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Aspen Opinion

Product Contamination and Recall: Risk Response

March 27, 2018

Nicky Alexandru

Senior Vice President, US Head of Crisis Management

Tel: +1 929 265 3750

Nicky Alexandru, U.S. Head of Crisis Management at Aspen Insurance, reflects on the shifting food safety environment from reaction to prevention.

Tighter regulatory supervision, better detection technology and more complex supply chains are making product contamination and recall a more costly event. Contrary to popular belief, property and general liability insurance does not always cover these costs and contamination and recall policies can provide a much more effective response.

Product contamination and recall is the central risk facing food manufacture and distribution. In 2017, the Food and Drug Administration (FDA) and U.S. Department of Agriculture (USDA) recorded almost 450 food recalls with allergen and biological contaminations cited as the leading causes as shown in Chart 1. Allergen contaminants are not only the primary culprit but have increased in significance from 33% of total recalls in 2016 to 48% in 2017.

Stricter regulation and advancing analytics

Trends towards stricter regulation and advancing analytics have continued as the FDA and USDA, in conjunction with the Centers for Disease Control and Prevention, are now using whole genome sequencing (a pathogen profiling analysis) to identify the source of food and beverage contaminations and outbreaks. The 2011 Food Safety Modernization Act (FSMA) has shifted food safety focus from reaction to prevention and covers all parts of the supply chain from suppliers through processing to distribution. A series of new rules for implementation of the FSMA were announced in 2016. The FDA now has the authority to stop production and distribution of products. Improved analytical results can also trigger a cascade of secondary results if the contaminated ingredients are traced to other products. These developments have occurred as the food supply chain has become increasingly global and has, therefore, added complexity. 

Counting the cost

Product recall is costly with financial consequences ranging from immediate costs of recall expenses and the value of condemned products, to damaged brand reputation that may continue for many years. Companies at risk span a wide spectrum and include importers, manufacturers (including contract manufacturers and private label companies), distributors (including storage warehouses and transportation) and retailers.

The cost of contamination depends on four main factors: the nature and extent of the contamination; the regulatory response; the level of negative publicity; and whether the product is an ingredient or final manufactured goods. Ingredients such as spices, for example, can contaminate a large amount of third-party products and the aggregated cost may far exceed the value of the contaminated ingredient product.

Costly recalls not only occur with large manufacturing companies that may have high visibility, brand recognition and greater resilience due to their diverse portfolio, multiple manufacturing sites and sizeable balance sheets. However, the recall and destruction of a product may be catastrophic for a small or medium-sized company, especially one with limited production capacity and a small portfolio of customers or products.

In terms of the profit and loss account, the impact is two-fold from both loss of revenue and additional expense to reduce the loss. Expenses will include clean-up costs, consultancy testing and analysis, product replacement or repair and product recall and/or destruction costs, as well as distribution costs for replacement products. There may also be third-party property damage and the associated defense costs.

Checking cover

Food contaminations and recalls are particularly susceptible to common exclusions and coverage limitations in property and general liability policies. There may be limited, if any, property insurance coverage if the product (property) damage is caused by mold, virus or pollutants. Some food recalls are triggered by on-site testing which occasionally generates false positive results. If direct physical damage is absent, recovery against typical property or general liability insurance becomes problematic. The pollution exclusion and impaired exclusions may also bar general liability coverage.

Specialist product recall insurance has evolved significantly in the last two decades. The core insurance product provides first-party coverage and contains the key building blocks of a property policy, including:

  • Property damage: replacement of contaminated (recalled) product and recall expenses;
  • Clean-up costs: removal of the contaminant from the site; and
  • Business interruption: loss of gross profit plus expense to reduce loss resulting from the recall of product of reduction in manufacturing output.

The most significant development in recent years is the emergence of coverage that includes third-party losses resulting from the recall of a contaminated product, typically a private label product or ingredient. For bulk ingredient manufacturers in areas such as sugar, flour and whey powder, for example, the third-party coverage may be the most important. Initially built around third-party consequential economic loss, the coverage has been increasingly broadened to protect against third-party costs not covered by general liability. As many manufacturers have found out to their cost, the nature of food recalls and the sensitivities around consumer safety mean that a significant share of third-party claims fall outside the realm of general liability.

In addition, most policies provide crisis consultants’ services. Typically these services will be provided by food safety consultants who can help companies understand the nature and severity of an incident and make decisions about a recall or communication with customers and regulatory bodies. In particular, small(er) companies stand to benefit from this provision of consultancy advice. The nature and extent of the contamination must be quickly understood together with the health risk to the public as well as any potential damage affecting commercial customers. The response often requires a different skill set to that of running normal manufacturing operations and the interaction with regulatory agencies adds an additional layer of complexity. Prompt response to food contamination incidents is critical as social media, in particular, has accelerated the speed and breadth of communication. Information and misinformation can be quickly transmitted to a wide audience and a company’s response within the first 24 hours is, therefore, crucial.

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