Controlling Environmental Liabilities

• By Ellen Moyer
• Mar 01, 2001

In the past decade there has been a shift in emphasis from the traditional, costly cleanup approach for environmentally-impaired assets to a more managed, proactive approach to controlling the liability. The fact that these environmental liabilities impact a firm's financial balance sheet, as well as the negative impact they have on the firm's perceived "good will," has catapulted these issues to the top of the business agenda for many firms. In order to better control these liabilities, strategies have evolved to proactively assess and manage the risk - thereby allowing for more cost-effective, technically feasible solutions - without sacrificing the health and welfare of the public and the environment.

Although most environmental exposures can be readily identified, the potential losses as a result of an environmentally-related occurrence are very difficult to quantify. We are surrounded by a multitude of potential environmental concerns: transportation and storage of hazardous materials, industrial processes that give rise to air quality and wastewater issues and the "brownfield" issue, just to name a few. With all of these exposures, it is prudent to look for a methodology to manage these potential losses. This is especially important in that many environmental concerns are either unseen (i.e., subsurface) or can be catastrophic (i.e., tank failures). Obvious benefits to managing environmental liabilities include:

• Protection of human health and safety,
• Environmental protection,
• Regulatory compliance,
• Financial control and
• Preserving corporate image/goodwill.

Overview of Risk Management

In general, experience has shown that a structured, planned approach to managing incidents is one of the most successful ways to control liabilities. The risk management process provides a framework for managing environmental liabilities. It is composed of the identification, quantification and ultimate treatment of loss exposures. Two of the primary objectives of risk management are to control losses and to minimize the financial impacts resulting from the loss. There are several strategies that can be used singularly or in combination that enable the Risk Manager to accomplish these objectives. The purpose here is to outline these strategies as they pertain to the control of environmental liabilities or losses.

Risk management is composed of the identifications, quantifications and ultimate treatment of loss exposures.

Risk Assessment Process

Understanding the nature of hazard is paramount to being able to effectively manage the risk associated with that hazard, as well as any potential impacts that result from the occurrence. The process of identifying, analyzing and measuring exposure to risk is known as risk assessment. And as exposures are dynamic in nature, the process is an ongoing one.

Due diligence surveys, such as environmental site assessments, property condition surveys and compliance audits are examples of risk assessments that are typically performed prior to a property transfer, and are used to evaluate the environmental and physical conditions of the subject property. The main purpose of these surveys is to uncover any potential problems or issues that will negatively impact the value of the property, thereby providing a baseline and assisting in managing the business risk associated with the transfer and/or operation of the property or facility.

Screening Process Based on Expected Negative Outcomes

First, perform a qualitative screening and if the risk exceeds a given set of predetermined parameters, then a quantitative evaluation should be done. For this, the evaluator must first determine an established set of measurable criteria or factors that are most likely to contribute to a loss. There must also be a set of standards or threshold values, such as regulatory concentration limits or other values, against which the measured data is to be compared.

In order for the risk assessment process to be effective, it is important to identify the factors that are most likely to contribute to a loss. For instance, a fleet manager may track a variety of specific factors such as travel routes, weather, materials transported, time and day of the week that an accident occurs, driver, etc. Although all of these factors can play a role in any given loss, some are more key than others, and therefore will be the focal point of future control efforts. Using general statistical methods can help to identify areas with potentially high exposures. Parameters such as hazard rating, probability of occurrence, vulnerability of the asset and severity of the incident, may be used to help quantify and prioritize - hence manage - potential liabilities.

Risk Control Process Overview

Although we cannot predict the actual timing of many events, we can make reasonable assumptions regarding their likelihood of occurring and can take steps to reduce, or even eliminate that specific occurrence. Once the risk/hazard has been identified and quantified, the next step is to identify appropriate strategies for treating or controlling the risk. Risk control is the term given to a collection of risk management tools or strategies whose purpose is to eliminate or reduce the frequency, severity or uncertainty of losses. Based on the information obtained during the risk assessment phase, one or more treatment strategies will be implemented.

Risk Control Strategies

Avoidance

Avoidance is a pre-loss type risk control strategy that essentially eliminates the chance for the loss to happen by electing not to accept the exposure in the first place. It is the only risk control strategy that completely eliminates the exposure that is attributed to the specific hazard. However, by avoiding an exposure due to a specific hazard, we may be accepting a different risk from a completely different hazard. For example, by choosing not to install underground storage tanks (UST) for fuel storage, hence avoiding the regulatory and environmental concerns associated with UST systems, you inherently accept the potential exposures associated with the alternatives such as: concerns about surface spills from aboveground storage tanks (AST), or business exposures associated with outsourcing a critical part of your business operation (i.e., fueling) to a third-party.

Note that selecting an avoidance strategy is not always desirable, or even feasible, as there are "opportunity costs" associated with doing nothing. Ultimately we do have to choose a course of action if we are to meet typical business objectives such as increased growth, profits and shareholders' equity.

