Howard Kunreuther and Peter Schmeidler Risk Management and Decision Processes Center

1. Third Party (Voluntary) versus Government Certifications for Food Safety Howard Kunreuther and Peter Schmeidler Risk Management and Decision Processes Center E-mail: pschmeid@wharton.upenn.edu Presented at a Conference on ALL FOOD IS NOT CREATED EQUAL: Policy for Agricultural Product Differentiation Berkeley, CA. November 16, 2004

2. OUTLINE OF TALK Examples of Safety Inspections Introduction to EPA Risk Management Program (RMP) Third Party RMP Audit Project Introduction to the Risk Management and Decision Processes Center at the Wharton School Product differentiation and safety and quality certification Examples of Third Parties in Food Safety Potential for Third Parties in Product Differentiation?

3. Focus on low probability-high consequence events Natural Disasters Chemical Manufacturing Incidents Terrorism and Interdependent Security Workplace Safety Use of Public-Private Partnerships to develop strategies to manage these risks Private Component: Insurance and Third Party Inspections Public Component: Regulations and Well Enforced Standards WHARTON RISK MANAGEMENT CENTER

4. Agreement with EPA Office of Emergency Prevention, Preparedness and Response (OEPPR) Near Miss Third Party RMP Audits Accident Epidemiology Lockheed-Martin - Airline Security Drug-Related Risk Management – with a large pharma firm Managing and Financing Extreme Risks Nat’l Institute of Standards and Technology – Safer Communities Web site: http://opim.wharton.upenn.edu/risk WHARTON RISK CENTER PROJECTS

5. EXAMPLES OF SAFETY INSPECTIONS • Steam Boilers - mandatory (by insurer) • Workers Compensation – mandatory (by insurer, if indicated) • LA County Restaurant Ratings • Mandatory (by County)

6. NEED FOR WELL ENFORCED CHEMICAL SAFETY REGULATIONS Firms Don’t Make Benefit-Cost Tradeoffs Threshold Models Myopia (NIMTOF) Limited Assets Interdependencies in Multi-Division Firms Externalities And these points hold for other industries!

7. EPA RISK MANAGEMENT PROGRAM (RMP) BACKGROUND There are 15,500 sites that meet the RMP threshold of handling at least one of 143 listed hazardous chemicals The threshold chemical at ~50% of the sites is ammonia (refrigeration for food processing) and at ~30% of the sites is chlorine (waste water treatment and purification) EPA has ~50 inspectors to cover the above Some states such as Delaware and NJ have their own RMP programs and carry out inspections in lieu of EPA RMP is administered by OEPPR formerly CEPPO , the Chemical Emergency Preparedness and Prevention Office

8. WHY THIRD PARTY AUDITS FOR RMP? An alternative to “Command and Control” Limited EPA resources – infrequent inspections Volunteer sites means EPA can focus on “bad” facilities 3rd Party provides benchmark for best practices Private party rather than a regulator inside the facility Opportunity for Community goodwill via transparency Potential to avoid penalties by self reporting Potential for lower insurance premiums Regulatory/litigation relief in case of an incident

9. INSURANCE AS THE THIRD PARTY Insurers want inspections to be “complete enough” because otherwise they lose in claims Inspection can reveal ways the individual company can reduce its safety and legal risks Analysis of all inspection data can identify patterns to reduce safety risks  Insurers should reduce premiums to reflect lower risk

10. Two day training of insurance engineers and safety consultants in ammonia and chlorine safety by DNREC Delaware – has state RMP program; 4 ammonia and 4 chlorine sites; follow-up inspections by DNREC Pennsylvania – does not have state RMP program; 4 ammonia and 9 chlorine sites; follow-up inspections by EPA Region III Conclusions: Trainees are capable of conducting RMP compliance inspections with performance parallel to an implementing agency PILOT STUDY: AUDITOR TRAINING

11. Voluntary participation EPA establishes qualification standards for auditors  Facility hires auditor or works with insurer  Comprehensive RMP audit performed  Auditor provides report to facility  Facility reviews report  Facility can: Take corrective action and submit report to EPA or Take corrective action and not submit report to EPA or Take no action and not submit report  If report is submitted, EPA provides regulatory benefits of waiver of fines for non-compliance (within limits) and a three year window of freedom from an EPA RMP audit PROPOSED REVISION TO SECTION 112(r) OF THE CLEAN AIR ACT AMENDMENTS FOR 3RD PARTY AUDITS

12. SAFETY & QUALITY CERTIFICATION IN FOOD MARKETS • Supermarket Food Products are Becoming More Differentiated • More processing outside the home • For example, branded meat entrees • Distinctive agricultural production • Organic produce; hormone free meats • Large scale Production + special processing • potential for greater impact if breakdown occurs • Foreign sourcing

