If previously unknown contamination is discovered on a brownfield site, cleanup costs not covered by pollution legal liability insurance can seem like a bottomless pit.
The ease and quickness with which a company can buy environmental insurance should make it a routine part of leasing or purchasing a new business facility.
In addition, the market for environmental insurance is increasingly competitive, resulting in constantly decreasing rates. Lower-cost insurance offering higher protection limits for environmental liability enables riskier real estate development to occur.
Until recently, commercial general liability insurance policies offered little or no protection against environmental contamination. Citing poor claims experience, mushrooming costs and unpredictable conditions, most insurers wrote a standard "pollution exclusion" into such policies to avoid what they perceived to be a Pandora's box of coverage issues.
Of late, however, several insurance companies have begun offering policies to protect against specified environmental risks. These policies provide protection against the financial uncertainty involved in cleaning up a site caused by, among other things, the nature of the contaminant, regulatory changes in remediation standards and unknown contamination.
As more insurance companies insure contaminated sites, a growing number of property owners, financial institutions and redevelopers are taking advantage of the available products. Depending on the circumstances, insurance brokers are able to compare rates and secure the best deals almost instantly. The market is competitive, and a policy that cost $250,000 two years ago may only cost $50,000 today. This article provides an overview of currently available insurance products that property owners and developers should consider when evaluating environmental insurance for transactions once thought too risky-or too expensive-to pursue.
Who Needs It?
Many different parties may benefit from environmental insurance, including buyers and sellers of property, landlords and tenants of commercial property, redevelopers of contaminated property, small business owners, financial institutions and even homeowners. Indeed, environmental insurance may enable these parties to take advantage of real estate opportunities that they once would have avoided because of an inability to assume, quantify or transfer environmental risk.
Brownfield Developers-Historically, redevelopers were hesitant to become involved with abandoned industrial property, or brownfields, because of the environmental risk attached to the property. However, insurance facilitates redevelopment through the transfer of environmental risk from buyers and sellers to the insurance company.
Utility deregulation offers a particularly promising opportunity for brownfield redevelopment. Increased competition from deregulation has forced utilities to sell off contaminated real estate that they previously could have afforded to retain (usually by passing the costs of such properties on to consumers). Rather than holding on to these costly properties, utilities may transfer the environmental risks to an insurer, and eliminate a potentially expensive liability from their balance sheets. For these, and other corporations, the elimination of a costly real estate liability can translate into an immediate increase in stock value.
Lenders-Financial institutions that take possession of contaminated properties may be responsible for their cleanup, particularly if they are acting as the owner or operator of the properties. Lenders also may be liable to third parties for harm incurred by the presence of pollution. To protect themselves from these potential liabilities, lenders can purchase insurance themselves, or they may require a mortgagee to secure insurance. Insurance coverage also may be necessary prior to refinancing a loan.
Commercial Property Owners- Commercial property owners can use environmental insurance to protect themselves from pollution resulting from the general operation and maintenance of their property. Commercial property owners may also require insurance for commercial tenants, such as dry cleaners, as part of a leasing agreement in order to protect the landlord from liability arising out of chemical spills and other risks.
Real Estate Investment Trusts- REITs may act as a real estate owner, developer or financier. Generally, REITs invest in properties with traditionally low risk, such as apartment buildings and retail establishments. However, even low-risk properties present environmental problems, such as pollutant seepage and poor indoor air quality. Environmental insurance protects REITs from liability due to low-risk hazards, and enables REITs to invest in riskier properties as well.
Small Business-Smaller scale pollution can be very costly to businesses or even homeowners. Examples of small businesses that face environmental risks include dental or veterinary offices, dry cleaners, gas stations and funeral parlors, just to name a few. Further, if a homeowner or business owner is unable to pay for cleanup, the costs could default to the municipality in which the residence or business is located. Public entities, however, have not yet begun to purchase environmental insurance to protect them, due in part to the novelty of the product.
Superfund Sites-To date, environmental insurance products have not been widely used to help clean up federal Superfund sites; insurance, however, has been used to transfer risk to a single environmental contractor at some state sites. Some insurers have lobbied federal legislators to include environmental insurance products in Superfund reform as a legitimate form of risk transfer. Although nothing in the Superfund law explicitly precludes risk transfer through insurance, potentially responsible parties (PRPs)-past owners or operators who may have caused or contributed to an environmental problem-fear that they ultimately may be held responsible if the insurance company does not pay for claims.
Environmental Contractors and Consultants-An environmental contractor may create a cleanup cost estimate and then secure insurance to back its cleanup services at a site. This can include Pollution Legal Liability insurance that releases the property owner from liability by transferring it to the contractor. Often, if an environmental contractor has secured insurance to clean up a site, the insurance company will require co-insurance as a way to share costs and to ensure that the contractor does not charge for more hours than necessary. The co-insurance may be as much as 15 percent to 25 percent of the cleanup costs.
Others-More and more industries are opting for the protection of environmental insurance. Because each industry has its own unique characteristics that require different types of coverage, some insurers are developing customer service units to meet these specific needs. For example, the chemical industry may require coverage for warehouses, drumming and re-packing facilities, and manufacturing facilities. Hospitals may need protection for underground tanks, infectious and hazardous wastes, chemicals and wastewater. Insurance products can be tailored to each individual client to ensure maximum protection from liability.
