Dispelling the myth
Remediation stop loss (RSL) insurance is an innovative risk management solution available to site owners and consultants. Also known as cleanup cost cap coverage, RSL insurance is designed to cover cost overruns on remediation projects above an attachment point or self-insured retention (SIR). RSL insurance is a novel tool for mitigating the inherent uncertainties associated with environmental remediation projects on a wide variety of sites. Creatively applied, these programs bring another solution to the table when site owners and consultants face uncertainty.
RSL insurance, however, is neither a panacea nor a cure-all for mitigating the risk in remediation projects. The use of this product is not widespread, although a number of high profile properties have utilized this insurance as part of a custom risk management solution. In practice, RSL programs are the exception rather than the rule, with unique circumstances usually dictating the placement of this coverage.
A shift in remediation management
The advent of voluntary cleanup programs and brownfield initiatives, along with a strong economy, has dramatically increased the remediation and redevelopment of contaminated property. Site owners and developers are driving a revitalization of the environmental services market by conducting cleanups to resolve owned liabilities or to capitalize on risky but lucrative environmental arbitrage opportunities. But along with these new opportunities have come heightened expectations of risk assumption and a paradigm shift in the way remediation projects are managed. Contractors and consultants are often faced with fixed cost bid requests in a competitive environment. These contracts may require the contractor to directly assume various uncertainties associated with a remediation project.
On the surface, the allocation of monies to include RSL insurance in most cleanup scenarios would appear to be a prudent business decision. This misconception has been perpetuated by extensive marketing efforts praising its use as a safety net. But a closer look at the concept of RSL and an understanding of the variations in risk assumption reveals that RSL insurance has specific and unique applications.
Combining risk transfer and risk sharing
RSL insurance is not designed to be a complete risk transfer mechanism. Rather, it is a combination of risk transfer and risk sharing mechanisms. This distinction is important, as a fundamental "moral hazard" would result if an insurance carrier assumed all of the adverse financial risk associated with a cleanup. What is the incentive for a contractor or landowner not to low-ball a cleanup estimate or control costs if an insurance carrier is willing to foot the bill for overruns? Insurance carriers consider and mitigate this hazard through two mechanisms:
- Diligent underwriting to qualify the site characterization and cost estimates; and
- Inclusion of an SIR or co-insurance requirements.
By ensuring that these underwriting parameters are met, the insurance carrier removes the incentive for an unjustified loss scenario by having the insured financially participate in, or share, the loss.
RSL coverage structure
RSL insurance programs are structured so that coverage is triggered when remediation costs exceed the SIR, which is comprised of the anticipated cleanup costs and a buffer layer. The SIR and buffer layer component is generally a function of a derived confidence level in the cost estimates. With this underwriting dynamic in mind, it becomes clear that a less expensive cleanup provides a smaller margin of error. In simplified terms, a small remediation project insured with an RSL program includes a smaller SIR, which results in an increased likelihood of loss.
As a general rule, when an insurance company assumes more risk it commands a higher rate or insurance premium. A small remediation project may not have the required economy of scale and cost to insure the project's worth could be potentially greater than the amount of the most probable loss. An insurance broker with expertise in placing RSL programs can assist in producing a preliminary cost/benefit analysis and determining if the project is worthwhile to consider for coverage.
Beneficial applications of RSL coverage
Outlined below are scenarios where RSL insurance programs may provide a distinct benefit.
Fixed fee contracts. A request for proposal (RFP) for the remediation of a site recently acquired by a municipality includes contract specifications for job completion based on a fix fee. Unwilling or unable to place reserves for the entire risk on its own balance sheet, the consultant seeks an alternative means to satisfy the bid requirements. By securing RSL insurance as part of its bid package, the consultant can fulfill the fixed bid specifications (by transferring adverse risk to a financially secure insurance carrier) without exposing the company to catastrophic financial risk.
One time settlements. A non-profit organization with limited capital resources receives a contaminated parcel of land as a gift and plans to remediate for future use as a nursing home. Since budget allocations are only granted once a year with oversight from a board of directors, remediation cost overruns cannot be met and will jeopardize the success of the project. By including RSL with coverage for other unknowns in the project, the non-profit can quantify worst case scenarios and receive appropriate funding to guarantee the successful completion of the project.
Property transactions with existing conditions requiring remediation may be sold "as is" to a buyer with an allowance for estimated cleanup costs. Naturally, cost estimates prepared separately for the buyer and seller may vary widely as part of negotiating an agreed price. An RSL insurance program can help balance these disparate interests and remove the friction from the transaction. The insurance may also eliminate the need for any other indemnities between the parties in the purchase and sale agreement.
Exit strategy. A modestly-sized commercial developer is purchasing a former munitions site from a Fortune 500 corporation. In an effort to expedite the transaction, the developer has accepted a one-time cash settlement in return for assumption of the remediation liability that will incorporate the remedy into future development plans. Aware of the liability hierarchy for previous site owners, the corporation is concerned that the developer could become insolvent and the site could revert back for cleanup. By using a RSL program backed with the superior financial security of an AA+ insurance carrier, the corporation is assured that the developer can meet its obligations.
Balance sheet relief. A publicly-held company owns multiple sites with known environmental contamination resulting from historical manufacturing operations. As a note to its annual report, the company must disclose reserves allocated for remediation of the uncapped environmental liabilities as a factor that might impact company performance. By employing an RSL insurance program, the company has put a financial cap on these liabilities that may result in more favorable treatment of these reserves. As always, experts in accounting and tax law should be consulted.
Critical factors for success
When evaluating the risk involved in an RSL program, the insurance carrier will perform detailed analysis of site characterization, qualification of the remedial action plan and associated costs. Insurance carriers are also keenly interested in the motivation for acquiring an RSL insurance program. Site owners and consultants should be aware of the following key factors for success:
- Remediation stop loss insurance programs are tied directly to an established scope of work necessary to complete the contemplated remedy. A complete submission to the insurance carrier should include previous site characterization data and a detailed scope of work with cost breakdown by each remediation activity;
- Quoting from preliminary or speculative cost estimates is generally inappropriate. Insurance carriers usually rely upon final approved remedial action plans with detailed cost estimates. A near final draft plan may be utilized with some confidence, however;
- The first item an insurance underwriter will look for when evaluating a site for RSL coverage is an adequate site characterization. Often a site owner may request an indication of the cost of an RSL program on a site where impacts exist but the extent of contamination has not been completely delineated. Since RSL coverage is tied directly to cost overruns which might result from inaccurate volume estimates, the complete delineation of contaminates is required; and
- Allow sufficient lead time for the quotation process. Thirty to 60 days, or more, may be required to evaluate complex sites. The underwriting of RSL insurance programs requires the investment of considerable time and expense by the insurance carrier. Potential buyers should be selective when considering insurance carriers as partners in order to assure that their submission and project receives priority.
RSL insurance programs are a valuable tool for addressing uncertainties associated with environmental remediation projects. An understanding of how these programs function can help consumers make informed decisions about when an RSL program is appropriate for their projects. Consulting with an insurance broker with expertise in placing RSL programs is recommended to determine if the coverage is worthwhile for you.
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This article appeared in the June 2000 issue of Environmental Protection magazine, Vol. 11, No. 6, p. 53.
This article originally appeared in the 06/01/2000 issue of Environmental Protection.