Waves of bankruptcies convulsing the coal industry in the United States leave billions of dollars in mine remediation costs potentially unfunded, and raise ominous questions for both tactical insurance and strategic risk management.
Dozens of coal companies are in court-supervised reorganization or liquidation, some of them for the second time in just a few years.
Many had taken advantage of the Surface Mining Control and Reclamation Act of 1977, or SMCRA, a federal law that allowed self-bonding in lieu of surety bonds, dedicated cash reserves or other provisions for environmental obligations.
Self-bonds are legally binding corporate promises without separate surety or collateral, available only to entities that meet certain financial tests.
In response to the volatility in the coal industry and recent bankruptcies, the Office of Surface Mining Reclamation and Enforcement (OSMRE), part of the Department of the Interior, sought public comment in response to a petition from WildEarth Guardians asking the office to consider restricting or eliminating self-bonding.
Specifically, the group wants to prevent coal companies with a history of financial insolvency, and their subsidiaries, from using “self-bonding” as a means to ensure disturbed lands are restored after mining operations are completed.
VIDEO: There are many challenges when working to remediate abandoned mines.
OSMRE received more than 117,000 comments on the petition to restrict or eliminate self-bonding, and announced on Aug. 16 that it would begin the rulemaking process to “strengthen regulations on self-bonding to help ensure that companies are financially able to restore lands disturbed by coal mining when extraction operations are completed.”
“The U.S. coal market is dramatically different from when our self-bonding regulations were last updated 30 years ago,” said OSMRE Director Joe Pizarchik.
“This is a turbulent time of energy transformation in our country, of declining use of coal and increased use of cheaper natural gas and renewable energy. These conditions have exposed the limitations of the current self-bonding rule and we have a responsibility to protect the public’s interest by keeping up with these changes.”
Requests for public comment on similar initiatives are underway in several states for mines under their jurisdiction; states where taxpayers could be on the hook for cleanup costs for busted mines if bankruptcy courts do not set those funds high enough in the hierarchy of expenses to be paid.
Within the broader economic and social dislocation in the near-collapse of a major industry, there are two key questions for insurance markets and risk managers.
On the commercial side, will the surety and broader insurance markets have the capacity and the willingness to underwrite billions in new coverage for an industry with a notorious past and a checkered future?
In risk management, there is a larger question of whether the 1977 self-bonding provisions were flawed from the start, or whether they were functional until overwhelmed by the tsunami of corporate failures in recent years.
“We know that there are many companies that rely on the surety bond market for meeting their compliance obligations,” said Tom Sanzillo, director of the Institute for Energy Economics & Financial Analysis (IEEFA), based in Cleveland.
“We imagine that would expand significantly if there were new regulations that restricted or even eliminated self-bonding for coal companies.”
In response to an inquiry from R&I, an OSMRE representative stressed that, “self-bonding remains a legal option sanctioned by [SMCRA] as a means that a qualified company can guarantee reclamation. There are cases in which self-bonding guarantees have been replaced by surety and collateral bonds.
“In addition, it is important to note that no operator currently in operation with self-bonds has ceased operations and forfeited on the bonded obligations. OSMRE stands committed to ensuring that mine operators will be held accountable to complete the legally required reclamation when or if they complete mining operations.”
The forthcoming rulemaking process is intended to modify “self-bonding eligibility standards, including for parent and other corporate guarantors, to include criteria that are more forward looking, instead of only focusing narrowly on past performance.”
It also will require an independent third-party financial review of self-bonded entities, establish the percentage of self-bonds supported by collateral and provide regulatory authorities with better tools to obtain replacement bonds when a self-bonding entity no longer meets the eligibility criteria.
However, federal rulemaking, even the simplest, is a long and complex effort. Congress can also amend SMCRA to modify the bonding system.
“What we have here is a [self-bonding] system that is flawed in many respects, and the industry’s decline exposes those flaws graphically,” Sanzillo said.
“When I saw the OSMRE statement expressing concern about possible collusion between state regulators and coal companies,” he said, “I nodded, because we did an initial study on the self-bonding program in Texas several years ago and found that it was completely inadequate,” he said.
In addition to West Virginia, Texas recently became one of the states that intervened in bankruptcy proceedings pressing for full funding of remediation costs.
