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The changing risk and liability landscape - Defective product and recall threats evolve

Modern corporate risk and liability exposures can arise from many sources, including third parties, supply chains, products, IT security, new technology and the environment. Global Risk Dialogue examines current and emerging risk management and insurance issues across a number of trends.

A car’s faulty ignition switch shuts off, disabling certain safety devices. Overheating batteries result in a host of laptop fires. Product-related risk is one of the biggest perils businesses face today and tomorrow – with exposures growing in size and number

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Photo: iStock

RISKS

Defective products not only pose a serious safety risk to the public, they can also cause significant financial and reputational damage to the companies concerned. Analysis of more than 100,000 insurance industry liability claims by AGCS shows the extent of the risk.  Defective product/work incidents have caused insured losses in excess of $2bn over five years, accounting for almost a quarter (23%) of the value of all claims analyzed, making them the top cause of liability loss for businesses globally. Product recall losses are a major contributor to this total.

Manufacturers whose faulty products cause damages may be subjected to a product liability lawsuit by an injured individual or a class-action lawsuit on behalf of many consumers filing non-injury claims. The original manufacturer, however, isn’t the only one potentially on the hook in product liability cases; others can be component or materials suppliers, assemblers, wholesalers, retailers or repairers (or healthcare professionals, in drug and medical device cases).

Product risk incidents have increased and with complex global supply chains and large numbers of products and suppliers being concentrated on a smaller number of larger companies, liability and recall claims have also become larger and more challenging to settle. In large product recall scenarios, a considerable loss in profits and reputation can follow, as companies have to deal with a number of liabilities that can include: first and third party recall costs; expenses to inspect, withdraw, destroy and replace the product; business interruption; consultancy costs; and even customer loss of profits. Businesses often underestimate the impact of a defective product or recall incident and the negative effect it can have on financial and reputational damage.

“For a company to understand their own risks, including the manufacturing supply chain, thinking in worst case scenarios helps with mitigating problems and product defects, including future liabilities. For example, a construction company might consider the impact of long term stability of its supplied products that are used in bridges and the potential reputational exposure should a bridge collapse. To adopt a ‘No, that can’t happen to me’ attitude is wrong and the business could suffer significant losses.”

Juergen Weichert, Head of Global Product Development, Liability, AGCS juergen.weichert@allianz.com

“There is now much attention on how companies deal with defective or contaminated products, how responsive they are and how resilient their product safety systems are. More than ever, consumers are part of the agenda by making choices subject to how companies deal with crises. Tougher regulations and harsher penalties, the rise of large multi-national corporations and complex global supply chains, growing consumer awareness, the impact of economic pressures in research and development (R&D) and production and even growth of social media are just some of the contributing factors behind this.”

Christof Bentele, Head of Global Crisis Management, AGCS
christof.bentele@allianz.com

TRENDS

AGCS analysis shows the average value of a defective product liability claim is almost $300,000 (€263,903). However, the average cost of a significant product recall incident is in excess of $12m (€10.5mn) with the costs from the largest incidents far exceeding this.

Although recall frequency fluctuates year-on-year, and by industry, there has been a steady rise in activity over time, driven by contributing factors such as a rise in product safety regulation; technological advances in testing, making issues easier to detect; identification of new pathogens; impact of economic pressures and cost-cutting; a rise in consumer awareness; growth of social media, which can help early identification of issues but can also exacerbate product recall risk if not well managed; and retailer/original equipment manufacturer (OEM) pressure.


The automotive sector is most impacted by product recalls, followed by the food and beverage sector, based on AGCS analysis of insurance claims, reflecting wider trends. For example, in three out of the past four years record numbers of cars have been recalled in the US.  Although this number declined to 30.7 million units last year[1], this still means the industry recalled around 74% more vehicles than it actually delivered[2]. The automotive supply chain is completely different to 15 years ago. Consolidation has brought efficiencies but has also increased defective product and recall risk, driven by factors such as engineering becoming more complex; faster speed to market, leaving less time for product testing; outsourcing of research and development to first and second tier suppliers; as well as increasing cost pressures.

Looking to the future, advancements in technology will be both a boon and a challenge for defective product and product recall risk across different industries. Developments such as genome-sequencing provide an opportunity to improve the quality and traceability of products. Meanwhile, machine learning and Artificial Intelligence (AI) can help identify emerging product safety risks.

However, new technology also brings new risks and will become a bigger driver of recalls. Automated manufacturing plants boost efficiency but also increase cyber risk, which is currently underestimated for product recall, despite recalls due to vulnerabilities in cars and cameras.  There are huge pressures to get innovations and advances in material sciences, AI and biotechnology to market. But while fast-evolving technology is good news for product development, it can also bring new recall risks. Failure can happen when there is a shortage of time and not enough testing.

Already used to manufacture products ranging from aircraft parts to food, pharmaceuticals and human tissue, 3D printing is another area that could change defective product and recall exposures.

RISK MANAGEMENT AND INSURANCE IMPACT

When a product’s safety comes into question, time is everything, particularly in the digital age. Decisions need to be made quickly but ill-judged ones can add cost and damage reputation. Response capability is vital in fighting the size of a product recall claim, for example. In event of a recall, a company that embraces crisis management is far less likely to suffer a major incidence. Around 75% of AGCS’ work is in this area is pre-event crisis consultation, testing protocols and recall plans and running scenarios to put the crisis team through its paces, yet AGCS estimates around 70% of recall plans have some inadequacies.

Specialist product recall insurance can provide additional protection, but it is estimated that out of 250,000 manufacturing companies in the US, at least 70% do not have policies[3]. Yet, this dedicated insurance coverage provides access to crisis management services, which can help with contingency planning and stress-testing, recall action, product testing, legal support, regulatory liaison, crisis communications, and malicious contamination investigations –  all services that will be required in event of a recall but are not easily found in-house or at short notice. It also covers likely costs, such as identification and tracking of defective products, repairs, disposal/replacement, laboratory testing, investigative costs, sanitizing contaminated factories, rehabilitation costs to restore brand and lost sales.

Download AGCS’ report, Product Recall: Managing the Impact of the New Risk Landscape.


[1] US National Highway Traffic Safety Administration

[2] Forbes, Auto Recalls Hit A Four-Year Low Last Year, But Still Exceed Units Sold

[3] Independent Agent, Why product recalls are on the rise – and why you should care, August 21, 2017