Environmental Insurance Can Address Liability Problems If Businesses Lay the Groundwork

Since federal statutes governing liability for environmental contamination were passed some 20 years ago, concerns about environmental liabilities have derailed many business transactions, and the magnitude and uncertainty of potential environmental liabilities and claims have challenged corporate planners.

More often than not, insurance companies have refused to pay environmental claims under comprehensive general liability (CGL) policies, which has led to lawsuits in which billions of dollars have been and are still under dispute.

Insurance companies have, however, begun offering policies that give businesses a way to address liability for environmental cleanup. The complexity of environmental issues and the sheer size of the liabilities involved make these insurance policies different from off-the-shelf products. Before buying an environmental liability policy, a business should:

  • Clearly identify the risks it wants to cover;

  • Have a good grasp of the history of the site or sites and the technical issues relating to contamination and remediation; and

  • Rely on someone familiar with insurance coverage, environmental law and the vast body of case law that has developed in the wake of the Superfund Act (CERCLA) to negotiate the terms of the policy.

    If a business fails to take these preparatory steps, the policy it purchases may turn out not to provide the coverage it expects.

    Policies Fall Into Two Categories

    The new environmental insurance policies fall into two broad categories:

  • Cost-cap policies typically provide coverage when a claim requiring the insured to incur cleanup costs has already been made. These policies usually cover cost overruns and other cost increases resulting from unexpected factors (for example, a change in the law or the failure of a remedy) up to a limit beyond a self-insured retention.

  • Pollution legal liability policies typically provide coverage for a broader range of environmental exposures, provided that claims are first made during the policy period.

    Here are some examples of situations in which these environmental liability policies have proven effective:

  • Capping CERCLA Liability. The former owner/operator of a manufacturing facility with large environmental liabilities under CERCLA wanted to cap its exposure and reduce unknown liabilities for planning and balance sheet reasons. It was the only potentially responsible party (PRP) that was solvent and available to fund the cleanup.

  • Buying Facilities With Environ-mental Problems. A business was interested in purchasing a facility with environmental liabilities. It did not, however, wish to obligate itself to unknown future environmental costs and did not feel that standard indemnity and liability-shifting contract provisions would be effective.

  • Selling Contaminated Property. A company was interested in selling an environmentally contaminated site but was unwilling to establish enormous escrow funds to cover future unknown environmental liabilities.

  • Providing Settlement Protection. The PRPs at a Superfund site wished to enter into a final settlement agreement even though there remained substantial potential cleanup costs that had not yet been fully quantified.

    Negotiating Environmental Liability Coverage

    It is impossible to give an exhaustive list of all issues that may arise in negotiating environmental liability coverage; each insured and each site will have specific issues to be addressed. Some of the most common issues are:

  • What risks do you want to insure? To negotiate coverage successfully, you must identify the risks you want to insure. Once these risks are identified, you and your attorney need to review the policy carefully to determine whether the risks come within at least one of the coverage sections and to ensure that they do not come within any of the exclusions from coverage. In performing this analysis, pay particular attention not only to the coverage grants and the exclusions, but also to the definition section of the policy since terms may not have their commonly understood meaning.

  • Is cost-cap insurance appropriate? Cost-cap insurance is most frequently used when there is already a remedy selected for the site. However, if there is enough information available for the insurer to underwrite the risk, it is possible to get cost-cap insurance even before remedy selection. If you know you will be undertaking a cleanup and you want to limit your exposure, cost-cap insurance is worth considering. If you want to insure against both the increased costs of a cleanup and possible future claims, consider a combined cost-cap/PLL policy.

  • How much risk are you willing to retain? The higher your deductible or self-insured retention, the lower your premium will be. If your main concern is catastrophe exposure and not cost overruns, consider insuring above a high self-insured retention to reduce your premium. Similarly, your premium will decrease if you agree to some co-insurance, whereby you pay a percentage of the otherwise covered costs, since this gives the insurer some assurance that you will use your best efforts to control cleanup costs. If you are willing to co-insure but want to limit your exposure, you may be able to negotiate a cap on the amount of your co-insurance.

  • Will claims made during the policy period be "claims first made?" If you are considering PLL coverage, which typically provides insurance only for claims first made during the policy period, be certain that there are no existing claims that will preclude coverage. If there is something, such as a PRP letter that could be considered an existing claim, you will need to negotiate policy language or endorsements to ensure that coverage will exist if a more specific claim is made in the future.

  • What policy period is appropriate? Unlike a typical commercial general liability (CGL) policy, cost-cap and PLL policies often have a relatively long term, such as 5, 10 or even 15 years. For cost-cap coverage, costs must be incurred during the policy period. To give a very simple example, if you expect a cleanup to cost $20 million and take five years, but you are concerned that delays may increase the cost of the cleanup and want to insure for any increased costs, a five-year policy is unlikely to provide you any coverage for that risk. For PLL coverage, you need to consider when any claims are likely to be made for the risks that you want to insure.

  • How much will the policy cost? It is difficult, if not impossible, for the insured to predict how much an extra $20 million or $100 million in coverage will cost or how much it will save by increasing its self-insured retention for at least two reasons:

    1. The insurer evaluates the risks differently than the insured does; and

    2. Particularly on big risks, the re-insurance market may heavily influence the price of the policy.

    To determine the most cost-effective and appropriate coverage, get several premium quotations from each insurer for different levels of coverage and self-insured retentions.

    The new environmental insurance products offer great opportunities to address difficult problems. With sufficient planning and caution, they can be very powerful tools in controlling corporate exposure, settling the seemingly unsettleable claim or closing a difficult transaction.