A specialist underwriter has warned brokers about the hidden costs associated with product recalls, saying claims can reach well over the $100 million mark.
“Every manufacturer, including finished product, component part and raw material providers in the region and globally has the potential to experience a product recall,” says Manzhi Zheng, senior casualty underwriter and product recall specialist for APAC at Swiss Re Corporate Solutions.
“On average, the cost of product recalls can be close to US$10 million – however, in our experience, it can reach up to over US$100 million.”
Zheng’s comments come after a noticeable rise in product recalls across the APAC region – from the recent strawberry crisis in Australia to several high-profile Singaporean recalls, including ones from IKEA, Samsung and Toyota.
“These product recall cases have made risk managers and CFOs question whether they also need to explore their recall exposure in order to protect their balance sheet and, perhaps more importantly, their reputation,” says Zheng.
“In our experience, while many organisations buy product liability, product recall insurance (although increasing) remains lower than in Europe and the US,” she continues.
“There are many hidden costs surrounding a product recall, and to be aware of these and then actively managing them is key to preparedness and keeping the company protected.”
According to recent report from Swiss Re, product disposal costs, business interruption and customer reimbursement rank as the three largest cost drivers captured by a company when dealing with a product recall.
However, Zheng warns that, once the need for a recall has been identified, the costs can quickly increase according to several factors.
“Once the need for a recall has been determined, the seriousness of the recall needs to be established,” says Zheng. “This will typically include laboratory testing and investigations to understand the cause and nature of the recall and how widespread the issue is, for example is it contained to a consignment or batch, or a larger issue?”
While costs are often manageable if the problem is limited to a single batch or production period, Zheng says the situation becomes entirely different if a design fault is to blame.
“A key issue that a company will try and establish at this early stage is how much of the product has been distributed and where is the product in the supply chain,” she says.
“If the batches are at a warehouse waiting to be shipped, the cost of recall will be far less than if the product is already in the hands of the consumer. Speed is of the essence at this point because if the product continues along the supply chain, the issue and cost can accelerate.”
The emotional component of a recall can also wreak havoc on costs with Zheng pointing to the 2008 baby milk recall as a prime example.
“The emotional component linked to infant fatalities and hospitalisation was huge and the industry is still reeling from the impact eight years on, with mothers buying baby milk from Hong Kong, Singapore or Australia rather than China,” she says.
“Certain jurisdictions mandate the reporting of a product related issue if any defects become known to a manufacturer or distributor, which may necessitate a recall,” says Zheng.
“In turn, the regulatory bodies will contact their counterparts across the globe if the product is sold in different jurisdictions. Depending on where the product is sold will clearly impact the cost of the recall and also the potential damage to the brand if the recall is handled badly.”
Should a recall be required, there are a number of potential costs and decisions that must be made – these include:
Advertising and communications
“Companies need to decide which media channels should be used to release the recall notice,” says Zheng. “Social media platforms have reduced the potential costs but advertising space in newspapers, television and radio may still be required and costs can increase considerably.”
The message about the recall will need to be carefully crafted to ensure it is clear and concise while also informing consumers that the company is managing the issue effectively.
“The product may need to be physically removed from outlets, supermarkets and/or showrooms,” says Zheng. “Retailers may also need to be reimbursed for their costs and loss of trade as well as for removing the affected product from their shops.”
Repair, disposal and replacement
Zheng also warns that the repair, safe disposal and replacement of a product can be one of the most significant costs associated with a recall and pointed to a specific Swiss Re case as an example.
“Swiss Re Corporate Solutions indemnified a client for more than US$200,000 for the retrieval and replacement of a single batch of tinned food when it had turned bad in transit,” she says. “In addition, costs can increase if the product has complex disposal procedures.”
The ripple effect
If a faulty product is used as a component in other products, then the cost of recall will also be considerably higher, says Zheng.
While this is most common in the automotive sector, where a faulty part can easily damage other products in close proximity, which must also be paid for, there are other sectors that see similar situations.
“When a base product, such as sugar, is being recalled, the product will have been used in so many products - for example, ice-cream, cakes, biscuits, then all products will need to be recalled and the costs will skyrocket,” notes Zheng.
It is almost certain that there will be some business interruption associated with a product recall – whether this is due to sanitising and certifying a warehouse where salmonella was identified or shutting down operations entirely until an issue is fully resolved.
“Typically, business interruption would not be covered for the automotive segment but would be available for the food and beverage sector,” says Zheng.
Consultants, lawyers and extra staff costs
“Depending on the severity of the recall, lawyers, consultants and extra staff may be required to help manage the recall,” Zheng explains. “In addition, the potential lost man hours associated with the distraction of a recall could be significant.”
While the actual product recall is likely to be incredibly costly for a client, the expense doesn’t stop once everything is safely off the shelves.
“Once the recall has finished, the next major cost can be in returning the company and brand to the position it was in before the recall,” says Zheng. “This may include extra promotional expense and sales promotion offers.”