Risky business

Matthews regards increasing legislation as the main driver: "More and more regulations are being introduced. Companies are struggling to keep up with the burden of ensuring that ingredients comply with rules, through audits. It's increasingly difficult."

"The increase in food and drink recalls in the UK and Europe is being driven by a change in legislation," agrees Ed Mitchell, senior underwriter with XL Insurance. Mitchell highlights the General Food Law Regulation (EC 178/2002) as the chief culprit: "The legislation not only sets out specific obligations for food and drink companies regarding putting safe products on the market, but also provides specific and onerous obligations on the food and drink companies regarding recalling their products."

Simon Plumridge, manager for crisis management in the liabilities division of insurance firm AIG Europe (UK), also stresses the onerous nature of the General Food Law: "Anyone who identifies that there is a safety issue with food has a responsibility to act immediately, whether it's the manufacturer, distributor or retailer. Before the legislation was introduced, companies were able to make judgement calls about whether they needed to withdraw a product on safety grounds. Now they only have to have a concern and they're forced to act."

Figures from the European Commission's Rapid Alert Service for Food and Feed bear out this perception. Recalls have been following an upward trend for years, with 2,310 in 2003, and 2,588 in 2004, for example. Following the implementation of the new regulations in January 2005, recalls in Europe leapt by almost a quarter to 3,158.

The General Food Law is not the only ?legislation behind the increase, however. "Changes in allergen labelling legislation in 2005 also increased the exposure to recalls," says Mitchell. "The most frequent cause of food recalls currently in the UK is related to allergen-labelling errors." This was how Cadbury was caught out earlier this year.

It's difficult to gauge how much all this is costing, because many of the negotiations on product recalls take place behind closed doors. "Commercial relationships between retailers and manufacturers are so important that it never usually gets to court," says Matthews. "There may be negotiations about fines or administration charges levied, but supermarkets are generally keen to sort those issues out."

Perhaps this is one reason why many food companies are still not aware of how vulnerable they are to the risks of product recall. "The big retailers and manufacturers have the appropriate coverage in place, but there's a lack of knowledge among medium-sized and smaller companies," says Nicola Hall, an insurance broker with Miller Insurance Services. "In the product recall market, about 90% of our business comes from the US and Canada. In the UK it's increasing but its growth is slow and steady."

Product recall insurance

Product recall also remains a niche market for insurers, with only a handful of companies in the London market offering product recall packages, as opposed to more conventional product liability insurance.

According to Hall, too many manufacturers think that product liability insurance is all the cover they need. In fact, most standard product liability policies would cover them for legal liabilities, for example if they poisoned someone, However, it would provide no protection against the considerable costs of recalling a product, or the associated costs in terms of lost sales or damage to the brand's reputation. "Only product recall policies offer protection against recall costs and product rehabilitation, as well as covering the period following a recall for gross loss of profit," she says.

In terms of direct costs, a recall policy may cover: the initial laboratory testing of the suspect product; retrieval and reverse distribution of the stock; destruction and disposal of any faulty products as required by regulatory agencies; additional human resource requirements; repair or replacement of faulty product; and the redistribution of new or repaired product to retailers.

Of course, with brand reputation and future business at stake, these initial costs are only the beginning. There may be cancellation fees for advertising campaigns and the cost of rehabilitating the product using promotions such as two-for-one offers. Recall policies also cover these costs.

Not only will the specialist policies offer money to cushion the blow, they also tend to include an element of consultancy and crisis management, typically by working with specialist companies. This often includes a proactive element of upfront help, in terms of risk minimisation, rather than simply helping companies cope once a recall has started.

For example, AIG's recall policy includes cover from food safety and recall consultancy RQA and from Clayton Consulting, experts in the criminal aspects of malicious tampering. Clients can get advice from the consultants on quality assurance, recall plans, security or any other aspect of their business that could reduce their risk.

"Companies may not have the expertise to deal with these situations in- house," says Plumridge. "It's a very good additional feature for them and also for us, because it helps to mitigate our costs."

"Food and drink companies often think their own quality assurance standards are sufficient to minimise any risk. It is a tightly regulated industry and we've found that standards in many companies are extremely high. But our experience shows that even well-managed companies can end up making claims."

XL Insurance has recently teamed up with Razor PR, which specialises in crisis management. "We believe the crisis management service is a key part of our product and, as such, it is an important integrated service," says Mitchell. "An insurance policy cannot insure against damage to a company's brand per se, but the right crisis management service can go a long way to help a company protect its brand."

Chris Woodcock, md of Razor PR, adds that the punishment for not taking a proactive approach to crisis management can be severe: "You only have to consider recent cases of damage to prominent food brands, that might have previously appeared beyond reproach, to understand that built-in, pre-emotive product resilience and proactive corporate governance are invaluable."

Before everyone rushes out to buy product recall insurance, however, it's worth noting a few key points that are typically excluded from such policies. First, the recall has to be sparked by a risk to safety or a risk of property damage. "We are not looking to provide cover for a product that doesn't taste right or is the wrong colour," says Plumridge. This means that companies may not be protected against problems such as contamination with GM ingredients in a GM-free product, for example.

Also, Sudan 1 may have been one of the most high-profile cases of recent years, but it would not have been covered because the potential health risk of the dye was as a carcinogen. "The insurance isn't intended to cover situations related to long-term health issues," says Mitchell.

The insurers argue that without such exclusions, product recall premiums would be too expensive and no one would be able to afford cover. According to Plumridge, the important issue is for a firm to discuss its needs in detail upfront: "We can help companies strike a balance between the amount of risk they want to transfer to AIG and the premium for that risk."

One final point that ingredient manufacturers need to watch out for is the "no property damage" loophole. "It's been developed in case law over the last two or three years," says David Webster, head of insurance litigation at Eversheds. The problem can arise if a particular ingredient or component sparks the recall of an end product.

Take the hypothetical example of a faulty ingredient in a cake that makes it unable to be sold. The end product manufacturer may have product recall cover, but their insurer will then seek to recover any losses from the ingredient manufacturer. The ingredient supplier will have liability insurance, but it will typically need to show that its ingredient caused property damage in order to make a claim. But there was no cake to damage before it was manufactured, so the insurer may argue that the situation is not one of "property damage" but rather the production of a substandard product. This can result in the ingredient firm footing the bill.

Each case will be judged on its merits, but it can prove to be an expensive loophole if an ingredient manufacturer is caught out. FM

KEY CONTACTS

• AIG Europe (UK) 020 7954 7000
• Eversheds 020 7919 4500
• Miller Insurance Services 020 7488 2345
• Razor PR 01869 353 800
• XL Insurance 020 7933 7000

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