Authored by Brandon Schuh, VP and Product Liability Professional at Hays Companies
Product liability is an area that can rapidly change from the period of time when a company first launches to when they’ve truly penetrated the marketplace. With consumer products, the reach is to a very large audience. When the masses begin using a product, especially products that have more inherent risk, claims and litigation follow quickly regardless of how well the product is manufactured.
This scenario creates problems for manufacturers and importers of consumer products because they are not ready for the influx of claims. Claims are the biggest driver of premium costs. If your claims are low or non-existent, your premium will likely be small or inconsequential. If you have an inherently more dangerous product: ladders, power tools, trampolines, sporting goods, outdoor equipment or even office furniture, claims will occur and your premium increases as a result.
This is an unwelcome surprise, suddenly claims are an everyday event and there is a new expense item on the budget. Many companies, when they first start their business, buy very basic insurance policies with very small deductibles. Small deductibles are attractive because of the limited financial risk for the manufacturer. They simply transfer their risk to the insurance company. The problem with small deductibles in a high frequency claims environment is that insurance becomes something that you use every day instead of something for a worse case scenario. This is accentuated by the rapid growth of the organization; the more products in the hands of consumers, the more potential for accidents. When a policy is used frequently, the premium increase year over year become dramatic. The premium increase is further inflated by high allocated expenses driven by the carrier hiring counsel that are not experts in defending consumer product litigation. Thereby settling claims rather than denying or defending. This has a downward spiraling effect if not properly contained.
Total Cost of Risk (TCOR) is a term that’s overused in the insurance industry, however, consumer goods product liability is one area it is truly necessary. Your risk cannot be summarized in one line item on your P&L. The cost of insurance is not your only cost of risk. A manufacturer of inherently dangerous consumer products should always take retained risk (i.e. they should always have skin in the game). You know your product better than anyone, therefore you should have more control over the defense of those products with experts that specialize in this area. This is accomplished by maintaining a larger deductible or Self Insured Retention (SIR) where you, as the owner of the company, take a part in the cost of defense. This creates another line item (defense costs) and should be added to your calculation of TCOR.
The benefit to doing it this way is eliminating some of the carrier losses and doing your part to keep loss runs clean of nuisance claims and litigation. Again, claims drive the premium; if you positively influence claims by disposing of some yourself, you are in a far better position to keep your premium costs down.
Naturally, this process requires a strong team of legal practitioners, insurance and supporting players. Defense strategies, policies and procedures are also crucial to effectively producing good results. However, the end result is dramatically more economical than continuing to pay the premium for a low deductible/high claim frequency fueled by growing sales. With control over the process, you are in a far better position to affect positive cost savings.