The number of food product recalls reported in the UK through the FSA (Food Standards Agency) rose 78% in 2015. With many UK businesses operating internationally, a product recall situation can impact many countries and cost millions of pounds in recall related costs, associated sales losses; not to mention the potential damage to a company’s brand and the loss of public confidence.
A Contaminated Products Insurance policy may provide cover for economic losses resulting from a product recall but what type of costs should insurers expect when handling product recall claims? Cover is typically provided under three main areas: recall related costs, loss of profits and rehabilitation expenses.
1. Recall Related Costs
The immediate actions following the discovery of an issue typically focus on determining the extent of the product recall needed. Following this phase, affected stock will be withdrawn from the marketplace and replaced, and the affected product destroyed.
It is important to confirm that the recalled stock is affected stock only and not stock that would have been destroyed anyway, for example, discontinued stock or product that is past its sell by date. Cover for recalled stock is typically “the cost to replace” the affected product. Care needs to be taken to properly understand the basis of valuation in the claim. As there are different cost conventions used to value stock for financial reporting purposes, the insurers and their respected advisers would need to ensure fixed costs are evaluated in line with the policy cover to avoid an overstated recovery. Therefore, as well as verifying the volume of stock is appropriately captured, a detailed costing exercise should be performed to confirm that only costs directly linked to the manufacture of stock are included in the claim.
A recall can result in multiple additional costs being incurred such as transportation (to retrieve the affected stock), overtime to manage the recall, storage costs prior to disposal of the affected products and product disposal costs. For all claimed costs it is important to review the detail of the claim and to confirm the costs submitted are additional to costs that would have been incurred irrespective of the recall.
2. Loss of Profits
As with any loss of profits calculation, it is necessary to project what the sales would have been if the incident had not occurred and compare this to what was actually achieved. Depending on the business, and the length of time that sales are impacted, different factors may need to be considered such as weather, competition or planned changes in product offering. A detailed review of sales of other products may also be necessary to evaluate potential mitigation through sales of other products as “substitutes” for those affected by the recall.
3. Rehabilitation Expenses
The impact on the reputation and sales of a business following a product recall can be significant. Consumers may be concerned about the on-going safety of products and this may need to be addressed through public relations campaigns or incentives offered to customers. Rehabilitation expenses are those costs incurred in order to ensure the sales or market share of the business are restored to the level expected prior to the incident. In a claim scenario, these may include television, newspaper or billboard advertising.
Insurers and their respective advisers need to know what to expect and how to deal with such claims when they arise. A forensic accountant will consider the insured’s losses and the basis of the claim presented to evaluate the quantum in light of the applicable policy wording. This means giving particular attention to those areas where misunderstanding can typically occur such as the appropriate basis of valuation for the affected stock or projecting the performance of the business irrespective of the recall since if this is not done correctly the impact from a quantum point of view can be significant.
By Mark Mangan. Published in the Insurance Post – November 2016.