MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION
From: Naomi Petersen, Lead Associate, Calderwood & Harkness LLP, 600 Lexington Avenue, 30th Floor, New York, NY 10022; Yuki Nakamura, Associate, Calderwood & Harkness LLP, 155 North Wacker Drive, Suite 4200, Chicago, IL 60606
To: Douglas Fairchild, Responsible Partner, Calderwood & Harkness LLP
cc: Angela Fontaine, Billing Partner, Calderwood & Harkness LLP; Priya Sundaram, General Counsel & Corporate Secretary, Nexford Industrial Holdings Inc.; Trevor Haines, Vice President, Risk Management, Nexford Industrial Holdings Inc.; Donna Kowalski, Director of Insurance and Claims, Nexford Industrial Holdings Inc.
Date: June 7, 2022
Re: Adequacy of Product Recall Sub-Limit — Midland Casualty & Surety Company Primary GL/PL Policy (Policy No. MCS-GL-2021-55671) — Nexford Industrial Holdings Inc.
Matter No.: 1005-00003
I. Executive Summary
This memorandum analyzes the adequacy of the current $2.5 million per occurrence / $5 million aggregate product recall sub-limit within the Midland Casualty & Surety Company primary general liability / products liability policy (Policy No. MCS-GL-2021-55671), covering the policy period July 1, 2021 through July 1, 2022, as issued to Nexford Industrial Holdings Inc. ("Nexford" or the "Company").
This analysis has been conducted as part of the comprehensive Directors & Officers and product-liability tower review that Calderwood & Harkness LLP is undertaking for Nexford in advance of the upcoming 2022–2023 renewal cycle, with the renewal effective date of July 1, 2022. The purpose of this memorandum is to provide the client with a thorough assessment of whether the existing product recall sub-limits are sufficient to address Nexford's current and reasonably foreseeable recall exposure, taking into account the Company's operational scale, product complexity, historical recall experience, pending product-liability litigation, and prevailing industry benchmarks.
Based on our analysis, we conclude that the current product recall sub-limits are inadequate given Nexford's operational profile. The Company is a $1.42 billion consolidated revenue industrial manufacturer shipping approximately 42,000 SKUs annually across three operating subsidiaries, with products deployed in safety-critical automotive and construction applications. Nexford has experienced two recall or advisory notice events in the past five years, with combined costs of $1.44 million, and a single one of those events consumed nearly 44% of the per-occurrence sub-limit. Moreover, the Company currently faces two pending product-liability lawsuits—Higgins v. Nexford Conveyor Systems, LLC et al. and Consolidated Builders Supply Co. v. Triton Fastener Corp.—both of which involve products with documented recall or advisory notice histories, thereby elevating the probability of future recall activity.
We recommend that Nexford increase the product recall sub-limit to $5 million per occurrence / $10 million aggregate at the July 1, 2022 renewal, to be negotiated through Ashford Breckinridge LLP, the broker of record (contact: Phillip Garza, Senior Vice President, and Tamara Fisk, Account Executive), with the incumbent carrier, Midland Casualty & Surety Company. Preliminary broker indications suggest that the estimated incremental premium for this recommended increase would be approximately $67,000, representing a 5.96% increase to the primary layer premium and a 2.53% increase to the total product-liability tower premium. We view this as a cost-effective enhancement that brings Nexford into alignment with peer median sub-limit levels and provides meaningful additional protection against realistic single-event and multi-event loss scenarios.
The balance of this memorandum sets forth the factual and analytical bases supporting this recommendation.
II. Background and Scope
A. Client Overview
Nexford Industrial Holdings Inc. is a Delaware-incorporated industrial holding company headquartered at 2200 Corporate Center Drive, Suite 800, Schaumburg, Illinois 60173. The Company operates through three wholly-owned operating subsidiaries, each of which manufactures and distributes industrial products serving the automotive and construction sectors:
1. Nexford Conveyor Systems, LLC ("NCS") — A Delaware limited liability company operating from its primary manufacturing facility located at 4500 Industrial Parkway, Joliet, Illinois 60436. NCS manufactures heavy-duty belt and roller conveyor systems for use in automotive assembly plants, distribution centers, mining operations, and construction material handling. NCS is Nexford's largest operating unit, accounting for approximately 56% of the Company's consolidated revenue, or $795.2 million of the $1.42 billion reported for fiscal year 2021.
2. Triton Fastener Corp. ("Triton") — An Illinois corporation operating from its primary manufacturing facility located at 1010 Whitman Avenue, Rockford, Illinois 61101. Triton manufactures industrial fasteners, bolts, and anchoring systems, including Grade 5 and Grade 8 hex bolts, structural anchor bolts, and specialty fastener assemblies used in steel construction, bridge building, automotive chassis assembly, and heavy equipment manufacturing. Triton accounts for approximately 28% of consolidated revenue, or $397.6 million for fiscal year 2021.
3. Marlowe Asset Management Precision Machining, Inc. ("Marlowe Asset Management") — An Ohio corporation operating from its primary manufacturing facility located at 775 Summit Industrial Boulevard, Akron, Ohio 44311. Marlowe Asset Management produces precision-machined automotive and construction components, including engine block fittings, suspension components, hydraulic valve bodies, and structural steel connectors. Marlowe Asset Management accounts for approximately 16% of consolidated revenue, or $227.2 million for fiscal year 2021.
