Tighter regulatory supervision, better detection technology and more complex supply chains are increasing the frequency and severity of food product recalls. Contrary to popular belief, property and general liability insurance do not always cover first and third party damages resulting from a product recall. 

Instead, specialist product recall insurance has evolved significantly in recent years and can provide better financial protection and a more effective crisis response.

Product contamination and recall is the central risk facing food manufacturing and distribution companies. There were nearly 450 food recalls in 2017. Trends toward stricter regulation and advancing analytics have continued as the FDA and USDA, in conjunction with the Centers for Disease Control and Prevention, use whole genome sequencing to assist in identifying the source of food and beverage contamination and outbreaks.

Whole genome sequencing reveals the DNA makeup of an organism, enabling precise differentiation between organisms. The FDA performs whole genome sequencing analysis on samples taken during inspections of food manufacturing facilities and food products in the market. During foodborne illness outbreaks, the CDC compares clinical isolates from sick patients against the FDA database, which helps identify the source of the outbreak and the responsible companies.

The 2011 Food Safety Modernization Act (FSMA) has shifted food safety focus from reaction to prevention and covers all parts of the supply chain. The FDA now has the authority to stop production and distribution of products. Improved analytics can 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. From 2004 to 2014, U.S. foodstuffs and animal and vegetable product imports nearly doubled—from $66.9 billion to $126.6 billion. Although it may be economically sound to make products in regions that afford lower labor and ingredient costs, product quality can be critically affected. Moreover, food safety protocols and regulatory oversight may be very different, particularly in developing countries.

COUNTING THE COST

Product recall is costly. The financial consequences range from the immediate costs of the recall and the value of condemned products to damaged brand reputation that may continue for years. Those at risk include importers, manufacturers (including contract manufacturers and private-label companies), distributors (including storage warehouses and transportation) and retailers.

The cost of contamination depends on 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 good. Ingredients, such as spices, can contaminate a large number of third-party products. The aggregated cost may far exceed the value of the contaminated ingredient.

Expenses include clean-up costs, consultancy testing and analysis, product replacement or repair, and product recall and/or destruction. And don’t forget the distribution costs for replacement products. There may also be third-party property damage and the associated defense costs.

Food contamination 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 damage 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.

A vast majority of food manufacturers rely on supplier or contract-manufacturer indemnity to cover product contamination and recall losses. But contamination often occurs during the manufacturing stage. Even if the loss is attributable to third parties, indemnity is far from certain. The vendor may crash under the weight of multiple claims and limited coverage. A recent spice recall triggered recalls affecting more than 100 brands and nearly 800 products with different packages. A similar sunflower seeds recall affected more than 100 products.

Specialist product recall insurance has evolved significantly in the last two decades. This provides first-party coverage, thus removing the uncertainty associated with third parties. The insurance contains the key building blocks of a property policy: 

  • Property damage: replacement of contaminated (recalled) product and recall expenses
  • Clean-up costs: removal of the contaminant from the site
  • Business interruption: loss of gross profit plus expense to reduce loss resulting from the recall of product or reduction in manufacturing output. The most significant development in recent years is the emergence of coverage that includes thirdparty 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, third-party coverage may be the most important. The coverage has been increasingly broadened to protect against third-party costs not covered by general liability. As many manufacturers have found, the nature of food recalls and the sensitivities around consumer safety mean a significant share of third-party claims fall outside general liability.

Most policies provide crisis consultants’ services. Typically, these services 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, smaller companies stand to benefit from this 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. Prompt response to food contamination incidents is critical since social media has accelerated the speed and breadth of communication. Information and misinformation can be quickly transmitted to a wide audience.

A company’s response within the first 24 hours is, therefore, crucial.

Alexandru is U.S. head of crisis management at Aspen Insurance.