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RECALL COVER SITS ON SHELF

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Splash Off Water Rockets were meant to be a blast, but not the kind that some users of the toy experienced.

So Ohio Art Co. last month permanently grounded some 68,000 of the rockets, which consist of a 16-inch, clear plastic tube with a rounded rubber nose that promised to shoot up to 60 feet in the air.

This was the first product recall for the Bryan, Ohio-based manufacturer, which began making toys in 1917 with a galvanized toy windmill and has made the Etch-A-Sketch since 1960.

In the weeks leading up to the July 17 recall, the Consumer Product Safety Commission and Ohio Art had received reports that 37 of the rockets had malfunctioned. They exploded during the rocket lift off, which was fueled by the water pressure of a garden hose, or broke apart upon its crash to earth.

Three people were cut, one on the hand, another on the forehead and one more on the shoulder.

The faulty rockets were traced to a batch with a contaminant in the resin of the rocket's clear plastic shell, said Guy Thomas, Ohio Art's vp of sales.

At nearly $20 per water rocket, Ohio Art estimates it will lose $1.4 million in sales, not including the recall expense and the cost of storing the rockets in Ohio Art's warehouses while the company decides on the toy's future.

Despite lost sales and the cost of storing or destroying recalled goods, many manufacturers are hesitant to purchase product recall insurance, even though it could finance recall-related expenses. Although Ohio Art's insurance broker, Hylant-MacLean Group of Toledo, Ohio, presented product recall insurance in discussions last year, Ohio Art decided against buying the coverage.

Now, however, "We may look at it a little more closely," said Paul McCusty, vp-finance for Ohio Art, which had sales of $37.5 million last year. Ohio Art's decision to buy product recall insurance will depend on the cost, he said."You can be insurance poor," he said.

The toy manufacturer, which has general liability insurance underwritten by CNA Insurance Cos., has filed three claims with its insurer to cover compensation for the injured paries, said Mr. McCusty.

The CPSC, an independent agency of the federal government, last year issued 375 recalls involving more than 85 million "consumer product units," according to the commission.

The CPSC works with manufacturers to issue a product recall when the product "either violates mandatory safety standards or presents a substantial risk of safety to the public."

Separately, the Food and Drug Administration recalled more than 3,000 products last year.

The FDA ordered and coordinated 819 product recalls of food and cosmetic products last year, more than twice the number of products recalled by the CPSC.

Despite the number of recalls, recall insurance remains difficult to sell.

"In the last year or so, we haven't had a request for product recall or product tampering coverage," said Ken Fekete, senior vp-special accounts for Reliance National Insurance Co. in New York. That's in spite of the fact that Reliance insures against recall for "virtually any product," Mr. Fekete added.

One reason for the lack of interest is that insurers may require potential policyholders to conduct product safety tests or add safeguards to minimize the risk of a defective product. Once manufacturers have done all that, they may think they've reduced the recall risk enough to eliminate the need for coverage, he explained.

"There's a lot of interest in product recall insurance, but in the past, a lot of clients felt it was inadequate or expensive," said Emily Freeman, vp and regional broking director for Sedgwick of Oregon Inc. in Portland. "It hasn't taken off as much as underwriters would like."

Product recall coverage is being sold as a monoline policy or as an endorsement to a general liability policy, Ms. Freeman said.

In addition to CNA Insurance Cos., Reliance National and Lloyd's of London, other insurers offer product recall policies.

Most of her sales are to food manufacturers, and the coverage is endorsed general liabilty policies, Ms. Freeman said. These endorsements which range from limits of $100,000 to $250,000, cover extortion, malicious tampering and product recalls, she said.

Endorsements have their limitations, Ms. Freeman pointed out: For example, some cover only voluntary recall and not malicious tampering, and the small limits usually just cover the expenses of issuing the product recall.

When it comes to product recall, there's "no such thing as a standard coverage," said Pete Conway, president of risk management for CNA in Chicago. CNA has designed product recall insurance specifically for bottling and food processing companies, Mr. Conway said. CNA policies cover one recall with a standard limit of $2 million per recall, Mr. Conway added.

Some brokers and insurers warn clients it is foolish not to buy a form of product recall or product tampering insurance. They also contend that the market for product recall insurance, along with a demand for product tampering coverage, is growing.

"There's around $100 million in premiums for malicious accident cover written in the United States today," said Jean McDermott-Lucey, vp of AIG's crisis management division in New York. Although she acknowledges it's a "niche product" and a "difficult sell," Ms. McDermott-Lucey said there is potential for the market to double or triple in the next few years, as buyers become more aware of the product and their need for the coverage.

AIG underwrites two monoline products, Ms. McDermott-Lucey said. They are policies for malicious tampering and accidental damage, which can also be combined.

"If someone calls the media and says, 'I poisoned the water,' malicious tampering coverage kicks in," Ms. McDermott-Lucey said.

She compared the potential of product recall insurance to another coverage that was once a "niche" product: kidnap and ransom insurance.

"No one wanted it a few years ago," she added, "and now it's become common."

Risk managers, brokers and insurers agree, however, that companies must act quickly and responsibly before and after a product recall. This will protect their future sales and a company's good name, they say, which is quite often a company's most valuable asset.

"What's important is to maintain a relationship with the public" and keep distribution channels open, said Greg Higgins, Deloitte & Touche L.L.P.'s associate national director for business insurance consulting in Chicago.

When facing a product recall, businesses must quantify and document their potential losses, try to maintain the product's market position and create a paper trail to document recall-related procedures expenses, Mr. Higgins said.

Structuring a product recall program can help companies prevent losses, various trade organizations say.

According to the National Soft Drink Assn., companies should set up product recall committees well before the threat of a recall. The committee should include the company's president as well as members of its legal, public relations and production staffs.

A recall coordinator appointed by the president of the company should oversee and administer the recall, the NSDA states in its Guidelines for Product Recalls. The group stresses the importance of documenting decisions made by the company during a recall as well as its accomplishments.

During the recall, the product recall coordinator can manage a quality assurance staff, which will: collect and analyze samples of the suspected prodect; identify the presence or absence of a real or potential problem or defect; review original laboratory records for indication of a problem or defect; document and submit all findings to the product recall coordinator