The recent highly publicized recalls of products containing salmonella-tainted peanut butter and E. coli-tainted beef underscore the liability challenges middle-market firms face as part of complex supply chains.

The travails of Portales, N.M.-based Sunland Inc., which manufactured a variety of recalled peanut butter products under its own brand and for grocery store chains such as Trader Joe's, exemplify the outsized liabilities that midsize firms can face.

William Harrison, Princeton, N.J.-based managing director and product recall practice leader for Marsh Inc., said the scope of losses being incurred by companies that used Sunland's peanut butter may well exceed the limits of any third-party liability insurance Sunland may have.

“Many companies assume that their suppliers will be able to indemnify them for the losses,” he said. “This is a perfect example where it is pretty unlikely.”

Almost any midsize company would be unable to afford the level of recall liability insurance limits that would be necessary to protect them from losses of such magnitude, Mr. Harrison said, noting a tainted ingredient can cause economic losses to an entire product line, not just the product or products that contained the tainted ingredient.

“With the organism found in an area that produces multiple products, there is a chance for all sorts of things being contaminated,” said Charles Czuprynski, a professor in the Department of Pathobiological Sciences at the University of Wisconsin-Madison. “The problem with salmonella in something like peanut butter is that it is a very hardy organism. A few cells of the organism can become resistant, so it's tough to say that they are not there.

“Companies involved in contract manufacturing are finding out that when they are making things for other people that their potential liability can be much greater than the total revenue derived from the contract,” he said. “The liability you are taking on is very different than it was 10 or 20 years ago.”

%%BREAK%%

Ian Harrison, London-based executive director of Lockton Cos. L.L.P., agreed that as the scope of product recalls expands, the financial ramifications of product recalls are becoming especially onerous for smaller and middle-market firms. For example, a large company such as Kellogg Co., which this month announced a voluntary recall of certain Kellogg's Mini-Wheats cereals due to concern about metal debris contamination from the manufacturing process, likely would have a sufficient amount of recall coverage in place. Conversely, smaller firms would face a material threat to their business in similar circumstances.

“The relative cost to smaller players is much more significant,” Mr. Harrison said.

In addition to the increasing severity of product recall claims, they are happening with greater frequency as diagnostic techniques to detect food-borne pathogens improve, Mr. Harrison said. “The more accurate ability to detect more minute traces means that there's a lot more claim activity,” he said. “If you go back 20 years, there probably was a lot more contamination in the system but it went undetected.”

Florian Beerli, senior vice president for Ace USA subsidiary Ace Westchester's product recall underwriting unit, said that there were more than 3,000 product recalls initiated by the U.S. Food and Drug Administration last year. “You only see the big ones in the press,” he said.

The prospects for food recall are more likely given that the FDA Food Safety Modernization Act, which was signed into law by President Barack Obama on Jan. 4, 2011, gives the FDA the authority to order recalls, as opposed to recommending them.

Mr. Czuprynski said the law will bring greater scrutiny to food manufacturers and to the private companies manufacturers employ for safety inspections. “The FSMA is going to place a greater emphasis on auditing and auditing organizations,” he said.

Given these circumstances, the market for product recall liability insurance and, more specifically, contaminated products insurance is burgeoning, Lockton's Mr. Harrison said. “We do see spikes of interest when well-publicized contamination events come along,” he said. “So, there's growing interest from both the buyers' segment, but also growing interest from the seller market.

%%BREAK%%

“The market is much more robust now than it was 10 years ago, when it was down to two to three” major insurers, he said.

Headed by Mr. Beerli, Ace Westchester opened its specialty product recall underwriting unit in June.

“It is a challenging product to underwrite because there are so many variables and influencing factors within a supply chain that we have to take into consideration,” Mr. Beerli said. “A company may be well in control of what is happening within their plant, but how much can you control your suppliers?”

Thus, Ace Westchester's product recall policies were meant to complement traditional product liability, property and errors and omissions policies, Mr. Beerli said. “It closes the gap,” he said. “It's a balance sheet, brand-name protection.”

The product recall policy offers baseline wording that covers recall and consulting costs, he said, adding that endorsements for adverse publicity as well as governmental recall are available as options.

“The difference between recall and liability is that you need to have an actual bodily injury or property damage for liability. On the recall side, just knowing that if you would eat the product you would get sick triggers the policy,” he said.

Lockton's Mr. Harrison said that as the demand for product recall coverage rises, the market is becoming more sophisticated. Whereas the coverage was once crafted primarily for food and beverage companies, there are now insurers specializing in product recall coverage for toys, automobile manufacturing and auto parts.

“Not only is it growing, but there are more segments,” he said. “There's a (recall insurance) product development going on, because more people are selling this product.”

%%BREAK%%

Mr. Harrison of Marsh said this diversity in recall product insurance is especially important to companies operating in the food industry.

“Depending on whether you are an ingredient supplier, contract manufacturer, supermarket chain, restaurant or distributor, they all have risks that need to be addressed by a policy created specifically for their risks,” he said.

Yet, insurance alone will not keep manufacturers safe. Mr. Harrison said companies should perform due diligence on the quality control measures of business partners, including their financials and insurance policy limits.

“One of the lessons learned is to be careful who you buy ingredients from,” he said. “The second thing is that at the end of the day, your reputation and business interruption is your responsibility. It's better to protect yourself than rely on somebody else.”