EMERGING OPTIONS IN ENVIRONMENTAL INSURANCE

By: H. Edward Abelson and William M. Seuch

The owner of a real estate portfolio buys environmental insurance for all of the property in the portfolio at an attractive price to protect against environmental problems. A seller is able to close a deal by paying a one-time premium for environmental insurance for the buyer, so the buyer is comfortable that any contamination encountered during construction will not add additional costs to the project. Another seller purchases environmental insurance to address a known groundwater contamination condition, which may or may not require additional remediation depending on the final form of draft regulations, and structures that insurance so that at closing it will be assigned to the buyer but the seller will remain as an additional insured on the policy.

What do these situations have in common? They are all examples of business people involved in real estate who have used environmental insurance to quantify the cost of environmental risks and to transfer those risks by paying a fixed price in the form of a one-time insurance premium.

When it was first introduced to the market several years ago, environmental insurance was expensive and coverage provisions were not always clear. Now, the cost of both portfolio coverage and single deal policies is much more affordable and, at least occasionally, can be attractively priced. These pricing changes are due to both increased underwriting experience on the part of the relevant carriers and increased competition in this marketplace.

In addition, while the language in the current policies is neither perfect nor easy reading from the perspective of the insured, the carriers are more willing than before to negotiate specific language changes and to tailor coverages to particular situations. As a result, environmental insurance is now a much more attractive risk-reduction technique than it was previously, and it can often be used as one of several risk-reduction measures in facilitating transactions involving contaminated real estate.

Types of Policies Available

A number of different types of environmental insurance are currently available. They include the following:

• Environmental Remediation Insurance: covers investigation, defense and remediation costs associated with the cleanup of contamination on the insured’s property and any migration of contaminants from the insured’s property onto adjacent land. Typically, only those releases that occurred prior to policy inception and that were not discovered until after policy inception are covered. However, some policies do provide coverage for contamination arising after policy inception, e.g., midnight dumping and tenant-caused releases.
• Pollution Legal Liability Insurance: covers liability to third parties for bodily injury, property damage and cleanup costs caused by contamination emanating from specifically-covered locations. One critical distinction between pollution legal liability policies and environmental remediation policies (described above) is that the pollution legal liability policies often do not include coverage for the remediation of the insured’s property.
• Integrated Environmental Insurance/Environmental Protection Insurance: covers the types of risks covered by environmental remediation insurance, but often also covers claims for bodily injury.
• Stop Loss Coverage: covers traditional environmental remediation costs, in combination with self-insurance principles. This type of policy is particularly suitable for those properties with known environmental problems. In essence, the insured accepts what is often a substantial deductible, i.e., the stop loss amount, which includes the estimated cost of cleanup plus an additional amount for cost overruns, and the insurer bears the risk of cleanup costs in excess of the stop loss amount, up to the policy limit.
• Future Contamination Insurance: covers remediation of contamination from an insured’s ongoing operations. Typically, the contamination must be discovered and reported during the policy period.
• Finite Risk Financing: covers prospective and retrospective environmental impairment exposure, and can provide closure and post-closure liability funding and financial guarantees concerning future environmental cleanup. Funding for anticipated cleanups, for example, can be established through payment of equal premiums over a designated period of time. Many financial and accounting benefits attach to this type of coverage.

Benefits of Environmental Insurance Coverage

The primary benefit afforded by environmental insurance coverage is that in exchange for a fixed, one-time premium, certain environmental risks can be transferred during the term of the policy, with the result that the insured may achieve a much greater degree of certainty than would otherwise be the case.

In addition, in a transactional setting it may be possible to substitute environmental insurance policies for more traditional indemnity and hold-harmless agreements, which in turn may lessen the purchaser’s need to be concerned about the seller’s continued financial condition. Further, owners and landlords of real estate may wish to consider environmental insurance policies as a part of prudent portfolio risk management.

Based on the comparatively recent SEC reporting requirements regarding environmental liabilities, corporate real estate managers may find value in procuring these policies so that properties that would otherwise need to be reported as environmental liabilities on a balance sheet may not need to be so reported. In addition, environmental insurance carried by a seller usually adds value to the property, as most policies can be assigned to a buyer. Further, these policies are often used to resolve liability disputes which otherwise would inhibit the transfer of real estate.

It is also worth noting that most environmental remediation policies are direct pay policies, which means that the insurer pays the covered costs up front as opposed to reimbursing the insured for costs only after they are incurred.

Issues When Purchasing Environmental Insurance

As an initial matter, environmental insurance policies are still relatively new, and the terms of these policies can vary markedly depending on the insurer. Thus, it is important to analyze each coverage and exclusion item, and not just the certificate of insurance. Also, because environmental insurance is still fairly new, the premiums do not reflect significant claims experience. This lack of experience can make it difficult to predict exactly how the insurer will handle particular claims in the future.

Environmental remediation policies differ on whether contamination that arises after the inception of the policy constitutes a covered risk, often depending on which coverages have been selected. Additionally, coverage often depends on how the contamination arose, e.g., due to the owner, a tenant, a midnight dumper or off-site migration. Careful consideration should be given to the question of which coverages should be put in place. Relevant factors include historical information concerning the property, the neighborhood in which it is located and its anticipated future use.

Policy terms generally range from three to five years or, in some instances, for the duration of property ownership, although this issue is now more open to negotiation than before. Also, when negotiating the policy terms, it is important to determine whether the policy is assignable and, if not, whether the insurer will reimburse the owner for a portion of the premium in the event the owner sells the property during the policy term.

Focused Comment

Environmental insurance can provide real benefits to owners of contaminated property, especially in light of the number of different types of policies currently on the market and the flexibility we have seen in negotiating with insurance providers. In general, premiums differ depending on the special needs of the insured, the duration of the policy, the nature of the property’s current and historical use, the nature and quantity of the known contaminants and most importantly, in at least some cases, whether the property is part of a larger portfolio.

Within the last year, we have seen a great deal of progress with respect to the quality and breadth of the initial specifications insurance advisors and brokers are presenting to the available carriers and in the responses that have been received to those specifications. In addition, the quality and pricing of the coverages for specific site-related issues have improved. Relevant general examples include how cleanup “orders” from Licensed Site Professionals and their equivalents in privatized waste site clean-up programs are handled, as well as how work performed under a state’s Voluntary Cleanup Program is covered.

The two most useful observations we can provide regarding these policies are that, in some transactional settings, these policies have made the difference in allowing a deal to close and that, for large portfolios, the cost of coverage can be surprisingly low. In both cases, the policies appear to provide real value.

See the resume of H. Edward Abelson: Resume

See the resume of William M. Seuch: Resume

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Last Updated: 5/21/98