Contaminated Products Insurance (CPI) and the Food Industry

Impact of FMSA and Market Response
It was initially thought that the Food Modernization Safety Act (FMSA) passed by the U.S. Senate on November 30, 2010 and signed into law by President Obama on January 4, 2011 might have a significant impact on the Contaminated Products Insurance (CPI) market. The Act – the subject of a previous Lockton white paper produced in January 2011 – gives the U.S. Food and Drug Administration (FDA) significant new powers, including, for the first time, the right to require food producers to instigate a recall on a precautionary basis. The FMSA also provided for a vigorous new inspection regime, appearing to put firms at increased risk of being shut down and/or prosecuted. We expected early enforcement test cases through which FDA would communicate a clear message to the industry that it should be on notice.

In the eight months since the Act came into force, however, it has become clear that budgetary restraints and cuts are preventing the FDA from making extensive use of its new powers. How the situation will develop in the future remains to be seen, and there is clearly no room for complacency. But, as yet, the Act has not significantly affected the CPI market. From a food producer’s point of view, the key risk management target should be to stay off the FDA’s list of “high risk” producers. As and when the FDA can again afford the bullets for its new gun, it is “high risk” firms who are most likely to find themselves in the line of fire.

As previously highlighted by two 2009 systemic recalls of food ingredients produced by the Peanut Corporation of America (PCA) and Plainview Milk Cooperative (the latter recalled two years’ production of powdered milk), precautionary recalls can have major implications for insureds’ ability to claim on their CPI insurance. In each of these cases, companies to whom these producers have supplied ingredients were “strongly advised” by the FDA to recall their products without evidence that their own end products were contaminated. Since the standard trigger for CPI insurance has historically required actual evidence of contamination likely to lead to actual bodily harm, many of the affected firms found themselves facing significant uninsured costs.

Interestingly, food companies are also starting to challenge FDA decisions. Del Monte is challenging a restriction on imports of cantaloupe from Guatemala after a voluntary recall in March. The balance between safe food and overzealous regulation is clearly a thin line.

On August 3, 2011, Cargill Value Added Meats announced that it was recalling 36 million pounds of fresh ground turkey products due to possible salmonella contamination. The U.S. Department of Agriculture (USDA), which oversees primary meat processors, could clearly have required Cargill to call back its suspect products. It had no need on this occasion as Cargill implemented a voluntary recall while publicly affirming that there was currently no evidence of any injury suffered by its customers. In the wake of the PCA and Plainview recalls, Lockton produced a white paper highlighting the importance of purchasing cover that would respond on the basis of reasonable suspicion of contamination, rather than hard evidence. The Cargill recall underlines this point, but also raises other issues around voluntary recalls. XL Insurance has developed groundbreaking coverage in this area available as a sublimit.

Key Issue:  Recall after Suspicion or Wait for Hard Evidence?
The dilemma of whether and when producers should respond to a suspicion of contamination rather than waiting for hard evidence, or indeed for someone to become ill, is perhaps the key issue in the recall and contamination market today. Producers need to avoid putting themselves in a position where a conflict arises between what they need to do to protect their brands and reputations and the specific wording of their insurance policy. While insurers clearly have no interest in clients ignoring suspicions and potentially allowing a situation to escalate, they will also be concerned to avoid putting themselves in a situation where a company might initiate a recall based on commercial grounds rather than an authentic concern for the safety of its customers. This, once again, underlines the importance of fully interrogating the different wording insurers adopt and their full implications for the buyer.

The Leprino Property Decision
The recent U.S. appeal court judgment in favor of leading U.S. mozzarella producer Leprino Foods Company in a longstanding dispute with its all-risk property insurance provider Factory Mutual Insurance (July 27, 2011) raises a specific issue with implications for the CPI market. A large consignment of cheese stored with a third party warehousing firm went off-taste and off-flavor in 2001 following contamination from damaged containers of fruit juice concentrate.

Although property policies exclude contamination unless caused by “other physical damage,” Leprino ultimately secured a judgment in its favor by arguing that the contamination resulted from physical damage caused in the third party warehouse, to which a variety of witnesses attested. This judgment will almost certainly prompt property insurers to tighten their wording to exclude all instances of contamination or spoilage in storage. In light of which, demand for specific contaminated products insurance can be expected to increase.

Food Service Brand Damage
Insurers have continued to show interest in the food service operations sector of the market where a modified version of CPI provides cover against brand damage in the wake of contamination incidents for chains or shared or franchised trade names. Lockton has been particularly successful in this sector of the market and now acts for two of the world’s leading restaurant chain operators. C V Starr has been one of the more aggressive markets for this business and has recently begun offering a new type of cover triggered by adverse publicity over actual or alleged healthcare contamination where the brand names are tarnished through national media exposure.

Crisis Consultancy Changes
Recently, there has been a potentially significant shift in the nature of the relationships between insurers and the retained crisis consultant firms whose services they offer clients in the event of major loss events. Where traditionally each insurer had their own preferred consultants, now an increasing number are using a single firm, Red 24. This helps lower the barriers to entry for new insurers looking to enter the contamination and recall market, and is thus, a favorable development for insurance buyers. At least one broking firm, however, is now seeking to route its clients via an in-house crisis consultancy operation. Whatever its benefits to the broker in terms of maximizing revenue, this seems a questionable move given the inevitable restriction of choice it implies for the broker’s clients.

This paper inevitably provides only a very cursory overview of some of the key developments currently taking place in the contamination and recall insurance market. If you would like to discuss any of these issues further, please contact Ian Harrison.

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