The cost of having to recall a product from the market can be considerable for soft drinks companies, involving the investigation of the problem, the collection of the product, disruption to production and repairing damage done to brand image. But companies can insure themselves against these costs. Keith Sankey reviews the options available.

The legal and regulatory environment within which modern businesses have to operate is constantly evolving. While some of the initiatives are intended to protect the rights, safety and health of employees, others have the welfare of consumers at heart. Such is the pace of change that smaller businesses in particular often have difficulty in keeping up. Their larger counterparts on the other hand have sufficient resources in-house or can afford to pay the fees of commercial lawyers and other specialist firms.

One of the latest legislative outpourings involves businesses based in the EU, which is soon to be extended to include countries such as Hungary and Poland. The General Product Safety Directive 2001/95 is due to come into force from 15th January 2004. This builds on its predecessors, the General Product Safety Directive 1992 and the General Product Safety Regulations 1994, and also the national laws of individual countries, such as the UK Consumer Protection Act 1987.

The requirements imposed on businesses, including those involved in the soft drinks trade, are likely to trigger an increase in the number of instances where products have to be recalled from shops, warehouses and even consumers' homes. The reporting and notification obligations are based upon the US model, as they require a report to be made to the regulatory authorities immediately a product has been ruled unsafe. Any information made available to the regulators, which concerns the health and safety of consumers will also be placed in the public domain. This clearly has the potential to inflict severe damage to the brand.

Europe is merely following in the footsteps of North America and Australia where, for some time, high penalties have been applied for breaking the rules. In the US, the Food and Drug Administration frequently demands seven figure fines for breaches of reporting regulations, while Australia has onerous reporting requirements and one of the highest incidences of product recalls in the world. These can be enforced where the product will, or may, cause injury and can carry a penalty of more than A$1m for a particular situation.

The cover available
There are two types of insurance cover that are specifically designed to mitigate the financial damage. The first is product liability insurance, which covers the costs of defending any claims for injury, damage or financial loss, and, if the defence should be unsuccessful, of paying out compensation. However, if a product has to be recalled, something more will be required. This is where product recall insurance can step in and fill the gap. It is intended to provide financial recompense for three types of expense.

The first is the cost of carrying out the initial investigation. This may, for example, involve testing a soft drink in the laboratory for the presence of unwanted chemicals or foreign bodies (a classic 20th century legal case in Britain involved a small snail discovered in a ginger beer bottle!).

The investigation may then go on to try to resolve a number of other issues. These include: deciding whether the customer claim is genuine or fraudulent; identifying the source of any unwanted chemicals or foreign body; determining whether the insured business's processes are at fault or the blame lies with one of its suppliers; and resolving whether this is an isolated incident or symptomatic of a much larger problem.

If product recall turns out to be inevitable, the business then moves on to the second heading of major expense. It will have to quickly contact wholesale and retail customers and arrange for supplies to be withdrawn from warehouse and retailer shelves. But this is much more straightforward than the potentially colossal task of communicating with end consumers who have bought the product and taken it home.

If the defect is a public health hazard, the media may have to be involved in spreading the message far and wide. The business will then have to arrange for the collection of the suspect products and for their transport to a place where they can be checked and then destroyed under strict controls.

Third and finally, there may be a longer term and indirect impact on the business. The disruption to production and the damage to the reputation of the particular product and the company as a whole may knock a large hole in turnover and profitability. The business may also need to invest scarce resources in an effort to repair its brand in the eyes of the media, trading partners and consumers. This is where the 'consequential loss' or 'business interruption' element of the cover package can help out.

Steps to take
There are a number of 'risk management' steps that a soft drinks company can take to reduce the chances of falling foul of the regulations. They can also provide a means of keeping the premium costs of insurance cover down. The first is to establish a document retention policy to ensure compliance with legal, regulatory and commercial requirements. These days the records are as likely to be in electronic format as paper based.

The business should review its contracts with its suppliers of raw materials and distributors of finished products. Who is liable for what, and what insurance cover do these trading partners have in place? The company should endeavour to keep track of changes in regulations and legislation. This is potentially a mammoth task. If the business cannot afford to pay for its own tailored legal and other professional advice, it may want to consider one of the other less costly sources - such as trade associations and the legal assistance services that some specialist insurers provide - that are available.

The company should review any recall and crisis plans that it has in place and make sure that they are robust. And, if there are dealings with other countries, it may need to take cross-border regulatory issues into account. Finally, the business should take a long hard look at any product liability and product recall insurance arrangements that it has in place and ask if these need to be updated.