Product Recall Expense Coverage

Chocolate cookies on a silver dish
Image courtesy of [Monika Fuchs / EyeEm] / Getty Images.

Many small businesses manufacture products. While most of the products are sound, a few are occasionally defective. Flaws in finished products may not be discovered until after the products have been sold. Defective products that pose a threat to buyers may need to be recalled. As the following example demonstrates, a product recall can be time-consuming and expensive. It can even put a small company out of business.

Example

Debbie owns a wholesale bakery business called Delectable Delights. The firm makes a variety of baked goods, including a line of "allergy-free" cookies. Delectable Delights distributes its products to retail stores in three states. One of the firm's most popular products is a chocolate cookie that contains no eggs, wheat, nuts or milk.

One Friday morning, Debbie learns that an equipment malfunction occurred four days earlier (on Monday). because of the malfunction, all of the allergy-free chocolate cookies made that day may have contained peanuts. The defective cookies have already been distributed to vendors. The peanuts could pose a serious health risk to any consumer who has a severe peanut allergy. Thus, Delectable Delights must recall the cookies immediately.

Costs of a Recall

Debbie's first task is to notify her vendors and members of the public that the cookies are defective. She contacts vendors by phone.

To notify the public, she purchases ads in several newspapers and on social media sites. She also contacts news reporters at several television and radio stations.

Next, Debbie must ensure that the cookies are physically removed from the marketplace. She asks vendors to ship the cookies back to the bakery.

Delectable Delights pays the shipping costs and reimburses the vendors for the purchase price of the cookies. When the defective cookies are returned, Debbie pays an employee to stay after hours and destroy them.

Because of the recall, Debbie's firm has incurred substantial costs for advertising, shipping, and labor. The recall could also damage the bakery's reputation, and cause it to lose customers. 

Liability Insurance

Delectable Delights is insured for liability under a general liability policy. Debbie hopes her liability insurer will reimburse her firm for the costs associated with the recall. Alas, her insurance agent informs her that those costs are not covered. The policy specifically excludes expenses that result from the recall of any product that is withdrawn from the market because of a known or suspected defect. Delectable Delights will have to pay for the recall out of pocket.

Delectable Delights could also face legal costs. Some of the cookies have already been purchased by consumers. If a consumer eats a defective cookie and becomes ill from an allergic reaction, he or she may file a lawsuit against the bakery. Fortunately, the bakery's general liability policy includes products and completed operations coverage.

  The latter will cover claims seeking damages for bodily injury or property damage that arises from Delectable Delights' products.

Limited Product Withdrawal Expense Coverage

What could Debbie have done to protect her company against the costs of a product recall? The easiest and least expensive option is to purchase Limited Product Withdrawal Expense Coverage. Many insurers will add this coverage to a liability policy by way of an endorsement.

Limited Product Withdrawal Expense Coverage applies when a product of yours (or a product that contains your product) must be withdrawn. To be covered, the product must be recalled because it contains (or is suspected to contain) a defect, or because it has been tampered with. The defect or tampering must have caused (or is expected to cause) bodily injury or physical injury to tangible property.

Covered Expenses

The endorsement covers some (but not all) expenses you incur to recall a product from the market. These costs are listed below. You must pay these costs up front, and your insurer will provide reimbursement.

  • Notification Cost of newspaper ads, email distributions, social media ads etc. Also covers the costs of stationery, envelopes, printing and postage.
  • Overtime Cost of overtime paid to non-salaried workers, and costs they incur for transportation and accommodations. Also covers the cost of independent contractors or temporary workers you must hire to handle the recall.
  • Cost of Computer Time
  • Transportation, shipping packaging Cost to package and transport defective goods to your location (or elsewhere) for disposal
  • Warehouse or storage Cost of temporary storage if the defective products need to be warehoused
  • Product disposal Cost of disposing of products that cannot be reused

The endorsement includes an aggregate limit. This is the most your insurer will pay for all recall expenses you incur as a result of all product recalls initiated during the policy period. A deductible may apply to each product withdrawal. The deductible may be a flat amount or a percentage of the recall expenses.

Exclusions

The endorsement contains a number of exclusions. Here are some of them:

  • Breach of Warranty Excludes a product recall that is initiated because your product doesn't meet a warranty or isn't suited to its intended purpose. For instance, a manufacturing error has resulted in cookies that are too crumbly for stores to sell. Thus, Delectable Delights must withdraw them from the stores.
  • Banned Products Excludes any product banned by the government
  • Third-party Damages, Fines, Penalties, Punitive Damages or Defense Costs The endorsement does not cover damages (including punitive damages) awarded in third-party lawsuits. Fines, penalties and defense costs are also excluded.
  • Intangible Costs, Loss of Revenue Excludes costs to regain goodwill from customers or to regain market share. Also excludes loss of revenue and the cost to redesign your product.
  • Known Defects Excludes product defects you were aware of before the endorsement took effect

Product Contamination Coverage

The Limited Product Withdrawal Expense endorsement covers first-party recall expenses only. It does not cover third-party recall costs, loss of income, rehabilitation costs, crisis management costs, product extortion costs, or the cost of hiring a public relations consultant. You can protect your business against such costs by purchasing a separate product contamination policy.