Toolbox basics: Environmental insurance

• By Shishir Mohan
• Jun 01, 2000

In the past 12 years, since specific coverage for environmental loss was introduced in the insurance marketplace, the lines and types of coverage offered have diversified tremendously. Essentially, environmental insurance is now offered for five different practice or exposure types:

• Contractor's liability;

• Site operator's liability;

• Errors and omissions (E&O) for engineers and project managers;

• Lender's liability; and

• Real estate pollution liability and stop loss or cost cap supporting real estate.

Policies in each coverage area are at least partially customized to apply specifically to the insured parties by individual insurance companies, although the contractor's liability (CPL), site operator's (EIL) and E&O forms are more likely to follow the forms of their standard line counterparts. As a result, the CPL, EIL and E&O forms are more easily understood and various companies' policies can be compared. On the other hand, forms supporting real estate transactions vary widely and must be carefully read and analyzed to verify content and coverage.

Real estate policy diversity

Real estate-related policies have seen the most development — broadening of coverage, longer terms, more cost effective premiums — over the past eight years. These policies are being used in an ever-increasing variety of transactions. Given the material differences between the many real estate-related policy forms, both in language and coverage, it is critical that the form presented be scrutinized carefully to determine that policy language is clear and necessary coverage afforded.

Real estate-related policies can be structured either as separate policies — one as a liability policy and one as cost cap — or they can be merged into a single form. Cost cap is used only when there are known remediation costs to be covered.

Understanding the nature of risk

In order to understand these coverages and analyze a policy or policies it is necessary to understand the risks to which an owner or operator of the property might be exposed.

Remediation based risk. If site contamination exists, the owner/operator will potentially bear the cost of cleanup (at the insured site or other sites impacted by the insured site), including site investigation and assessment, legal fees and regulatory compliance consultant fees. Even if extensive site investigation has already been performed, quantification of environmental liability is still speculative. It is certainly not uncommon, particularly in litigation, to see widely varying estimates of remediation costs. If anything, the shifts in regulatory perspectives and statutes have caused remediation estimates to fluctuate more widely, with one party arguing that the site can be closed without cleanup by performing a health risk assessment and the other party asserting that a full cleanup, including groundwater, must be performed.

Property value impairment risks. If site contamination exists, the owner/operator will potentially bear the costs of lawsuits stemming from reduced value of neighboring properties and nuisance caused damages. The owner/operator's site may also be reduced in value.

Business risks. If unanticipated clean up is required, the business of the owner/operator (including tenants) or neighbors may be interrupted.

Personal injury risks. If site contamination exists, the owner/operator will potentially bear the costs of lawsuits stemming from bodily injury caused by contamination existing on-site or migrating off-site.

Types of coverage

Stop loss or cost cap coverage is issued to the owner, operator or other insurable interests such as lenders and other capital interests associated with the property. Stop loss policies provide a guarantee of the proposed costs of the remediation project. Even when combined in a single form, this particular coverage part is not a liability-type coverage but simply a cost overrun protection.

Given the material differences between the many real estate-related policy forms, both in language and coverage, it is critical that the form presented be scrutinized carefully to determine that policy language is clear and necessary coverage afforded.

Real estate pollution liability coverage is issued to the owner, seller, lender or other insurable interests in the property and can also be structured to provide automatic coverage for future owners and lenders. Real estate pollution policies vary widely, but coverage can include:

• Costs for the cleanup of previously unknown conditions that are discovered after the policy inception date including those discovered during the course of conducting remediation;

• Additional cleanup costs arising from a known condition after the site has received some form of no-action determination (e.g., a "no further action" letter from a regulatory agency, a health-risk assessment showing no need for remedial action or a determination by the underwriter that no action is required at this time); and

• Costs from unanticipated third party claims for cleanup, bodily injury, business interruption and/or property damage due to known or unknown contamination originating at the insured site or a scheduled off-site location such as a disposal site.

Special accommodations

With these improved insurance tools available and spurred on by a strong real estate market, transactions involving contaminated property have soared. Environmental insurance has been structured in many different ways to accommodate the needs of ongoing owners, buyers, sellers and other financial interests, including lenders.

Seller indemnification. There are many situations in which an entity selling environmentally impaired real estate may not have sufficient financial strength to offer a prospective buyer an acceptable indemnification in which the entity agrees to compensate the buyer for any future environmental expenses arising from the subject property. In many cases new corporate directives and an increasing awareness of the balance sheet implications of indemnities have made companies less willing to offer indemnification. A seller can now purchase environmental insurance in lieu of an indemnification or as a backstop to their indemnity.

Buyer indemnification. Whether one of the new "restoration companies" (companies that focus on the acquisition and redevelopment of contaminated property as a primary business objective) or a more traditional real estate development company, it is not uncommon to see the buyer indemnify the seller for environmental impairment given an appropriate consideration in purchase price. Few of these buyers have either sufficient balance sheet strength or the desire to take on the potential environment liability associated with the property. In these cases, the buyer purchases environmental insurance, negotiates coverage with the seller and the insurer, and names the seller as an insured.

Insurance has been structured to cover single site purchases and portfolio acquisitions. Each site can be covered by single policies. Blanket policies can also be structured to cover multiple locations under a single policy. The blanket policy approach has offered cost efficiencies in acquisitions where the overall value of the properties to be purchased does not support more expensive single site policies.

Property refinancing. As lenders more frequently require that borrowers indemnify the lender for any environmental damage arising from a property securing a loan, owners have turned to environmental insurance again, in lieu or as a back stop to their indemnification.

Litigation settlement. By capping the estimated cost of remediation and transferring future costs of potential liability to the insurer, litigants have been able to settle cases where the argument over cost allocation has gone on for years. Some of these settlements, supported by environmental insurance, have involved large groups of potentially responsible parties (PRPs) in actions under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), commonly known as Superfund, where cost allocations have been agreed to as a part of the insuring process. Finite costs (e.g. the remediation cost estimate) have been made a part of the insurance policy and all future environmental liability expense, up to the policy limits, are paid by the insurer on behalf of the PRP group. In some instances, the insurer may actually assume responsibility to manage the cleanup for the PRPs.

Securitization. A common practice is secruitization, which means collaterilizing a portfolio of real estate assets that are to be sold. Traditionally, when a portfolio is securitised, environmental due diligence must be performed on each asset. This is a time consuming and expensive process. If a property has been in the portfolio for a number of years, terms regarding that property may not allow access for new or additional site investigation. Depending on the property types included, portfolios can be insured under a spreading of risk concept that allows for limited due diligence using existing reports and database surveys.

Environmental real estate insurance is being used in a variety of new ways, with new applications arriving monthly. Underlying the growth of this new market is increased confidence that these policies provide coverage and will pay claims when the need arises.

E-sources

U.S. Environmental Protection Agency's brownfield Web site — www.epa.gov/swerosps/bf/new.htm

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This article appeared in the June 2000 issue of Environmental Protection magazine, Vol. 11, No. 6, p. 48.

This article originally appeared in the 06/01/2000 issue of Environmental Protection.