Environmental Time Bomb
The cost of failing to safeguard a vacant building against environmental risks such as mold and Legionella can run into multimillions of dollars.
And with tens of thousands of vacant and abandoned office buildings, hotels and other properties across the United States, according to federal government estimates, experts believe a growing list of serious health hazards is a time bomb just waiting to explode.
But that’s only the tip of the iceberg. The biggest emerging threat on the horizon is the sudden proliferation of crystal methamphetamine production laboratories in empty urban buildings, fueled by an industry believed to be worth almost $30 billion globally.
“Environmental risk has traditionally been viewed as an area with low frequency/high severity impact; however, due to more stringent environmental regulations and our increasingly litigious society, frequency of claims are on the rise.”– John Wasilchuk, account executive for commercial insurance, Lockton
Environmental risk, as a whole, is big business in the United States, with a market of more than 40 insurers estimated to be worth $1 billion to $3 billion, which is set to grow exponentially over the next decade as a result of a surge in demand.
Vacant Building Problems
The difficulty mainly stems from a sharp rise in buildings that have become vacant as a result of tenants being unable to pay their leases, or hotels partially shutting down during the off-season to save on running costs.
Veronica Benzinger, chief broking officer at Aon Risk Solutions Environmental Services Group, said the problem is exacerbated by increased vandalism, fire, and theft, as well as squatters and the general dilapidation of the building resulting from a lack of care and attention.
“A lack of basic supervision, security and maintenance can contribute to the building quickly falling into disrepair and becoming uninhabitable,” she said.
Mold: The “No. 1” issue
Despite all of those issues, the No. 1 problem with vacant buildings remains mold, according to Richard Sheldon, environmental practice leader at Willis North America.
Once it finds the right conditions, he said, mold rapidly multiplies and spreads within 72 hours.
“The scale of the problem can be anywhere from a simple and relatively inexpensive remediation process to full scale clean-ups running into the tens of millions of dollars, when you factor in business interruption,” Sheldon said.
Benzinger said the worst form of growth is Stachybotrys Chartarum, known as black or toxic mold. It produces toxic compounds called myotoxins, which when released into the air are harmful when they come into contact with humans.
Although mold can affect all buildings, she said, it’s often worse in more modern properties where the air flow is restricted, creating greater potential for them to become breeding grounds for mold.
“The biggest problem is water intrusion,” she said. “Once that happens, mold can grow and proliferate throughout the building.
“Mold can affect any building, but it’s often worse in new buildings. All it needs to grow is the right temperature, moisture and food.”
Susan Doering, vice president and director of Tokio Marine Specialty Environmental, said: “The bottom line is that vacant buildings are prime real estate for mold growth — which can lead to loss of property value, potential harm to new inhabitants, and costs incurred to mitigate the problem.
Construction projects that are restarted after a period of dormancy can also face issues related to damaged building materials that were exposed to the elements while the project was abandoned.
“The most common issue faced in this scenario is damp building materials that will be enclosed in the building envelope, creating an environment that is perfect for mold growth,” Doering said.
Spread of Legionella
Letting a building fall into disrepair carries with it a multitude of health risks, including the Legionella bacteria, which causes Legionnaire’s disease. The bacteria can quickly develop and spread through the building’s heating, ventilation and air conditioning systems (HVAC) if they are poorly maintained, Benzinger said.
This is prevalent in hotels that close down some of their units in the winter months, she said.
“It’s particularly common in artificial water systems, fire sprinkler systems, and hot and cold water systems because the bacteria can survive at relatively low temperatures,” Benzinger said.
“So unless the system is properly maintained, when the next person moves in and they turn on the taps again, they can get a nasty shock.”
Or worse. If the bacteria makes contact with humans, it can become a potentially fatal form of pneumonia.
Sheldon of Willis said that, as a result of the potential threat it carries, Legionella has become one of the key areas of cover in environmental liability insurance in recent years.
“The issue has been around for quite some time now, but it hasn’t necessarily been covered in standard policies previously and has only really come to light recently, which goes to show that the level of concern about it has heightened,” he said.
“We have seen some big losses in the U.S. in the last couple of years, particularly in the hotel and hospitality trade, due to the spread of Legionella, which have resulted in payments of $10 million and upwards.”
Sheldon said the costs aren’t limited to the clean-up operation either.
He’s also seen some substantial bodily injury claims due to exposure to Legionella, which have resulted in large settlements being paid.
“Our estimates are that some of these losses are in the multimillion range,” he said.
