Contractors Pollution Liability Update

October 2007

Contractors pollution liability (CPL) is a contractor-based policy, offered on a claims-made or occurrence basis, that provides third-party coverage for bodily injury, property damage, defense, and cleanup as a result of pollution conditions (sudden/accidental and gradual) arising from contracting operations performed by or on behalf of the contractor.

by Jeff Slivka and Tony Polini
New Day Underwriting Managers

CPL is available to any type of contractor performing operations or conducting work. From environmental or remedial contractors to general and specialty trades, CPL has become a viable financing option for environmental loss providing insurance for large or even catastrophic loss scenarios at a reasonable premium.

Policies can be offered on a project or blanket program basis. Project policies provide coverage for all operations performed by the insured during the construction period and can include "tail" coverage (extended reporting period or ERP for claims made policies and completed operations for occurrence policies) to address the statutes of repose in many states or other contractual requirements. Usually a maximum term of 10 years is offered. Additionally, wrap-up programs can be implemented to afford coverage for all contractors regardless of activity undertaken (environmental or nonenvironmental) on a specific project. A blanket program provides coverage on an annual basis for all defined covered operations taking place during the policy term.

Marketplace

In 2006, CPL comprised approximately 30 to 40 percent of the entire environmental insurance marketplace which is estimated at $2 billion in annual premiums. There are approximately 20 insurers offering various forms of CPL coverage. Some insurers have forms specific to nonenvironmental contractors such as general contractors and specialty trades and other forms specific to environmental contractors. It is estimated that these 20 insurers offer 30 to 40 different products all on unique company forms—vastly different endorsements, definitions, exclusions, etc. This lends to the difficulty in many insurance professionals with understanding the marketplace and, more importantly, coverage intent.

Several markets offer online CPL programs. These platforms offer lower premium and reduced retention for smaller companies (usually under $5 million in revenue). Access to these programs requires completion of qualifying documentation. Once completed and favorably reviewed, an applicant (broker/producer) will receive access to the system via a password entry point. The broker/producer can access the system on an insured's behalf and answer the application questions. Once the application is completed the system—if the risk is acceptable—will provide limits and terms. The policy can be purchased and bound through the system. The limitation of these systems is the relatively low revenue threshold, single form coverage and the need to satisfy all questions favorably. Any negative answer often negates the whole transaction. These platforms are efficient and provide simple access to basic programs.

Market appetite remains strong with the core risk classes such as:

• General contractors
• Trade contractors
• Artisans or specialty trades

Each market has its own tolerance for higher risk activity, i.e., mold, asbestos, silica and other specific contaminants.

Capacity

During 2006, the capacity available for CPL continued to exceed $300 million; with the most any one insurer can offer remaining at $50 million. The major insurers continue to have access to the reinsurance marketplace for facultative capacity above the $50 million.

A question that is often asked of brokers by their clients is what limits should be purchased when considering CPL coverage. The matrix presented in Table 1 provides a guideline for discussion with the contractors. The variables needed to be considered are: types of structures, geography, experience level, and risk appetite.

Table 1: Guidelines for Purchase of CPL Coverage

Medium to larger size contractors typically take higher retentions, $100,000 each loss or $250,000 each loss to offset the cost of the higher limits. This tracks with the logic in purchasing CPL, that it is a catastrophic coverage, and to insure for the claim that will have the potential to threaten the existence of the organization.

Retentions

Retentions continue to start at $5,000. CPL insurers offer both self-insured retentions and deductibles. Typically deductibles have to be negotiated prior to policy inception. Size of the actual retention will depend on the insurer and the financial strength of the insured.

Premiums

Typical minimum premiums begin around $10,000 for the $1 million per loss/$1 million aggregate limit of liability. However, online programs have minimum premiums as low as $2,500.

Buying Motivators

The buying motivators for CPL typically fall into three categories: contractual requirement, asset protection, and loss events.