For fiscal year 2021, Nexford reported consolidated revenue of $1.42 billion and EBITDA of $218 million, as reflected in the audited financial statements prepared by Pemberton & Associates CPAs, LLP. The Company ships approximately 42,000 distinct SKUs annually across all three operating subsidiaries. The products manufactured by each subsidiary serve safety-critical applications in the automotive and construction sectors, a factor that materially affects the Company's product recall risk profile.
Nexford is majority-owned (68.5%) by Veltrano Capital Partners Fund IV, LP, a 2017-vintage private equity fund with $4.8 billion in committed capital. The remaining equity is held by management rollover participants (19.3%) and co-investors (12.2%). Nexford was acquired in a leveraged buyout consummated on June 15, 2018, at an enterprise value of $2.1 billion. Based on current financial performance and applicable valuation multiples, the estimated current enterprise value is approximately $2.6 billion. The private equity ownership structure is relevant to this analysis insofar as Veltrano Capital Partners maintains portfolio-wide risk oversight standards that inform expectations regarding insurance coverage adequacy across its portfolio companies.
B. Current Product-Liability Tower Structure
Nexford maintains a four-layer product-liability insurance tower, structured as follows:
The total product-liability tower provides $75 million in aggregate coverage. Total annual premium across all four layers is $2,642,900, representing a rate-on-line of approximately 3.52%.
The product recall sub-limit that is the subject of this memorandum sits within the Midland Casualty & Surety Company primary layer. It is further sub-limited at $2.5 million per occurrence / $5 million aggregate. Product recall expenses erode the primary policy's $10 million aggregate—that is, recall payouts reduce the aggregate available for other general liability and products liability claims—but are themselves capped at these lower thresholds. The product recall sub-limit is subject to the same $500,000 per occurrence self-insured retention that applies to the broader primary policy.
C. Scope of This Memorandum
The scope of this memorandum is limited to the analysis of the product recall sub-limit within the Midland Casualty & Surety Company primary GL/PL policy. This memorandum does not address the adequacy of the broader product-liability tower limits, which is the subject of a separate PL Limits Adequacy Memorandum dated June 8, 2022. Nor does this memorandum address completed operations tail issues, which will be treated separately in the comprehensive tower review.
Specifically, this memorandum addresses the following topics:
(1) The terms and conditions of the current product recall sub-limit within the Midland Casualty primary policy;
(2) Nexford's historical recall and advisory notice experience over the past five years;
(3) Industry benchmarking of product recall sub-limits among comparable PE-backed industrial manufacturing companies;
(4) Scenario modeling to illustrate the potential financial impact of realistic recall events under the current and recommended sub-limit structures; and
(5) Our renewal recommendation, including cost-benefit analysis and consideration of alternative structures.
III. Current Product Recall Sub-Limit — Policy Terms
A. Coverage Grant
The Midland Casualty & Surety Company primary GL/PL policy (MCS-GL-2021-55671) includes a "Product Recall Expense" coverage part, which provides coverage for certain costs and expenses incurred by the insured in connection with a qualifying product recall. This coverage part is distinct from, and supplementary to, the standard products-completed operations liability insuring agreement, which covers third-party claims for bodily injury and property damage arising out of the insured's products.
Under the Product Recall Expense coverage part, the following categories of expenses are covered, subject to the sub-limit and self-insured retention described in Section III.B below:
• Notification costs: Reasonable and necessary costs incurred by the insured to notify customers, distributors, end-users, and regulatory authorities of the recall, including costs of preparing and disseminating recall notices, media announcements, and customer communications;
• Shipping and transportation costs: Costs of transporting recalled products from the point of use or distribution back to the insured's facility or designated collection point, including freight charges, carrier fees, and packaging materials;
• Inspection and testing costs: Costs of inspecting and testing recalled products to determine whether individual units are affected by the defect or condition giving rise to the recall, including laboratory testing, metallurgical analysis, and third-party inspection services;
• Disposal costs: Costs of destroying or disposing of recalled products that cannot be repaired or reworked, including costs of environmentally compliant disposal methods;
• Temporary warehousing: Costs of storing recalled products pending inspection, testing, repair, or disposal, to the extent such warehousing is necessitated by the recall;
• Loss of product value: The insured's cost of the recalled product (based on cost of goods manufactured, not retail or wholesale value) to the extent the recalled product is rendered unsalvageable;
• Consultant and crisis management fees: Reasonable fees paid to third-party consultants, public relations advisors, and crisis management firms retained by the insured in connection with managing the recall, to the extent such engagement is pre-approved by the carrier or is documented as reasonable and necessary.
Importantly, the Product Recall Expense coverage part does not cover the following categories of loss:
• Lost profits or revenue: The insured's own lost sales, revenue, or profits resulting from the recall, whether arising from the withdrawal of the recalled product from the market or from reputational harm to the insured's brand;
• Business interruption: Costs associated with disruption to the insured's manufacturing operations, including production downtime, overtime labor to address the recall, or costs of retooling manufacturing lines;
• Reputational harm: General diminution in brand value, loss of customer relationships, or other intangible reputational losses;
• Third-party bodily injury or property damage: Claims by third parties for bodily injury or property damage arising out of the defect that gave rise to the recall are covered under the standard GL/PL insuring agreement, not the Product Recall Expense coverage part. These claims are subject to the primary policy's full per-occurrence and aggregate limits, not the recall sub-limit.
