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.

Exclusions

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.

Warranties

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.

Recall costs

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?

Rehabilitation costs

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.