Beware Insurance Gap In Offshore Sourcing

July 2, 2007
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With this latest series of shocking recalls, including tires lacking a key safety feature, toothpaste manufactured with a toxic chemical, a fake eyeball toy filled with kerosene and 1.5 million Thomas & Friends trains and rail components coated with lead paint, China is now responsible for 60 percent of all product recalls, according to the federal Consumer Product Safety Commission, up from 36 percent in 2000.

The number of products recalled from China alone has doubled in the past five years, driving the total number of U.S. recalls to a record 467 last year. With horror stories from pet food to automobiles, it seems only a matter of time before such defects cause injuries or death on U.S. soil, and with that some substantial liability concerns.

“If I’m a manufacturer and I’m making a product — it doesn’t matter if I’m making it in a plant in Grand Rapids or somewhere in China — anytime you make a product that is unsafe, you’re got some potential liability problems,” said Kevin Dougherty, an attorney at Warner Norcross & Judd LLP in Grand Rapids specializing in product liability.

Complicating the matter is a unique cultural twist: Product liability insurance is virtually unheard of in China.

“In the U.S., you would always ask your suppliers for evidence of product liability insurance. You would know that if that product or component failed, they would be responsible for the claim,” said Toni Martin, senior consultant in the Grand Rapids office of Aon Risk Services, which has five offices in China. “In China, it’s not typical to carry that insurance — you are going to be picking up the risk.”

The reasons for this are cultural, political and economic, explained Aon Director Lynn Jekkals. “They just don’t believe in it. By buying insurance, it’s admitting that something bad could happen,” she said. “Unlike the U.S., China is not a very litigious nation, and when there are lawsuits, the value of those is very small.”

According to Aon’s China Summary Market Report, the only required coverage in the Chinese market is automobile liability, which is called motor third-party liability. Legal action is rare, but the courts are using their power to enforce individual rights on issues such as medical negligence, breach of copyright, fraud and defamation.

The judgments in all cases are minuscule by U.S. standards. Personal injury awards arising out of traffic accidents rarely exceed $13,000 in the eastern provinces and $3,000 in the west. Work-related injuries tie compensation to salary, with judgments ranging from $52,000 to $130,000 for death and permanent disability in the moderately wealthy Shanghai area, for example. Workers’ compensation insurance is not required.

Product liability can be represented by export liability policies, the report said, but Chinese firms only purchase this insurance as the insistence of overseas buyers, and the policies normally have indemnity limits of less than $5 million.

Aon recommends a U.S.-based policy assuming the liability risk that normally would have been the responsibility of the supplier.

“Sometimes, these aren’t very strong companies; you might not want to transfer the risk to them,” said Jekkals.

For companies that source from several Asian suppliers, these policies can be packaged together. If the Asian company is named in a lawsuit, the policies would not protect against its losses.

In addition to the product liability insurance issue, companies entering the Asian theater also should take careful notice of the local insurance customs, said Martin, the Aon consultant.

“On the property side, it’s real common to just get FLEXA (fire, lighting, explosion, aircraft) insurance, and that is unheard of in the states today,” she said. “Most U.S. companies won’t settle for the compulsory insurance. It is just not enough.”

That also applies to workers’ compensation insurance, Martin said, suggesting that employers attain the coverage as a selling point to recruit talented workers.

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