The distinction between Product Recall Expense coverage and standard GL/PL coverage is significant because, as discussed further in Section VI.D below, a recall event may simultaneously generate both categories of covered loss, and both categories erode the same primary policy aggregate.
B. Sub-Limit Structure
The Product Recall Expense coverage part is subject to the following sub-limits within the Midland Casualty primary policy:
• Per occurrence sub-limit: $2,500,000
• Policy-period aggregate sub-limit: $5,000,000
• Self-insured retention: $500,000 per occurrence (same SIR as applies to the broader primary GL/PL policy)
• Net available coverage per occurrence after SIR: $2,000,000
Several structural features of the sub-limit warrant particular attention:
First, product recall expenses erode the primary policy's $10 million aggregate. This means that any recall costs paid by Midland Casualty reduce the aggregate limit available for other general liability and products liability claims during the same policy period. In a year in which Nexford experiences both a product recall and one or more bodily injury or property damage claims, the combined effect on the primary aggregate could be substantial.
Second, the excess layers do not provide separate or additional product recall sub-limits. Great Basin Insurance Company (1st Excess/Umbrella), Cornerstone Reinsurance Corp. (2nd Excess), and Allegheny Pacific Underwriters, Inc. (3rd Excess) all follow form to the Midland Casualty primary policy with respect to recall coverage, but these layers only attach once the primary $10 million aggregate has been exhausted. Because the recall sub-limit caps total recall payouts at $5 million in the aggregate—an amount that alone cannot exhaust the $10 million primary aggregate—product recall costs as a practical matter cannot independently trigger excess layer coverage. The recall sub-limit effectively functions as a hard cap on the total recall coverage available to Nexford, regardless of the existence of $65 million in excess layer capacity above the primary.
Third, the $500,000 per occurrence SIR significantly reduces the net coverage available per event. For a recall event costing $1.5 million, for example, the SIR absorbs the first $500,000, and the policy pays only $1.0 million. The effective coverage ratio—net insurance recovery as a percentage of total recall cost—declines as recall costs approach the SIR threshold and increases only as costs significantly exceed the SIR.
C. Key Definitions
The Midland Casualty policy defines "Product Recall" as the withdrawal of the insured's product from the stream of commerce, initiated either (i) voluntarily by the insured upon determination that a product defect or unsafe condition exists that creates a risk of bodily injury or property damage, or (ii) as mandated by a governmental authority, including but not limited to the Consumer Product Safety Commission ("CPSC"), the Occupational Safety and Health Administration ("OSHA"), or any successor or equivalent federal, state, or local regulatory body.
A critical distinction exists between a formal product recall and an advisory or safety notice. Under the Midland Casualty policy definition, an advisory notice—which alerts customers to a potential issue and recommends inspection or field adjustment but does not involve the physical withdrawal or return of the product from the stream of commerce—may or may not qualify as a covered "Product Recall." The policy language requires that the product be "withdrawn" from commerce, which implies a physical removal or cessation of use. Field corrections, calibration adjustments, and inspection campaigns that allow the product to remain in service after servicing may not satisfy this definitional requirement.
This definitional issue is not merely theoretical. As discussed in Section IV.B below, Nexford Conveyor Systems issued an advisory notice in August 2020 concerning the Model NCS-7200 conveyor system's emergency stop mechanism. Midland Casualty declined to treat that advisory notice as a covered "Product Recall" under the sub-limit, contending that because the notice did not require the physical withdrawal or return of the affected conveyor systems, it fell outside the policy definition. Nexford absorbed the full $340,000 cost of the advisory notice out of pocket. This coverage gap is addressed in our recommendations in Section X below.
D. Exclusions and Limitations
The Product Recall Expense coverage part is subject to several exclusions and limitations that further narrow the scope of available coverage:
• Known defect exclusion: The policy excludes coverage for recall expenses arising out of any defect or unsafe condition that was known to the insured prior to the inception of the policy period. This exclusion underscores the importance of accurate and complete disclosure of known product issues during the underwriting process and at each renewal. For the upcoming July 1, 2022 renewal, Nexford should ensure that the known defect exclusion does not inadvertently preclude coverage for recalls involving the NCS-7200 emergency stop mechanism issue or the Triton Grade 8 hex bolt hardness inconsistency, both of which have been disclosed to the carrier and are the subject of pending litigation. We will address this point specifically in the forthcoming Renewal Negotiation Points Memorandum.
• Contractual recall obligations exclusion: The policy excludes recall expenses incurred solely because of a contractual warranty obligation, as opposed to an actual product defect. If a customer's purchase agreement requires the insured to conduct a recall upon certain specified triggers that are contractual in nature rather than defect-driven, the resulting costs would not be covered. This exclusion is generally not problematic for Nexford given the nature of its products and customer relationships, but should be monitored as Nexford enters into new supply agreements, particularly with automotive OEM customers that may impose broad contractual recall provisions.
