Hardly a month passes without a product recall being in the news. Hot on the heels of the Aston Martin recall, General Motors’ Chief Executive appeared before a US Congressional Inquiry into the ignition switch recall that has been linked to 13 deaths.
As discussed below, motor vehicle recalls illustrate some important points for insurers to consider when underwriting product contamination lines and considering coverage issues under such policies.
Aston Martin recall
In early February 2014, it was reported that Aston Martin is recalling almost 18,000 cars (approximately 75% of those built since 2008) because of a defective accelerator pedal. The recall was a preventative measure; no accidents had actually occurred due to a pedal failing. It has been widely reported that the pedals were apparently produced by a manufacturer in China using a counterfeit plastic.
One advantage of sourcing goods from China and other Asian countries has generally been the competitive prices offered to buyers compared to say the European market. However, many buyers quickly become accustomed to paying lower prices. Price pressure can lead to quality control concerns, as manufacturers may look to maintain profit margins despite pressure to produce goods at a lower cost. Such concerns appear to be particularly relevant to the transportation and motor sector industries.
Whilst the Aston Martin recall appears to concern only first party losses, it highlights the importance of an insured’s quality control measures from both a first party and a third party perspective. Therefore, it is not surprising to see policies contain wording that seeks to focus on quality control measures as a way to manage the risk being underwritten and reduce overall potential exposure. By way of illustration, we consider some examples below.
According to some media reports, the Aston Martin recall was initiated following the discovery of some counterfeit and, no doubt, cheaper material being used. It is for these reasons that policies tend to include an exclusion concerning product tampering. Such exclusions can be drafted to exclude losses arising from the use of counterfeit or substandard components supplied by a third party without malicious intent.
Another way to emphasise the importance of the insurer’s quality control is to employ the use of warranties dealing with “quality control” of products produced during a supply chain; for example, compelling the insured to undertake a six monthly audit of all suppliers. Such provisions put the onus on the insured to ensure that quality controls are in place, wherever in the world their products or parts are sourced.
The insured event
The policy often contains wording to the effect that: “as of inception the insured was not aware and could not reasonably have been aware of circumstances which could produce a loss under this policy.” The wording “could not reasonably have been aware” puts an onus on the insured to have adequate quality control procedures in place. A related issue arises as to whether coverage is called into question if the insured has poor quality control measures or whether insurers should address quality control issues at the proposal stage? The answer is, of course, fact specific but the point does highlight the importance of considering quality control when underwriting both first party and third party product lines of insurance.
The Aston Martin case also raises some interesting points from a policy wording perspective, particularly when considering what losses are covered.
A recall of thousands of cars distributed around the world is a costly exercise and involves various mediums of communicating that recall. It is, therefore, important to set out exactly what “recall costs” are covered under a policy. For example, are insured’s distributors’ costs incurred during a recall covered (and, if so, should a sub-limit of indemnity be imposed), or the costs of any cancelled advertising campaigns and/or overtime paid to an insured’s employees as a result of the recall?
At the other end of the loss spectrum are “rehabilitation costs”. Does the policy cover the costs of re-establishing the product to the level of sales pre-recall? An issue that often arises is how this is calculated and what is the time period for this cover. Rehabilitation costs, by their nature, have the potential to be significant; therefore, insurers may consider it appropriate to impose a sub-limit of liability.
The developing market
The product manufacturing industry in Asia is faced with two distinct insurance markets for placing first party cover and third party cover. For now, few (if any) insurers are willing to underwrite an all risks product policy. There may well be scope for innovation here with some carefully drafted wording.
When claims such as Aston Martin or General Motors arise they can be expensive. Another important consideration for insurers is, therefore, the extent to which the blame lies with a third party and scope to pursue a subrogated recovery against, for example, suppliers responsible for product defects. This is not always straight forward but is increasingly being looked at across Asia by insurers to recoup some of the substantial losses incurred in this line of business.