October 27th, 2008

Uncover and Mitigate Product Liability Risk: Avert a Casualty Catastrophe

Posted at 7:00 AM ET

Emil Metropoulos, Senior Vice President

Danger routinely enters product supply chains. An error at a plant or even a flawed product design could lead to extensive economic damage. While the direct cost of these events comes to mind first, few grasp the full extent of product liability insurance exposure. The integrated business relationships required to bring a product to market mean that one event could trigger a “casualty catastrophe” that sweeps up component manufacturers and distributors – and their insurers.

Casualty Cat, a new model developed jointly by Guy Carpenter and Arium, Ltd., seeks to identify the hidden product liability accumulations in a carrier’s portfolio and delivers the insights needed for informed action.

A Problem of Unknown Extent

The efficiencies that facilitate the flow of product to the marketplace also cause risk to spread. Every stop on the supply chain exposes a participant to product liability risk. In fact, each company involved could spread the contagion to its suppliers and partners, even if they are not involved with the product directly.

Industries exposed to product liability include:

  • Consumer Products (food and non-food)
  • Heavy/Industrial Equipment
  • Pharmaceuticals
  • Medical Devices
  • Manufacturing (e.g., auto, aviation)

Increased litigation threatens carrier balance sheets. As more companies around the world become involved in the manufacture and sale of consumer products, exposure to product liability risk reaches further. Broader targets tend to increase total loss potential. While (re)insurers are acutely aware of the fact that they are exposed to claims related to product liability, they have been unable to ascertain the extent. A single event in an integrated business environment could drain balance sheets quickly and even jeopardize solvency.

Elusive Exposure

Product liability is a mature sector of the (re)insurance market, but the industry has struggled to identify development and accumulation risks. A carrier may be overexposed without realizing it – thus imperiling capital and insolvency.

The problem is exacerbated by the evolution of product technology, manufacturing processes, and distribution practices – and the extensive legal, financial, and advisory infrastructure needed by almost any company to succeed in a global marketplace. Nobody acts alone; therefore, risk is not isolated. It is easy for a potential problem to go unnoticed; the complexity inherent in the modern supply chain results in a distributed effort, which naturally leads to unforeseen links in the chain of responsibility. By the time a product defect is discovered, the costs incurred generally have had time to mount. If the flaw affects consumers, the situation could become even more severe and potentially result in their seeking financial compensation from multiple companies in the product supply chain.

To grasp the extent of the event, a carrier would have to trace the implications of a product recall, for example, through a company’s vast network of relationships and follow the spread of risk to remote corners of the total operating environment. A manufacturer’s error could reach the accounting, financial services, and legal industries, as litigants look for sources of compensation. In trying to assemble a view of the event manually (or with the limited use of technology), potential exposures will be overlooked, and insured loss projections will be much lower than actual outcomes.

Casualty Catastrophe Evolution

What could start as a product liability event has the potential to morph into a “casualty catastrophe.” As lawsuits turn into settlements and jury awards, directors and officers (D&O) and errors and omissions (E&O) claims may be filed, in addition to general liability claims. A carrier covering the manufacturer and retailer for D&O, for example, could be exposed to the same event twice. Casualty portfolio diversification across industries and lines of business could increase a carrier’s exposure instead of reducing it.

A new approach to product liability risk management is necessary. The analysis and transfer of individual risks must give way to an integrated evaluation of the entire portfolio. All vulnerabilities that cross lines of business have to be identified and linked to the causal relationships in a casualty portfolio … and not just the obvious ones. Scenario modeling should follow – and form the foundation of enterprise-wide risk and capital management plan.

Understanding Casualty Catastrophe Risk:

  1. Locate areas of vulnerability to catastrophe risk in a portfolio
  2. Identify casualty catastrophe mechanisms and determine how they operate within a portfolio
  3. Model the major event scenarios that could trigger substantial casualty losses
  4. Formulate a risk management plan that addresses the full reach of each scenario identified

Product liability risk management involves a blend of experience, instinct, and analysis (to the extent possible). Claims history, though, may shed little light on the nature of future product liability events. With new technology and the expansion of component sourcing throughout global supply chains, past product liability catastrophe loss scenarios can no longer be the only data source used to forecast the future. To protect their capital, carriers have needed a way to measure product liability catastrophe exposure, with information that can translate to executable risk transfer strategies. Advances in casualty modeling now make this possible.

Casualty Cat Reveals Hidden Exposures

The Casualty Cat model equips carriers to evaluate the single- and multi-peril casualty catastrophe risks held in their portfolios. Through a rigorous analysis of inter-industry trading and supply chain data, carriers can assess key vulnerabilities, providing a foundation for risk transfer planning and execution.