• Governmental fines and penalties exclusion: Fines, penalties, punitive damages, and similar assessments imposed by governmental authorities in connection with a recall are excluded from coverage. This exclusion is standard and generally not negotiable.
• Product redesign exclusion: Costs of redesigning, re-engineering, or improving the product to correct the defect or unsafe condition that gave rise to the recall are not covered. The policy reimburses costs of withdrawing and replacing the defective product, not costs of developing a new or improved product design.
IV. Nexford's Historical Recall Experience
A. Triton Fastener Corp. Voluntary Recall — March 2020
On March 12, 2020, Triton Fastener Corp. initiated a voluntary recall of certain production lots of Grade 8 hex bolts manufactured at its Rockford, Illinois facility. The recall was prompted by internal quality assurance testing that identified hardness inconsistency in certain production lots, creating a potential for premature failure under load in structural applications. The hardness inconsistency was traced to a deviation in the heat treatment process during a specific production window affecting bolts produced between November 2019 and January 2020.
Triton initiated the recall voluntarily, in coordination with its distributor network, and notified Midland Casualty of the event contemporaneously. No government mandate or CPSC involvement was required, as Triton's prompt voluntary action preempted regulatory intervention. The recall affected approximately 15,000 units distributed across 42 distributors and end-use customers.
The total cost of the recall was $1,100,000, broken down by category as follows:
Triton submitted a claim under the Product Recall Expense coverage part of the Midland Casualty primary policy. The $500,000 per occurrence self-insured retention was applied, resulting in a net insurance recovery of $600,000 against the $1,100,000 total cost. Nexford absorbed the remaining $500,000 (the SIR amount) out of pocket.
Several observations are significant for purposes of this analysis:
• The single Triton recall consumed 44% of the $2.5 million per-occurrence sub-limit. Had the recall been even moderately more expensive—for example, if a larger number of production lots had been affected or if the defect had been identified later in the distribution chain, requiring more extensive field retrieval—the per-occurrence sub-limit could have been reached or nearly reached.
• The $600,000 net recovery represented only 24% of the $2.5 million per-occurrence sub-limit (or 30% of the $2.0 million net-of-SIR coverage). While the SIR appropriately shifts first-dollar risk to Nexford, the low recovery ratio highlights the limited ceiling of protection available under the current sub-limit.
• The Triton recall cost of $1.1 million was relatively modest by industrial fastener recall standards, as discussed in the industry benchmarking analysis in Section V below. A recall affecting a broader range of fastener grades or production lots, or one triggered by actual structural failure in the field rather than proactive quality assurance testing, could be substantially more expensive.
Relationship to pending litigation: The Consolidated Builders Supply Co. v. Triton Fastener Corp., Case No. 1:21-cv-08914, United States District Court for the Northern District of Illinois, filed November 2, 2021 (motion to dismiss denied February 11, 2022), involves allegations that Grade 8 hex bolts manufactured by Triton experienced structural failure at a commercial construction site, causing property damage to structural steel connections and alleged construction delay damages. The plaintiff seeks $6.8 million in damages. While the Consolidated Builders litigation constitutes a separate occurrence from the March 2020 recall and is being managed under the standard GL/PL insuring agreement rather than the Product Recall Expense coverage part, the litigation involves the same product line and similar defect allegations. The existence of this litigation elevates the risk that additional recall activity involving Grade 8 hex bolts—or an expansion of the recall to Grade 5 fasteners or other product lines manufactured on the same equipment—may be warranted in the future.
B. Nexford Conveyor Systems Advisory Notice — August 2020
On August 7, 2020, Nexford Conveyor Systems, LLC issued an advisory/safety notice to customers operating Model NCS-7200 conveyor systems manufactured between the first quarter of 2019 and the second quarter of 2020. The advisory notice was prompted by field reports and internal engineering review indicating a potential issue with the calibration of the emergency stop mechanism on certain NCS-7200 units. Specifically, the emergency stop mechanism was found in some units to have a delayed activation response exceeding the design specification tolerance, creating a potential safety concern in high-speed conveyor operations.
The advisory notice recommended that customers schedule field service visits to inspect and, if necessary, recalibrate the emergency stop mechanism. NCS dispatched field service technicians to customer sites and, in some cases, provided replacement calibration modules and associated components. The advisory was not classified as a formal product recall because NCS did not instruct customers to cease use of the affected conveyor systems or to return the equipment; rather, the notice called for in-place field correction.
The total cost of the advisory notice was $340,000, broken down as follows:
NCS submitted the advisory notice costs to Midland Casualty & Surety Company under the Product Recall Expense coverage part. Midland Casualty declined coverage, taking the position that the advisory notice did not constitute a "Product Recall" as defined in the policy because the NCS-7200 systems were not withdrawn from the stream of commerce—they remained in service at customer sites, subject to field inspection and recalibration. Nexford absorbed the full $340,000 cost out of pocket.
We note that even if the advisory notice had qualified as a covered recall under the Midland Casualty policy, the $340,000 total cost would have fallen below the $500,000 per occurrence SIR, resulting in no net insurance recovery. However, the coverage characterization issue remains significant for two reasons:
First, if the NCS-7200 advisory notice had been treated as a covered recall occurrence, it would have counted against the $5 million policy-period aggregate sub-limit. In a policy year featuring multiple recall events, the aggregation of smaller events—including advisory notices—could contribute to aggregate exhaustion.
