Product recall - Managing the impact of the new risk landscape

A product recall is potentially the most risk-laden situation a company can face. And whether a manufacturer, retailer or wholesaler, this risk is increasing, as supply chains grow more complex and the regulatory landscape becomes more robust. Yet businesses can often underestimate the impact of a recall and the negative effect it can have in terms of financial and reputational damage, despite the growing number of large loss events.

This report examines current and emerging risk and loss trends in product recall and includes exclusive insurance claims analysis. It focuses primarily on the automotive and food and beverage industries, but also incorporates other sectors. The report also highlights the increasingly important role of crisis management services, including specialized insurance, in a recall scenario and outlines what can be done to mitigate the fall-out when an incident occurs.

Product–related risk is one of the biggest perils businesses face today. Defective products not only pose a serious safety risk to the public but can also cause significant financial and reputational damage to the companies concerned. Defective product incidents have caused insured losses in excess of $2bn over the past five years, making them the largest generator of liability losses, according to AGCS.

Product recall losses are a major contributor. Although recall frequency can fluctuate year-onyear, and by industry sector, there has been a steady rise in activity over time. A more robust focus on safety and regulation by authorities,
the rise of complex global supply chains, the knock-on effect from the current economic landscape, growing consumer awareness, and the increasing influence of social media are among those factors ensuring recall exposures are growing significantly. In addition, malicious product tampering and even extortion incidents pose an increasing threat. Meanwhile, advances in product testing could see a rise in litigation activity in future, as DNA technology makes it easier to establish the link between an incident and a company.

However, many businesses still underestimate the impact a recall event can have, with the costs often exceeding expectations, due to inadequate planning. Typically, the biggest costs are loss of sales and business interruption. However, even if a recall event doesn’t result in the billion dollar losses that hit the headlines, losses can mount. According to AGCS analysis of insurance industry product recall claims across 12 sectors, even the average costs of a recall can exceed €1.4m ($1.65m), rising to over €12m ($14.5m) and almost €8m ($9.42m) for significant claims in the two most impacted sectors – automotive and food and beverage respectively. The loss totals from individual events can far surpass these figures.

Product recalls are also increasing in size. Global companies now sell their products to millions. At the same time many manufacturers are sourcing components or ingredients from fewer suppliers. This has seen huge increases in values of risk and the emergence of a multiplier or “ripple effect” where a single recall can impact whole industries. The recent recall of Takata airbags is thought to have affected some 60 to 70 million units  worldwide. Managing a complex global supply chain 24/7/365 poses an increasingly difficult challenge.
Regulatory scrutiny is increasing, as many countries implement stricter product safety laws. Regulations such as the Food Safety Modernization Act in the US means authorities are now far more proactive. In the UK the number of recalls of food and drink products involving mislabeled allergens surged by over 60% in 2016 following the introduction of new European Union legislation. And product safety regulation is also increasing for automotive and consumer goods. Globally, when the regulatory bar is raised it increases risk for companies, as they have to adapt their safety culture to maintain higher standards.
Undeclared allergens are fast-emerging as a primary cause of food recalls. Typically involving such products as nuts, milk and wheat, such recalls can often be the result of manufacturing error (mislabeling) or unintentional cross-contamination. Toxins in consumer products, in many cases imported from Asia, is another growing concern, while incidents of environmental contamination are also rising. Recent cases have come from sources such as micro- and nano-plastics, while the discovery of insecticide in Dutch eggs in 2017 triggered recalls in 16 countries across Europe and China.
Economic pressures continue to bite in many sectors, increasing the risk of human error. Meanwhile, food fraud, including economic adulteration and counterfeiting, has become a major issue that has resulted in large recalls, reputational damage and major losses. The 2013 horsemeat (substituted for beef) scandal in Europe is a prime example. There have also been issues with organic foods and milk powder. Many food fraud losses are uninsured. The insurance market is looking at solutions to address this.
Non-safety recalls are an emerging phenomenon. Companies increasingly feel obliged to recall products if it emerges that child or slave labor has been used during production in the supply chain or if there are issues around religious or ethical designations, like halal or vegan food, in order to protect their reputations.
It can be a fast and effective way of communicating with customers, but social media can also exacerbate recall risk. An erroneous post can impact the size of the recall and cause reputational damage. Social media can even have a bottom line impact on those companies not responsible. An academic study shows that negative comments on social media sparked by recalls in the automotive sector helped erase $7.3m on average from the market cap of an “innocent” firm over just six days.

Products from Asia continue to account for a disproportionate number of recalls in the US and Europe, reflecting the eastwards shift in global supply chains and historically weaker quality controls in some countries. In 2015 Chinese products accounted for over three times as many recall cases in the US as US products.

Across Asia product safety regulation is improving, and consumer awareness is growing, leading to more government-led recalls.

Developments such as genome-sequencing provide an opportunity to improve the quality and traceability of products but new technology also brings new risks. Future product recalls will come from new areas. Automated manufacturing plants increase efficiency but also increase cyber risk, which is underestimated, despite recalls for cyber security vulnerabilities in cars and cameras. Motivated by extortion or malicious intent, hackers could change or contaminate a product by controlling machinery. Nanotechnology and 3D printing are two further examples of innovations that could change recall exposures.

Pre-event preparation and planning can have a big impact on the size of a recall and the financial and reputational damage sustained. As part of a holistic risk management program, specialized product recall insurance can help businesses recover faster.

As well as covering recall costs, including business interruption, it can also protect against other emerging triggers, such as malicious tampering. It  also provides access to crisis management services which can help companies  prepare by putting both recall and crisis management plans in place and organizing simulations which test a company’s procedures, highlighting areas of improvement. While companies periodically conduct a traceability exercise, a full product recall simulation goes further, incorporating media, customers and other stakeholders.

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