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abcd. General Insurance Spring Seminar 19-20 May 2003 Scarman House. Session G (Plenary). Assessing, Managing and Insuring Pollution Risk Dr Simon Johnson Dale Lee (FIA). Introduction and Agenda. The Pollution Problem and How Insurers have been caught Legal Background - UK

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General insurance spring seminar 19 20 may 2003 scarman house

abcd

General Insurance Spring Seminar

19-20 May 2003

Scarman House


Session g plenary

Session G (Plenary)

Assessing, Managing and Insuring Pollution Risk

Dr Simon Johnson

Dale Lee (FIA)


Introduction and agenda
Introduction and Agenda

  • The Pollution Problem and How Insurers have been caught

  • Legal Background - UK

  • Underwriting Practices

  • FRS12 and pollution liabilities

  • Case Studies

  • Summary and Questions



The Pollution Problem

  • Gradual Seepage of pollution into the environment over many years

  • Headline problems such as Love Canal increased public awareness and prompted action

  • In late 1970's claims began to hit premises/operations coverage under Comprehensive General Liability (CGL) policies

  • In USA CERCLA passed in 1980 - 'polluter pays' strict and retro, joint and several liability on PRP's

  • Superfund tax where no PRP or emergency clean up

  • London market hit on excess layers and reinsurance

  • Insurance risk not assessed and legal environment changed


Claim Triggers and Components

  • Triggers - Exposure, Manifestation, Continuous, Injury in Fact - 'All Sums'

  • Remediation costs - Design and implementation of (normally) long term clean up scheme. NB - scheme could fail

  • Third party bodily injury and property damage

  • Defence costs. Primary policies often costs in addition with 'duty to defend'.

  • Coverage disputes leading to Declaratory Judgement (DJ) costs


Insurance Market Reactions

  • Do not write pollution business - absolute pollution exclusions - most common reaction

  • Design a separate new policy to cover pollution risk - i.e. a new insurance product

    • Consult experts to understand the risk technically and legally - each site is unique

    • Assess the risk financially

    • Historical - Ongoing differentiation

      • Pollution present as at date of inception - historical risk

      • Pollution deposited after date of inception - operational risk

      • Clear policy wordings - claims made clear triggers



Uk environmental legislation
UK Environmental Legislation

  • Some key dates:

    • Upto 1990

      • miscellaneous Acts e.g, Alkali Act & Public Health

      • Statutory Nuisance etc.

    • Environmental Protection Act 1990 (EPA)

    • Environment Act 1995

    • Implementation of Part IIA of EPA 1990 in April 2000

    • 2003+ - influence and impact of ‘new’ EU Regulations


Framework of Contaminated Land Law in England & Wales

EU Draft Directiveon Environmental Liability

Historical

Contamination

Part IIA EPA

Waste Management

Part II EPA

Redevelopment

(Change of Use)

T&CPA 1990

Water

Pollution

WIA 1991

WRA 1991

(Amendments due)

Industrial

Activities

Part I EPA

(PPCA 1999)

Civil

Liability &

Human Rights

Act


Contaminated land a lawyer s definition
Contaminated Land - A Lawyer’s Definition

“Land which appears to the Local Authority to be “contaminated” because:

1. Significant Harm is being caused or there is a significant possibility of such harm being caused; or

2. Pollution of controlled waters is being or is likely to be caused


Part iia epa 1990
Part IIA EPA 1990

  • First time Contaminated Land has been specifically legislated

    • Remediation Notice served on ‘Appropriate Person’

    • Appropriate Persons fall in two categories

    • Class A - Caused or Knowingly Permitted

      If no Class A can be found then

    • Class B - Current owner/occupier

  • Complex rules for exclusion and allocation of liabilities

  • Few Sites Classified (so far) - about 50



Underwriting philosophy
Underwriting Philosophy

  • Gradual Pollution risks

    • experience rating - site specific assessment

    • use of experienced qualified environmental professionals

    • information intensive - adherence to industry good practice

    • site specific consequence analysis

    • assumed maximum event probability over policy period


Environmental policies
Environmental Policies

  • EIL - new and old gradual and sudden and accidental pollution conditions

  • CLI/PLL/PARLL - site specific contaminated land insurance (some new as well as old pollution conditons)

  • CPL - Contractors Pollution Liability

  • Cost-Cap/Stop-Loss - for clean-up schemes

  • Property Portfolio and secured lenders


Policy cover triggers cli
Policy Cover & Triggers (CLI)

  • Claims made Policy

    • typically up to 10/12-years

  • Policy responds to:

    • Notice under Part IIA of EPA 1990

    • any other Regulatory or third party notice alleging liability

  • Policy indemnifies insureds against:

    • Regulatory liability - clean-up costs (including own site)

    • Third Party liability - including bodily injury

    • Legal and Technical Defence costs

    • Loss of rent receivable/Business Interruption


Risk Assessment - Sources, Pathways and Receptors

From ICE Design and Practice Guide - Contaminated Land 1994


Is land contaminated
Is Land Contaminated?