Second, the advisory notice establishes a pattern: NCS has identified and addressed a product safety concern in the field involving the NCS-7200 emergency stop mechanism. If a more serious manifestation of the same issue arises in the future—particularly one that requires a formal, full-scale recall involving product withdrawal from service—the costs are likely to be substantially higher. The coverage gap for advisory notices leaves Nexford without insurance protection for an entire category of product safety response activity.
Relationship to pending litigation: The Higgins v. Nexford Conveyor Systems, LLC et al., Case No. 2021-L-04382, Circuit Court of Will County, Illinois, filed September 14, 2021, involves allegations that a defective emergency stop mechanism on a Model NCS-7200 conveyor system caused or contributed to a workplace injury at a distribution facility. The plaintiff alleges that the emergency stop mechanism failed to activate within design tolerances, resulting in severe bodily injury. Damages sought total $14.5 million. This litigation involves the same product model and the same emergency stop mechanism issue that was the subject of the August 2020 advisory notice, heightening the concern that a CPSC-mandated or voluntary recall of the NCS-7200 may be required in the future.
C. Combined Historical Recall Costs
Over the past five years, Nexford has experienced two recall or advisory notice events with combined costs as follows:
For contextual reference, Nexford's broader five-year product-liability loss history includes 12 reported claims, of which nine have been closed with total paid losses of $4.72 million, and three remain open with combined reserves of $8.3 million. The Kessler Quinn Advisory Group, Nexford's actuarial consultants, has estimated incurred-but-not-reported ("IBNR") liabilities at $2.1 million. Total incurred product-liability losses over the five-year period (paid plus open reserves plus IBNR) are $15.12 million. The recall and advisory notice costs of $1.44 million represent approximately 9.5% of total incurred product-liability losses over the same period.
D. Trend Observations
The historical data yields several observations relevant to the adequacy assessment:
• Frequency: Two recall or advisory notice events over a five-year period suggests an approximate frequency of one event every 2.5 years. While two events constitute a limited data set from which to draw robust actuarial conclusions, the frequency is notable for a company that did not experience any recall activity in the first two years of the observation period (2017–2019), followed by two events in a single calendar year (2020). This clustering pattern may reflect the impact of increasing product complexity and manufacturing volume.
• Severity: The average cost per event is $720,000. However, severity is highly variable—the Triton recall cost $1.1 million while the NCS advisory notice cost $340,000. As discussed in Section V below, industry data suggests that large-scale industrial equipment recalls can cost $4.2 million or more per event, indicating that Nexford's historical experience may understate potential future severity.
• Product complexity trend: Nexford Conveyor Systems' NCS-7200 series represents the Company's most technologically sophisticated product line, incorporating programmable logic controllers, sensor arrays, and integrated safety systems. The increasing complexity of Nexford's products inherently increases the potential points of failure and the cost and difficulty of recall execution. Moreover, NCS has introduced three new conveyor system models since 2019, and the Company's total SKU count has grown from approximately 36,000 in 2018 to approximately 42,000 in 2021.
• Litigation overhang: The pendency of both Higgins v. NCS and Consolidated Builders v. Triton—each involving products with documented recall or advisory notice histories—elevates the probability that additional recall activity may be triggered by litigation outcomes, discovery findings, or regulatory inquiry prompted by the litigation.
V. Industry Benchmarking
A. Methodology
To assess the adequacy of Nexford's current product recall sub-limits relative to market norms, we reviewed recall sub-limit data from multiple sources:
• Publicly available insurance market reports addressing product recall coverage trends in the industrial manufacturing sector, including the 2022 Penrose Benefits Consulting Product Recall Market Review and the Ridgeway Risk Advisors Product Recall Landscape Report (Q1 2022);
• Proprietary benchmarking data provided by Ashford Breckinridge LLP, Nexford's broker of record, through Phillip Garza (Senior Vice President) and Tamara Fisk (Account Executive), reflecting placement data from their industrial manufacturing client portfolio;
• Actuarial and risk advisory data provided by Kessler Quinn Advisory Group, through Arthur Kessler (Managing Director) and Diana Cho (Senior Consultant), including loss frequency and severity analyses for the industrial manufacturing sector for the period 2017–2021.
We benchmarked Nexford against a peer group of comparable private equity-backed industrial manufacturing companies in the $1 billion to $3 billion revenue range, with a focus on companies manufacturing similar product types: heavy industrial equipment, industrial fasteners, and precision-machined components for automotive and construction applications. This is the same peer group utilized in the PL Limits Adequacy Memorandum dated June 8, 2022, ensuring consistency across our tower review workstreams.
B. Peer Comparison Data
The peer group consists of eight comparable private equity-backed industrial manufacturing companies. For confidentiality reasons, peer companies are identified by number rather than by name. The following table summarizes the product recall sub-limits maintained by each peer:
Key observations from the peer comparison:
• The median product recall sub-limit per occurrence among the peer group is $5.0 million, exactly double Nexford's current $2.5 million per-occurrence sub-limit.
