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The high costs of low prices.

The large number of Chinese-made product recalls over the past year has eroded profits, diminished market share and damaged brands. Mattel, for example, suffered multiple toy recalls and a related ban on its imports into Brazil. Other companies have recalled Chinese-made products ranging from defective tires and poisonous toothpaste to contaminated pet food and unstable scooters.

Now, the plaintiffs' bar in the United States is capitalizing on this "Made in China" scandal by suing importers. Congress and several other federal agencies have also begun investigations.

To cope with the potential legal fallout, many importers have sought liability insurance with product coverage, which typically covers claims arising from product-related damages to third party property, injuries to consumers, and the costs of defending a product liability lawsuit. Importers are realizing, however, that these policies cannot offer complete protection. Generally, the coverage does not include product recall and other costs in addition to-or in the absence of--actual or alleged injury to third parties. It does not even apply to the extent that property damage or bodily injury was caused by sales of products that the importer had recalled or otherwise knew were defective.

Many importers are now looking to supplement their insurance portfolios with product recall coverage. Unlike product liability coverage, no actual or alleged damage or injury is required for a product recall policy to respond. Instead, coverage is triggered when an importer incurs costs proactively to prevent injury or damage. It will also typically cover costs to communicate a recall to consumers, replace unsaleable products, and mitigate corporate brand damage through public relations and crisis management--any one of which can be devastating.

The plight of Foreign Tire Sales is a case in point. Foreign Tire, a family-owned tire import company, was forced to recall 450,000 defective Chinese-made tires at a projected cost of $90 million.

The flip side of this situation is that product recall coverage often garners a hefty price. Given this, and the continuing governmental investigation of Chinese imports, some companies are finding political risk insurance (also known as trade disruption insurance) to be another viable option.

This type of coverage is designed to cover lost revenues should an overseas supplier fold for political reasons or suffer trade restrictions that affect--or potentially even eliminate--supply. Through this mechanism, importers are covering the costs of securing a replacement supplier, including retooling costs.

Many companies are also attempting to recoup losses through their Chinese suppliers' liability insurance. If Chinese suppliers maintain adequate and accessible liability insurance, an importer faced with a product liability lawsuit in the United States, for example, may be entitled to make a claim against a Chinese manufacturer's insurer. (One likely stipulation would require the insurer to confer additional insured status to the importer or to include in its policy a provision extending coverage to entities contracting with the named insured.) Although these rights can offer additional protection to an importer's insurance, the company must still negotiate these terms and ensure they are properly implemented by the supplier and its affected insurers in order to ever receive retribution.

Market restrictions and cultural impediments can further muddy this task. Insurance markets in China only recently opened to foreign underwriters, and manufacturing firms there have been slow to embrace the concept of product liability insurance. As a result, if a Chinese firm has product liability insurance, it is likely underwritten by a Chinese insurer or a Chinese subsidiary of a foreign insurer. This makes it difficult, if not impossible, for an importer to enforce its rights against the supplier's insurer. One other notable difference is that liability policies issued by Chinese insurers often feature uncommon exclusions and carry insufficient liability limits to adequately protect an importer faced with litigation in the United States or other Western markets.

On the Dotted Line

In lieu of insurance, there are various contractual solutions that many companies are employing to help mitigate supply chain risks associated with Chinese suppliers. The following are five of the most useful:

1. Require Chinese suppliers to maintain product liability insurance, at the supplier's expense, with acceptable occurrence and aggregate limits. Request certificates of insurance confirming compliance.

2. Oblige the supplier and its insurers to notify the importer if any of its insurance contracts are cancelled, not renewed or materially changed.

3. Request access to the supplier's product liability claims history and losses to evaluate its track record and to assess any erosion of its in-force policies' aggregate limits.

4. Confirm that the supplier has assets in the importer's domicile and is subject to suit there. For Chinese suppliers that do not meet these criteria--and most will not--importers should require suppliers to arbitrate any disputes in the importer's domicile or in a neutral one.

5. Specify that the supplier's liability, including any duty to indemnify, is not limited to the extent of its potentially applicable insurance.
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Title Annotation:Forefront
Author:Smethurst, Ryan S.
Publication:Risk Management
Geographic Code:1USA
Date:Apr 1, 2008
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