Casualty Cat develops a risk accumulation profile, showing a portfolio’s exposures and providing a starting point for risk mitigation planning. The model provides a starting point, grounded in network theory, for quantifying realistic disaster scenarios. Casualty Cat maps out the trading links among all insureds in a carrier’s portfolio and uses metrics such as the insureds’ potentially exposed policy limits and premiums to assess the relative level of catastrophe exposure for different portfolio segments. No longer concealed, casualty accumulation risks become knowable and therefore manageable. Casualty Cat enables risk-bearers to take action.

Case Study

A tainted product batch can have worldwide ramifications. In the dairy sector, an intricate cold supply chain is forced to move product quickly, as lost time can render product unsuitable for sale. Margins are already razor-thin. The broader food, drink and tobacco sector (which includes dairy) had an average net profit margin of only 6.7 percent in 2006[1],  leaving virtually no room for error. When an unsafe product does slip into this environment, consequently, its movement is facilitated by the tight-knit relationships that are focused on reducing time to market. Risk moves through the supply chain just as quickly as its cause.

Affected NAICS Codes[2]

The basic supply chain – from manufacturer to distributor to retailer – may constitute the focal point of exposure, but it is not the entirety. Exposure seeps into Healthcare and Social Assistance, for example, because of the need for medical treatment that could result from the consumption of milk (and the attendant risks of providing such treatment). Arts, Entertainment and Recreation and Accommodation and Food Services are exposed as well. After all, dairy products are served at event venues, hotels, and restaurants. This is also the case for the Educational Services sector: schools serve breakfast and lunch (and plenty of milk). Plaintiffs in search of deep pockets have plenty of choices beyond the basic dairy supply chain . No two casualty portfolios are the same. Each will consist of different industries and lines of business, and the limits exposed vary, As a result, each cedent’s exposure to a given product liability scenario is unique.

Mapping the Proliferation of Product Liability Risk (by NAICS code)

Source: Guy Carpenter & Company, LLC

The relationships involved in putting milk in a consumer’s glass can increase carrier exposure significantly. In addition to the direct liability (from D&O and E&O) claims pertaining to the manufacturer, distributor, or retailer responsible for the sale of tainted milk, the carrier may also cover liability risks for other companies affected by the ensuing litigation. Diversifying liability coverage across industries provides little protection, with everything from child day care centers to cafeterias exposed to one dairy company’s mistakes.

A Platform for Action

While Casualty Cat makes the domino effect from the root cause seem intuitive, the threats derived from the cause are not readily discernible on their own. A carrier would have to devise a scenario, trace the implications through a vast network, and hope that nothing is missed. A scenario could be overlooked, or an implication may not be captured. As this relatively straightforward example shows, complexity arises quickly. Without the capabilities of a robust model, a consistent and systemic approach is not possible. There is also plenty of room for error.

Since no event occurs in a vacuum, a single incident can gain momentum rapidly and take months – even years – to run its course. Even the seemingly unrelated could be contaminated. Casualty Cat discovers the hidden links that could lead to unexpected claims well into the future, allowing carriers to take preventive measures now.

Using Casualty Cat to determine the full extent of the risks to a casualty carrier’s portfolio, it is possible to construct and implement a thorough risk management plan. If a casualty catastrophe does strike, the protection afforded by the Casualty Cat-supported plan should prevent balance sheet damage and, in the extreme, threats to solvency. Of course, the carrier will be able to improve capital management as a result of more informed decision-making.

Contain and Hedge

Product liability remains one of the most stubborn problems that casualty carriers face. A web of capabilities converges on the development and distribution of a single consumer product; no company can do it alone. Cooperation and collaboration – typically valued in today’s global economy – become risk conduits, disseminating exposure rapidly and in a manner that has been virtually impossible to trace.

Casualty Cat helps carriers identify and mitigate potential exposures—or at a minimum, price them accordingly. Further, it supports diligent product liability risk management. Instead of trying to hedge integrated risks individually, the solution maps exposure across industries and around the world, to deliver a robust platform for decision-making and prudent capital management. Buried risks come to light, and carriers can move them off the books … but only when they know about them.


  1. Deloitte. Global Powers of the Consumer Products Industry. January, 2008, p. 14.
  2. North American Industry Classification System.

Additional Contributors:

  • George Carrington, Managing Director
  • David Lewin, Managing Director
  • Wolfram Schultz, Senior Vice President
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