By Donald S. Malecki, CPCU

In recent years, one of the disappointments suffered by some insurance company product developers was with the coverage that came be known as product recall or withdrawal expense insurance. The idea for this coverage was sparked by a 1966 exclusion to general liability forms. This exclusion was deemed necessary in order to keep insurers from having to pay the mitigating costs of some manufacturers who were required to recall their products because of some large and costly product-related incidents.

The exclusion, coupled with the introduction of nonstandard product recall/withdrawal policies, still was not viewed as a big motivation for sales until the enactment of the Consumer Products Safety Act in 1972 and the creation of a commission to regulate and enforce this product-related law aimed at consumer safety. This law was also aided by other laws regulating the matter of safety products, such as the Food and Drug Act, which still plays an important role in regulating many products for consumption.

As it turned out, the high expectations of this newly developed coverage fizzled, and some insurers eventually withdrew their policies. Even though some entities did not purchase this coverage, they sometimes were able to obtain coverage for their recall costs by arguing that the product recall exclusion of liability policies was ambiguous. The specific point of dispute was that the exclusion appeared not to apply to the costs incurred by others who then sought reimbursement from the insured manufacturer. In light of the success of many insureds with this dispute, ISO clarified its exclusion, to close the door on this point, with its 1973 general liability revisions.

Why product recall/withdrawal coverage did not sell can be left to speculation. However, large firms that could afford to purchase this coverage chose not to buy it, and smaller firms that really could have used some form of product recall coverage could not afford it.

To be more precise, the larger manufacturers had in place the necessary programs to systematically withdraw their products from the market or use, when necessary. Many also were large enough not only to play the odds about ever being required to recall their products, but also were able to expense the costs of recall if they ever arose. Insurance, therefore, was an unnecessary cost from their perspective.

Smaller manufacturers, on the other hand, had to implement certain costly procedures to qualify for the systematic withdrawal of products; and by the time they met those standards, they often could not afford the insurance to cover them. The insurance was not only expensive, but also limited in scope. They, too, decided to play the odds, but with bigger swings in the risk than larger firms.

New standard coverage becoming available

Amidst this turbulent history of product recall/withdrawal insurance, the Insurance Services Office (ISO) is introducing its own standard endorsement for use, officially in 2001, titled "Limited Product Withdrawal Expense" endorsement.

Reference to the word "limited" in insurance policies usually connotes a red flag about the scope of coverage. In fact, most product recall/withdrawal coverage forms of the past were less than comprehensive because the idea was to help insureds defray some of their costs of withdrawing products from the market or from use.

The ISO endorsement is no exception. There are many limitations in this coverage, as one might expect. But, interestingly, it offers coverage that, in some respects, is broader than what some previous policies provided. An example is coverage for product tampering, a coverage that was undoubtedly generated following the Tylenol episode and other "copycat" incidents.

Scope of coverage

The new ISO coverage endorsement's definition of "product withdrawal" describes the basic parameters of coverage. Barring reference to "product tampering," one will likely note a similarity between this definition and the CGL policy's exclusion for recall of products.

This endorsement is not a liability coverage form. Insureds therefore do not have to show they were liable for purposes of triggering coverage. The endorsement is strictly a means of reimbursing the insured for certain costs listed as part of the endorsement's definition of "product withdrawal expenses." To make it more cost-palatable, this endorsement also does not offer cover the defense of a claim or suit brought against the insured.

The costs covered are not limited solely to recall. Also covered, for example, are the costs of disposing of the named insured's products, or products that contain the named insured's products that cannot be reused, subject to certain limitations on the amount payable. For example, the insurer is not going to pay more than the named insured's purchase price or cost to produce the product in question.

However, specifically outside the scope of this endorsement's coverage are the costs to replace, repair or redesign the named insured's products and the consequential loss, such as the costs to regain the named insured's market share and goodwill. The reimbursement of these expenses is contingent on recalls considered necessary by the insured or when a recall is ordered by a governmental entity, such as the Consumer Product Safety Commission, subject to other limitations.

The endorsement is subject to a number of exclusions and conditions precedent to coverage, as one might expect. The idea of the exclusions is to carve out what the intent of the coverage is. In this vein, it is important to note that the objective here is to pay for covered costs in situations where the withdrawal will serve as a preventive measure where bodily injury or physical injury to tangible property is reasonably expected.

The phrase, physical injury to tangible property, is emphasized to make clear that this endorsement does not apply to situations where loss of use of tangible property brought about by a named insured's product is the reason for taking steps to prevent loss. In other words, where the named insured's product is incorporated into someone else's property that is rendered useless or unusable, no coverage is to be expected. A prospective client with this type of an exposure will require broader coverage, if it otherwise available.

The endorsement's definition of "product tampering" also sets the parameters of coverage where it states that it involves "an act of intentional alteration of the 'your product' which may cause or has caused 'bodily injury' or physical injury to tangible property."

This definition goes on to state that when a product tampering is known, suspected or threatened, the withdrawal is not limited to the particular batches of the named insured's product that are known or suspected of having been tampered with. This is good, considering it is not always possible to pinpoint precisely the batches or lots that may have been affected.

The trigger remains the same whether the limited product withdrawal expense endorsement is attached to the occurrence form or the claims-made form. Coverage is written subject to an aggregate limit, as one might expect, given the subject of this coverage. The expenses also must be incurred and reported within one year of the date of withdrawal. It also is subject to a cut-off date; that is, the product that is the subject of the withdrawal also must leave the named insured's control or possession after the cut-off date shown in the endorsement.

Among the notable exclusions are:

* failure of the named insured's products to accomplish their intended purpose, unless the failure has caused or is reasonably expected to cause bodily injury or physical injury to property;

* expiration of the designated shelf life of the named insured's product;

* withdrawal initiated because of a defect known to have existed by the named insured or its executive officers prior to the inception date of this coverage or prior to the time the product leaves the named insured's possession or control;

* and recall of a product that has been banned by an authorized governmental entity prior to the policy period.

Viable market?

It is unfortunate that this product is being introduced for use while the insurance industry is getting deeper into a hard market. It is uncertain, therefore, that underwriters will be receptive to offering this coverage and, more important, at what price.

However, given that product withdrawals are more commonplace today than ever before, it would be worthwhile for producers to offer this to middle market prospects. In fact, there have been situations where small manufacturers have gone virtually bankrupt because they could not afford to handle the costs incurred to recall their product from use because of some suspected defect following physical injury to property of others.

Not all prospects may need product tampering coverage, but it is a definite plus to be able to offer it. One never knows when this type of an event may occur. While third parties may be the most likely to be implicated for product tampering, charges also have been filed against disgruntled employees.

When promoting this coverage, producers need to be careful that prospects are not misled to believe that this coverage endorsement will encompass what is addressed in the product recall/withdrawal exclusion of CGL forms. Without question, the policy exclusion is broader than the scope of the new endorsement.

While it appears that this new ISO product will help the middle market to defray part of its product recall costs, much of the success in selling this coverage will depend on the price tag. *

The author

Donald S. Malecki, CPCU, is chairman of Donald S. Malecki & Associates, Inc. He is chairman of the Senior Resource Section of the CPCU Society, serves on the Examination Committee of the American Institute for CPCU, and is an active member of the Society of Risk Management Consultants.