  • Published guideline levels

    • background levels

    • target levels

    • intervention levels

  • Quantitative Risk Assessment

    • RBCA - partly quantitative

    • models - e.g. Risc Human, CLEA, etc.


Common contaminants of concern
Common Contaminants of Concern

  • Organic materials

    • fuel oil, petrol, diesel, tars, phenols

    • solvents e.g. TCE

  • Metals

    • e.g. lead, arsenic, mercury

    • coper, chromium, nickel, zinc

  • Others

    • PCBs, pesticides, dioxins/furans, cyanide, corosives


Information and documentation
Information and Documentation

  • Phase 1: Desk Study

    • hazard identification (potential for contamination)

  • Phase 2: Site Investigation

    • intrusive sampling, testing and analysis

    • risk evaluation

  • Phase 3: Remediation

    • design of remedial startegy, setting objectives

    • remedial works

    • validation


Known contamination long term risk
Known Contamination - Long-term Risk

  • Missed Hot Spots

    • require both a pathway and receptor - low risk /cost events

  • Residual concentrations

    • residual levels recorded, land assessed (risk) as suitable for specified use in the insurance contract

    • principal sources removed, reduced at clean-up

    • residual levels and risk of contamination for many common contaminants should reduce with time

    • low probability of retrospective clean-up being required

    • can re-assess suitability for use

    • any residual contamination requires pathway and receptor to complete the pollutant linkage


Unknown contamination long term risk
Unknown Contamination - Long term risk

  • Unknown, unidentified and unexpected

  • Identificati post-inception of insurance unlikely:

    • expert assessment minimises unknown risk

    • re-development risk excluded

    • no known problems to date (many sites have been in a contaminated condition for many years)

  • Unknown contamination risk - low as most investigations test for a wide range of expected or possible contaminants


Approaches to remedial action
Approaches to Remedial Action

  • The Source e.g. removal, treatment or neutralsation

  • The Pathway e.g. interception or removal

  • The Receptor e.g. modification or removal

    Most remediation schemes address either the Source and/or the Pathway



Introduction to frs12
Introduction to FRS12

  • New accounting standard effective for accounting periods ending on or after 23 March 1999

  • Specific guidance on when / how to set up provisions

  • Potential for major impact on the balance sheets of many companies : some additional provisions likely to be required; some existing provisions may be disallowed

  • Extensive disclosure requirements

  • Specific relevance to companies with contaminated land and other pollution liabilities and exposure


Frs 12 provisions
FRS 12 Provisions

A provision should ONLY be recognised when:

  • An entity has a present obligation (legal or constructive) as a result of a past event (an “obligating event”); and

  • it is probable (more likely than not) that a transfer of economic benefits will be required to settle the obligation; and

  • a reliable estimate can be made of the amount of the obligation (extremely rare that this is not the case) - but may be difficult where costs are volatile


The obligating event
The Obligating Event

Key points:

  • Constructive obligation arises where the event creates valid expectations in other parties ( through an established pattern of past practices, published policies etc) that the obligation will be discharged

  • No provision allowed for costs required for futureoperations i.e. the past event must exist independently of an entity’s future actions

  • Changes in law or public company announcements may create an obligation that did not previously exist. Trigger point for new law is when enactment is “virtually certain”


FRS12 Insurance

  • FRS12 provides insurance opportunities

  • Long term protection against:

    • Inadequate provisions

    • Emergence of contingent liabilities as FRS12 provisions in future

    • Other liabilities

  • Insurance provides support to long term management of balance sheet provision over time


FRS12 Case Study

  • UK chemical company purchased a US company with a polluted site

  • Site requires long term management of pollution problem

  • Clean-up costs represent a balance sheet provision

  • Company wanted to control provision over time

  • Detailed environmental consultant reports including initial cost estimates and annual cost estimates for planned activities

  • Consultants reports used to build a model of costs during the policy period


FRS12 Case Study continued

  • Likelihoods, timing and amounts modelled to give a distribution of the cost of the liability

  • Long term real rates of investment return modelled using Vasiceck model based on historical investment data

