A product recall is a request to return a product after discovery of safety issues or product defects that may endanger the consumer or put the maker/seller at risk of legal action. The recalls are made by manufacturers/producers of the products.
The recall is an effort to limit the damage caused by the product to the users and to the corporate image of the manufacturers/producers from adverse and unwanted publicity; and the legal liability for corporate negligence, which can cause significant legal costs.
Product recalls is a costly affair. Costs may include the cost of handling the recalled product, replacing it and possibly the cost of being held financially responsible for the consequences of the recalled product. In addition, there may also be the cost of suits and awards should the product cause harm to the users.
The product recalls may be initiated voluntarily by the producers or compulsorily by the Country’s protection laws.
A country's consumer protection laws will have specific requirements regarding product recalls. Such regulations may include how much of the cost the maker will have to bear, situations in which a recall is compulsory (usually because the risk is big enough), or penalties for failure to recall.
Several recent high profile product recalls have demonstrated the potential damage to brand and revenue. These have been witnessed from all areas of production as well as from all parts of the world. The recalled items are various ranging from exploding smartphones, harmful toys, choking hazards in tinned foods, industrial goods and defective motor vehicles, amongst many others.
In January 2010 Toyota recalled several million vehicles because of faulty throttle pedals that could cause uncontrolled acceleration and faulty software that could cause delayed braking.
In February 2011, Honda Motor Company issued a voluntary safety recall of 700,000 cars due to potential damages likely to occur from a spring in the Engine. The spring was placed improperly in a small box inside the engine. The spring had the potential to cause the engine to stall. At the time of the recall, no crashes or injuries emanating from the defect had been reported.
As Samsung is quickly discovering, product recalls are costly affairs and may require a company to refund its customers' money, give them replacements, in addition to the meeting the cost of lawsuits arising from the injuries and damages caused by the products.
There is also a lot of damage to the brand image as well and this has been shown by various headlines regarding the Samsung Galaxy Note experience.
Samsung's Galaxy Note 7 Recall Is Facing Problems in South Korea
Customers in South Korea are complaining that the replacement Note 7 phones are overheating. Samsung says this is an unrelated issue to the exploding phones problem.
China Accuses Samsung of "Arrogance" For Note 7 Recall
The Chinese State TV said Samsung was "full or arrogance" and discriminating against Chinese consumers in its handling of the Galaxy Note 7 recall in the country.
Samsung Will, Pay You to Replace the Galaxy Note 7 With a Samsung Phone (AAPL, GOOG)
Samsung has announced it will offer a $100 bill credit to Galaxy Note 7 owners willing to exchange their phone for another Samsung model.
Other cases where massive expenses have been incurred towards product recall and liabilities are listed below:
This is one of the most publicized product recalls in history. Bottles of Johnson & Johnson Tylenol were laced with potassium cyanide, killing seven people around Chicago in 1982. The Company spent more than US$. 100 Million to recall 31 million bottles of Tylenol and relaunch the product.
Firestone Ford Tires
In 2000, Bridgestone/Firestone recalled 6.5 million tyres after treads varied on models used in Ford Explorers and Mercury Mountaineers. Ford engineers had suggested safety changes that were not heeded by either company. The tyre failures resulted in some 200 deaths and 3,000 major injuries.
Bridgestone spent US$440 million on recall-related costs; the recall cost for Ford was $3 billion, and US$600 million in lawsuits.
In 2004, pharmaceutical giant Merck [MRK] voluntarily recalled Vioxx, an arthritis drug, after a study found that patients who took the drug for at least 18 months were prone to suffer heart attacks and strokes. At the time, the company said it expected $725 million in lost Vioxx sales, which it ultimately removed from the market. In 2007, Merck agreed to pay $4.85 billion to settle 27,000 lawsuits over the drug.
Sony Batteries in Dell Laptops
In 2006, Dell recalled more than 4 million laptop computers because lithium-ion batteries made by Sony posed a fire threat due to excessive overheating. The recall costs were predicted at US$400million for both Dell and Sony.
Product recalls and related costs and expenses are insurable risks.
As has been noted above, the supply of a defective batch of articles or contaminated food stuffs could have a far-reaching consequence. As far as the insured is concerned, there may only be one accident or mistake, but such mistake could produce literally thousands of claims from affected claimants.
The core cover provided by the Recall Insurance is the cost of recall directly emanating from the recall itself, the downtime of the plant and the cost of business interruption up to and agreed point.
