A continued increase in product recall events represents a growing risk for private equity firms, potentially resulting in harm, reputational damage, and loss of earnings. By selecting a portfolio-wide insurance policy, firms can unlock economies of scale and higher limits, helping to drive profitability while protecting against loss.
Growing incidence of product recall events
Recent years have seen a growing number of product recalls. According to data from Sedgewick, the US saw 580.43 million units recalled (opens a new window) in the first three quarters of 2024. This was the highest total on record, up from 528.71 million in the first three quarters of 2023. This increase is a long-term trend: only two years on record have registered a declining number of units recalled. In the UK and EU, the third quarter of 2024 saw the highest quarterly total of product recalls (opens a new window) for more than 10 years.
Where a single fault hits a critical supplier, the subsequent recall can result in industry-wide disruption. An example of this occurred in 2013, when airbags produced by Japanese automotive parts supplier Takata that were found to be unsafe. The fault has since triggered the recall of approximately 100 million vehicles (opens a new window) worldwide, affecting 19 different automakers, and 34 individual automotive brands. Approximately 67 million of the recalls took place in the US, making it the largest product recall in US history. The event is still ongoing: as of May 2024, more than 6.4 million vehicles fitted with the airbags were still on US roads (opens a new window), as per estimates from vehicle data provider CARFAX.
More recently, Virginia-based food producer Boar’s Head recalled more than 7 million pounds of deli meat products in July 2024, owing to a listeria risk (opens a new window). The products, including packaged meat and poultry products, were distributed to retail locations across the US and abroad. The outbreak led to a total of 61 people becoming ill (opens a new window) across 19 states, resulting in 60 hospitalisations and 10 deaths. Earlier in 2024, an E. coli outbreak (opens a new window) prompted the recall of at least 60 types of pre-packaged sandwiches in the UK. The outbreak affected multiple food manufacturers, resulting in one fatality, at least 86 hospitalisations (opens a new window), and legal proceedings (opens a new window) against two leading supermarkets.
The risk to private equity
When they occur, product recalls can inflict significant damage on a firm’s portfolio company (or companies). Immediate outgoings include the cost of conducting the recall itself, as well as the cost of any replacement or repairs for affected goods. Financial liability may arise in any business interruption or loss of earnings caused to a company’s clients due to the defective product.
However, the area of biggest potential loss for firms is the reputational damage arising from recall events, and associated loss of earnings. Product recalls can reduce confidence among end-consumers and clients, who may be fearful of a repeat event. Larger retail clients may take a particularly tough approach to recalls, potentially suspending or cancelling major and highly valuable contracts. If a firm is overly reliant on one retailer, this could result in an existential loss of earnings. Even where a firm can withstand the financial impact of a recall, it may complicate efforts to secure future contracts.
Private equity firms looking to insure their portfolio will typically purchase a standalone policy for each company under management, with an individual limit appropriate to that company’s risk exposure. However, this exposes firms to catastrophic events that exceed those limits. Firms may be left without cover for a substantial proportion of the cost of a loss, with knock-on consequences for business profits and continuity.
How insurance can create economies of scale
As the risk of recall increases, private equity firms face a growing incentive to mitigate and transfer risk as efficiently as possible. Bespoke insurance arrangements, tailored to all portfolio companies with a product recall/contamination exposure within a firm’s portfolio, are one such solution. These arrangements can create economies of scale, unlocking access to higher limits on a cost-effective basis. This can help firms to become more profitable, while protecting them against a major loss event.
Cost comparison: holistic protection for 12 portfolio companies A private equity firm held 15 individual policies for separate portfolio companies, each with a singular limit per portfolio company. The policy included an excess limit of $20m on an umbrella, for a total of $22m. The firm paid a premium in excess of $850,000. Lockton provided a solution for a bespoke private equity insurance programme comprising of a single policy with a higher umbrella limit of $30m, for a premium saving of almost $150,000. As well as the reduced cost, the firm benefited from bespoke claims language tailored to their portfolio, as well as broader overall coverage. |
Advantages that may be available as part of a bespoke insurance arrangement:
Economies of scale – insuring multiple portfolio companies under an aggregate insurance policy creates economies of scale and greater leverage, for which insurers are likely to offer improved premium rates.
Broad balance sheet protection – higher limits give firms greater protection in the event of a catastrophic loss to a single portfolio company, or significant losses affecting multiple companies under management.
Aggregate retentions – applicable on an umbrella basis across a firm’s portfolio, offering greater protection against catastrophic loss events.
Claims efficiencies – this can be achieved through tailored policy wordings and manuscript language.
Strong carrier relationships – firms with long-standing relationships typically receive better terms with their insurer. This is easier to achieve with a single, bespoke policy.
Consistency of coverage – where possible, coverage can be aligned across multiple portfolio companies. For firms, this creates clarity about what is a business risk, and what is transferred risk, improving simplicity and efficiency in the event of a claim or loss.
Cover for non-homogenous industries – where firms hold investments across multiple industries, these can be brought together under a single policy that includes fit-for-purpose wordings for each portfolio company.
Optimised working capital – lower insurance premiums and reduced cost expenditure on losses means more capital can be channelled into business growth.
For more information, reach out to a member of our team.
More insights are available via our Product Recall (opens a new window) page.