Crystal Meth Production
Another fast growing problem, said Benzinger, is the proliferation of methamphetamine laboratories, where the drug can be quickly and cheaply manufactured using toxic substances such as drain cleaner and paint thinner.
Video: The illegal production of meth contaminates properties with hazardous chemicals and creates a strong risk of fire or explosion.
“These hazardous toxins can quickly spread to and contaminate the adjoining properties, putting the health of residents at risk as the fumes permeate into shared amenities such as air conditioning systems and are inhaled,” she said.
“Ultimately, it can kill your brain cells and also damage your lungs and other vital organs.”
Sheldon said the clean-up costs of the residual toxins produced by methamphetamine labs can be “catastrophic,” depending on the quantity and type of materials used in its production.
“It has to be handled very carefully and generally involves a full blown hazardous waste disposal team to handle the materials involved properly and safely,” he said.
On the whole, these types of environmental risks — and the litigation defense costs associated with them — are excluded from most general liability or property insurance policies, leaving property owners to defend themselves against lawsuits arising from the threat of contamination.
But, Sheldon said, there are tailored policies available that allow building owners to manage these risks while protecting their main assets.
“There are insurance policies available that extend beyond the traditional general liability cover and will provide you with a high level of cover for mold and Legionella clean-up, as well as the remediation of methamphetamine labs and their contents,” he said.
A number of industry organizations have launched new practices in recent years to provide cover for vacant and distressed properties, in response to this growing list of environmental problems.
With many abandoned buildings in inner cities being demolished and removed, contractors’ pollution liability insurance policies are also being put in place to protect workers against pollution claims brought against them, with cover limits starting from $500,000 and rising to more than $50 million.
Site pollution or pollution legal liability has also become more readily available, providing property owners with protection against third- and first-party claims — including defense costs — resulting from pollution conditions.
Variations of this policy include secured creditor environmental insurance and lender liability, which cover financial institutions and borrowers throughout the buying and selling process.
Risk Strategies Needed
Tokio Marine’s Doering said good property management is key to avoiding the build-up of mold and Legionella in the first place. HVAC systems need to be kept at a moderate temperature, and regular surveys to check for leaks, musty odors or mold growth should be carried out.
She added that water systems should also be flushed regularly and drained when not in use to reduce the likelihood of Legionella spreading.
John Wasilchuk, account executive for commercial insurance at Lockton, said having a sound environmental risk management strategy is paramount, particularly in the hospitality industry, where a clearly defined water management plan and a comprehensive pollution prevention plan are essential.
“Environmental risk has traditionally been viewed as an area with low frequency/high severity impact; however, due to more stringent environmental regulations and our increasingly litigious society, frequency of claims are on the rise,” he said.
Therefore it’s fundamental for businesses to have an effective strategy in place to mitigate against those risks and to make sure they are covered should the worst happen.
Challenges and Opportunities
Competition in the excess and surplus (E&S) lines market has become increasingly fierce over the last 12 months, driven by new entrants and greater capacity.
Berkshire Hathaway Specialty Insurance (BHSI) has already staked its claim, capturing a generous slice of market share during its first year in the business, which has resulted in a squeeze on prices and a wider availability of programs.
However, despite the increased competition, there are still significant growth opportunities for those companies willing to take on the risk, particularly in the professional liability market, most notably directors’ and officers’ (D&O) and cyber liability, according to experts.
“Generally capacity is plentiful, but pricing varies between different lines of business,” said David Bresnahan, executive vice president at BHSI.
“Pricing in the property market, for example, is negative, however health care and D&O are flat, and casualty is still rate positive.”
In its 40th anniversary year, the National Association of Professional Surplus Lines Offices (NAPSLO) will have several issues to keep top of mind at the organization’s annual convention in Atlanta in September.
Overall, the E&S market continued to grow in the first quarter of 2014, with more than half of the top 30 companies by market share reporting double-digit increases in premiums written year-on-year, according to SNL Financial.
However, as a segment, experts said, the market remains increasingly competitive as insurers fight for better rates in a soft market, driven by greater capacity and firms’ deployment of capital.
Such has been the squeeze on prices, said Wyeth Coburn, associate broker at CRC Insurance Services, that E&S carriers are being forced to compete for business with the traditional insurance market.
“Added to that,” he said, “is the strength of capital in the traditional market right now, which has resulted in many of those carriers moving into areas that were historically surplus lines’ territory.”
The E&S market, traditionally a bellwether for the wider insurance market, is big business — worth $33 billion, according to A.M. Best.
