Environmental Insurance Insuring the Deal

Once considered a special luxury for regulated industries, the environmental insurance market has broken out of its “niche” to provide pollution coverages totaling nearly US$900 million in annual gross written premiums, with an estimated US$1 billion in premiums still to be written. More importantly, a growing number of policies available in the market today are being used more frequently to facilitate deals that many businesses would have walked away from in the past.

Location, location & location

Here is where insurance is playing a key role in protecting all parties involved in such real estate transactions. Selling and reusing any formerly used property, whether it be a former factory, steel mill, gas station or shopping mall, was hindered by that possibility and all the expense and hassle of properly dealing with it. Having a mechanism, however, to handle potential environmental liability that may crop up now and in the future is an important tool when attracting buyers, investors and tenants. For instance, the use of environmental insurance provides reassurance to potential buyers by eliminating or reducing the uncertainty surrounding the property.

In its traditional role, environmental insurance provides a financial cushion if an environmental incident occurs. A low annual premium for environmental insurance is certainly more attractive than a five or six figure cleanup expense, which diverts money that could have benefited a development project elsewhere. Without financial protection for unforeseen expenses, a project could reach a stalemate and remain that way until cleanup expenses become available.

The use and availability of environmental insurance has helped spur activities in property redevelopment, such as the reuse of “brownfields”, abandoned properties tarnished by some degree of contamination, in both the U.S. and Canada. As activity in this market has increased, the insurance industry has responded by developing new insurance programs to fill the vacuum that has stymied growth in the redevelopment of potentially contaminated properties. Realizing the unique needs of participants in brownfield projects, insurers have responded by creating custom insurance packages uniquely designed to address these issues.

Environmental coverages are now available to insure every party and every aspect of various real estate redevelopment projects, property transfers or sales transactions, including contractors, developers, subcontractors, financial institutions, and future buyers. Without some kind of protection, these groups were often understandably hesitant to undertake a project that involves known environmental contamination and, more importantly, the risk of unknown pollutants. Any one group, therefore, could impede the deal from moving forward. Common environmental insurance programs used in these situations include:

Pollution and Remediation Legal Liability (PARLL) policy provides coverage for on-site and off-site losses, remediation expense and legal defence expense under one policy for sudden and gradual pollution conditions at or from covered locations.

Commercial Property Redevelopment Pollution Policy (CPR) serves the needs of all parties involved in transfer or redevelopment of contaminated sites. The policy provides both first and third party coverage, as well as Remediation Stop Loss coverage, to any eligible property located in the United States or Canada. This coverage can be written for an individual site or a portfolio of properties.

Remediation Stop Loss Programs (RSL) provide protection against cost overruns resulting from scheduled remedial activities.

M&A issues

Now consider the use of environmental insurance in the buying, selling or merging of businesses. Just as environmental liabilities were well-known deal breakers in individual real estate transactions, they have also been known to set up roadblocks in merger and acquisition activities. Many businesses have their work cut out for them when handling their own environmental issues, much less taking on another business’ environmental liability. Buyers want to be assured that they cannot be held liable for pollution conditions that resulted from a business years ago.

For instance, in 2000, when steel giant Ispat International N.V., based in the Netherlands, purchased Inland Steel Company, with operations in the U.S., Canada and several other countries, the acquisition included a US$90 million environmental insurance policy provided by Inland Steel Industries, the parent company of the purchased subsidiary, as part of the closing conditions. Similarly, when U.S.-based The United Companies, which is involved in a wide range of enterprises, sought to sell off a mining-supply division and purchase a roofing-supply company, it purchased a US$4 million pollution insurance policy. The single policy transferred the environmental liabilities of both the mining operation it was selling and the roofing company that it was acquiring.

Environmental insurance providers are recognized for their flexibility in writing coverages for transactional business. Often an acquisition or business merger encompasses multiple and varied facilities in a number of different locations. For that reason, pollution insurance policies are underwritten specifically to accommodate the environmental concerns of the individual transaction. As in real estate transactions, the most widely purchased insurance programs used in m&a transactions are the PARLL policy and the RSL policy. Enhancements or endorsements can be attached to the standard PARLL policy to address issues of indoor air quality, underground storage tanks, use of incinerators, concern for air emissions, asbestos, or lead paint as well as to provide coverage for illegal dumping or the contingent liability of subcontracted waste haulers.

Insurance innovation

The insurance programs designed in some merger and acquisition deals are as innovative as the overall transactions themselves. For instance, there was a recent purchase of 12 bulk storage facilities and four propane distribution centers by a power utility. The utility was acquiring the facilities from a petroleum distributor which, following its owner’s death, was selling off its assets. While the facilities were an attractive buy for the utility, the sites required US$10 million in cleanup. That was liability the buyer certainly did not want to assume. Therefore, the utility suggested that the seller place US$10 million in escrow to assure availability of the money for the cleanup so that nothing would be paid out of the utility’s pocket. Anxious to sell the property, rid itself of any liability associated with it, and liquidate the company’s assets in a timely manner, the seller purchased a finite risk program that combined an insurance policy with a funding mechanism for known and unknown environmental liabilities. The insurance policy, with a US$75 million liability limit, was comprehensive and protected the seller and buyer against any future claims. It offered several kinds of insurance coverage under one policy, including first and third-party coverage for on-site and off-site bodily injury, property damage, remediation expense and legal defense, as well as “remediation stop loss” coverage to help cap the costs of known cleanup activities.

Then, instead of restricting US$10 million in an escrow fund as the buyer originally requested, the seller set aside US$4 million in a fund to start paying for the site’s remediation. The seller’s insurance provider took on the responsibility of overseeing the US$4 million dollar fund, from which it will pay expenses toward the remediation of the distributor’s properties for its new buyer. The additional US$6 million of the anticipated US$10 million cleanup expenses was “fronted” by the insurance provider. The insurance provider will work to collect the additional money from the seller’s existing insurance policy and from an established fund to help Underground Storage Tank (UST) owners to pay the cost of cleanup, remediation and third-party damages.

In a recent Wall Street Jo urnal column on the hottest mergers, Harvard University professor of finance Samuel Hayes was quoted as saying, “whenever you buy another firm, you’re buying a pig in a poke, you never know what you’re buying until you open the bag and see the animal”.

While no business jumps into merging with another company, or any business transaction for that matter, without careful scrutiny, the professor’s words ring very true. Once a business has seen the nature of the “animal” it has bought, is it prepared for it?

The good news is that insurance providers are meeting that challenge by designing solutions to meet the specific needs of each individual transaction. The end result is leaving many businesses sitting comfortably in lucrative business deals.