In Texas, the IEEFA findings were submitted to the state Railroad Commission, which has jurisdiction over coal mining, and the legislature.
“We had a robust discussion,” said Sanzillo, “and they took some diligent action, including requesting $1 billion in notes from one debtor-in-possession financing.”
OSMRE added that the State of Texas successfully navigated the problems associated with self-bonding, through its actions with respect to Luminant, the largest electricity producer in Texas, in 2011-2012.
The Railroad Commission, the state attorney general’s office, and the operator devised a way to have Luminant replace several hundred million dollars in self-bonds with collateral bonds when the company declared bankruptcy.
In a recent large bankruptcy case involving Alpha Natural Resources, “the West Virginia Department of Environmental Protection has been very vocal that the $1.1 billion in remediation costs have got to be addressed in the reorganization plan,” said Ted O’Brien, CEO of Doyle Trading Consultants, a coal-industry advisory.
Reorganized as Contura Energy Inc., the producer will contribute up to $100 million to help Alpha’s ongoing reclamation activities, according to published reports.
“What this down market is revealing is that there is far more coal being claimed as reserves than is economically available for mining. Insurance companies should ask if the valuations that are being reported to them are valid,” Sanzillo said.
“Any insurer looking into coal as a new market may get some pushback from other stakeholders,” said O’Brien, “but there has always been a market for surety, if you have someone willing to get their hands dirty. Coal is not going away. ” &
Corporations Get Creative With Cells
Cell captives have become extremely popular self-insurance tools for companies of various sizes across all sectors, with cell legislation enacted in more than half of U.S. states and cell formations now outstripping stand-alone captive formations in many onshore and offshore captive domiciles.
Protected cell companies (PCCs, also known as a segregated accounts companies or segregated portfolio companies) consist of a core company that writes and administers ring-fenced insurance policies in underlying cells, whose policies and accounts are segregated from other cells in the PCC.
The recent development of incorporated cell company (ICC) legislation in a handful of jurisdictions enhances PCC features by granting each cell distinct legal status.
As well as being quick to set up, cells require significantly less capitalization than stand-alone captives, while shared costs among the participants and core lead to economies of scale. It is little surprise that since the first PCC was formed in Guernsey in 1997, they have proliferated and broadened.
“Risks written through cells are becoming more sophisticated, expanding beyond traditional medical malpractice, workers’ compensation and property insurance,” said Paul Scrivener, a partner in the Cayman Islands’ law firm Solomon Harris.
Cells are being touted, for example, as a potential solution to cyber risk, one of the insurance industry’s great challenges.
Cells for Every Risk
“If you have a structure with different risk profiles within different cells, it may make sense to put cyber risk in a separate cell rather than co-mingle it with traditional lines of insurance as it is very different and unique,” said Scrivener.
“Some have suggested using a cyber cell because you are looking at low frequency, high severity situations,” added Tom Jones, partner with McDermott, Will and Emery. Questions remain, however, over how best to address coverage terms, exclusions and payout limits, he said.
Cells are also growing in popularity in the health care space, particularly for medical malpractice risks.
“Hospitals may set up cells for independent physicians or group faculty plans if they want to assist them with insurance but don’t want to co-mingle the loss reserves,” Jones said.
Scrivener recently converted a single parent health care captive to a cell structure so it could put its existing hospital program into one cell and create a second cell to insure the risks of the self-insured physicians within the hospital.
Ascension Insurance Services set up Cayman’s first portfolio insurance company, AARIS, in 2015 to offer workers’ compensation solutions to agribusinesses, but now intends to roll out flexible workers’ comp cells to other sectors including the trucking and automobile racing industries.
“We’re getting calls from all around the country,” said Paul Tamburri, Ascension’s West Coast risk management practice leader, adding that the next step could be to write employee benefits stop loss through AARIS.
Cells can offer a fast route into captive insurance for employee benefits programs, while many regulators have yet to find a comfort level with stand-alone employee benefits captives.
“Getting the whole cell structure approved up-front makes it relatively easy to add cells. Instead of taking six months to get approval, we can get a cell approved in a matter of weeks,” said Karl Huish, president of captive services for Artex Risk Solutions, which runs a PCC-like employee benefits series business unit named Sentinel Indemnity in Delaware.
