Product defects put manufacturers, suppliers and retailers at risk of product liability claims, and factors such as globalisation and new technologies mean that these exposures are becoming increasingly complex, explains Jon Elvidge of XL Insurance

Companies involved in the manufacture of goods may be subject to product liability claims if they are deemed to be defective. It is not only the finished product manufacturer who is exposed: suppliers, retailers, component manufacturers – anyone in the supply chain may be implicated. Due to many factors, including globalisation, new technologies, increasing litigation and contractual relationships between companies, these exposures are becoming increasingly complex as Jon Elvidge of XL Insurance explains.

If a product is deemed to be unsafe and results in an injury or damage, a product liability claim may arise. It is then generally only necessary for the plaintiff to establish that the product was defective; it is not required to establish that the manufacturer or any other company in the supply chain was negligent – ie product liability is strict liability. For a product to be defective, it is usually necessary for at least one of the following to be established:

• A manufacturing defect existed

• A design defect existed

• There was a failure to warn (of an inherent hazard)

• There was a failure to monitor the performance of the products in the market.

Today’s manufacturing practices are such that large ‘standard’ product liability claims are becoming less common. By ‘standard’ we mean where the insured has simply designed or manufactured an unsafe product which has resulted in bodily injury or property damage to a third party. An analysis, though, of recent large product liability claims (greater than $500,000) has reveals the following trends:

• Large recall and dismantling re-installation claims are increasing,

• Claims where the defect was in a component or sub-system sourced from a third party are increasing,

• A number of large claims occurred where the product was not considered ‘defective’ at all,

• ‘Failure to warn’ related claims still remain high (particularly for the US).

This trend in recall claims is not surprising. Regulatory authorities in the EU and North America are increasingly cautious and more likely to play safe by demanding or encouraging a recall. Data from European Union’s RAPEX system indicate that the number of General Product Safety Directive ‘Article 12’ notifications doubled in the period 2004-2008, and an increasing trend in recalls is also noted in the automotive industry. The reasons for the rise in dismantling and re-installation claims, which affect suppliers rather than Original Equipment Manufactures (OEMs), may well be related to increased outsourcing of components or sub-systems. Such claims can prove very expensive as the price of removing and re-installing an alleged defective component can be many times the unit cost. There is also evidence that in some industries, suppliers are being increasingly squeezed in terms of contractual conditions and performance requirements that also make such claims more likely.

The increase in product safety issues relating to defects in parts or materials sourced by a company is considered predominantly related to the general increase in outsourcing by major manufacturers, or the movement of manufacturing and assembly operations to lower costs countries to take advantage of reduced labour and local materials / component costs. However, product quality can suffer as the number of supplier interfaces increases and the ability to monitor supplier quality may reduce.

Product liability claims where the product is not actually defective may seem contradictory at first glance. The problem here is that a failure by the company to ensure that they have (and use) a robust contract risk management system may lead to scenarios where design responsibilities between manufacturer and customer are not as unambiguous as they perhaps should be. This can particularly affect suppliers who produce customized components and where responsibility for the component interfaces is not always clear-cut. The argument that ‘it was fine when we tested it in the factory’ may not be a valid defence.

There is no evidence that ‘failure to warn’ claims are necessarily increasing in Europe. Any European manufacturer selling goods, particularly in the US, needs to be aware of the potential for large claims, including class actions. Poorly worded or missing instructions for use, labels or hazard warnings can be easily exposed by plaintiff’s lawyers in court.

Managing the product liability risks

So, what can a manufacturer do to minimise their exposure to such claims?

• Product Development Plans (PDP) and Risk Assessments

A formal PDP, specific to the product is a significant benefit to reducing design interface type product liability claims, especially if adequate attention is given to the pre-contract stages. Proper bid review, both legal and technical with formal sign-off at appropriate toll-gates is vital, as is a strict approach to external validation and sign-off at the various manufacturing stages. Risk assessments by casualty risk engineers have shown that even global manufacturers of products with high inherent risk profiles may not always put the necessary effort into this area. The benefit may not be apparent until many years down the line; some companies have been able to distance themselves from multi-million dollar claims solely because they had and kept the right paperwork or agreed appropriate contract clauses following early stage contract risk assessments.