Contractual requirements have always been and continue to be the primary driver for an entity looking into the purchase of a CPL program. Contractual requirements can appear in virtually any contract. Often these requirements are generic and unclear, and are drafted as part of a standard insurance package. This language should be carefully reviewed to determine true intent of requested coverage. Contractual requirements should address these basic items:

• Clearly request a contractor based program
• Blanket versus project policy (Is a dedicated limit required?)
• Define limits, retention and term and any unique needs
• Define the term of any tail coverage

In some cases these requirements can be negotiated out of the contract if an entity demonstrates its services pose no significant potential for an environmental incident. However, all construction activity has the potential for triggering an environmental incident, and to that end, the owner/general contractor may make these requirements absolute and apply to all parties involved in a project. In this scenario, a wrap-up program may be an option because it affords coverage for all entities involved on a simple and cost efficient basis.

Many firms believe that the first step in addressing CPL coverage requirements in contracts is to negotiate them out of the contract. While this may be prudent in some cases, negotiating the requirement out of the contract may actually be exposing the firm to greater risk without a loss financing tool in place. Every project needs to be assessed for potential risk because even if the scope of work does not include remediation or other environmental work, there may be environmental exposures and therefore, a need for CPL coverage.

Many contractors are buying CPL as basic asset protection. As with any program, if this is the buying motivator, scope of coverage should be the driver of the coverage. Even experienced brokers often have limited expertise with regard to environmental liability. Brokers routinely discuss this coverage in general terms with their clients; however, the focus should be to assess the overall need and research the market to procure the optimal solution for the company's exposures. For current purchasers of environmental insurance the challenge is to maintain the continuity in the optimal program. The environmental marketplace is very dynamic and changes quickly in comparison to the standard commercial general liability (CGL) and workers compensation (WC) markets. Once the appropriate coverage is purchased, the daily business activity must be monitored so that it is concurrent with the current insurance program. Often market appetite changes during the policy term and such changes must be negotiated upon program renewal. Failure to stay on top of these market changes may result in an inadequate program.

Loss events or potential loss events serve as a motivator to purchase any insurance and are an especially good driver for environmental insurance. Most environmental coverages provide catastrophic coverage, for infrequent but significant claims. The inherent value of an environmental program lies in having insured a catastrophic event and the legal defense provided by the policy. Providing coverage for defense costs alone may save a company involved in an environmental claim from financial ruin. Virtually all CGL polices contain an absolute pollution exclusion and claims may be excluded or denied, leaving the firm to face an uninsured loss. An example of the type of loss event that has affected the insurance world over the past several years is mold or fungus liability. Many organizations in the construction industry have been exposed to such events, which can lead an organization to consider the purchase of CPL coverage to finance against loss.

Policy Terms

Most insurers will only provide a total term (construction period and ERP/completed operations) of 10 years for project policies. Some insurers may offer higher terms up to 13 years depending on the state and project types. Blanket programs are commonly written on an annual term; however, some markets have begun offering multi-year programs. While the multiyear option tends to be cost effective, premiums for the full multiyear are required to be paid in the first 30 days, and limits are typically not reinstated. This trend will continue.

Rate Adjustments

Rates are generally flat to decreasing in the market and we expect to see no changes for the upcoming year. Existing business (current purchasers) is generally flat on renewal. Renewals are being bolstered by enhancing coverage for the same price—adding transportation coverage, nonowned disposal site coverage, and even environmental coverage for real estate owned by many construction firms.

New business rates are largely driven by insurance insurer appetite. They are generally on par with existing business but may increase as a result of some specific exposures such a residential work or mold. If a market is comfortable with a particular risk, pricing is usually very competitive. In the event more than one insurer is interested in a particular risk, coverage enhancements then often become the deciding factor.

Coverage Considerations

In addition to the basic form, there are many coverage considerations that should be discussed which can be added via endorsement to the CPL form.

Mold

Many insurers offer mold coverage depending on the class of business and overall exposure. Virtually all insurers offer some capacity for mold. Mold coverage is often provided via endorsement. The endorsement can establish its own limit and retention. Minimum information required to procure this coverage is a mold-specific application. Some programs require completion of a recognized mold awareness training program. Many insurers provide this training as part of the CPL program.

