Companies have faced explosive growth of their environmental liabilities in recent years as a result of federal regulations promulgated under laws such as the Resource Conservation and Recovery Act (RCRA) and the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).
Any financial, environmental or corporate professional who has ever participated in a large-scale remediation project may have had to learn the hard way that budget forecasts and the actual costs associated with a program seldom align perfectly.
Aon Risk Solutions' Environmental Services Group recently published a report that examines the past, present and future of one strategy companies have used to combat endemic uncertainty in the remediation business: buying insurance. For context, Aon's analysts identified some of the most common reasons why initial budgetary projections tend to fall short of the final cost of a project, including:
- Previously undetected contaminants are often discovered at sites once work begins
- Regulatory updates can impose new requirements after a project has been initiated
- Specific remediation technologies or strategies may not work as expected in the given circumstances
- Interest rates may increase, increasing the cost of financing a project.
The first three issues are extremely common, while the fourth can emerge as a significant problem for any large-scale project that is allowed to drag on for years on end, which can happen as a result of the other events.
Why did cost cap products disappear and why is a 'new generation' emerging now?
Aon noted that, because remediation costs are so difficult to predict in advance, so-called cost cap insurance quickly became very popular when it was introduced. However, as a result of plunging interest rates and the "horrible loss experience" suffered by insurance carriers who offered cost cap products, they essentially disappeared from the marketplace several years ago.
"For a time it appeared that these products would never be revived," Aon asserted. "However, in a highly competitive marketplace in which carriers are seeking to set themselves apart from competitors, two carriers have once again decided to take on the underwriting challenge by offering cost cap insurance coverage. In addition, a third carrier is now offering a form of cost cap or rather a remediation liability loss portfolio transfer product, that serves as an alternative funding mechanism."
The firm cautioned that interested parties should carefully review their options before jumping to purchase any of these new cost cap products. Specifically, Aon explained that "the new cost cap products are different in that they provide a narrower scope of coverage" compared to those from the "first generation."
The insurer warned that stakeholders should be particularly conscious of various "conditions that have been added [to cost cap products] in order to restrict the potential protection provided."
Overview of 'second-generation' cost cap products
According to Aon, AXIS Insurance is now offering an Environmental Remediation Management Policy that is designed to provide liability protection to property owners, developers and other "responsible parties." However, it is "not intended for contractors or consultants."
The insurance product covers:
- Cost overruns related to remediation of known contaminants
- Unexpected costs linked to unknown, pre-existing conditions discovered during the project
- Defense against third-party claims
- Damages arising from negligence.
To be eligible for coverage under this policy, a project must have an approved Remedial Action Work Plan, with projected expenses between $2 million and $25 million. The policy provides protection for a maximum of five years. On the issue of overall project failure, AXIS is reportedly "willing to negotiate specific language to address this risk."
In contrast to the approach taken by AXIS, Beazley's Environmental Cleanup Costs Insurance Policy is solely available to contractors that operate under a Guaranteed Fixed Price Remediation (GFPR) contract practice. Aon noted that the firm considers insuring contractors to be an attractive business model, as they "have a direct interest in successful performance of the project because their profits and reputations are at stake."
Beazley's product provides coverage for costs related to:
- Higher-than-anticipated concentrations or volumes of known pollutants
- Long-than-expected remediation timelines
Addressing a remediation failure or changes in regulatory requirements would require a modification of the policy. Costs related to newly discovered conditions would need to be covered through a companion policy.
Like AXIS, Beazley requires that a project have an approved Remedial Action Work Plan. The firm's policy is open to projects with budgets between $3 million and $10 million and provides coverage for a maximum of 10 years.
Rather than a traditional risk transfer insurance product, Southport Re is offering an "Environmental Liability Indemnification Agreement" that involves the funding of an independent trust with cash or assets from the insurer and the client. The trust would then enter into a contract with a property owner to reimburse it for specified expenses.
This program has several unique features, including the fact that it has no time limit. According to Aon, Southport is "interested primarily in long-term projects that are expected to take 10 years or longer to complete" and "will consider either single-site projects or portfolios of projects." The firm reportedly "has capacity to transact deals with remediation liabilities of up to $250 million."
Southport's solution offers reimbursement for cost overruns caused by:
- Discovery of new contaminants
- Excess volumes of known pollutants
- Changes in regulatory requirements
- Errors or inefficiencies in the remediation plan
Insurance isn't the only way to hedge against unexpected costs
Although cost cap insurance may provide a viable source of stability for some companies with significant environmental liabilities, there are ways to effectively manage costs within the remediation process. Implementing enterprise software that is designed for these complex projects can help prevent budget overruns in the first place by reducing dependency on spreadsheet-based management systems, which often produce costly errors.
Even in cases where stakeholders do purchase cost cap insurance, they will still have a tangible need for the advanced financial and operational planning capabilities provided by enterprise environmental software.
For example, AXIS requires insured parties to submit a "remediation progress report" at least once every 90 days. In the same vein, Beazley requires "cleanup plan status reports." Without the ability to accurately report pertinent data in a timely manner, companies could lose their coverage.
These policies also have payout limits, which means that particularly large cost overruns may not be fully covered by the insurance policy. Also, as Aon noted, stakeholders have their reputation to consider. A high-profile environmental debacle can attract a significant amount of negative media coverage, potentially tarnishing the reputation of the organizations involved.
Enterprise platforms enable stakeholders to manage all aspects of remediation projects more effectively, reducing the cost of program management and facilitating the successful completion of large-scale projects.