For years I have been advising clients to obtain additional insured (AI) status on their supplier’s product liability coverage. This adds another, separate layer of protection, in addition to the product liability insurance purchased in their own name. Conversely, offering AI status to a potential customer may be an additional reason for that company to do business with you. 

In the dietary supplement industry, AI status for products moving up the supply chain is usually provided by the so-called vendor’s endorsement. Vendors view AI status for their company as a positive thing, as their protection under the vendor’s endorsement comes at the expense of the supplier. It’s smart business; if a product liability plaintiff’s lawsuit arrives, it will name everyone in the supply chain as a defendant, regardless of whether one or more of the parties are remotely responsible for the injury.

In addition, there may be an indemnity or hold harmless agreement that the manufacturer or distributor was required to execute in order to do business with the vendor. While in my experience, contracts including indemnity agreements are still not widely used in the nutraceutical industry, they are slowly becoming more widely utilized. It is also common in these contracts to require liability insurance to fund the legal liabilities transferred in a hold harmless clause.

However, it is important to understand that the indemnity/hold harmless agreement may actually transfer to the indeminator some liabilities that are not or cannot be insured. For instance, pollution liability and professional liability are both examples of coverage not provided by a product liability policy. Thus, the mere existence of the insurance policy does not guarantee that funds will be available to respond to all responsibilities of the indemnitor captured in the hold harmless agreement.

What’s Covered?
Returning to the AI status provided by the vendors endorsement, let’s examine what is/isn’t covered under certain circumstances.

Most people do not realize that the AI vendor’s endorsement has several exclusions that apply. You could characterize this as “the insurance company giveth, and the insurance company taketh away.” In any event these are some of the exclusions that will erase the AI status ostensibly granted to the vendor in the endorsement:

• An express warranty unauthorized by the vendor;
• A physical or chemical change in the product made intentionally by the vendor;
• Any repackaging by the vendor of the supplier’s products;
• Any failure to make inspections, adjustments or tests as the vendor has agreed to make or normally undertakes in the usual course of business, in connection with the sale of the products;
• Products that have been labeled or relabeled or used as an ingredient of any other product by or for the vendor.

Anyone with knowledge of the procurement process for dietary supplements can see that one or more of these exclusions could easily preclude the AI status of a vendor he or she thought was gained by receiving this coverage from the supplier.

Another exclusion on the vendor endorsement precludes coverage for any person or organization from whom you have acquired such products or ingredients. In other words, the AI status does not extend to your “downstream” suppliers from whom you have acquired products or ingredients. The vendor AI status is specifically designed to go to organizations “upstream” in your chain of commerce, not “downstream.” Often we get requests from our customers to provide this “downstream” coverage to a supplier, frequently because somebody in the sales department thought it sounded like a good idea.

Problems with Additional Insured Status
Obtaining AI status on a supplier’s product liability policy is not without some pitfalls, mostly for the party that is getting the AI status. Let’s look at two of those first.

Dilution of Limits. This is probably the most widely known disadvantage. Since product liability policies are subject to an annual aggregate amount of insurance, loading up your policy with scores of your customers as additional insureds could possibly lead to a dilution of the insurance available to you to pay a serious claim, if your AI customer is also going to lay claim to some of those limits by virtue of their AI status.

While it is theoretically possible to cap the amount of coverage available to an AI, it is cumbersome and rarely if ever done. I have had clients say to me “we automatically add every customer as additional insured to our policy.” It is usually pretty easy to talk them out of continuing this policy once they understand this dilution issue.

Defense Conflicts. When a lawsuit is brought against you and one of your additional insureds, quite often one party quickly and loudly blames the other for the problem. This becomes an issue for the insurer who is charged with defending both parties and the resulting conflict of interest. In many jurisdictions, this dilemma is resolved by statutes requiring the insurer to retain separate counsel at the expense of the insurance company. However, this creates an additional dilemma as this will without a doubt accelerate the dilution problem discussed previously, because in claims-made product liability insurance prevalent in the nutraceuticals industry, defense costs erode the aggregate limit of liability.

Now let’s examine a downside risk of AI status from the standpoint of the party granting it.

Loss of Defense Control. Many people purchasing liability insurance mistakenly assume that if they have a claim, they can choose their own attorney to represent them and have the insurer pay for it. Not the case—the insurer will select the law firm without much if any regard for the insureds’ wishes. Similarly, many large corporations have negotiated with their insurer the right to select their own legal counsel, which the insurer is willing to do because usually a very large deductible is in place, which in turn means the corporation is going to end up paying for it anyway. In both cases, being named AI on the policy of another means the real possibility exists that legal counsel will be defending a claim that neither their own insurer or the organization itself would have selected to defend the claim. 

In conclusion, the AI vendor’s endorsement widely used in product liability policies of the dietary supplement and nutraceutical industry can be a valuable tool, but it has certain pitfalls and constraints you need to be aware of.    

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Greg Doherty is a commercial insurance broker with Poms & Associates, Woodland Hills, CA. He is the Dietary Supplement Practice Leader for the firm, which specializes in the nutritional product and dietary supplement industries, including but not limited to contract manufacturers, raw materials suppliers, distributors/retailers. Mr. Doherty has four decades of experience as a broker, focusing solely on the dietary supplement industry for the last 12 years. He can be reached at gdoherty@pomsassoc.com; Website: www.gregdoherty.net.