All insurers today offer mold liability coverage on a claims-made basis. Up until 2007, only one insurer was offering mold liability coverage on an occurrence basis. Recently, we have seen this insurer convert its current CPL policies offering occurrence-based mold coverage to claims-made mold coverage.

Construction firms with lower overall mold exposure, such as excavators, street and road/heavy highway contractors, concrete/flatwork contractors, and others with similar operations often receive mold limits at full capacity with limited underwriting information, such as a supplemental application, to qualify the risk. Firms that have a higher exposure to mold such as general contractors (depending on the type of structures built), roofing contractors, residential contractors, drywall contractors, and others with similar operations must complete the required applications, complete appropriate training, develop a water intrusion or mold prevention program, and may be subject to sublimits of insurance specific to mold.

Residential and/or habitational work is still the most sensitive class of business for mold liability. All insurers have various thresholds with regard to residential/habitational work and only one or two insurers routinely offer mold coverage to pure residential/habitational risks. These insurers will demand that a comprehensive mold/water intrusion prevention program is in place. The maximum percentage of residential/habitational is approximately 50 percent of total revenue for a blanket program. Select insurers will write 100 percent commercial residential/habitational structures on a project basis but most need to fall into the category of "commercial-grade" construction. Generally speaking, "commercial-grade" construction is a condominium project constructed of concrete and steel.

A critical item that needs to be understood is how each insurer defines residential/ habitational work. Each market has it own unique definition based on their own set of tolerances and appetite. One defines residential/habitational as condominiums, townhomes, and single family homes. Others consider any dwelling where the occupant sleeps as residential/habitational. This is important when seeking mold coverage since two programs may be competitive in pricing, terms, and conditions, including mold, but one may not cover a contractor's specific mold exposure.

Exhibit 1 illustrates the potential mold exposure by building type. Healthcare Facilities, Elder Care Facilities, Residential and Multi-Family Habitational are considered high exposure. Contractors building these structures have the highest potential to expose third parties to mold, primarily from a completed operations standpoint. Healthcare Facilities, Elder Care Facilities house populations with compromised or suppressed immune systems which can be more susceptible to ill health effects of exposure to mold.

Exhibit 1: Mold Exposure by Building Use

Residential and Multi-Family Habitational have various occupants from children to the elderly that may also fall into the compromised immune system category. In addition, people spend large amounts of time in their homes, which can increase the potential for exposure. Education and Commercial Office Buildings are listed as medium-high. Educational facilities often contain populations of younger people and children which can elevate the overall concern of exposure. Commercial Office Buildings contain various occupants and the concern is the amount of time spent within these structures. A full-time employee may spend more hours at work than at home. If mold is present, the duration of exposure can be a concern.

Hospitality is listed as a medium exposure, as these structures often see a transient population and the exposure concerns focuses on close quarters and large amount of time that may be spent in these spaces including sleeping. Retail structures and Industrial spaces are considered low exposures. These spaces are often large and have transient populations. The size and scale of these spaces tend not to place the occupant in close proximity to mold sources. Furthermore, industrial spaces may be highly ventilated or partially enclosed.

Although it appears the mold and fungus issue has settled a bit, it is anticipated this will continue to be an area where underwriters will focus their attention, especially on higher risk projects.

Nonowned Disposal Sites (NODS)

We have seen an increase in the purchase of NODS over the past year and attribute it to more knowledge of the exposure and coverage availability. A NODS endorsement is attached to the CPL. NODS, or sites that accept waste from generators, can be added via endorsement to most CPL policies. Generators of waste may be liable for the cleanup of the nonowned disposal site. Most insurers require the name, address, and EPA identification number to add a nonowned disposal location. This enhancement is most appropriate for environmental firms and general contractors. NODS are subject to an additional premium of $1,000 to $5,000 per location. It must be noted that even if prenegotiated, insurers will not issue an affirmative endorsement until they perform a favorable review of the requested information. Education of the brokerage community and the construction industry will drive this coverage enhancement, and we anticipate an increase in requests for this coverage in 2007.