SNL estimated that premiums written for the property and casualty market increased 4.5 percent, to $6.5 billion in the first quarter of 2014.
Much of that growth has resulted from a better understanding by insurers of the risks being covered, and their pricing accordingly.
Realizing the financial rewards available, several new entrants from the traditional insurance space, most notably Berkshire Hathaway, have made a push into the E&S market since 2012.
BHSI has already established itself as the 9th largest E&S player by market share, with its premiums increasing 48 percent, to $190.7 million in the first quarter of 2014. Most of that growth came from coverage written on the nonadmitted paper of Berkshire Hathaway subsidiary National Fire & Marine Insurance.
Validus Holdings’ $690 million acquisition of Western World Insurance Group and Endurance Specialty Holdings’ recent spirited attempt to buy Aspen Insurance signal that competition and M&A could reasonably be expected to increase further.
Scott Culler, regional president at Markel, said that, while competition has increased, new opportunities have also become available.
“From a company perspective,” he said, “I think the biggest challenge we face is there are so many more competitors out there and options in terms of programs available to wholesale and specialist distributors than there were just 10 years ago.
“Over the last few years especially we have seen a much higher level of investment in new ventures and existing businesses looking to grow their book. It’s just mushroomed from there really.
“But what’s encouraging from our point of view,” Culler said, “is that at the same time there’s also been a continued opportunity for growth as the E&S market has become more central to the wider insurance industry.”
Among the biggest growth opportunities, Culler said, is professional liability.
But in order to unlock that potential, he said, businesses first need to improve their underwriting discipline.
“From a company perspective, I think the biggest challenge we face is there are so many more competitors out there and options in terms of programs available to wholesale and specialist distributors than there were just 10 years ago.” — Scott Culler, regional president at Markel.
As consumers know more about the policies they’re buying and demand a higher level of cover not readily available in the traditional insurance marketplace, they are increasingly turning to E&S providers for greater risk management expertise, particularly in claims and loss prevention, he said.
One sector that has benefitted most from this heightened awareness is cyber liability, as data breaches and security have become more prevalent.
“It reminds me of the implementation of Employment Practices Liability Insurance in the early 1990s in response to an upsurge of employment claims,” Culler said.
“It’s true to say that we’re not just seeing large companies getting hit by data breaches, but now ‘mom and pop’ shops are starting to be adversely affected as well.”
Jeremy Johnson, president and CEO of Lexington Insurance, AIG’s E&S division, said the evolution of companies’ new business models, allied with the advancement of technology and globalization has created an opportunity for the market to provide new and more innovative solutions.
His firm, he said, has already seen a strong uptake from the energy, transport and infrastructure sectors.
In recent months, Johnson said, Lexington has deployed new products for commercial real estate financing, for unmanned aerial vehicles and for evacuation coverage associated with extreme weather events.
“There is a great deal of opportunity in the market today for those organizations that can recognize it quickly and develop strategies to support it,” he said.
“Understanding change signals in the market is absolutely critical to the development of new products and services.”
BHSI’s Bresnahan said the two areas receiving the most attention at his company are D&O and property catastrophe lines.
“When it comes to counterparty exposure,” he said, “it’s the C-suite and directors and officers of our potential clients who are paying the most attention to credit quality.
“From a property catastrophe standpoint, we are proving very popular with larger clients that are looking to be creative in the way they do business, and want to enter into a long-term partnership with a company that specializes in that business and is insulated from the whims of the reinsurance market,” he said.
He added that there are also significant opportunities for companies to improve their service levels in claims and underwriting.
On the property side, Jim Dowdy, senior vice president at Zurich Insurance, said E&S carriers are fighting to keep their existing business due to increased competition and capacity in the market stemming from a largely benign catastrophe year.
“The traditional carriers are becoming more competitive,” he said, “and, as a result, more of that type of business is leaving the E&S market, so the biggest challenge right now for wholesalers is trying to hold onto their existing business.”
As competition has increased, consolidation of the E&S market has continued. Last year resulted in a number of significant takeover deals, led by Enstar Group, which, in July, announced the acquisition of Torus Insurance Holdings for $692 million.
A month earlier, Fairfax Financial Holdings said it would be buying American Safety Insurance Holdings for $306 million, as Tower Group International agreed to a deal for American Safety Reinsurance for $59 million.
Markel’s Culler predicted additional M&A activity in the future as companies continue to cut rates and release reserves.
Despite the recent growth enjoyed by the E&S market, there remain obstacles on the regulatory front.
