Transforming premiums into profits
Let's begin with the following scenario: a 30-acre site with 2,900 potentially responsible parties (PRPs), and an insolvent owner. This scenario, unfortunately, is real, and is Maine's largest Superfund site. The Portland-Bangor Waste Oil Site in Wells, Maine, was an oil recycling operation that used land disposal to discard oil and tank bottom sludges.
The remediation at this site will be performed by TRC Companies, an engineering and construction firm based in Windsor, Conn. TRC combined its own expertise with cost cap insurance, setting the stage for remediation to begin.
Consenting to risk
We talked with Michael Salmon, TRC's senior vice president. The corporation signed a consent decree with the state of Maine substituting itself for the PRPs. Each PRP was then provided with an opportunity to resolve its financial obligations to TRC. Many PRPs have already paid TRC a pre-determined fixed amount, absolving themselves from any further liability. PRPs who refuse to settle will be pursued by TRC until they contribute equitably to the cleanup.
Why was TRC confident enough to do all of this? First, it employed sophisticated cost modeling, and called on its extensive experience with similar projects. Second, TRC purchased cost cap insurance from American International Group (AIG). Cost cap insurance covers cleanup costs that exceed the price agreed to by the remediation firm. The risk of additional costs is shifted to an insurer, in this case AIG. Salmon emphasizes that TRC proceeded only after it eliminated uninsured risk. However, according to Salmon, TRC has no intention of using the insurance policy. Doing so would mean that insurance on the next project would be more expensive, or unavailable.
AIG's financial strength provided the comfort zone nervous PRPs required. With AIG on board, PRPs that decided to settle knew that their financial obligations at the site had ended.
Insuring against uncertainty
Uncertainty is one of the main reasons so many brownfields - abandoned industrial sites stigmatized by real or perceived contamination - continue to languish. The uncertainty most often concerns money. How much money will it take to satisfy regulators? Can the job be completed for the price quoted?
We spoke with Joe Boren, president of AIG's environmental division. He described the certainty cost cap insurance offers. "Remediation always involves risk. One risk is that cleanup costs will be higher than anticipated," Boren said.
Who, then, will shoulder this risk? Owners don't want to assume this risk, and often try to transfer it to the remediation firm. And, of course, remediation firms frequently either can't or won't accept this risk.
One solution is to transfer the risk to a third party - an insurance company in the business with the financial resources to accept the risk. AIG is an AAA-rated carrier. PRPs know that AIG has the financial resources to fund cost overruns. "Our cost cap product builds a high wall around the insured," Boren said.
Cost cap coverage provides more than theoretical protection. Historically, more than half of cleanups have gone over budget. There are various ways to handle the risk of cost overruns. Many AIG clients want liability wrapped in insurance, immediately. Experience has taught them that news of uninsured exposure will be poorly received.
Eliminating large escrow accounts
Many brownfield buyers require escrow accounts to cover the seller's cleanup obligations. Escrow accounts ensure that funds are readily available to discharge obligations incurred by the seller. Many sellers would prefer to invest in a cap insurance product rather than tie up their money in escrow. Cost cap insurance often helps sellers gain immediate access to funds.
Tax benefits
Remember, premiums can be deducted from income in the year they are paid. So, a company in the 40 percent tax bracket ends up paying only 60 percent in after-tax dollars for the remediation. At the Wells site, TRC tried to maximize tax benefits by opening an escrow account on Dec. 28 and leaving it open into the next year. That way, the PRPs could take the deduction in the year it would be more useful.
Return on risk
Salmon mentioned that TRC's profit at the Portland-Bangor site will be higher than average if risk is managed well. If risk is not managed well, the profit margin will be the same as at the company's other remediation projects. So, through the use of cost cap insurance, TRC may be able to increase its profit margin without any additional risk. At the same time, hundreds of PRPs have been freed from burdensome negotiations and may run their business, instead of being tied up in litigation. And, the brownfield is returned to productive use.
Lessons learned
- Cost cap insurance transfers the risk of remediation cost overruns to an insurance company.
- This type of insurance can eliminate the need for large escrow accounts.
- Well-managed risk can increase a company's profit margin.
This article originally appeared in the November, 1999 issue of Environmental Protection magazine, Vol. 10, Number 11, p. 47.
This article originally appeared in the 11/01/1999 issue of Environmental Protection.