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By Cyril Tuohy

The rash of fines levied against oil and gas exploration and production companies in particular has buyers scurrying for specialty coverage to supplement their sudden and accidental pollution policies, according to industry experts.

"Deepwater Horizon and a host of other environmental lawsuits have resulted in civil fines being levied, and that has been a big driver in insurance," Hanneman said. "So their exposure is much greater than they initially realized in environmental losses."

The idea behind buying specialty coverage is for risk managers to get additional coverage for pollution that seeps rather than gushes into the ground, and for insurance to protect employers against fines and penalties levied by state and federal regulators.

"We've seen a pick-up of activity of risk coming out of commercial casualty and moving into the specialty markets," said Bill McElroy, senior vice president of Boston-based Liberty Mutual Group.

The past two years have seen some record fines levied against individual oil and gas companies.

While some critics insist oil and gas drillers are still getting off easy, risk managers would rather have too much coverage than not enough. Many other companies have settled with U.S. authorities for huge sums as well.

Given the amounts involved in the most recent penalties levied against industry for violation of environmental protection laws, it's not hard to see why buyers are rushing to add supplemental coverage.

Shale gas producers are among the latest companies to incur heavy penalties.

In May 2011, Pennsylvania regulators fined Chesapeake Energy more than $1 million for contaminating water supplies in Bradford County, in the Marcellus Shale gas formation, and creating a fire hazard in connection with poor drilling practices.

The contamination of the water wells in the northeast corner of Pennsylvania was the largest single penalty ever assessed by the Pennsylvania Department of Environmental Protection against an oil and gas company, said DEP Secretary Mike Krancer, at the time.

In a separate case, Houston-based Cabot Oil & Gas Corp. had paid $5.5 million to settle drinking water contamination claims in Dimock, Pa., in Susquehanna County, including $1.3 million in fines and settlements paid to the state, and $4.2 million for affected property owners, according to 2011 company filings.

Other states with natural gas reserves are starting to impose heavy fines on oil and gas drillers alleged to be in violation of environmental protection laws. State regulators and health officials in 2011 fined as many as 19 oil companies in North Dakota's Bakken oil patch millions of dollars for failing to protect waste pits from spring flooding, according to news reports. New York City-based oil giant Hess Corp. accounted for nearly one third of the spills, North Dakota oil and gas regulators said.

Fracking Suits Multiply

A tally compiled last year by the law firm of Edwards Wildman cited more than 30 fracking-related lawsuits -- disputes related to the method of extracting natural gas from shale -- filed against well operators and drillers. The bulk of the suits allege contamination of groundwater with methane or other pollutants.

Still more suits -- about 20 -- have been brought by environmental groups, property owners and energy companies seeking to enforce federal or state rules either to block or to allow natural gas drilling.

Because pollution connected to hydraulic fracturing involves allegations of slow seepage and isn't "sudden and accidental," insurers are denying coverage on the grounds that the casualty coverage "doesn't fit that description," Hanneman said.

Big insurance underwriters of risks connected to hydraulic fracturing include Liberty Mutual, Ironshore Environmental, Aspen, XL, Zurich and AIG, he said, and the way many policies are structured for energy companies is for the casualty policy to respond first, and for the pollution coverage to respond second.

"As an example, if the oil and gas company receives a civil fine, the casualty coverage will decline it, but the pollution coverage will step up and pay the amount above the deductible," Hanneman said. "It's a great way to wrap around your sudden and accidental coverage, or around your control-of-well insurance to provide coverage for those gaps."

John T. O'Brien, president of New York-based Ironshore Environmental, a global environmental underwriter, said the Deepwater Horizon disaster was an "inflection point" for insurance companies to look at coverage grants, and whether insurance companies were charging enough to cover the risk.

What underwriters may have once considered adequate may no longer be enough, certainly not in the wake of Deepwater Horizon well blowout nearly three years ago. Fines levied against oil and gas companies in connection with the spill have been among the steepest ever.

London-based BP PLC in November agreed to accept criminal responsibility for the disaster and as part of the guilty plea agreed to pay $4.5 billion in fines and restitution in connection with the 2010 blowout.

Separate civil claims by the government against the drilling giant could cost it another $20 billion in fines, four times the criminal penalty it has agreed to pay, if found guilty of "gross negligence," under the Clean Water Act, according to legal experts.

The catastrophe, which took nearly three months to control and disgorged the equivalent of 5 million barrels of oil into the Gulf of Mexico, fouled hundreds of miles of habitat, cost local economies millions of dollars in lost revenue, and led to unprecedented litigation between federal and state governments, and BP. The explosion aboard the rig killed 11 people.

Transocean Ltd., the Houston-based drilling company that owned the oil rig implicated in the catastrophe agreed in January to pay a $1.4 billion fine in connection with violation of the Clean Water Act, the U.S. Department of Justice said.

In a separate announcement last year, MOEX Offshore 2007 LLC agreed to a $90 million settlement with federal authorities in connection with the Deepwater Horizon spill, the EPA, DOJ and U.S. Coast Guard said. As much as $70 million of that settlement will go toward penalties, the government said.

In the wake of Deepwater Horizon, all kinds of "derivative companies" around the ownership of the well, oil and gas operators, drilling mud suppliers and even charitable organizations and university endowments with nonoperating interests in oil and gas wells, are asking about extra environmental coverage, O'Brien said.

"The story really is around the shift of premiums from commercial general liability coverage to specialty underwriters," O'Brien said, as companies decide whether to add $500 million in umbrella coverage.

Because the new risks posed by the fines and penalties, many insurance buyers don't believe they can move forward without the peace of mind that the specialty coverage provides on top of their environmental coverage.

Beyond Oil & Gas

Fines against oil and gas companies often generate the loudest headlines, but other companies have been assessed hefty penalties in 2012 for alleged violations of federal environmental laws, according to the EPA and the DOJ.

In September, Scotts Miracle-Gro Co., the producer of pesticides for commercial and consumer lawn and garden uses, was sentenced in federal court to pay a $4 million fine and perform community service for eleven criminal violations of the Federal Insecticide, Fungicide and Rodenticide Act, according to the DOJ. This is the largest criminal penalty under FIFRA to date.

The company pleaded guilty in February 2012 to illegally applying insecticides to its wild bird food products, falsifying pesticide registration documents, distributing pesticides with misleading and unapproved labels and distributing unregistered pesticides.

In a separate civil agreement with the EPA, Scotts also agreed to pay more than $6 million in penalties and spend $2 million on environmental projects under a settlement that resolves additional civil pesticide violations, the DOJ said.

Violations include distributing or selling unregistered, canceled or misbranded pesticides, including products with inadequate warnings or cautions. This is also the largest civil settlement under FIFRA to date, the DOJ also said.

For a list of companies that have settled Clean Water Act disputes in 2012, please turn to Page 90.

CYRIL TUOHY is managing editor of Risk & Insurance®. He can be reached at ctuohy@lrp.com.

February 19, 2013

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