Do Device Suppliers and Distributors Need Their Own Product Liability Insurance Coverage?

Recently, a savvy insurance broker—and a good friend—approached me on behalf of a medical device distributor. The latter was an additional insured on the product liability policy of a manufacturer it represents. The distributor had its own coverage but chafed under the cost of paying for insurance and, as a result, wondered if it made any financial sense. Was this like wearing both a belt and suspenders? The distributor considered dropping its own coverage and riding along as an additional insured on various manufacturer policies. The cost-savings beckoned.

Many medical device component suppliers and distributors wrestle with this decision. Let’s eavesdrop on the possible thought process.

“Why should I buy my own product liability insurance coverage if I am afforded protection by the manufacturer’s policy? I’m only a pass-through player in the stream of commerce,” you could almost hear them say. “Am I wasting money with a redundant layer of insurance protection when I can ride the manufacturer’s insurance coattails if a claim arises? Finances are tight. Isn’t this a logical place to trim costs? If a product liability claim or lawsuit names me, surely the manufacturer and/or its insurance company will protect me—right?”

Such rhetorical questions deserve thoughtful risk management considerations. The questions—and the assumptions contained in them—can lead companies into perilous risk management waters, though.

Let’s look at six scenarios where medical device suppliers and distributors might need their own insurance protection. In truth, those coattails that these entities plan to ride may be as strong as tear-away jerseys worn by NFL running-backs. Make sure that in the event of a claim or litigation you do not lose a grip on coattails that are insufficient to pull you along. In many situations, a supplier or distributor added as an additional insured could find itself in hot water.

Here are some scenarios:

• Manufacturer’s insurer goes belly up—the supplier or distributor is out of luck and left bare;

• Manufacturer’s carrier depletesinsurance limits from other, prior claims—nothing left for the supplier or distributor;

• Manufacturer’s insurer carries only low limits, insufficient to protectall parties;

• Manufacturer’s insurer offers lousy claim service—little or nothing the supplier or distributor can do;

• Manufacturer’s insurer declinescoverage to the supplier or distributor,asserting that their independentnegligence nullifies coverage;

• Manufacturer’s insurer controls the defense, selling out the other parties’ interests, leaving them holding the(financial) bag or saddling them with a weak attorney; and

• Manufacturer’s insurer controls the defense and shifts the liability more to the supplier or distributor.

Let’s look closer at the dangers resulting from relying solely on the manufacturer’s insurance coverage.

Manufacturer’s insurance companybecomes insolvent. Insurance companies sometimes become financially unable to pay claims. If a manufacturer’s insurance company becomes insolvent, both the manufacturer and distributor may be “bare” with regard to financial protection. Not all insurance coverage is created equal. Moral: If a distributor or supplier relies on the manufacturer’s insurance, verify the latter’s financial fitness.

Depletion of manufacturer’s insurance policy limits. Here, the manufacturer faces other liability claims that do notinvolve the distributor or supplier. Those claims are so expensive or numerous as to deplete the manufacturer’s insurance coverage. Thus, the financial “well” runs dry by the time the claim against the distributor or supplier “ripens” to where a settlement or court award materializes. What now?

Manufacturer has inadequate insurance limits. In this example, Manufacturing Company Inc. struggles with its own financial pressures. The company decides to buy only $500,000 in product liability coverage. Its surgical device is cited as defective in a laparoscopic procedure gone awry. An injured patient claims damages of $750,000. A jury awards the injured patient $1.2 million, with the judgment entered against both the manufacturer and the distributor. Most of the judgment—more than $700,000 in fact—is not covered by the manufacturer’s insurance policy. The plaintiffs now look to the manufacturer anddistributor to pay.

Manufacturer’s insurance company gives lousy claims service. Claimadjusters often are overburdened with claim files. As a result, they ignore phone messages, e-mails, letters and faxes. The other insurer’s adjusters are inexperienced or incompetent. The manufacturer’s insurer hires defense attorneys based on the cheapest hourly rate rather than hireexperts in defending medical devices. The distributor or supplier which relies solely upon the manufacturer’s insurance company is at the mercy of that company’s claims service. If the service is platinum, great; if the service stinks, they are stuck.

Manufacturer denies coverage to the distributor. Insurance policies for manufacturers may try to cover other entities under a vendor’s endorsement. Often overlooked is the fact that this vendor’s

endorsement had limitations and exclusions. Not all endorsements are created equal. For example, if the manufacturer or its insurance company believes the accident was due to a supplier’s or distributor’s negligence, the insurer may decline coverage. Maybe the insurer says they altered the product in some way. Or it says thedistributor was casual in instructing users about the device, or failed to instruct the user, allowing the accident to occur. A manufacturer’s insurer looking to evade coverage may grasp at straws.

Manufacturer’s insurer controls thedefense. This can be problematic for a supplier or distributor. Under the insurance policy terms, the manufacturer’s insurer controls the claim defense. It hires, pays and directs the lawyer. The manufacturer’s insurer may steer the defense in a way that extracts the manufacturer from the lawsuit and shifts liability to the other parties. This can leave them as the “deep pockets,” exposed to significant financialliabilities. That security blanket the distributor and supplier thought they had with the manufacturer’s insurance policy—under closer examination—proves to be moth-eaten and threadbare.

Much here depends on what suppliers and distributors can afford in terms of their own insurance coverage. Another factor is management’s risk tolerance. Imagine if, for example, a supplier’s chief financialofficer must report to the CEO or board of directors that the company’s financial

existence is in peril due to a reliance on the manufacturer’s insurance policy. That may be a painful conversation. Suppliers ordistributors who think it couldn’t happen to them may face nasty surprises when a claim or lawsuit arises and an insurer with which they have no relationship steers the ship of claim defense.

Any one of these scenarios by themselves can financially wallop medicaldevice firms. Short of disaster, they create worry and uncertainty. The security blanket that distributors often feel exists through a manufacturer’s insurance coverage can prove to be as strong as cotton candy. Like cotton candy, the appearance of financial protection can end up being more elusive than substantive.

Unlike cotton candy, however, theaftertaste for suppliers and distributors may be anything but sweet! Avoid the bitter by thinking twice about putting all your insurance “eggs” in the manufacturer’s “basket.”

Kevin Quinley, CPCU, is a risk management consultant in the Washington, D.C., area with more than 25 years experience working with medical device companies. You can reach him at (703) 239-1694 or at [email protected]