• The median product recall sub-limit aggregate is $10.0 million, again double Nexford's current $5.0 million aggregate sub-limit.
• The range of per-occurrence sub-limits across the peer group is $2.5 million to $10.0 million. Nexford's current $2.5 million per-occurrence sub-limit sits at the very bottom of this range, at or below the 25th percentile.
• The range of aggregate sub-limits is $5.0 million to $15.0 million. Again, Nexford's $5.0 million aggregate sits at the bottom of the range.
• Three of eight peers (Peers 1, 2, and 5) maintain recall sub-limits at or above $5.0 million per occurrence / $10.0 million aggregate, which is the level we recommend for Nexford.
• Two peers (Peers 3 and 4) carry standalone product recall or product contamination policies in addition to their GL/PL recall sub-limits, providing dedicated recall limits that are not eroded by standard GL/PL claims. Both of these peers have revenues exceeding $1.5 billion and operate in product segments with heightened recall risk profiles.
C. Industry Loss Data
In addition to the peer comparison, we reviewed industry-wide loss data for the industrial manufacturing sector, drawing primarily on actuarial analyses prepared by Kessler Quinn Advisory Group:
• Manufacturing sector average product recall cost (industrial equipment), 2017–2021: $2.8 million per event. This figure reflects the average across all industrial equipment recall events in the Kessler Quinn database, including both voluntary and government-mandated recalls.
• Large-scale industrial equipment recalls (conveyor systems, press equipment, crane components): $4.2 million per event on average. This subcategory is directly relevant to Nexford Conveyor Systems and reflects the higher costs associated with recalls of large, installed-base equipment that requires field service rather than simple product return and replacement.
• Fastener and component recalls: $1.5 million per event on average. However, fastener recalls exhibit high severity variance—while many fastener recalls are relatively contained, recalls affecting fasteners used in widespread structural applications (bridge construction, high-rise steel framing, automotive chassis) can escalate to $5 million to $8 million per event due to the sheer volume of installed units, the difficulty of identifying and accessing installed fasteners, and the potential for cascading structural integrity concerns.
• CPSC-mandated versus voluntary recalls: Recalls mandated by the Consumer Product Safety Commission or other governmental authorities average approximately 35% higher in total cost than voluntary recalls. This premium reflects the additional regulatory compliance requirements imposed on mandated recalls, including broader notification mandates (publication in the Federal Register, coordination with CPSC recall notices), extended monitoring and reporting obligations, and the inability of the insured to limit the scope of the recall to the most cost-effective approach. For Nexford, this data point is relevant because a future recall of the NCS-7200 conveyor system—particularly if prompted by the Higgins litigation or by OSHA involvement following a workplace injury—could be government-mandated rather than voluntary, driving costs to the higher end of the severity range.
D. Key Takeaway
The benchmarking analysis leads to three clear conclusions:
First, Nexford's current $2.5 million per-occurrence product recall sub-limit is 50% below the peer median of $5.0 million. This disparity is particularly concerning given that Nexford's revenue ($1.42 billion), product complexity, and safety-critical end-market applications are squarely within the profile of the peer group.
Second, Nexford's current $5.0 million aggregate sub-limit could be exhausted by a single large recall event or by two moderate recall events occurring in the same policy year. Given the industry average recall cost of $2.8 million per event for industrial equipment and $4.2 million for large-scale equipment recalls, a single conveyor system recall could approach or exceed the aggregate sub-limit.
Third, given Nexford's revenue scale, product mix, and the safety-critical nature of its products, the current sub-limits represent a meaningful coverage gap that exposes the Company to significant out-of-pocket costs in realistic recall scenarios.
VI. Scenario Modeling
To illustrate the practical impact of the current sub-limit structure and the benefit of the recommended increase, we modeled four scenarios ranging from a single large recall event to a complex multi-event year with concurrent bodily injury claims. Each scenario is grounded in realistic assumptions derived from Nexford's historical recall experience, the pending litigation, and industry loss data.
A. Scenario 1: Single Large Conveyor System Recall
Hypothetical: A CPSC-mandated recall of Model NCS-7200 series conveyor systems is issued due to confirmed failures of the emergency stop mechanism, analogous to the issues underlying the August 2020 advisory notice and the pending Higgins v. Nexford Conveyor Systems, LLC et al. litigation. The CPSC mandates a full recall requiring removal of the affected emergency stop modules and installation of replacement units, with field verification and reporting to the CPSC.
Key assumptions:
• Estimated affected units in the field: 400 to 600 units (reflecting NCS-7200 systems manufactured between Q1 2019 and Q2 2020 that were sold and installed at customer sites).
• Estimated recall cost: $3.5 million to $5.5 million, encompassing customer notification, field service dispatches, removal and replacement of emergency stop modules, logistics coordination, CPSC compliance reporting, and crisis management consulting. The estimate reflects the Kessler Quinn industry average for large-scale industrial equipment recalls ($4.2 million), adjusted upward for the CPSC-mandated recall premium (35%) and the geographic dispersion of NCS-7200 installations across the United States.