“Getting the whole cell structure approved up-front makes it relatively easy to add cells. Instead of taking six months to get approval, we can get a cell approved in a matter of weeks.” – Karl Huish, president of captive services, Artex Risk Solutions
“The cells in Sentinel each have different employee benefit captive structures, including one that is for a group of credit unions who want to pool risk together for their health insurance,” he added.
According to Guernsey Finance, multinational corporations can use cells as fronting vehicles through which to gain access to the reinsurance market. A cell can be used to issue an insurance policy to the insured that is mirrored by a policy between the cell and a reinsurer, and while the cell retains no risk, the corporation benefits from access to cheaper wholesale reinsurance cover.
The ability for numerous small companies to group their insurance risks in a cell means the self-insurance business is no longer reserved for big corporations. Huish believes a group of insureds must have projected annual losses in the region of $5 million or above to justify forming a cell, while that figure would be closer to $3.5 million for individual cell owners.
Insured Turns Insurer
More than simply participating in their own risks and enjoying greater control and premium savings from self-insurance, an increasing number of companies see PCCs as an opportunity to generate cash flows while strengthening bonds with business counterparts. Indeed, any company comfortable with the self-insurance concept can set up its own PCC to offer insurance solutions to third-party clients, suppliers or partners.
Not only does the sponsor of the PCC get closer to the risk of companies that affect its own risk profile, but it can also add value to its service propositions by offering valued third parties a quick, cheap route into self-insurance.
“Setting up your own PCC is a way of locking in clients, strengthening relationships and generating revenues, while also offering profit sharing opportunities between the PCC owner and its clients,” said Clive James, consultant at Artex Risk Solutions.
While this may be a natural fit for financial services firms, the concept can be applied to any sector, and may be particularly useful for those that operate on a project-by-project basis.
Construction firms, for example, are setting up PCCs through which the underlying cells write segregated insurance coverage for distinct projects, partners or groups of subcontractors. Freight storage unit owners are already using cells to self-insure the fire, theft and flood insurance they provide to licensees of the units, and there are myriad opportunities for health care organizations to offer insurance across their networks via cells.
Companies that lack the insurance expertise to run a PCC themselves would outsource this responsibility to an insurance manager in the same way stand-alone captive administration is outsourced — at a similar cost.
As PCC sponsors must ultimately compete with guaranteed cost options in the commercial marketplace, Tamburri noted it is essential to educate potential clients that participation is both a long term commitment and also an opportunity to recoup underwriting profits they would otherwise lose if they stayed with commercial insurers.
“One hurdle is getting data from prospective clients,” said Tamburri. “It’s a lot of work for them to get together historical loss and exposure information. Smaller companies may wish to join the group but fear that they will do a lot of work only for the cell not to get off the ground.”
Such is the decision all companies must make when considering self-insurance, whether taking an individual cell or going a step further by forming a full PCC for third parties to join. What is clear is that cells give risk managers more options than ever before. And when insured becomes insurer, it is surely a sign of insurance industry evolution and innovation.
Sparking Innovation and Motivating Millennials
Two trends in the insurance industry, if they continue, could compromise its vitality in today’s fast-paced, technology-driven business world: slow innovation and a scarcity of millennial talent.
The quests to develop innovative solutions and services and to recruit young people to the field have raised concerns in the industry for several years, causing some insurers to think about how they will stay viable in the future when senior-level managers begin to retire.
But Lexington Insurance Company, a member of AIG, may have found a way to spark innovation that also engages millennial minds.
Innovation Boot Camp started three years ago as a one-off project meant to identify young, high-potential employees, give them exposure to senior management and evaluate their teamwork and leadership capabilities.
“The original concept was fairly straightforward. We would bring together a group of about 30 high potential employees for some semblance of team project work and it would allow management to gauge and assess talent,” said Matt Power, Executive Vice President, Head of Strategic Development, Lexington Insurance.
Little did he know how well the program would not only generate a plethora of innovative ideas that would drive the company forward, but also reinvigorate younger employees.
“The boot camps would be focused on innovation, with the idea that if we ended up with a concept or product that we could commercialize, then the boot camp would have been effectively self-funded. When they came back at the end of the 12 weeks, we were absolutely shocked because they produced about half a dozen products that have since been commercialized and are in some phase of being rolled out.”
