When products go bad

The phone call that every food and drink company dreads is to hear that their product has to be recalled because of a contamination or it has been tampered with. How to deal with such an occurrence should be an integral part of any company's management handbook.

Unfortunately, these calls have become rather more frequent in recent years. In December 2005 a dangerous strain of E-coli was feared to have contaminated Camembert cheese sold by more than a 100 British retailers.

And in June this year more than a million Cadbury chocolate bars were removed from shelves amid fears that they may be contaminated with salmonella from a leaking pipe at Cadbury's Marlbrook plant in Herefordshire.

Arnaud Langlois, an analyst at JP Morgan, estimates that Cadbury could lose as much as £30m due to costs associated with the recall, including lost sales, reducing the company's 2006 operating profit by 3%. Although, last week Cadbury announced it had lost £20m so far.

Brand Index, which monitors the reputation of hundreds of organisations on a daily basis, compiled a 'brand score' for Cadbury based on the responses of those polled to a number of questions about how the company is perceived.

In the days before the salmonella scare broke, Cadbury enjoyed a score of 44, but that had fallen to just 22 a few weeks later.

The negative publicity has not been confined to the confectionery company's safety problems. Cadbury has also come under fire for taking six months to report the problem to the authorities.

Recall has widespread implications for the food industry as a whole. Confusion over the interpretation of new EU rules has led insurance underwriters to predict a rise in the number of product recalls. The confusion relates to the tolerance levels allowed in food and drink products - for example, pesticides on fruit and vegetables, benzene in soft drinks and salmonella in meat and dairy products.

The main law governing food safety

is the EU General Food Law Regulation 178/2002, which was implemented in the UK in January 2005 and is policed by the Food Standards Agency and local Environmental Health Officers.

The law places responsibility on companies not to place unsafe food on the market. It also states that companies must immediately initiate procedures to withdraw food if they have a reason to believe that it is not safe.

While authorities do not have the power to force companies to recall products, the obligation for companies to do so is set out in 178/2002. However, the effect of involving the Food Standards Agency can make it seem like a forced recall.

Silent recall
Prior to the new legislation it was possible to conduct a 'silent' recall of a product avoiding the glare of publicity. Now, however, companies must tell the agency that a product is being recalled. The agency posts details of the incident on its website, triggering a possible media alert.

Not surprisingly, in a recent food industry survey, 25% of respondents cited product liability and product recall as their number one business risk.

Despite these concerns, product recall insurance is still rarely purchased. It is estimated that in the US 95% of food and drink companies do not have product recall insurance and the figure in the UK is likely to be even higher.

This is somewhat surprising considering the potential financial risks.

Ed Mitchell, a product recall underwriter at Beazley, believes that take-up is low due to a lack of awareness of the product.

"Because product recall cover is perceived to be expensive and is not compulsory, the number of food and drink manufacturers buying this type of insurance has traditionally been relatively low," he says.

"Although recalls are low in frequency, they are high in severity and with the new legislation, the number of incidents is likely to increase."

The number of companies seeking product recall cover is also likely to accelerate as a result of pressure from supermarket chains. They dictate that suppliers of their 'own brand' goods should take out product recall cover to indemnify them.

With supermarket branded food products commanding nearly 50% of the market the potential for growth in product recall insurance is considerable.

There are three main areas of loss provided for in a food and drink recall policy, which can be bought separately or in a combined package.

Accidental contamination would include incidents such as salmonella contamination; malicious tampers where, for example, a disgruntled member of staff has inserted a foreign object into food during the production process; and extortion demands, where a company is held to financial or operational ransom to avoid the threat of tampering.

Principal underwriters
London has become the major centre for product recall insurance with AIG, Beazley, Catlin and QBE being the principal underwriters in this field. In addition, XL will shortly be entering the market.

Beazley provides a free 'crisis management' consultation with a network of experienced independent consultants, all experts in their specialist fields, to help review policyholders' crisis management programmes.

Mitchell says: "We lay great emphasis on helping clients prepare for a potential crisis and if necessary recovering from the incident. Preparation is vital in ensuring that damage to brand, reputation and profits are kept to a minimum."

Product recall insurance typically covers the costs associated with actually pulling goods off the shelves, replacing stock that has to be destroyed, advertising and public relations costs.

Loss of profit and rehabilitation after a food scare are included as standard within the scope of the cover. The costs associated with rehabilitation include, for example, the money a company may have to spend to regain market share.

However, companies need to be aware that there can also be conditions attached to policies that limit the cover available. One typical exclusion is the cost of recalling products, where the consequences of consumption would not manifest themselves quickly, generally specified at 90 to 120 days.

Other common exclusions are that policies would not cover the costs of recalling products because they could contain carcinogenic ingredients or banned substances.

Cover is provided on an aggregated limit with certain products having higher premiums depending on the possibility of contamination. For example, raw meat processing, dairy products and raw vegetables have a higher risk of contamination than canned vegetables.

Food and drink manufacturers invest huge resources in creating and maintaining their brand image with customers, suppliers and investors. But it is their reputation following a crisis that will prove vital to their survival. IT

' Alison Roberts is a product guarantee and recall specialist in the international division at Alexander Forbes Risk Services