June 4, 2009

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By Product Safety Letter staff

Enforcing a requirement that companies have the financial ability to recall or destroy unsafe products could put a strain on CPSC’s already stretched resources, according to the Government Accountability Office (GAO). Also, costs might outweigh benefits given the relatively low number of companies that historically have had financial difficulties related to recalls. The GAO study stemmed from section 224 of the CPSIA, which directed the office to review the feasibility of such financial requirements.

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GAO also noted that given the huge number of consumer product types and the large number of companies, it could be difficult to establish which products and companies would need to show financial ability. As well, giving the authority to CPSC alone would exclude many products that fall under the jurisdiction of other agencies such as the Food and Drug Administration or National Highway Traffic Safety Administration, which GAO noted also have had a few recalls in which companies could not or would not cooperate.

Moreover, warned some stakeholders that GAO questioned, the perception that such financial requirements are targeted at imports could raise trade barrier concerns and even could be seen as violations of the various international trade agreements to which the U.S. is subject.

On the other hand, GAO explained that consumer interest groups it interviewed suggested that some sort of “financial backstop” is needed because the frequency of problem recalls could rise due increased U.S. reliance on imported products, new CPSIA provisions that require increased testing and vigilance, and the agency’s increased recall authority.

POTENTIAL FINANCIAL TOOLS FOR RECALLS
(verbatim from GAO’s report)

Escrow	CPSC develops master escrow agreement and partners with one or more banks that act as escrow agents to establish escrow accounts with consumer product companies. Companies deposit cash or other approved assets in the account; the bank holds the funds until CPSC approves disbursement, and; CPSC, an agent of CPSC, or the consumer product company gets the funds to conduct or complete the recall.
Insurance	CPSC establishes coverage requirements, including minimum limits and covered risks. Consumer product companies purchase required coverage from private insurers and submit claims to cover costs of a troubled recall.
Bond	Sureties assess the financial strength, character, and capability of a consumer product company to perform a recall in accordance with requirements established by statute or regulation. CPSC makes a claim on the bond if a company failed to comply with regulatory requirements. The surety would pay CPSC for its claim, or it could conduct the recall according to regulation.
Line of credit guarantee	A consumer product company pays an annual fee to access a line of credit from a financial institution in an amount established by CPSC to fund potential recalls.
Guarantee of personal or corporate assets	Sole proprietors or the senior officers or principals of consumer product companies provide a written guaranty to CPSC that personal or corporate assets, such as real estate or machinery, would be available to fund potential recalls.
Lien on personal or corporate assets	CPSC receives a security interest in the personal assets of a sole proprietor or the corporate assets of a consumer product company to prioritize its right to collect payment in the event of a troubled recall before other creditors collect payment on unsecured claims.

GAO looked at six fincial instruments that could provide the desired assurances, but it also noted that some stakeholders suggested it might be better simply to give CPSC the funds to assist troubled companies, “citing [the option] as a potentially more efficient and suitable approach for industry and the federal government given the low incidence of troubled recalls in CPSC’s history … CPSC could maintain an account to fund troubled recalls by completing them itself or through its agent, or by providing the responsible company with the funds.” An additional benefit of this option, suggested its proponents, is that it could cover cases in which the responsible company is no longer in business and no other company could be held responsible.

Among other possibilities raised was to require companies to have documented recall plans. Advocates said preparing these might have the benefit of giving companies greater understanding of the costs of recalls, thereby increasing the likelihood they would budget for them or otherwise prepare financially. Other stakeholders urged no changes to CPSC authority, suggesting the agency could increase use of its existing powers, including those related to mandatory recalls and administrative complaints.

As for the six potential financial instruments, GAO said that stakeholders suggested that they could be prohibitively costly, depending on various factors that include the size of the company, the health of the economy, and types and numbers of products potentially involved. GAO wrote, “Recalls can cost from a few thousand dollars to tens of millions of dollars … For example, items that require specialized repairs, such as fire sprinkler systems, might be more costly to recall than toys and other low-priced items, which consumers tend to discard rather than return for repair or other replacement.”

Meanwhile, representatives of the financial industries told GAO that the limited number of large and specialized financial companies that would be willing to provide such services could mean the demand would be hard to meet. As well, providers could become reluctant if only high-risk companies were required to obtain the services or if likely affected recalls were those with costs rising to the millions of dollars.

Further, providers might balk at costly remedies such as repairs or product replacements. GAO also noted, “The willingness and ability of financial service firms to extend coverage for product recalls would depend on the terms and conditions of a financial assurance, including the financial service firm’s obligations, types of recall events or company actions that trigger provision of coverage, and pricing.” Among examples cited by GAO was that surety bonds typically cover short-term obligations in the two-year range, but recalls can occur much longer after production and sale of products.

The report also explained, “Pricing these new instruments would also be difficult because the financial firms would need to fully understand all the risk challenges of both the companies and their products – an especially daunting task if all companies were required to obtain coverage. Many of these financial instruments – excluding insurance – are not currently designed for consumer product recalls, so financial services firms would have to design financial products to cover product recalls.”

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