— Matt Power, Executive Vice President, Head of Strategic Development, Lexington Insurance
New Ideas Emerge
The inaugural Innovation Boot Camp began with a two-day kick off meeting for participants— consisting of six teams with five or six participants. Each team was tasked with developing a business plan, and began to connect virtually over the next 12 weeks. The plan would culminate in a presentation to a senior management judging panel at the program’s conclusion.
“The boot camps would be focused on innovation, with the idea that if we ended up with a concept or product that we could commercialize, then the boot camp would have been effectively self-funded,” Power said. “When they came back at the end of the 12 weeks, we were absolutely shocked because they produced about half a dozen products that have since been commercialized and are in some phase of being rolled out.”
Power credits the program’s success in part to the participants’ youth. They were tuned in to different trends and issues than their more experienced counterparts.
Cyberbullying, for example, was a problem that didn’t exist for Power and his contemporaries as they grew up, but was salient for millennials. Based on the presentation of one group, Lexington developed coverage on their personalized portfolio for exposures associated with cyberbullying.
Likewise, “they educated us on the emergence of the craft brewing industry and how rapidly it was growing in the U.S.,” Power said. “That led to us launching a whole suite of products for craft brewers.”
Another team brought forth the concept of how rapid sequencing laser photography could be used to create a three-dimensional picture of a construction work site. That would allow contractors or claims managers to virtually walk through the site at a given point in the construction process to identify deviations from the original blueprint plans.
The images could memorialize the building process down to the millimeter, to every screw and wire. If a loss emerges later on due to a construction defect, the 3D map would be a valuable investigation tool.
Innovation Boot Camp proved so successful that Lexington expanded it to other arms of AIG all over the world.
“Suddenly we started getting calls from London, Copenhagen, Brazil,” Power said. “We were doing these programs for our global casualty team, for our lead attorneys in New York, for our financial lines group, and so on. We recently embarked on the 16th iteration of this program in London, with additional programs in the works.
“It’s a journey that has evolved from trying different things and not being afraid to fail, not being afraid to try new ways of thinking about the business.”
Engaging Millennial Minds
In addition to generating new product ideas, Innovation Boot Camp also engages younger employees more fully by offering the opportunity to make meaningful contributions to the company through independent work that requires some creative thinking.
Past participants are often great crusaders for the program.
“A program like IBC is something rarely seen at a large corporate conglomerate, and really a concept for new age startup companies,” said Alyson R. Jacobs, Vice President, Broker and Client Engagement Leader in AIG’s Energy & Construction Industry Segment. “But we were given a chance to work with people of all different professional backgrounds, and that environment unearthed concepts and solutions that have made a significant impact in the lives of our insureds and their employees.”
The chance to do work that makes a difference, both for the success of their company as well as the clients its serves, is what attracts millennial employees to the program and motivates them to devote their best effort to the project.
“Millennials want to be able to share their ideas and make meaningful contributions at work,” Power said. “Innovation Boot Camp has evolved into the perfect forum for that.”
David Kennedy, Esq., Product Development Manager for Lexington Insurance and former Coach for two Innovation Boot Camps, said the program engenders an “entrepreneurial spirit of developing something new, of applying analytical rigor to emerging risks to create unique and timely solutions for our clients and the marketplace.”
Exposure to senior executives doesn’t hurt either.
“It provided a platform for me to not just interact with our Senior Executive leadership but present a concept that could potentially be adopted by our company in the future,” said Ryan Pitterson, Assistant Vice President, AIG. “It helps to build your internal network, elevate your profile in the company and connects you with our client base as well.”
At a time when recent college graduates choose employers based on how much opportunity they’ll be given to have meaningful input — as well as opportunities for advancement — projects like Innovation Boot Camp could be the answer to the insurance industry’s struggle to pull in millennials.
“We give them the time, space and resources to create something new,” Power said. “When employee engagement is done right, it inspires passion and creativity.”
As multiple arms of AIG adopt Innovation Boot Camp around the globe, both the quantity and quality of new ideas are bound to flourish.
“The bottom line is, many heads are greater than one, and AIG has figured out how to leverage this. AIG hears their employees’ voices and enables those ideas to take our company into the future,” Jacobs said.
To learn more about Lexington Insurance, visit http://www.lexingtoninsurance.com/home.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Lexington Insurance. The editorial staff of Risk & Insurance had no role in its preparation.