Loss prevention (Pre loss)

Another pre-loss risk control strategy is loss prevention. Generally, we are given to accepting some degree of risk associated within our business in order to achieve our business objectives. Although we have accepted the exposure and the probability of its outcome, we can take steps to eliminate or prevent the occurrence from happening. Preventing losses is almost always less expensive than paying for losses once they have occurred. Loss prevention is a proactive strategy that focuses on reducing the frequency or probability of occurrence. From an environmental standpoint, regulatory programs such as pollution prevention and waste minimization are examples of loss prevention strategies. Mitigation refers to those activities that eliminate or reduce the chance of an occurrence or the effects of a disaster.

Loss prevention strategies can be grouped into two broad categories: administrative and engineering. The administrative approach focuses on procedural issues. Written plans and work standard operating procedures (SOPs) such as spill prevention plans (SPCCs), asbestos operating & maintenance (O & M) plans, site health and safety plans and material safety data sheets (MSDSs) /labeling, are examples of administrative or procedural control measures. Training, education and drills are procedural control measures as well.

Parameters such as hazard rating, probability of occurrence, vulnerability of the asset and severity of the incident may be used to help quantify and prioritize - hence manage - potential liabilities.

The engineering approach focuses on processes and attempts to eliminate unsafe conditions. Wet methods and containment for asbestos removal are examples of this approach. Another example is using different size/types of couplings for the loading connections for storage tanks holding incompatible materials. Substitution, a process-type engineering control strategy can also be used. In substitution, we use a less hazardous alternative to prevent or eliminate the exposure. An example is the replacement of perchloroethylene used in many dry cleaning processes with a less hazardous chemical.

Loss reduction (Post loss)

As many risks cannot be fully prevented, a strategy for loss reduction must be considered. Loss reduction involves activities that occur after a loss, which are used to reduce the impact or severity of the loss. Emergency response actions such as fire fighting and spill plans - facility response and contingency plans - are common examples of loss reduction strategies. Although loss reduction is primarily viewed as a post-loss ("after the fact") action designed to reduce the impact of the occurrence, there is also a proactive element. The strategy must be defined during the planning and preparedness phase of the emergency management program. The personnel must be trained, and the strategy tested through exercises and drills.

A special variety of a loss reduction strategy is that of separation / segregation. In this strategy, the exposed assets are divided or separated from each other in order to prevent all of the assets from being affected by an incident. Note that this approach does not prevent or reduce the severity of any single occurrence, but does limit the total loss of all of the specific asset. Such an approach is used in many high risk situations, such as the manufacturing of explosives.

Risk transfer

Not all risk control strategies are physical in nature. Risk transfer is a strategy that focuses on the management of the uncertainty associated with the exposure, typically by assigning all or part of this uncertainty to another party. In this strategy, we can elect one of several options:

• retention of all or part of the uncertainty;
• non-insurance transfer of the exposure;
• non-insurance transfer of the financial impact; and/or
• insurance (financial retribution).

For some exposures we elect to accept, or retain, all or some of the potential for loss. A common example of this is "self-insurance." The decision to retain all or part of the potential loss is a function of many factors such as the probability of loss, the ability to pay for a given loss, the unavailability of affordable insurance, etc.

In non-insurance transference, the loss exposure is accepted by another party. This may be through the sale of the asset with that exposure, or by outsourcing the specific hazardous process. Note that this is not the same as avoidance because the exposure still exists and is just transferred to another party.

Another form of non-insurance transference is to transfer the financial consequence of the loss exposure to a third party who is not an insurance company. In essence, the third party agrees to pay for the damages associated with that result from the occurrence. These transfer strategies are contractual and are not related to insurance in the tradition sense.

Insurance is another form of transference of a loss exposure, this time to an insurance company that agrees to pay for the financial impact that results from the occurrence within the obligations in the terms of the insurance contract.

Closing

Once a strategy or combination of strategies has been implemented, the program must be monitored to ensure that the selected strategies are meeting the original objectives of the program and as most exposures are dynamic in nature, to ensure that it is still applicable.

Environmental conditions, like business conditions, are dynamic and must be evaluated on a regular basis. This starts the cycle of assessment- selection- implementation-monitoring again and provides an added measure of control for your environmental exposures.

e-sources

Risk and Insurance Management Society - www.rims.org

U.S. Environmental Protection Agency Office of Prevention, Pesticides and Toxic Substances - www.epa.gov/internet/oppts

U.S. Environmental Protection Agency Office of Solid Waste--Waste Minimization Resources and Links - www.epa.gov/epaoswer/hazwaste/minimize/

This article appeared in the March 2001 issue of Environmental Protection, Vol. 12, No. 3, on page 88.

This article originally appeared in the 03/01/2001 issue of Environmental Protection.