The pace of defective products being recalled has increased so much that they are now a leading cause of liability loss for businesses globally. This came to light in a recent study by Allianz Global Corporate & Specialty, which analyzed more than 100,000 corporate liability insurance claims from more than 100 countries between 2011 and 2016, finding that defective products or work is the number one cause of liability loss by total value of claims. In fact, defective products account for nearly a quarter of all claims, with an average cost of $295,000 due largely to the recalls they trigger.
Risk managers can no longer assume or hope their businesses are prepared for such a crisis. They must now insist that recall response plans are in place before a recall happens, or risk spending millions of dollars to correct preventable missteps.
The top challenge for risk managers is the uncertainty surrounding cost containment. Manufacturers are responsible for retrieving recalled products and properly managing the recall logistics, and typical costs can include shipping or collecting the product, effectively destroying or recycling it, and replacing it.
While these recall management costs vary depending on factors such as scale, scope and type of recall, they are relatively foreseeable. The key factors that drive recall costs include the threat to public safety, the number of products affected, the demographic population affected, the retail value of the product, how long it has been in the marketplace, and the remedy offered to consumers.
Another foreseeable cost driver is public relations and communications. Companies are required to make as many consumers as possible aware of a recall. Costs here include the development and distribution of press releases and managing communication with media outlets.
The most troublesome risks for insurers stem from unpredictable product liability expenses that can add up quickly. These include unknown monetary penalties from regulatory bodies such as the Food and Drug Administration, the U.S. Department of Agriculture and the Consumer Product Safety Commission. Manufacturers that do not have solid recall response plans in place can incur fines as they scramble to meet all the regulatory requirements surrounding recalls.
And then, of course, there are potential litigation costs as product failures, threats to health or safety, or mismanagement of the recall process itself can lead to lawsuits. In many cases, companies incur these expenses years after the initial infraction occurred, which should underscore how the financial repercussions of recalls frequently extend long after the last defective product is removed from circulation.
A Plan Based On Best Practices
Thorough preparation is the best way to predict and control costs. What’s more, having a solid plan can sometimes result in premium reductions or other financial incentives. When preparing for a product recall, keep in mind:
- Product recalls are data-intensive endeavors. Ensure systems are in place with good data and tracking for impacted products, including data on where products are located and the value of lost products. Data is also critical in mitigating risks related to regulatory non-compliance. To avoid penalties, manufacturers must be able to report to government regulators with accurate data on the progress of the recall efforts and demonstrate that they are meeting all applicable reporting obligations.
- A recall plan should be developed before an incident occurs. Risk managers need to encourage their businesses to be recall-ready with a designated team that has received any requisite training and is ready to implement the plan. Every recall plan is different, but several broad components are universally applicable, including the definition and responsibilities of the recall management team. This section should include a clear outline of the specific authority and responsibilities of each individual, department, and affiliate. It should also include contact information for each member of the recall management team and backup personnel.
- Once the plan is in place, companies should conduct an initial mock recall to evaluate how their teams and procedures would function in practice. This process can highlight ways to improve recall plans before a real crisis occurs.
- Product recalls also frequently involve supply chain partners. It is critical to understand the recall protocols and capabilities of supply chain partners. Many lack an effective method for removing affected products from shelves and consumers’ homes, for instance. In some cases, entire product lines may be pulled out of an abundance of caution, significantly raising the recall costs. Worse yet, those who fail to respond to a recall fast enough threaten consumer safety, creating unnecessary liability.
- Lastly, it is critical that manufacturers understand the standards and recall regulations governing their industry. One of the biggest questions to ask is whether a product is “defective” and whether it could create a significant risk of injury to the consumer. If yes, then a recall is probably necessary. When a defect is first discovered, it is difficult to determine the level of public exposure or the severity or probability of possible injury, so the problem should be promptly reported to the relevant regulatory agency to reduce risk exposure, even if there is still some doubt as to whether a substantial hazard exists.
By helping to develop plans that specifically addresses how to respond to a recall, risk managers can ensure that their company or manufacturing client is better prepared to address liability issues, thus minimizing unnecessary risk, time and expense.