There has been a lot of discussion around inflation in the economy and its impact on recall risk. Inflation is a topic that has many complex layers, although we do not intend to address all of those here. At its core, inflationary pressure will affect prices, which in turn will impact sales values and costs faced by a business. Product recall policies address the risk associated with both those operational elements.
The extent to which inflation impacts a business depends on the nature of the business, the customer base and the nature of the products and services being sold. It is fair to say that all businesses will feel the cost pressure. But how they deal with that pressure (and the resulting impact it has on performance) might differ by business. Let us break it down into three financial elements for now, setting aside operational impact, and examine the impact inflation has on these elements and, in turn, recall exposure and business interruption loss.
There has been a rise in sales prices – to protect margins and meet rising costs – but what impact will this have on customer demand? Is a price increase tolerable for customers, or will it erode demand? Does the price increase exceed the cost inflation being felt? Such questions will address whether the business should expect gross revenue to increase, remain flat or decrease. Of course, this will also impact future revenues/sales levels. The market has traditionally looked at revenue levels during the underwriting phase. It is common to look at sales levels as indicators of growth. But in isolation, is it misleading when gross profit is the actual risk protected by insurance through business interruption language?
As operational and material costs increase, how does this directly impact current and future profitability? Can cost increases be transferred to the customer, or must the business absorb them? Where does the insured sit in the supply chain, and with what position? Are there alternatives to their product, or are there limited options? Changing suppliers is too complex, too risky. Again, such questions will address the impact that cost inflation will have on future performance. And of course, inventory levels and inventory shelf life will have a bearing on replacement cost issues.
For me, this is the key to the inflation question – how economic forces will impact gross margins. A loss of profit, or business interruption loss, continues to be a significant risk attached to a recall. Data shows us that sales losses have the potential to become significant when impacted by a recall leading to a profit loss. As such, the future profitability, or inflation’s impact on margins, is a key to how economic forces are impacting business risk.
We are just scratching the surface here when it comes to inflation and insured risk. Many other aspects exist which need consideration. There are many operational decisions being made in the face of economic and supply chain challenges, as well as regulatory forces. But inflation will remain a factor into 2023.
This article is part two of four of the Hot topics in product recall series. Read part three, “Complex claims process: recalls, third-party claims, and CPI/CGL/STP crossover”, to learn more.