (or overuse) of these painkillers can also result in heart disease and stroke are now resulting in major headaches, not to mention lawsuits for pharmaceutical manufacturers.
Consider some of the pharma-ceutical industry’s side effects. Merck, the maker of Vioxx, has voluntarily recalled its product from the market. Pfizer, the manufacturer of Celebrex and Bextra, did not pull its pain killers from the market but has pulled its advertising for Celebrex. Federal drug officials have warned the public to restrict their use of Celebrex and Bayer’s Aleve to the recommended dose of two 200-milligram pills a day and not to continue therapy for more than 10 days without consulting a physician. The Food and Drug Administration also recommended that physicians limit their prescriptions of Celebrex and Bextra. Sales of these drugs are down and stock prices of the drug companies that manufacture these painkillers have fallen considerably. Moreover, the drug companies themselves have certainly suffered damage to their reputations.
All of these developments are now shining a spotlight on a coverage called product recall insurance. Risk managers of pharmaceutical firms are undoubtedly nervously reviewing their insurance coverages to determine what losses are covered by these recent events.
Product recall insurance, not to be confused with product liability insurance, really surfaced as a viable coverage in the 1980s as a result of the Tylenol® tampering incident. There is no doubt that product recall is an expensive proposition in terms of profitability and brand value.
As for what companies are out there to underwrite product recall insurance, the London insurance market appears to be on top of the game in terms of the broadest coverages available.
“Product recall is a relatively new product in the insurance industry and is sure to grow,” says Graeme Berry of the London office of Pricewater-houseCoopers. “When billions of dollars are spent on creating brands and total quality management to maintain the integrity of products, many companies hope that they have managed the risk of a product recall. Sometimes, risk management is not enough. When considering product recall insurance coverage, there are four main areas that need attention: pre-recall expenses, recall expenses, data capture, and loss of profit.”
Berry says that, in terms of pre-recall, a company’s first task is to identify and isolate a problem. Here, costs will be incurred in setting up the crisis management team from within the organization; bringing in specialist external advisers to handle public relations, security and laboratory testing of the suspect product; planning and managing the recall; and measuring the cost and preparing for any claim.
“If a recall is necessary,” continues Berry, “it needs to be initiated quickly. Any delays in removing the product from the supply chain or from the retailers’ shelves can be disastrous. Companies have to be seen as confident that they are on top of the problem and dealing with it. Costs will be incurred recalling the product from consumers, retailers and other parts of the supply chain. These costs will typically relate to transport, storage and any additional staff required. Effective batch traceability, mandatory in pharmaceutical products, can help isolate the problem and minimize the extent of the recall.”
Berry says that determining the cost of the recall, to support a claim on insurers or on a supplier of defective ingredients, means that the business must establish systems for data capture to record additional costs. “A common problem is insufficient evidence that the cost claimed is a genuine additional cost caused by the recall,” he says.
Usually, the most difficult area to control and quantify is the consequential loss of profit and additional cost incurred in mitigating that loss, says Berry. “Depending on the lead time for production, and on existing stock levels, it may be possible to re-manufacture a replacement product in time to minimize or even avoid stock outs and lost sales,” he says. “A clear understanding of the dynamics of the supply chain is needed to quantify the likely impact of a product recall. For products with a limited shelf life, and where retailers usually expect suppliers to carry the risk of surplus stock, it may be necessary to identify and allow for the normal levels of stock returns. Recall policies will typically offer a range of indemnity periods for sales to recover to normal levels. Companies seeking to recover lost profit under their insurance arrangements will need to check carefully the measure of loss which is covered, including the extent to which fixed costs are insured. Depending on the wording, a policy covering net profit only may leave the policyholder underinsured. The required indemnity period will also need to be carefully considered. A policy may cover loss of profits for a three-month period, six months or a year, depending on policy wording and, of course, the premium paid.”
Berry says that product recall insurance is available in the London market at Lloyd’s and among non-Lloyd’s insurance companies.
The U.S. market
According to Jill Wadlund, vice president and life science casualty manager for Chubb, few U.S. companies offer protection for loss of profit. “Companies here primarily cover the withdrawal expenses associated with product recall,” she says. “Product recall is a very broad term, and the extent of coverage can vary greatly. It may be limited to product withdrawal or product tampering. Product withdrawal expense insurance usually covers the expenses associated with the announcement of the withdrawal, shipping costs and disposal of a product. Product tampering, as the name implies, is associated with losses incurred with products that are tampered with. We write product withdrawal expense insurance. If a product is found to be defective for some reason, our policy responds to the expenses of the withdrawal, but not loss of profit or loss of revenue.
“Crisis management expense is also part of product withdrawal expense insurance,” says Wadlund. “Chubb provides a $25,000 limit for Class 1 recalls for product withdrawal/crisis management expense on its product liability policies for no additional charge if the insured has a formal recall program. Additional limits and terms are available through a separate insurance policy, but again we do not offer coverage for loss of profit or revenues.”
Some product categories have additional challenges in performing a recall. An over-the-counter drug recall must deal with the fact that the product cannot practically be traced to all the ultimate customers. This situation presents another product liability consideration. “Let’s say an over-the-counter drug is recalled and some people still have it on their shelves and may still be taking the medication, or begin taking the medicine after the recall,” says Wadlund. “Claims may arise after the recall has been completed and after a policy has expired. We offer a product for that contingency. It’s an extended occurrence period option that can extend the occurrence period of the claims-made policy for one year if activated after the product liability policy expired.”
Product recall or product withdrawal insurance is not only for large firms such as those in the pharmaceutical industry, according to Wadlund. Smaller firms, both on the manufacturing and retail ends, that make or sell food and beverages, or cosmetics, etc., may also benefit from this protection, she says. *