CPCU Liability Coverage for Defective Products, Impaired Property, and Product Recall Updates on Homeowners Residency Issues and an Employee Dishonesty Loss That’s One for the Books
What’s Your Problem?With this column I’m starting an occasional discussion of problems sent by readers and friends. If you have a problem you’d like my thoughts on, send it to me at cpcuwest@aol.com. Here’s the first one: An agent in Rockland County, NY asks: I have a contract metal/plastic fabrication firm as a client. They have products liability but do not have Errors and Omissions coverage. If one of their parts causes their clients product to fail, would the claim (for the products that have to be replaced) be a property damage claim on the GL? Loss of revenue on behalf of their client who is now unable to make a profit on those products would be an E&O claim, correct? My answer is: it depends on just what the facts are. Let’s consider some possibilities and look first at CGL coverage. Then we’ll consider E&O. If the part fails and damages the customer’s product into which it was incorporated, the metal/plastic fabricator’s (hereafter “MPF”) CGL policy responds2. The CGL will also respond to the claim for resulting loss of use. However, it won’t cover the cost to replace the part MPF supplied. Here’s the policy wording from ISO form CG 0001 1207 2. Exclusions This insurance does not apply to:… m. Damage To Impaired Property Or Property Not Physically Injured “Property damage” to “impaired property” or property that has not been physically injured, arising out of: (1) A defect, deficiency, inadequacy or dangerous condition in “your product” or “your work”; or (2) A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms. This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to “your product” or “your work” after it has been put to its intended use. SECTION V – DEFINITIONS… 8. “Impaired property” means tangible property, other than “your product” or “your work”, that cannot be used or is less useful because: a. It incorporates “your product” or “your work” that is known or thought to be defective, deficient, inadequate or dangerous; or b. You have failed to fulfill the terms of a contract or agreement; if such property can be restored to use by the repair, replacement, adjustment or removal of “your product” or “your work” or your fulfilling the terms of the contract or agreement. MPF’s CGL policy will respond to the claim for loss of use of the machine, even if the only damage is the part that MPF supplied. This is a frequently overlooked aspect of the CGL form. The definition of property damage clearly states that it includes claims for loss of use of tangible property that is not itself physically injured. (The classic example is a contractor that negligently severs power and communication lines while excavating a trench outside an office building occupied by a large stock brokerage firm. The brokerage firm’s claim against the contractor for lost income is covered by the contractor’s CGL policy even though no property belonging to the brokerage firm was damaged.3) To reinforce the point, the impaired property exclusion shown above ends with a statement that it does not exclude loss of use of other property arising out of sudden and accidental physical injury to the insureds work or product after it has been put to its intended use. For example4, assume roller bearings manufactured by an insured are installed in an engine and have to be replaced because they are inadequate. If nothing has been damaged, there’s no coverage under a CGL for the cost of replacement or any loss of use. If the roller bearings are damaged by a sudden and accidental failure, the insurance company will cover the claim for loss of use of the engine, but not the cost of repairs unless other property was damaged. If the failure of the bearings damages a part of the engine that is not the insured’s product, the insurer responds to the claim for the cost to repair the rest of the engine as well as the resulting loss of use. Product Recall What if the customer realizes that all the parts supplied by MPF may be defective and must be replaced in all the engines it which they’ve been installed even though those engines have not yet had a problem? Known as “product recall” or “sistership” liability, that’s clearly excluded in the CGL policy. Here’s the exclusion: 2. Exclusions… This insurance does not apply to:… n. Recall Of Products, Work Or Impaired Property Damages claimed for any loss, cost or expense incurred by you or others for the loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal or disposal of: (1)”Your product”; (2)”Your work”; or (3)”Impaired property”; if such product, work, or property is withdrawn or recalled from the market or from use by any person or organization because of a known or suspected defect, deficiency, inadequacy or dangerous condition in it. Product recall can be a huge exposure. The U.S. Consumer Product Safety Commission has ordered more than 300 recalls a year since 2005; the peak year so far was 2007 with more than 450 recalls5. And that’s just one agency. The Food and Drug Administration, the Department of Agriculture and state and local authorities can all order recalls. There is insurance coverage available to close this gap. A fellow insurance maven just told me about such an occurrence. His client incorporated contaminated ingredients received from a supplier into its product. The problem was discovered before anyone was injured, but the insured was required to recall all the products containing those ingredients. Fortunately, his client had product recall insurance. Its insurer paid more than $1,500,000 to settle the claim. There’s no standard product recall policy. The insured’s expenses and business income losses as well as the insured’s liability to others are generally covered6. This may include: • Cost associated with notifying customers, recalling the product and recalling the products made by others that incorporate the insured’s product. • Business interruption losses • Return and