Clearly Define Exclusions.

Underwriters can learn from a court ruling that required a property insurer to cover product-recall losses, because those costs were not specifically excluded from the policy.

In September 2000, a group of environmental organizations announced that a variety of food products had been contaminated by the use of genetically modified corn. The corn in question, called StarLink, had been manufactured by the pharmaceutical group Aventis SA. Aventis reportedly had received approval from the Food and Drug Administration to sell the corn as animal feed.

The FDA had ruled out human consumption of the corn because of a concern that it might cause allergic reactions in people. More than 430 million bushels of corn--that's more than 4% of the U.S. corn production in 1999--turned out to contain some of the genetically engineered variety. While 99% of the affected corn has now been redirected to animal feed and ethanol production, an unspecified amount has found its way into the human food supply.

How the mix-up occurred is still under investigation, but according to a Reuters news report, the engineered corn apparently was mixed with other corn by farmers who inadvertently delivered StarLink to buyers without notifying them. It also could have occurred via pollination--pollen from StarLink fields blowing onto nearby plants.

You may wonder what all of this has to do with property insurance. As a result of the mix-up, several food processors used genetically modified corn to prepare products from corn dogs to taco shells. Once the story broke in the media, some of these manufacturers started recalling the affected products. Those that lacked specific or sufficient product-recall coverage have begun filing claims under their property insurance policies.

These companies apparently were emboldened by the legal success of General Mills Inc. over its property insurer in a ruling issued Feb. 6. In this case, a large quantity of oats and cereals had been contaminated by the use of an unapproved pesticide applied by one of the insured's contractors. The Minnesota Court of Appeals affirmed the Hennepin County District Court summary judgment that General Mills was entitled to coverage for $168.5 million of losses related to a product-contamination claim under its "all risk" property policy issued by its captive, Gold Medal Insurance Co.

In its ruling, the court stated: "We have previously held that direct physical loss can exist without destruction of property or structural damage to property," dismissing the insurer's argument that no physical loss or damage had taken place. The court also rejected a specific policy exclusion for "loss or damage caused by or resulting from any of the following, regardless of any other cause or event contributing concurrently or in any other sequence to the loss:...Contamination... unless caused by or resulting from a peril not excluded hereunder." The court ruled that since negligence by a contractor wasn't an excluded peril, the resulting contamination was covered.

To the captive insurer, the proper policy interpretation is that the exclusion and anti-concurrent clause apply, unless the contamination is caused by a peril not excluded by the policy as a whole. But this argument didn't find fertile ground either. The court noted: "When relying on an exclusion to coverage, the insurer bears the burden of proving the application of the exclusion."

Finally, the court rejected an exclusion for loss caused by the use of faulty materials despite the application of concurrent causation language. The term "faulty materials" was grouped with faulty workmanship and faulty design and, hence, thought to apply only to materials used for the construction of property, rather than to raw stock for making cereal products.

Of course, a Minnesota court of appeals decision does not have a precedent-setting value in other states, and the ruling may be appealed. Nevertheless, the lesson learned here is that insurers need to be as articulate and direct as possible in the policy language they draft or accept.

Most property underwriters probably will agree that product contamination and product recall are neither priced for nor intended to be covered under a commercial all-risk policy. These exposures are subject to highly specialized underwriting and specifically tailored insurance products that can be purchased in the insurance market. It is, however, incumbent on property underwriters in a litigious environment to clearly exclude product contamination and product recall to avoid unreasonable expectations and unnecessary legal defense costs.

Klaus Gebhardt, a Best's Review columnist, is senior vice president of Ace Bermuda Insurance Ltd.