  • Deductible adjusted annually - a key feature

  • Deductible can be set at e.g. 80%, 100%, 150% of the provision

  • Client set deductible at confidence level at which prefer to retain risk

  • Pricing provides for premium structure - risk premium, capital loading, expenses, investment risk

  • Client benefits from valuation control over time



Case studies1
Case Studies

1. US Inward Investor

2. Regeneration: Cokeworks

3. Former Industrial Site

4. Retail Development

5. Retail Portfolio

6. European Chemicals Company


Case 1 american inward investor
Case 1 - American Inward Investor

  • Distribution Depot

  • US investor

  • UK FTSE 350 vendor

  • £7.5m Indemnity by vendor - 12 years

  • Contamination risks

  • Legal exposure

  • Solution : Indemnity back to back Risk Transfer


Case 2 regeneration cokeworks
Case 2 - Regeneration: Cokeworks

  • Setting: Former colliery/cokeworks

  • Objectives: Regeneration of site to produce a development platform for light industry. Remediation involved excavation and disposal on-site into a number of engineered cells leaving the rest of the site ‘clean’.

  • Problem: Need to provide protection to future site owner against failure of engineered cells. Area of cells to be subjet to monitoring but otherwise used as managed public open space.

    Solution: a long-term bespoke transferable environmental insurance policy for the current owner


Case study 3 former industrial site
Case Study 3 - Former Industrial site

  • Setting: Site cleared but residual contamination from fill materials across site plus hotspots. Fill heavily contaminated with metals, hot-spots of hydrocarbons.

  • Problem: Proposed redevelopment for warehousing and distribution. Remediation of hot spots plus encapsulation (engineered cover) of fill. Residual contamination from fill and any ‘missed’ hot-spots.

  • Deal Driver: Transfer of liability. Funding requirement. Deal stalled.

    Solution: Environmental Insurance to protect ‘new’ owner having bought with information and facilitate the deal and allowed ‘new’ owner to obtain institutional funding


Case study 4 retail development
Case Study 4: Retail Development

  • Setting:Former gasworks site - South of England Town Centre. Non-food and food retail development, multiple occupancy.

  • Problem: Residual contamination both known and unknown in a highly sensitive groundwater environment.

  • Deal Driver: Indemnity required of purchaser from seller (and original polluter). Residual liability as new owner/occupier.

    Solution: Bespoke Environmental Insurance covering the Indemnity risk as well as the liability of the new owner. 12-year policy, £5m Limit of Indemnity


Case study 5 retail portfolio
Case Study 5: Retail Portfolio

  • Setting: Portfolio of both in-town and out-of-town retail outlets across the UK.

  • Problem: potential exposure to environmental liabilities, particularly on older sites and out-of-town sites on remediated brownfield land.

  • Driver: Protection of asset value; corporate governance; corporate reputation; and balance sheet protection.

    Solution: Bespoke Portfolio Environmental Insurance for a 3-year fixed term allowing new properties subject to agreed due diligence to be added automatically to the policy


Case Study 6: Chemical Plant

  • International chemical company selling a business in Germany

  • Located on large polluted industrial complex with numerous other businesses

  • Transaction involved sale of factory

  • Site ownership remained with client

  • Client was contributing to on-going clean up costs across the whole complex

  • Under Sale and Purchase Agreement Client retained liability for long term environmental exposures

  • Client required professional valuation of liabilities for tax purposes


Case Study: Chemical plant (2)

  • Client is exposed to the following liabilities

    • Clean up costs arising from buyer choosing to increase the capacity of the business

    • Business interruption costs arising from increasing capacity of the business

    • Volatility of client contributions to scheme costs including increases arising from insolvency of other contributers

    • Failure of buyer to meet financial obligations as specified in the Sale and Purchase Agreement

    • Client's contingent liabilties under the Sale and Purchase Agreement


Case Study: Chemical plant (3)

  • Provision was assessed using a model of the exposures including:

    • Volatility of long term clean-up costs

    • Economic factors

    • Credit risk of other businesses on the complex

  • Added Value to client approximately E20m


Summary
Summary

  • Insurers have been caught in the past as the pollution risks were not assessed on a site or project specific basis and by experts

  • Uncertainty about contaminated land liabilities and exposure gives rise to unacceptable risks to companies, organisations and individuals - change of law and risk perception

  • Risk Management is key to maximising environmental and pollution opportunities

  • Aim to maximise value and minimise long-term environmental exposure

  • A multi-disciplinary strategic management approach is recommended, using technical, legal, financial, insurance and commercial management skills

  • Effective Risk Management requires broad Environmental Consultancy and Insurance Service support


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