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March 31, 2005. Financial Market Solutions for Environmental Risk Management University of Toronto. Managing Environmental Risk. Why Environmental Risks are Financial Risks Main Types of Environmental Risks Managing Environmental Risk Using Insurance Evolving Risk Transfer Solutions.

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Financial Market Solutions for Environmental Risk Management University of Toronto

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    1. March 31, 2005 Financial Market Solutions for Environmental Risk ManagementUniversity of Toronto

    2. Managing Environmental Risk • Why Environmental Risks are Financial Risks • Main Types of Environmental Risks • Managing Environmental Risk Using Insurance • Evolving Risk Transfer Solutions

    3. Why Environmental Risks are Financial Risks • Increased pressure on companies, specifically Directors and Officers, to report on their significant liabilities (e.g. Sarbanes-Oxley et al) • Increased pressure to identify and quantify environmental liabilities and to disclose this information in financial statements • Increased costs associated with the regulation of activities that can affect the environment • Often difficult to obtain financing on sites/operations that have environmental liabilities (actual/potential) • Reputational issues can affect demand for stock

    4. Main Types of Environmental Risks • Legacy Exposures • Resulting largely from past operations, mergers/acquisitions/divestitures • Operational Exposures • Risks associated with day-to-day operations • Include operation & maintenance, products, waste-disposal activities, and compliance with local, Provincial, Federal environmental rules and regulations • Strategic Exposures • Effect of environmental issues on corporate reputation • Effects of changes in regulations and treaties (Kyoto) Conclusion: • Unmanaged Enviromental Risk can slowly undermine a company’s financial stability • Companies that manage their environmental risks can create competitive advantage

    5. Managing Environmental Risk • Identify and Assess Risks • Due diligence (site assessment/audits, etc) • Risk Mapping • Avoid Risks • Change process or don’t buy site/operation • Manage Risks • Develop appropriate Environmental Management System (e.g. ISO 14001) • Transfer Risks • Insurance and alternate risk financing

    6. Managing Environmental Risk Using Insurance • Back up/substitute for /augment indemnity • Bring certainty to known cleanup costs • Transfer risks of unknown, pre-existing contamination and new contamination • Transfer risks of 3rd party liability • Provide an environmental cleanup “warranty” • Transfer risk associated with cleanup process • Transfer risk associated with financing site/operations

    7. Main Types of Environmental Insurance • Environmental Impairment Liability (EIL) • Also known as Pollution Legal Liability (PLL) • Contractors Pollution Liability (CPL) • Cleanup Cost Cap (also known as Remediation Stop Loss) • Blended Finite Risk Transfer • Combination of pre-payment for known/expected liabilities and risk transfer for unknowns and cost overuns • Lender Environmental Insurance (so called “Secured Creditor”)

    8. Pollution Legal Liability (“PLL”) • Primary coverage -- on- and off-site: • Third-party claims for bodily injury • Third-party claims for property damage • First- and third-party cleanup costs for unknown pre-existing environmental conditions • First- and third-party cleanup costs for new environmental conditions • Defense costs triggered by pollution conditions • Environmental exposures related to owned transportation, vendor transportation, business interuption and non-owned disposal sites ↓ Reliable Risk Management Tool That Covers Third-Party Liabilities

    9. Cleanup Cost Cap (“CCC”) • Protection from cost overruns associated with a remediation project • Offsite cleanup costs adjacent to the covered site • Other unknown contamination found during remediation • Increased cost of remediation due to change in regulations during project • Turns an unknown liability into a manageable, defined number • Policy responds when remediation expenses exceed an agreed-upon cost (Self Insured Retention) • Underwriters review environmental studies and remediation design reports ↓ Manages the Economic Risk When Environmental Remediation Exceeds the Projected Costs

    10. Premium Variables • Limit of Liability Purchased • Self-insured Retention Level • Expected Remedial Costs / Stage of Remediation • Future Site Use and Surrounding Occupancies • Variability of Risk (Severity / Frequency) • Competition between Insurers • Level of Characterization (i.e. the more data the better - as long as it’s understandable!)