Financial analysis under current sub-limit ($2.5M per occurrence / $5M aggregate):
• At the low end of the cost range ($3.5 million): $500,000 SIR is applied; policy pays $2.0 million (per-occurrence sub-limit of $2.5 million minus $500,000 SIR); Nexford bears the remaining $1.5 million out of pocket (SIR of $500,000 plus $1.0 million in excess of the sub-limit).
• At the high end of the cost range ($5.5 million): $500,000 SIR is applied; policy pays $2.0 million; Nexford bears the remaining $3.5 million out of pocket.
• Coverage gap: $1.5 million to $3.5 million.
Financial analysis under recommended sub-limit ($5M per occurrence / $10M aggregate):
• At the low end ($3.5 million): $500,000 SIR applied; policy pays $3.0 million; Nexford bears $500,000 (SIR only).
• At the high end ($5.5 million): $500,000 SIR applied; policy pays $4.5 million (per-occurrence sub-limit of $5.0 million minus $500,000 SIR); Nexford bears $1.0 million ($500,000 SIR plus $500,000 in excess of the sub-limit).
• Coverage gap: $0 to $1.0 million. The recommended sub-limit eliminates the gap entirely at the low end of the cost range and reduces it to $1.0 million at the high end.
B. Scenario 2: Multi-Lot Fastener Recall
Hypothetical: Triton Fastener Corp. initiates a voluntary recall of multiple production lots of Grade 8 and Grade 5 fasteners due to a metallurgical defect affecting structural integrity, representing an escalation of the pattern identified in the March 2020 recall. The recall is broader in scope than the 2020 event, affecting multiple fastener grades, a larger number of production lots, and a wider distribution footprint.
Key assumptions:
• Estimated recall cost: $2.5 million to $4.0 million, reflecting the broader scope and the Kessler Quinn data indicating that widespread fastener recalls can escalate to $5–$8 million when structural applications are affected. The midpoint of this estimate represents a recall approximately 2.5 to 3.5 times more costly than the 2020 Triton recall.
Financial analysis under current sub-limit ($2.5M per occurrence):
• At the low end ($2.5 million): $500,000 SIR applied; policy pays $2.0 million; Nexford bears $500,000 (SIR only). The recall exactly reaches the per-occurrence sub-limit.
• At the high end ($4.0 million): $500,000 SIR applied; policy pays $2.0 million (capped at per-occurrence sub-limit); Nexford bears $2.0 million ($500,000 SIR plus $1.5 million in excess of sub-limit).
• Coverage gap: $500,000 to $2.0 million.
Financial analysis under recommended sub-limit ($5M per occurrence):
• At the low end ($2.5 million): $500,000 SIR applied; policy pays $2.0 million; Nexford bears $500,000. Identical outcome—the sub-limit increase does not change the result because total costs are below the new sub-limit.
• At the high end ($4.0 million): $500,000 SIR applied; policy pays $3.5 million; Nexford bears $500,000 (SIR only).
• Coverage gap: $0. The recommended sub-limit eliminates the coverage gap entirely across the full range of estimated costs.
C. Scenario 3: Two Recalls in Single Policy Year
Hypothetical: Nexford experiences two recall events in a single policy period—a Triton fastener recall costing $1.5 million and an NCS conveyor system recall costing $3.0 million.
Financial analysis under current sub-limit ($2.5M per occurrence / $5M aggregate):
• Triton recall ($1.5 million): $500,000 SIR applied; policy pays $1.0 million; Nexford bears $500,000.
• NCS recall ($3.0 million): $500,000 SIR applied; per-occurrence sub-limit of $2.5 million caps the payout at $2.0 million (after SIR); Nexford bears $1.0 million ($500,000 SIR plus $500,000 in excess of sub-limit).
• Combined policy payouts: $1.0 million (Triton) + $2.0 million (NCS) = $3.0 million. This amount is within the $5.0 million aggregate sub-limit, so the aggregate does not further constrain recovery.
• Combined Nexford out-of-pocket: $500,000 (Triton SIR) + $1.0 million (NCS SIR plus excess) = $1.5 million.
• Coverage gap: $1.5 million (representing two SIRs of $500,000 each and $500,000 in excess of the NCS per-occurrence sub-limit).
Financial analysis under recommended sub-limit ($5M per occurrence / $10M aggregate):
• Triton recall ($1.5 million): $500,000 SIR applied; policy pays $1.0 million; Nexford bears $500,000.
• NCS recall ($3.0 million): $500,000 SIR applied; policy pays $2.5 million; Nexford bears $500,000 (SIR only — cost of $3.0 million is within the $5.0 million per-occurrence sub-limit).
• Combined policy payouts: $1.0 million + $2.5 million = $3.5 million. Well within the $10.0 million aggregate.
• Combined Nexford out-of-pocket: $500,000 + $500,000 = $1.0 million (two SIRs only).
• Coverage gap: $1.0 million (representing two SIRs only). The recommended sub-limit reduces the coverage gap by $500,000 and eliminates the per-occurrence cap shortfall entirely.
D. Scenario 4: Regulatory-Mandated Recall with Concurrent Third-Party Bodily Injury Claims
Hypothetical: A CPSC-mandated recall of NCS-7200 conveyor systems generates $3.0 million in recall costs. Concurrently, multiple third-party bodily injury claims arising from the same emergency stop mechanism defect generate $5.0 million or more in liability exposure. Both the recall costs and the bodily injury claims erode the Midland Casualty primary policy's $10 million aggregate.