In addition, the Insurers will specify the associated costs that they will reimburse, such as the cost of destroying defective stocks or produce, cost of replacement or rehabilitation.
Destroying defective stocks happen when the Insured decides not to recall the product to the country of origin but chooses to have the defective stocks or produce destroyed where the defects are discovered.
Replacement or rehabilitation costs are costs that are meant indemnify the insured and put him back in the position that he occupied before the loss in terms of sales.
Insurers have it as a condition in the policy that the insured can only take the decision to recall a product after notifying them and obtaining the insurers agreement. This allows the Insurer to consult with experts and various stakeholders including their reinsurers. It is vitally important that circumstances surrounding the recall is properly investigated due to the potential magnitude of losses involved. Both the insured and the insurer must agree on whether a whole product family is affected or just a certain model. They must also jointly work out on whether the problem is confined to a certain batch, a certain set of circumstances, or if it is more widespread. If the losses are contained, it is possible the recall can even be used as a platform to demonstrate the company’s robustness and commitment to transparency.
The Insurer and the insured working together is important because it prevents the disputes that may arise between them regarding questions as to who is responsible for identifying the hazards, who set the performance characteristics of a product, who specifies its composition and any other issues.
There have been situations where several companies have not handled recalls very well. This happens when the investigation is not geared at establishing the scope of the recall quickly enough or even at all. In addition, a company could needlessly recall a wide range of products where it may be a very discreet issue.
Cover for Third Parties
Cover for third parties is also provided by the recall Insurance Policy covers. The third parties are covered for the Financial Loss incurred caused by the recall, for which the insured is liable. These may include first-party recall expenses and endorsements; Legal fees and Defense costs of a third-party recall liabilities, Investigations expenses, and settlement of a third-party recall liability claim.
This situation arose an event where McDonalds was forced to recall 29 million fitness wristbands distributed in Happy Meals after dozens of children reportedly developed skin irritations. The wristbands were manufactured by another company, which was covered by the third-party recall liability portion of a policy.
The Insurance Policies:
Insurance protection for product recall can be provided by Product Liability Insurance and Product Guarantee Insurances.
Product Liability Insurance:
Product liability policy covers the insured’s liability for bodily injury to persons or loss of or damage to material property caused by products or goods. The limit of indemnity usually applies to compensation payable and claimant’s costs and expenses. The cost of defending the claim and the cost of representation of the insured in certain courts will be included.
Goods may be defined as any goods or products sold, supplied, erected, repaired, altered, treated or installed by the insured during business. Goods may also include containers, labeling instructions, or advice given in connection therewith. Consequential losses following injury or damage.
Cover is dependent there being an element of an accident, responsible for injury or damage which results from the supply of the product and must occur during the period of Insurance.
There is however no cover for accidents occurring after the expiry of date of cover and it does not matter whether goods were manufactured in another period of insurance or before inception of the policy.
Financial loss not accompanied by bodily injury or damage to property are also not covered.
Product Guarantee Insurance
The product guarantee Insurance cover is concerned with covering the consequences of unfulfilled expectations associated with contractual obligations. The object of the product guarantee policy is to indemnify the insured against the failure of the product to fulfill its intended purpose, or to meet the performance requirement also known as efficacy risk. Examples are where oil may fail to lubricate engines or burglar alarms may fail to operate.
Cover is also available for some of other risks not covered under the standard product liability policy.
The product guarantee cover is on a claim made basis and the policy applies only to claims made against the insured and notified to the insurer during the period of insurance.
The policy meets the costs incurred in replacing or repairing the defective or unsuitable goods supplied; for the work involved in replacing the goods; for the loss of use by the customers; for hiring substitutes; for loss of trade sustained by the retailers, for financial losses incurred by the user when goods fail to fulfill the purpose for which they were supplied, without there being injury or damage and the cost of complete withdrawal of the product from the market and replacement or to recall it to have the fault corrected.
The growing number of product recalls is of course mirrored in an increasing volume of claims for insurers to settle. This has been driven by several factors including consumer awareness, which has been exacerbated dramatically by the advert of social media, especially in the Western world as demonstrated by the cases mentioned above.
In our regional Market, the experience has not been very bad, but the potential and possibilities of claims are numerous due to the growing import and export trade relations with the rest of the World.
Kenneth Obong’o Oballa
Zep Re (PTA Reinsurance Company).