    11. “Secured Creditor” or Lender Environmental Insurance • Policy purchased by the lender • Pays for the lesser of loan balance or clean up • Dual Trigger - combination of a default and an environmental condition. • Protects the lender from 3rd party bodily injury, property damage, and cleanup claims resulting from on and off site pollution conditions. • Provides coverage for 1st party claims for on and offsite cleanup costs if the insured has foreclosed on the property. • Third party or discovery trigger.

    12. Who Writes This Coverage? The Insurance Markets: AIG Environmental XL Environmental Chubb Zurich Environmental ACE INA Liberty Elliots Special Risk Term: Up to 10 Years Single site, multi site, portfolio Limits:Up to 150mm

    13. Evolving Risk Transfer Solutions • Use of Finite Risk Transfer as part of Financial Assurance requirements: • mine reclamation obligations; • landfill site closure/post-closure obligations; • Financial assurance related to cleanup orders • Substitute for escrow and/or back-up indemnity on transactions with identified environmental liabilities • Use of Risk Transfer to manage risks associated with greenhouse gas emission reduction projects/investments

    14. Attractive for long-term clean-ups and long-term operation & maintenance Takes advantage of discounted present value dollars Ensures funding is available for clean-up Incorporates all benefits of PLL & CCC May have tax advantages* Unspent monies may be refunded Option: Insured Fixed-Price Cleanup Blended Finite Risk Programs “Pre-funded” liabilities with Cost Cap and Pollution Legal Liability Cost Overrun Coverage for “Knowns” $25M “UnknownLiabilities” Coverage $25M e.g., 20 yrs. Estimated clean-up costs $25M Deductible $25M pre-funded with insurance carrier, @ discounted present value * Depending upon facts and circumstances, certain tax or accounting benefits may be associated with this product. Organizations should consult with their tax, accounting and legal advisors to determine whether such benefits would be applicable.

    15. GHG Reduction Project Risks Issue of Carbon Credits ROC’s Carbon Assessment Carbon Transaction Validation & Registration Verification & Certification Feasibility Assessment/ Financing Project Implementation / Commissioning Construction / Erection Permit Delivery Project Design *Potential Risk Existence Credit Risk Permit Quantity Risk Verification Risk Counterparty Risk Technology / Efficacy Risk Business Interruption Natural Peril Permit Price Volatility Risk Political Risk Carbon Related Project Cycle * It should be noted that many of the above risks may exist individually or in combination throughout the project cycle Conventional Project Cycle Project cycle

    16. Existing Insurance Solutions • Property Damage and Business Interruption (BI) • Contractors all risks and Advanced Loss of Profits (ALOP) • Efficacy or Performance guarantees for technology failure / machinery breakdown • Environmental Impairment Liabilities • Credit and Trade Credit • Political All can be extended to include GHG related activities and revenues but singly do not provide protection against the non delivery or shortfall of permits

    17. Emission Permit Delivery Guarantee Concept TRADE – Immediate Settlement ($10/tCO2e) Potential Forward Transaction Carbon Transaction Validation & registration Carbon Assessment Issue of Carbon Credits ROC’s Project implementation/ Commissioning Feasibility Assessment /Financing Construction/ Erection Surplus Credits Verification & certification Permit Delivery Guarantee Emission Reduction Project Credit / Counterparty Risk Political Risks Hazard Risk Delivery uncertainty Discounted carbon price $2tCO2e* Permit delivery/volume uncertainty Added value $8 t/CO2e* Audit error & omission Business Interruption Technology / Efficacy Risk Permit Price Risk Insurance Wrap It should be noted that many of the above risks may exist throughout the project cycle. *For a trade of nominal value $10 /tCO2e

    18. Who is buying Environmental Insurance • Real Estate owners/managers (e.g. REITs, Pension Funds, Property Management) • Manufacturing Companies • Brownfield sellers/purchasers • Lenders (or their borrowers) • Contractors and Consultants • Mining Companies • Waste Management Companies

    19. Questions? George Boire VP, Environmental Solutions Marsh Canada Limited 416-868-7015