This scenario is significant because it illustrates the aggregate erosion dynamic that is inherent in a sub-limit structure where recall costs and standard GL/PL claims share the same aggregate pool.
Analysis:
• Recall costs ($3.0 million) erode the primary aggregate by $2.0 million after SIR (under the current sub-limit, which caps recovery at $2.0 million, or by $2.5 million under the recommended sub-limit).
• Bodily injury claims ($5.0 million or more) independently erode the primary aggregate, subject to the $500,000 per occurrence SIR applicable to each claim.
• Combined erosion from recall costs and bodily injury claims could rapidly approach or exhaust the $10 million primary aggregate, potentially implicating the excess layers.
• Critical context: As of the date of this memorandum, Nexford's open product-liability claim reserves total $8.3 million across three open claims (including reserves established for the Higgins and Consolidated Builders matters). While not all of these reserves will necessarily result in payments within the current policy period, the defense cost and indemnity exposure associated with these open claims represents substantial potential erosion of the primary aggregate. A recall event layered on top of the existing open claims could leave minimal primary aggregate available for any additional claims that may arise during the balance of the policy period.
• Cross-reference to the defense cost erosion tracking guidance previously provided to Trevor Haines, Vice President, Risk Management, regarding the Higgins and Consolidated Builders claims.
This scenario underscores the importance of not only increasing the recall sub-limit but also actively monitoring aggregate erosion across all coverage parts of the primary policy.
VII. Cost-Benefit Analysis of Recommended Increase
A. Proposed Sub-Limit Structure
Based on the analysis set forth in this memorandum, we recommend that Nexford negotiate the following product recall sub-limit structure at the July 1, 2022 renewal:
• Product recall sub-limit per occurrence: $5,000,000 (increased from $2,500,000)
• Product recall sub-limit aggregate: $10,000,000 (increased from $5,000,000)
• Self-insured retention: $500,000 per occurrence (unchanged)
This represents a doubling of both the per-occurrence and aggregate recall sub-limits. The recommended limits align with the peer median identified in Section V.B above and are supported by the scenario modeling in Section VI.
Ashford Breckinridge LLP has provided a preliminary indication from Midland Casualty & Surety Company that the recommended increase would carry an incremental premium of approximately $67,000 over the current primary GL/PL premium. This indication is preliminary and subject to final underwriting review and negotiation at renewal. The new total primary GL/PL premium would increase from $1,125,000 to approximately $1,192,000.
B. Premium Impact on Overall Tower
The $67,000 incremental premium for the recommended sub-limit increase is modest in context:
The incremental premium represents less than six cents per one hundred dollars of primary layer premium and less than five thousandths of one percent of Nexford's annual revenue. By any measure, the premium increase is de minimis relative to the additional coverage purchased.
C. Value Proposition
The cost-benefit case for the recommended increase is compelling:
• Coverage enhancement: Doubling the available recall coverage—from $2.0 million net-of-SIR per occurrence to $4.5 million, and from $5.0 million aggregate to $10.0 million—for a 5.96% increase in primary premium is a favorable exchange. The incremental premium of $67,000 purchases $2.5 million in additional per-occurrence protection and $5.0 million in additional aggregate protection.
• Out-of-pocket risk reduction: In the single-event scenarios modeled in Section VI, the recommended sub-limit reduces Nexford's maximum out-of-pocket exposure by up to $2.5 million per occurrence. For a company of Nexford's size and financial profile, a $2.5 million uninsured recall cost is not existential, but it is material—representing approximately 1.15% of EBITDA. Reducing this exposure for $67,000 in annual premium is economically rational.
• Multi-event protection: The doubling of the aggregate sub-limit from $5.0 million to $10.0 million is particularly significant because it accommodates the possibility of two or more recall events in a single policy year. Nexford's historical experience—two events in 2020—demonstrates that multi-event years are not hypothetical.
• Peer alignment: The recommended sub-limit brings Nexford into alignment with the median recall sub-limit levels of its peer group, eliminating a coverage positioning that currently places the Company at the bottom of the peer range.
• Prudential considerations: The combination of historical recall activity, pending product-liability litigation involving products with recall histories, and a large and growing SKU count in safety-critical applications collectively warrants the recommended enhancement. From a governance and fiduciary standpoint—particularly given Veltrano Capital Partners' portfolio risk oversight standards—maintaining recall sub-limits at the bottom of the peer range is difficult to justify when the cost of improvement is this modest.
VIII. Alternative Structures Considered
A. Standalone Product Recall Policy
As part of the renewal preparation process, Ashford Breckinridge LLP explored the availability and pricing of standalone product recall policies from specialty insurance markets. Standalone product recall policies are dedicated policies that provide coverage exclusively for product recall expenses, with limits that are separate from and not eroded by standard GL/PL claims.
Indicative pricing: Ashford Breckinridge obtained preliminary indications from two specialty carriers for standalone product recall policies providing $5.0 million per occurrence / $10.0 million aggregate limits. The indicative premium range was $150,000 to $250,000 annually, depending on carrier, retention structure, and covered expense definitions.