Which Coverage for You?
Remediation Stop Loss or Cleanup Cap Coverage-This insurance is designed to provide protection when actual cleanup costs exceed remedial estimates. Coverage under this type of policy does not include contamination discovered during cleanup. Stop Loss covers the cost of cleanup when it exceeds the estimated cost plus a self-insured buffer layer, generally 10 percent of the cleanup cost estimate. Coverage ends when the cleanup is completed and the insured receives a No Further Action letter from the government.
Limits on Stop Loss policies range from $1 million to $70 million, depending on the insurance company, and generally last for one to two or more years. Policy renewals may be negotiated for lower premiums. Premiums usually are 2 percent to 6 percent of the estimated cleanup costs.
Pollution Legal Liability-This policy covers claims made by third parties arising from pollution conditions at covered sites. Covered claims include those arising from cleanup, bodily injury and property damage. Pollution Legal Liability protects the property buyer from losing future value in the event that previously unknown contamination is discovered. Additionally, the policy allows the seller to put closure to sold-off assets by transferring the risk associated with the sold property. Ten-year policies can be written.
Closure Coverage-This policy indemnifies the insured for costs related to closure/post-closure financial obligations such as future monitoring for contamination of Resource Conservation and Recovery Act (RCRA) facilities. These sites include hazardous and solid-waste treatment, and storage and disposal facilities. Closure coverage assists the insured in managing long-term costs. It provides limits of $1 million and up, and policies are generally written for one-to-five-year terms.
Secured Creditor Impaired Property Insurance-This product is offered to financial institutions to cover the sum equal to the lesser of either 1) the loan balance due on the real property that is found to be contaminated, or 2) the cost to clean up such property. In the first case, the company will indemnify the insured, and in the second, the company will pay on behalf of the insured. This policy excludes coverage for known contamination, asbestos or lead paint. There is no coverage if the loan goes into default outside the policy period.
Contractors Pollution Liability and Errors & Omissions Insurance-This insurance provides coverage for bodily injury and property damage arising out of covered operations performed by the insured contractor on a third party's property. Contractors Pollution Liability covers pollution arising from professional services performed by the insured contractor, including both sudden and gradual pollution. Protection is provided to the property owner if the contractor accidentally causes additional contamination during the cleanup process or neglects to detect pollution during a Phase I or II audit.
Limits on Contractors Pollution Liability and Errors & Omissions Insurance range from $1 million to $70 million for terms of one year. The policy should be renewed each year the work is being done, and no coverage is provided for intentional or deliberate noncompliance with the law.
Finite Risk-This is a type of self-insurance program that is fully funded by the insured and administered by the insurance companies. Coverage can be pooled with other insured parties. Such insurance can be structured similarly to an annuity in order to assure funding sufficient to cover a long-term remediation program over a designated time.
Property Transfer-This is a type of Pollution Legal Liability coverage that is used for property transfer. It covers claims arising from pre-existing unknown contamination, known contamination below reportable levels and third-party pre-existing unknown contamination. Property Transfer coverage protects the buyer, seller and lender involved in a real estate transaction.
Policy limits for Property Transfer coverage begin at $1 million and last for three to five years, although the trend is moving toward seven- or 10-year policies. Existing known contamination is excluded from coverage. In addition to the Phase I and II audits and remedial action plan that are required for most coverage, Property Transfer insurance may require a No Further Action letter as well.
Before You Buy
Environmental insurance generally is tailored to individual needs. Environmental insurance brokers require the insured to fill out an application that provides information on past and present owners of the site, purposes of the site and future concerns of the buyer or seller. The broker uses the information on the application to search for the best rates, which are determined on a case-by-case basis because there presently is no standardized rating system to assist in setting premiums. Environmental consultants and lawyers may review the application. Phase I and Phase II audits also are required in most cases. Finally, the insurance company likely will need to review any environmental reports attached to the property and governmental cleanup cost estimates, and it may send its own environmental consultant to the site.
There are six major companies offering environmental insurance: American International Group, Commercial Underwriters, Reliance International, United Capital, Zurich Insurance Co. and Kemper International. Because of the increased popularity of environmental insurance and escalating competition within the market, the rates offered by these companies recently have declined. Premiums for environmental insurance products are paid up-front, and cannot be spread out over the life of the policy.
Furthermore, most of the insurance policies described above are written on a "claims-made" basis only, which means that in order for coverage to apply, a claim must be made while the policy is in force. Thus, if the contamination occurred in 1990, but was not discovered until 1997, an insurance policy must be in effect and the claim made in 1997 in order to trigger protection. It should be noted that some coverage, such as the Contractors Pollution Liability and Errors & Omissions policies, are now being offered on an "occurrence" basis. This means that the 1990 contamination noted above would be covered as long as a policy was in effect at the time of the accident. The trigger event for coverage under an occurrence basis policy is the contamination itself, not the claim. ps&p
Tricia A. Haught is a partner in the Hartford, Conn., office of Day, Berry & Howard, one of New England's largest law firms. Gretchen Burger, a 1998 summer associate with Day, Berry & Howard and a law student, assisted with the article. Portions of this article originally appeared in The New England Real Estate Journal.