Naturally Occurring Hazardous Substances (NOHS)

Naturally occurring hazardous substances (NOHS) such as asbestos, mercury, arsenic, radon, and pyrite have gained attention over the past few years, for two reasons, discussed below.

First, more and more contractors have been involved in situations resulting in lawsuits where they disturbed a mineral containing a NOHS. For example, a general contractor in Connecticut who was building a "box store" hired a subcontractor to excavate and remove fill material from the job site. The subcontractor subsequently used the material as fill at three other project sites. The material they removed was soil containing remnants of an asbestos-containing mineral called Actinolite. They exposed third parties to asbestos, and they also exposed their own work force. It is important to note that the asbestos in naturally occurring minerals is much less concentrated than the asbestos utilized years ago as a fire retardant for insulation around piping and ceiling and floor tiles. It still poses unique exposures for intrusive type work.

Second, many CPL policy forms exclude NOHS. There are several ways exposure to naturally occurring hazards may be excluded. Some are fairly recognizable as straightforward exclusions. Others are more difficult to find, and may be found in the definition of pollutants or pollution conditions. For example, one insurer applies a specific exclusion for naturally occurring substances in the exclusions section of the policy that can have significant impact on coverage:

This insurance does not apply to claims or losses based upon or arising out of any naturally occurring substances in their original location and unaltered form, or altered solely through naturally occurring processes or phenomena.

Another insurer will exclude by definition. In its definition of pollution conditions, the definition does not include naturally occurring substances, therefore negating coverage for such exposure:

Pollution Conditions means the emission, discharge, dispersal, release, or escape of pollutants, provided such are not naturally occurring. The entirety of any such emission, discharge, release, or escape or any series of continuous, repeated, or related emissions, discharges, releases, or escapes shall be deemed to be one pollution condition.

Even though the underwriters may describe their intent is to cover such claims, such exclusions can have a tremendous impact on coverage when a claim is presented.

Another NOHS is silica. Silica exists on almost every construction project. Some CPL insurers have attached silica exclusions to their programs and call them "non-negotiable". Others apply such exclusions but have the ability to remove them from the program and afford proper coverage. Any intrusive type contractor or concrete contractor should not have such an exclusion.

We foresee NOHS will be an area that continues to gain additional attention in 2007 and beyond.

Welding Fumes (Manganism)

Manganism is a Parkinson-like disease that supposedly results from the inhalation of "toxic" levels of manganese (Mn). Such exposure can cause irreversible damage to the central nervous system. Cases of the illness have been dated back to the late 1800s. Some individuals exposed to very high levels of manganese for long periods of time in their work can develop mental and emotional disturbances and slow and clumsy body movements. Workers usually do not develop symptoms of manganism unless they have been exposed to manganese for many months or years. Manganism occurs when a significant amount of manganese is absorbed into the part of the brain that helps control body movements. Exposure to high levels of airborne manganese, such as in a manganese foundry or battery plant, welding operations, or pesticide application, can affect motor skills such as holding one's hand steady, performing fast hand movements, and maintaining balance. Exposure to high levels of the metal may also cause respiratory problems and sexual dysfunction.

From an insurance perspective, the major concern is exposure to employees and, of course, workers compensation-related claims. However, in those states that subscribe to third-party-over action claims, many construction firms can easily find themselves in the middle of such a claim, and the primary issue at hand will be, is manganese a pollutant? Most likely most CGL insurers would look to decline via the pollution exclusion in the policy. If a contractor is looking for an alternative to insure against such an exposure, a CPL policy may be the alternative. As an added benefit, many CPL policies are structured to provide coverage for pollution-related third-party-over action claims.

Manganism is another issue to watch to determine if this becomes a significant issue in the construction industry and how CGL insurers will handle these claims.

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Excerpted from the New Day Underwriting Managers Market Update 2007.

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Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author’s employer or IRMI. This article does not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.