Cover stories

Manufacturer's E&O

The standard ISO general liability insuring agreement form agrees to pay sums that an insured becomes legally obliged to pay as damages, because of bodily injury or property damage that their manufactured product causes to a third party.

But what happens if your manufactured product fails due to a flaw in your design or manufacturing process and causes financial harm to your number-one customer? For example, suppose that you are manufacturing a component for another manufacturer’s product. In order to manufacture the component more efficiently you changed the process that was specified by your customer. But when your component was incorporated,  their product didn’t work and caused them a financial loss. Will your general liability insurance policy respond? You cost your customer money due to your negligence. The answer is “no,” since your product did not cause bodily injury or property damage.

Most commercial general liability policies include a “damage to impaired property” exclusion. If your customer’s product cannot function or perform properly due to your faulty component product, resulting in financial loss to your client, your general liability policy will not protect you.

Manufacturers’ E & O coverage is designed to pick up these gaps in the manufacturers product liability coverage. It responds to an insured’s legal obligation to pay financial damages to any third party arising out of your negligence in designing or manufacturing your company’s product. It covers damages resulting from an insured’s negligent acts and errors or omissions.

Many manufacturers assume that their commercial general liability insurance policy will cover this exposure. They would be wrong.

All manufactures need to consider the potential impact of how an error or omission in the production of their component could cause their customers a financial loss. Most manufactures have this exposure and need to better understand how the current general liability programme won’t be there to protect their profit and loss account in the event of this type of loss. This is certainly something that brokers and risk managers should be talking to underwriters about because manufacturers face a serious exposure to third party financial loss that is not covered in the general liability and products liability policy. 

Core coverage

Manufacturer’s professional liability 

This exposure can take a number of forms. So, for example be there may be an efficacy exposure if a third party suffers a financial loss resulting from the failure of the manufacturer’s product to perform its intended function (breach of warranty as to the fitness quality), either as a result of an error in the manufacturing process or through poor design, only if the manufacturer is responsible for both designing and manufacturing the product. 

Take the following example. You manufacture a component that is incorporated into an end product of a third party and your product does not work in its intended manner through an error in your manufacturing process. Your faulty component does not damage the third party end product but renders it unusable and therefore unsellable. In this instance the third party end product seller will suffer financial loss through wasted production costs and halt in sales and, if the end faulty product is delivered to the customer, the third party may incur recall costs. Please note this policy does not provide cover for first party recall costs.

Another example might be in the situation where your product is a component in a customer’s finished product. A short time after installation, it is discovered that the product isn’t working correctly because your component is faulty. Your customer has to recall their product to remove and replace your faulty component. Further, many customers are unhappy and do not want replacements. Your customer suffers unforeseen expenses and lost profits as a result, and they sue you to recoup their financial loss.

Your product is a device that regulates portion control within the automated production line of one of your customers. Your device was not calibrated correctly, and it is several weeks before it is discovered that their product was being portioned at a higher volume than it was supposed to be. As a result, your customer's profit margin suffers on the affected batches, they incur extra expense to correct the problem, and lose revenue due to the down time. Your customer sues you to recoup their financial loss.

Your factory fabricates a part for a customer with a tight contract deadline in order to ship a product. After your customer receives your parts and starts installing them, they realise that the parts are not to their exact specification and cannot be used. Since there isn’t enough time to re-fabricate the parts, your customer cannot ship their end product in time and as a result they miss the deadline and lose out on the contract. Your customer sues you to recoup their financial loss.

In all of these cases a standard general liability policy would not protect an insured against the claims while a tailored manufacturers’ E&O policy could. Brokers with manufacturing clients should discuss with them their potential for exposures to such losses to make sure that their businesses are properly protected.  

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