Brady Kelley, executive director at NAPSLO, said one of the key reforms impacting the sector is the Terrorism Risk Insurance Act (TRIA), which expires at the end this year. TRIA, originally enacted in 2002, provides a federal backstop for terrorism claims.
NAPSLO has been lobbying for the program to be reauthorized in the same format to cover new policies that extend beyond this year.
The Senate has approved reauthorization, but as of the publication of this issue, legislation has stalled in the House.
NAPSLO has also been focusing its efforts on the Nonadmitted and Reinsurance Reform Act (NRRA), which governs the regulation and taxation of surplus lines transactions, and has already enjoyed considerable success, Kelley said.
Consolidation Remains Strong
The volume of insurance M&A deals is expected to be at least as high in the second half of 2014 as the first six months, according to industry experts.
A total of 35 property casualty and reinsurance deals worth approximately $5.6 billion were sealed in the first six months of 2014, according to AM Best. That’s more than half the $10 billion total recorded last year, with more deals expected, said one industry insider.
Edward Best, a partner at law firm Mayer Brown, who specializes in M&A said: “In the first half of the year, there were five deals in the U.S. over $500 million.
“For the second half, I wouldn’t be surprised if we have at least an equal number of large deals,” he said.
The surge in M&A activity is being fuelled by excess capital held by insurance companies looking to strengthen their position in core markets and boost their returns in a low interest rate environment.
New research by advisory firm KPMG revealed that more than half of 95 U.S. insurance bosses surveyed expect to be involved in an M&A deal in the next 12 months.
Laura Hay, national leader of KPMG’s insurance practice, who led the 2014 Industry Outlook Survey, said: “M&A activity is expected to ramp up in the next year as insurers leverage their strong capital positions to seek profitable growth, enter new markets and rationalize non-core operations.
“P&C insurers are acquiring companies with enhanced technology platforms to gain a competitive edge and view M&A as a crucial means to increase their distribution capacity.”
Insurance company leaders named access to new markets and geographic areas (45 percent) and regulatory changes and pressures (45 percent) as the two main drivers for M&A.
Moreover, 34 percent said strategic acquisitions were their top priority in terms of investment, closely followed by customer programs (25 percent) and information technology (24 percent).
Hay said there had been a significant shift from wholesale acquisitions of companies toward block-buying, focusing on specific distribution platforms or moving into new lines of business.
“There’s now a much greater focus on companies’ core business and building scale in areas that are strategically aligned with their business model,” she said.
And that is just the start, said Hay, following a period of uncertainty immediately after the financial crisis when insurers reined in capital to use as a buffer against market volatility.
Best said the M&A activity was being driven by the soft market and low interest rates, with insurers looking to put their capital to better use.
He said the latest push has been led by non-U.S. companies looking to extend their global footprint, citing the example of Brazil’s only publicly traded independent investment bank Grupo BPG Pactual’s recent purchase of Ariel Re and Validus’ $700 million deal for Western World earlier this year.
“A lot of large U.S. insurers are not making as many acquisitions domestically as before because of the soft market,” Best said.
“Most of the big insurers are already national and do not need to expand geographically in the U.S., so they are looking to expand their product lines, especially specialty lines which may have better pricing.”
And he doesn’t see the recent trend of M&A activity slowing down any time soon, provided there are no major catastrophe events.
He added that further consolidation of the market would serve to reduce the excess capital in the market and thus have a positive effect on rates, particularly in the reinsurance sector.
At an insurance agency level, Daniel Menzer, a partner at financial services firm Optis Partners, said the uptick in M&A deals was being driven by a proliferation of PE-backed buyers with investors looking for a steady return, as well as more attractive pricing as a result of increased competition.
“We see no reason now for the upward trend to change,” Menzer said. “With somewhere between 20,000 to 30,000 insurance agencies across the U.S., there are likely plenty of baby-boomer owners that want/need to sell, along with all the other strategic sellers that want to join something bigger to expand their growth opportunities.
“Barring major tax changes that could stall or accelerate transactions, a significant economic turn or some other kind of global event that could disrupt economies and other aspects of life, we expect the general strong M&A marketplace to continue.”
The impact of new regulations and legislation remains the biggest threat to insurers’ business models, according to 34 percent of the KPMG survey’s respondents.
Hay added: “Companies seem to be working on improving their core business but perhaps not taking some of the more revolutionary jumps or more dramatic changes that need to be made to their business models.
“How quickly they evolve their business models in this respect will play a big role in determining who the market leaders will be in three to five years’ time.”