By Bill Nellen
Faced with growing environmental risk and liability concerns, an increasing number of manufacturing companies are turning to pollution liability insurance as an effective risk management tool to cover the gap left by the absolute pollution exclusion on standard commercial general liability policy forms.
Environmental risk and liability concerns are growing significantly because of recent high-profile disasters and the expanding ranks of federal enforcement agency attorneys ready to prosecute damages and drive behaviors.
Today, there is a heightened awareness of the long-term environmental effects of human actions on the planet and an increased focus on such issues as global warming, sustainable agriculture, and green building, to name a few.
The capability to quantify the impact of a given action on human life and the environment is the initial step toward understanding what actions need to be taken. The second step is recognizing how this exposure can be managed.
A key management tool is transference of the risk to a financially secure intermediary -- insurance. Pollution liability insurance coverage has become an effective strategic tool for risk management departments to cover the gap left by the absolute pollution exclusion on standard commercial general liability policy forms. The convergence of these factors, as well as others, has created a rapidly expanding marketplace for these commercial insurance policies for manufacturing companies.
Traditional manufacturing has always been about the production of a finished, marketable product from raw materials. Inevitably, this process generates wastes, including off-specification raw material, excess, and materials used for maintaining production equipment.
Unfortunately, less than robust management of both on-site and off-site chemicals and waste materials has resulted in considerable environmental damage carrying an extraordinary price tag -- one that only takes into account damages that are immediately apparent. In fact, there are multiples of those damages that have not been reported and are not currently under any kind of regulatory oversight.
In addition, there is the ever-present possibility of a catastrophic release from the pipeline transfer of product, or an accidental dispersion or explosion that results in immediate and long-term damage. In that case, modern-day litigiousness is likely to lead to damaged reputations and significant liabilities from legally defending the entity.
The evolution of environmental impairment liability (EIL)/pollution legal liability (PLL) coverage began in the early 1980s. Initially used primarily as an adverse-selected product for bulk chemical transporters, hazardous waste transfer stations, and landfills, product innovation enabled EIL and PLL to provide greater coverage and contract certainty, accelerating the purchase of these products.
The capital markets have driven the product to become a more ubiquitous purchasing decision. This, coupled with the maturing of insurance carrier market capital, actuarial claims experience, and experienced underwriting staff and management, has led to an explosion in current commercial insurance carrier capacity.
The two forces that drive purchasing decisions for pollution liability insurance are transactional and operational. During equity investment or mergers and acquisitions, due diligence is typically applied to environmental risk. Once the technical work has been completed (Phase I and II Environmental Site Assessments), environmental insurance can be used as a "belts-and-suspenders" tool to place boundaries around any historical, legacy exposure that might exist or be suspected to exist. This is good protection to the pro-forma for the deal, as well as to attract preferable lending terms.
In many instances, insurance can be used in lieu of corporate indemnification, contractual liability transfer, or escrows. Operationally, environmental coverage can be utilized as a balance sheet tool to protect against unexpected/unintended adverse financial consequences due to pollution damages. The coverage should not replace internal engineering and risk management controls, but rather serve as a back-stop for them.
It is often misunderstood that even the offer of pollution coverage give-backs on commercial general liability policies is quite limited in both the circumstance and total limit afforded to a potentially covered loss.
A recent example of the successful strategic use of environmental insurance involves a large, multi-national Fortune 500 client of Alliant Insurance Services that recently signed a 20-plus-year lease for a large, long-abandoned manufacturing facility in the Midwest. Originally built in the 1970s for electronics manufacturing, the plant is impacted by high concentrations of residual hazardous chemicals in the subsurface. The environmental hazards are being managed by the former owner/operator under obligations dictated by state and federal environmental authorities.
With the cost to develop a new manufacturing facility on an undeveloped site in today's dollars estimated at $150-$200 million, the client chose to lease and retrofit the existing plant to manufacture next-generation transportation equipment.
However, after investing more than $100,000 in on-site engineering and environmental investigations prior to signing the lease, this high-profile firm decided the environmental risk from prior uses was too high to rely on the landlord's financial security.
Although the company had not purchased environmental liability insurance in the past -- believing it to be too expensive and not functional enough given the firm's high levels of "self-insurance" and balance sheet strength -- the Alliant team was able to show the client why this insurance was the best strategy to adequately protect its investment.
In fact, once the client learned how the breadth of coverage and value of protection relative to premium cost made pollution insurance the best choice, it was anxious to add coverage for "new conditions" as well as "pre-existing/historical" conditions. In addition, due to the industrial nature of its manufacturing operations -- use of chemicals, fuels, and the potential for reputational damage in the event of a loss -- the company is now open to coverage for the bulk of its portfolio operating locations.
Pollution coverage as a standard line of risk transfer insurance covers liabilities resulting from clean-up, bodily injury, and property damage. Along with these, related legal defense expenses are also covered, most often within the limits of liability. Policies are tied specifically to the insured's insurable interest in a real estate asset or property. However, recently, carriers have been willing to offer the coverage on a blanket basis. Effectively, this makes the policy act similarly to a general liability policy for pollution losses. Some enhancements to the off-the-shelf offering include:
* Business interruption
* First- and third-party transportation
* Disposal site liability
* Indoor air quality (mold, Legionella, MRSA, bacterium, fungi)
* Natural resource damages
In addition to risk transfer insurance, carriers offer 24-hour, manned 800-numbers for insureds to call in an emergency situation. Carriers can dispatch clean-up contractors and public relations professionals (in the event of potential reputational damages) and make claims staff technical experts available for a given situation. Value-added services may also include per-loss inspections of manufacturing facilities and coordination with on-site professionals to determine the best course of action to manage risk of loss.
Some insurers offer robust pollution coverage as a bolt-on to the standard general liability insurance contract, allowing customers to purchase both coverages, on the same form, to avoid any claims contention and for cost efficiencies in consideration of premium.
Pollution liability insurance is an important consideration for any professional tasked with risk management/insurance procurement in the manufacturing arena. Certainly, it is a product that must be selectively implemented. However, recognizing when the solution is best employed can be a smart use of capital for many companies.
Environmental insurance is a cost-effective balance sheet protection for unexpected/unintended events that have the potential for extremely severe losses.
BILL NELLEN is executive vice president of the Environmental Group at Alliant Insurance Services.
March 1, 2012
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