13. DIFFERENTIATION IMPOSES NEW PRESSURES ON REGULATORY & CERTIFICATION FUNCTIONS • Regulation: How should meat inspection respond to varying safety emphases? • Certification: What role should USDA play in responding to consumer demands regarding production processes? • Each stretches resources; alters traditional focus

14. INSURANCE AND FOOD SAFETY Insurer has staff with food experience that spend 80% of their time in facilities (including restaurants) Several certified in HACCP (Hazard Analysis/Critical Control Points) Regional firms are biggest challenge – normally started small and still behaving as a small organization despite growth Lack of resources – QC person becomes HACCP person and HACCP program done in-house without consultation Relationship with insurer grows such that facilities feel more comfortable with than regulator – leads to sharing of best practices Concerns: consolidation leading to fewer “batches”, if problem occurs it can effect a larger population Forces insurer to look at more closely at controls

15. EXAMPLES OF THIRD PARTIES IN FOOD SAFETY Pa. Egg Quality Assurance Program Ca. Dairy Quality Assurance Program Fresh Produce Audit Verification Program Qualified Through Verification Minnesota Certified Pork

16. PA. EGG QUALITY ASSURANCE PROGRAM(PEQAP) Voluntary program developed by PennAg Industries Poultry Council to minimize Salmonella enteritidis (SE) contamination Third party monitoring by the Pa. Dept. of Agriculture Program elements – rodent control, remedying positive houses,optional vaccination for SE, egg holding and processing requirements, testing PEQAP symbol for successful audit By 2002 85% of egg production PEQAP Program started in 1994 Results – 1992 SE positive product 23% vs. 2003 1.8% Flocks – 1992 38% positive vs 2003 4.4%

17. CALIFORNIA DAIRY QUALITY ASSURANCE PROGRAM (CDQAP) Three components – Food Safety, Environmental, Animal Welfare Environmental component fully operational with third party audits Food safety course ready for implementation “Food Safety and Emergency Preparedness” with focus on bio-terrorism Use of third-party audit for Food Safety under discussion

18. FRESH PRODUCE AUDIT VERIFICATION PROGRAM GAP/GHP –Good Agricultural Practices/Good Handling Practices Based on: Guide to Minimize Microbial Food Safety Hazards for Fresh Fruits and Vegetables Voluntary independent third-party audit by F/SIS Auditors are licensed fresh fruit and vegetable inspectors Passing audit results are posted on USDA website Results are valid for one year USDA Certificate (suitable for framing) Program has been in place for 2 years No plans for metrics

19. QUALIFIED THROUGH VERIFICATION (QTV) FOR MINIMALLY PROCESSED PRODUCE Based on AMS QTV manual Voluntary independent audits by AMS Facility develops QTV plan + 30 day trial AMS starts audit after plan trial successful Audit levels IV to I; frequency range – 2/mo to 1/3 mo Avg. audit cost - $1200; range - $400 to 1800 USDA shield with QTV in center band on passing Website designating participants in development Pilot of project started in 1996 Informal internal metrics

20. MINNESOTA CERTIFIED PORK(MNCEP) Pilot program covering five herds; part of wider Mn. Certified Production program Based on MNCEP Quality Handbook (ISO 9000 basis) Components: Best production procedures; Pre-harvest food safety; Environmental stewardship; Animal welfare; Recording and Documentation (SOP’s) Internal monthly audit by DVM/ Annual Handbook compliance audit by MN. Dept of Ag. Processing by Swift; sold to upscale grocery chain Salmonella levels reduced form 8.7% to essentially 0 Not successful because: competition from case ready goods consumer would not pay premium for guarantees quality inconsistent because herds not genetically identical

21. WHY THIRD PARTY AUDITS FOR FOOD SAFETY? An alternative to “Command and Control” Limited USDA resources – infrequent inspections Volunteer sites means USDA can focus on “bad facilities 3rd Party provides benchmark for best practices Regulatory/litigation relief in case of an incident Opportunity for Community goodwill via transparency Potential for lower insurance premiums

22. Questions for discussion Are there additional opportunities in food safety for third parties? Could these opportunities benefit the movement to product differentiation? Can insurers play an important role as third party certifiers in food safety in conjunction with USDA?

23. REFERENCES Collins, L. et al. The Insurance Industry as a Qualified Third Party Auditor.Professional Safety, April 2002, 31-38 Jin, G. and Leslie, P., The Effect of Information on Product Quality: Evidence from Restaurant Hygiene Grade Cards. The Journal of Economics, May 2003, 409-451 Kunreuther,H., McNulty,P. and Kang,Y. Third Party Inspection as an Alternative to Command and Control Regulation. Risk Analysis, Vol. 2, 2002, 309-318 Kunreuther, H., Metzenbaum, S., Schmeidler, P., Private Inspections and Mandatory Insurance for Managing Safety and Environmental Risks, Leveraging the Private Sector : Management-Based Strategies for Improving Environmental Performance(Cary Coglianese and Jennifer Nash, editors), forthcoming in RFF Press