replacement shipping costs • Extra warehouse and storage expense • Cost to dispose of the recalled products Cost of extra personnel required to conduct the recall • The cost to repair and rehabilitate the third’s parties brand reputation • Additional cost to purchase substitute goods to replace the products Endorsements are available from some insurers to cover claims for impaired property even when there hasn’t been a recall. E & O or Professional Liability The other part of the question dealt with E & O (errors and omissions) often referred to as professional liability. Insureds need E&O or professional liability for two basic reasons: 1.The errors they commit may lead to claims for damages arising from causes other than bodily injury, property damage, or personal and advertising. For example, insurance agents need E&O insurance because if they fail to place insurance within a reasonable time or notify the potential insureds of their inability to do so, they may be held financially responsible for the insured’s financial loss resulting from an uninsured loss. That type of claim won’t trigger CGL coverage—there’s no bodily injury, property damage, personal, or advertising injury. 2. There may be professional liability exclusion in the insured’s CGL policy that will eliminate coverage even for bodily injury, property damage, personal, or advertising injury claims. While the basic CGL policy does not contain an E & O or professional liability exclusion, there are more than two dozen ISO CGL E & O or professional liability for which professional or E & O exclusion endorsement is required by the ISO Commercial Lines Manual. These classifications range from blood banks to veterinarians. (The ISO BOP form and many company BOP forms do contain profes sional liability exclusion as part of the form that eliminates professional liability coverage for a number of occupations.) With regard to the question posed, metal worker and plastic goods manufacturing codes do not call for the professional liability exclusion. Therefore, claims for bodily injury cased by failure of a product MPF designed would trigger CGL coverage even though MPF arguably provided a professional service. We don’t have enough information about MPF’s operations to know if they have an E&O exposure for other than CGL-type claims, but f they do design work, they definitely do. Interior designers probably don’t pop into your mind when you think of E&O insurance, but one designer was sued for $1.8 million to redo a large project. The designer felt the error was the contractor’s fault, but to settle the claim he waived his $70,000 fee and his E&O insurance company paid $235,000 to the irate client. That doesn’t include the cost of defense, which exceeded $250,000.7 While MPF may not have an E&O exposure, many insureds do. The question is a good one—it should start you thinking about those insureds and prospects whose E&O or professional liability exposure you’ve overlooked. Any insured whose policy includes professional liability exclusion should look at E&O/professional liability coverage. Consultants of all types should also immediately come to mind. You could start with me, but I already have the coverage. UPDATES What Does “Reside” Mean in the Homeowners Policy— Two More Cases In the March 19th issue, I wrote about actual and hypothetical cases of homeowners who lost coverage because they were not residents of the insured houses. In April, two more cases of lost coverage made the news. Kathleen Neary, etc. V Tower Insurance8 and Bert v State Farm Fire & Cas. Co.9 In Neary v Tower, the appellate court reversed the lower court. The decision noted that “The standard for determining residency for purposes of insurance coverage requires something more than temporary or physical presence and requires at least some degree of permanence and intention to remain.” In Bert v State Farm, Shannett Demetrius, the homeowner, testified that she was living in Florida when she purchased the home and intended to move in shortly thereafter. However, she didn’t do that due to her mother’s illness. The court may have been sympathetic, but not enough to grant coverage. Producers should ask all new homeowners applicants when they expect to move into their new home and make a note to follow up on that date to see if it happened. That might have helped Shannett Demetrius and it might save one of your future clients from the same nightmare—the claim by a fireman injured in fighting the fire resulted in a $1,971,558 default judgment10. Small-Town Treasurer Accused of Stealing $30,000,000.11 Dixon, Illinois, a town of 15,000 residents 100 miles west of Chicago and best known as the boyhood home of Ronald Reagan, may be about to enter the Guinness Book of Records. The town’s treasurer is accused of stealing $30,000,000 from the town in 6 years even though its budget is only $8 or $9 million a year. A comparable theft in New York City would amount to billions of dollars. The theft was uncovered when a substitute employee, who replaced the vacationing treasurer, noticed something strange in the town’s bank statements. Several insurance and risk management points that I’ve discussed in past columns jump out from this story. First, setting limits for employee dishonesty is a daunting task. The conventional wisdom is to set employee dishonesty coverage limits for a municipality at 10% of budget. That would have been woefully inadequate. And the typical $50,000 or $100,000 limit we often see on multi-million dollar enterprises is even more inadequate. Second, basic risk management steps are vital to avoid these disasters. While the details haven’t come to light yet, it’s doubtful that reconciliation of bank statements was being done by someone independent of those authorized to write checks and make deposits. Further, the requirement that all employees take annual vacations might have brought this to light much sooner with a much lower loss. After you’ve updated your firm’s employee dishonesty coverage and risk management procedures, you should tell your clients about this.