• Recall Planning

Whilst producers of consumer goods will no doubt be aware of the potential for a recall, this is an exposure that is sometimes overlooked for suppliers exposed to third party recall claims. A formal recall plan will not prevent a recall, but will go a long way in helping the company respond correctly and in a timely manner, thereby reducing the recall costs. As well as having a recall plan, key personnel need to be familiar with running a recall campaign and for this mock recalls are recommended.

• Traceability Systems

Recalls and claims relating to dismantling and re-installation in particular, can be minimised (in quantum) by an effective traceability system, allowing the defective products or components to be identified either individually or by batch. The design and complexity of the traceability system should be largely a function of the inherent risk or the product and the company’s exposure to recall/dismantling type claims.

• Supply Chain Management

A number of papers previously have focused specifically on risks and mitigation in the supply chain - see StrategicRISK March 2009. With regard to avoiding product liability claims, supply chain management procedures should consider the specific risk presented by an incoming component or sub-assembly to ensure that attention is appropriately focussed. Safety-critical part suppliers will require a more robust approach to quality auditing, testing and inspection with at least some testing of critical parameters of the incoming parts undertaken at the customer’s factory.

There has been a lot of discussion recently with regard to the increased risk of product defects where the products (or components) are sourced from low-cost countries. Large recalls, for example due to contaminated pet food or lead paint in children’s toys, have been widely reported in the media and data from RAPEX does indicate large increases in the number of notified products sourced from China.

However, there is no evidence that this trend is due to a deterioration in product quality –the increase could rather be explained by the increasing volumes of goods imported from China. Sourcing from low-cost countries is not considered to necessarily increase the risk of an unsafe product reaching the market. Problems occur more as a result of the more complex supply chain interfaces associated with low-cost country sourcing and the difficulties in ensuring that procedures to monitor and control product quality are appropriately robust.

• Instructions for Use

To reduce exposure to ‘failure to warn’ claims, OEMs must assign adequate resources to ensuring that ‘instructions for use’ and hazard warning labels are appropriate for the various markets in which their goods will be sold. This may include pointing out hazards that are considered ‘obvious’. Manufacturing companies are well advised to ensure that all ‘instructions for use’ and hazard warnings are subject to a technical review and legal review - appropriate to the country in which the company is selling its products.

• Claims Defensibility

There are various defensive measures that can also be taken to mitigate losses before a company is involved in an incident that may lead to litigation. The dynamic claims environment of the last 10 to 15 years has seen average claims costs driven to unparalleled levels, often being disproportionate to damages. Changes to civil procedure rules have created increased pressure to meet legal deadlines, which may inadvertently increase the final legal costs, creating an overall expensive defence process.

To aid this process of claims defensibility it is particularly important that robust documentation capture, retrieval and retention systems are in place. Casualty claims are sometimes difficult to defend without supporting documentary evidence such as test and inspection data, field performance data, risk assessments, and outputs from the various hazard analyses which may have been undertaken during the design stage.

• Learn from mistakes.

With some industries, claims are almost inevitable, but it is important to prevent similar occurrences in the future. Following a recall or major liability claim, a company should undertake a suitable analysis, not only to ensure that any necessary design / manufacturing / hazard warning changes are made, but also to ensure that key personnel in associated group companies are also aware of lessons learnt.

Future Concerns?

Emerging risk areas related to product safety may well affect both the manufacturing of the product itself, and how products are sold to the market.

The potential impact of nanotechnology and nanomaterials is being considered by the insurance industry. The different behavourial properties of nanomaterials compared to their larger counterparts certainly have potential to give rise to bodily injury (see studies into carbon nanotubes) or property damage (for example due to the greater explosion risk from organic nanomaterials with much higher surface area/volume ratios). A key concern is that regulation of materials and research into the possible effects may not keep pace with development of new materials.

Another growing concern is not only around how goods are produced, but also how they are sold. Companies are increasingly selling products via the internet. Manufacturers may therefore begin to accumulate large quantities of personal data of their customers, stored electronically. This leads to potential data protection issues. A failure to safeguard this information may lead to ‘identity theft’ or ‘invasion of privacy’ type claims especially if the company’s data security procedures are deemed to be inadequate. The number of identify theft cases is increasing rapidly and changes in the legislation may make it easier for affected parties to bring claims.

Global manufacturing companies may well have exposures to claims from the products they produce and services they provide in areas that are not always fully appreciated and mitigated. It is often not until a company has a major claim or series of claims that corrective action is taken. Appropriate analysis and identification of a company’s inherent exposures is vital and having appropriate loss prevention measures in place will have major benefits to the company and their insurers.