5 tips for understanding potential product liability

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Learn how the products you sell can put your company at risk and how you can protect it with product liability insurance.
Hot cup of coffee in a to-go cup.

Do you remember when asbestos manufacturers became poster children for the most infamous product lawsuits of all time? How about that McDonald's customer who got burned by a hot cup of coffee? But what do asbestos and hot coffee have to do with your small business? Your company is liable for damages caused by any product you distribute. This type of risk can prove costly to the point of catastrophe for any small business without product liability insurance.

Like it or not, your products could put you in the same category of risk as deadly asbestos and scalding coffee, and the potential losses can threaten your company's existence. From legal fees and court awards to the cost of recalls, lost business, and reputation damage, the exposures are probably well beyond the resources you have on hand.

Luckily, you can protect yourself with product liability insurance, which is often included in general liability insurance. But before you purchase a policy, it's vital to understand exactly how this type of coverage works.

Product liability basics and tips

1. What is product liability insurance?

This form of business insurance, sometimes called products-completed operations insurance, protects your company from claims related to the manufacture, sale, and distribution of products. Lawsuits asserting losses or injury due to defects, malfunction, faulty design, or a failure to provide proper warning or instructions can come directly from your client, from their customers, or from another third party.

Product liability policies cover medical costs, legal fees, and awarded damages, and can be extended to include the cost of recalling and destroying products as well as the resulting loss of business.

2. Why do you need products liability insurance? What's at stake?

It's a stark exposure: you're legally on the hook for any damage caused by your products – period.

Your small business is responsible for the safety of every product you sell or provide. You're liable for its performance as promised, without defect, error, or misrepresentation. By the act of selling or providing any product, you're taking on the responsibility that your merchandise is fit for its purpose and safe for the marketplace. You can be held responsible even if you aren't the manufacturer. All it takes is one product to go south to put your entire operation in serious jeopardy.

3. What does product liability insurance guard against?

Product liability claims are most commonly categorized as strict liability, negligence, breach of warranty and miscellaneous consumer protection claims. Essentially, your potential liability can originate from three types of third-party complaints:

  • Manufacturing or production flaw: This asserts that an unreasonably unsafe defect resulted as a direct consequence of the production process, even if unintended.
  • Design defect: This states that the product design itself is intrinsically unsafe.
  • Defective warning or instruction: This charges that labels or warnings were insufficient regarding the end user's risk. This most often relates to marketing or advertising, but not exclusively so.

Lawsuits making any of these claims may seek awards for medical costs, compensatory damages, economic or business damages, attorney's fees, and punitive damages. No matter how conscientiously you plan, your business faces risk exposure every step of the way. You can never remove all risk, but you can manage it with the adequate coverage.

A key point is that your business can be held responsible for any products you distribute, whether you manufactured them or not. In fact, you can be blamed for alleged negligence as part of the "stream of commerce" liability model followed by most state courts. In other words, if your firm placed the product into the commerce stream, you may be held legally liable for any harm to an end user.

4. How does product liability insurance work?

Let's return to the example of asbestos: one large chemical manufacturer faced more than 100,000 asbestos-related lawsuits, but plenty of claims are made against small businesses, too.

The technology industry is one example where evolving products and markets go hand-in-hand with increasingly powerful systems and software. With that power comes greater liability and greater claims.

In one lawsuit, a programming error caused a therapeutic radiation machine to administer incorrect dosages. The court found that a software failure was responsible for the deaths of two people and the serious injury of several others. In another suit, a construction company claimed that a faulty spreadsheet program resulted in their firm underbidding a $3 million contract. The company sued the software firm for damages in excess of $200,000.

From asbestos to spreadsheets, product liability insurance is the coverage that protects against damages related to a product.

Choosing a product liability insurance policy

Product liability insurance policies can vary greatly in cost. Imagine the difference in risk between a freelancer installing Microsoft Office products and a firm designing complete enterprise management systems.

Premiums for product liability coverage take into account product, sales volume, and your business's role. But business owners shouldn't underreport or lowball sales estimates – that practice can lead to penalties during an audit.

A safer practice is to assess products as accurately as possible to make sure you're receiving and paying for exactly the coverage you need. (You wouldn't want to pay car insurance rates to cover a BMW when you're only driving a Beetle.) You should also carefully review all your business insurance policies with your agent to look out for overlapping or redundant coverage.

Ultimately, the best way to keep premiums down is by managing and minimizing your risk. The more you can safeguard your work, the more you reduce risk, and the fewer claims you'll have to make.

Enhance your processes with thorough testing and recordkeeping. Do you…

  • Check and re-check your manufacturing process?
  • Have a quality assurance program?
  • Put your products through the equivalent of a car crash test program?

You should be maintaining an accurate log throughout all your processes. And you should be sure to request and file warranties for all the third-party products that you purchase.

These practices reduce your risk and can demonstrate your level of safety to your insurance agent (as well as to your customers).

Lastly, review all your policies at least once, if not twice, every year. You might be surprised to find something that could change your insurance needs or your costs.

No one wants to be the next asbestos manufacturer or hot java villain. Unfortunately, product liability is a risk your small business can't avoid. But you can protect your company assets and its reputation with the right insurance for your products. Remove the threat of financial loss and catastrophe, and give yourself the opportunity to plan even greater products for the future.

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