Ambitious claims: Volkswagen knows a thing or two about those.

In what is shaping up to be one of the biggest product recalls of all time, the extent of the hit to VW’s balance sheet may depend on the wording of its product recall insurance policy.

After admitting to cheating pollution tests, the German manufacturer faces a bill that market trend analysts UBS and Societe Generale expect will wipe out at least two years’ worth of profits, or about AUD$50 billion for fines, legal bills and recall costs.

From the perspective of Whitbread Insurance Brokers’ Product Recall Liability Specialist Ben Bowen, VW’s situation looks messy.  “It’s a nightmare,” Bowen says.

“Under pretty much any policy, if there is wilful and intentional damage you’re going to have big problems making a claim.”

Horses for courses

Recovering from recall

Under normal circumstances, product recall insurance covers the cost of withdrawing a product from the market and disposing of it if necessary, as well as communications expenses and expert advice.

Policies also generally cover loss of income as a result of the recall, plus expenses associated with providing an alternative product, repairing the defective one, or refunding customers.

Talbot Underwriting Senior Class Underwriter Neil Evans says if there had been evidence of malicious tampering – for example a rogue employee – then VW would have a stronger case for coverage.

“But when you’ve got clearly a corporate decision to manipulate the emissions, then that’s not going to fall into malicious tampering,” Evans says.

Evans says the VW case is a timely reminder of the importance of product recall insurance for manufacturers and suppliers alike.

“Clients often assume they’ve got cover for product recall under liability cover,” he says. “They go to make a claim and discover they’ve only got 5% of the loss actually covered.” Another trap companies fall into is having product recall insurance, but not having the right extensions.

Whitbread’s Ben Bowen says third-party extensions – which cover the recall costs or loss of profit incurred by others – are becoming increasingly popular.

Under pretty much any policy, if there is wilful and intentional damage you’re going to have big problems making a claim.

“That’s most important when you’re in a manufacturing supply chain or dealing with large companies like Woolworths because you’re not necessarily going to be carrying out the recall yourself,” he explains. “You don’t really have any control over third-party recall expenses or third party loss of profit.”

The normal trigger for product recall insurance is actual or imminent threat of bodily injury or property damage, explains AIG Asia Pacific Head of Casualty Risk Consulting Sheri Wilbanks.

“Unlike a product liability policy, the event does not need to have occurred,” Wilbanks says. “Only the potential for the event needs to be present.” But there are now extensions to broaden the triggers.

“There are sometimes options for governmental recall trigger … because an item does not meet government regulations,” Wilbanks says.

Branded by scandal

Recall rising

With increasingly strict government product safety regulations, the number of recalls has been rising steadily. There were 496 product recalls in the 2013-14 financial year, according to the Australian Competition and Consumer Commission (ACCC). Of those recalls, more than half related to general consumer goods.

Liberty International Underwriters National Underwriting Manager Michael Lincoln says traditional at-risk products include kids’ toys, infant clothing and electronic devices with rechargeable batteries.

Other high-risk areas include oil heaters, hot water heaters, solar panels and Christmas lights.

Lincoln says the globalisation of supply chains over the past decade means greater complexity in terms of quality control and product traceability. “This often means at the time an incident is first discovered, the root cause may not yet be known,” Lincoln says.

“Due to many suppliers being involved, it may take a period of time to discover.”

The ACCC report shows motor vehicles were the subject of 158 recalls, 30% in total, while 64 recalls involved food.

AIG Australia Crisis Management Underwriter Jae Ramsbotham says complex supply chains are also a problem for food and beverage manufacturers that are increasingly having problems with adulterated raw materials.

“But the most common food recall reasons are undeclared allergens, microbial or foreign matter contamination,” Ramsbotham says.

For food and beverage companies, AIG has a web-based calculator called NOVI, which estimates their probable maximum recall loss  from accidental contamination.

“That allows companies  to better understand their exposure and determine the split between the amount of exposure retained on their balance sheet versus the risk transferred via insurance,” Ramsbotham says.

Social media is also raising the risk for clients, but it can be mitigated by good public relations, which is generally covered by insurance.

“Giving consumers the ability to share negative comments means that reputational damage unfolds quickly and is far-reaching,” Ramsbotham says.

Product Recall

Click to enlarge.

Close shave

More than returns

Not all product concerns ultimately lead to recalls, as ACCC data shows. In 2013-14, there were more than 2600 mandatory reports made by suppliers who became aware of serious injury, illness or death associated with a product.

More than half were to do with food and beverage, and almost 20% related to cosmetics and personal use items.

Only a fraction of these cases led to recalls, yet product recall insurance could have kicked in, had the companies had it, Talbot’s Neil Evans says. “Quite often, because we call it ‘product recall’, there’s a misunderstanding that it’s the recall that triggers the cover and that isn’t really correct.”

Evans says before a claim is launched, clients make extensive use of their policy. “Most insurance companies will have a crisis hotline that’s manned by independent third-party recall consultants,” Evans says.

“They can arrange for testing from a proper accredited lab, explain how similar issues have unfolded, check companies have PR statements prepared.”

The broker’s biggest role is helping the insured make sure the information is being collated correctly.

Evans says about 70% of the calls his company’s hotline receives are one-off incidents that don’t evolve into a recall. “We would prefer to pay for $1000 of testing to make sure the product is safe than do a big recall and find out a week later there was no need,” he says.

“The client likes that too, because they feel they’re getting some value from the policy.”

But when a recall is required, brokers come into play. “The broker’s biggest role is helping the insured make sure the information is being collated correctly so the quantum of the loss is known,” Evans says. “Sometimes people don’t start recording the cost they’ve incurred for recalling the product, for extra warehousing, for storage, destruction.”

Brokers don’t have to target companies the size of Volkswagen, either. The cost of product recall insurance isn’t prohibitive, says Whitbread’s Ben Bowen.

“Probably in the past five years, the market has come off slightly and it’s certainly far more affordable than it used to be,” he says. “And it’s a very, very valuable policy – I don’t think any business that’s ever had a recall would consider downgrading it.”