Navigating the U.S. Environmental Liability Market (Part 1)
March 2002
In this two-part article, Alan Bressler examines
the current state of the environmental insurance market, including the players,
capacity, mold, and bio-terrorism.
by Alan
Bressler
Marsh Environmental Group
Before the 1970s, the potential effects of industrial activities on the environment
were not widely reported. Since that time, however, regulatory changes, social
awareness, and a few highly publicized cases against major corporations prompted
organizations to take significant strides in managing environmental risks.
Today, in addition to a wide variety of technological, process, and behavioral
improvements, corporations are using risk management tools and financing mechanisms
developed by a continually evolving environmental insurance marketplace. This
article examines the current state of the marketplace, how it got there, and
factors driving its growth. Part 2 examines the
impact of September 11 and new environmental concerns—mold and bio-terrorism—on
the environmental insurance market.
The Development and Growth of the Environmental Insurance Market
In the mid-1970s, organizations that had relied on general liability policies
to cover operational risks began to experience the effects of the emerging environmental
liability. In the aftermath of incidents like Love Canal in New York and Times
Beach, Missouri, new federal and state regulatory requirements began concentrating
on hazardous waste treatment, storage, and disposal operations, chemical manufacturers,
and the blossoming environmental services industry.
The regulations, along with increased social environmental awareness and
activism, helped give rise to the environmental insurance market. Consider,
for example, the passage of the Resource Conservation and Recovery Act in 1976.
It initiated the requirement that certain types of facilities provide evidence
of financial responsibility for certain pollution release incidents at the same
time that traditional property and casualty insurers began excluding pollution
risk from their general liability policies. This left a handful of insurance
markets that were capable and willing to provide specialized coverage for pollution.
The initial capacity of the environmental insurance market was limited by
a number of factors.
- Among the small number of insurers entering the market in the early
1980s, most attempted to teach traditional casualty underwriters how to
analyze and price environmental risks. Yet, the integration of environmental
science (engineering, geology, and hyrdogeology) with underwriting analysis
was not widely practiced. Compounding this problem was the lack of historical
underwriting data on which frequency and severity trends could be established
for a wide variety of environmental exposures.
- Largely as result of the first factor, the insurance products available
initially were narrow in coverage, costly, and cumbersome to apply for and
obtain.
- The underwriting community generally viewed the market potential as
relatively small, based on what was then a limited number of compliance-driven
applications.
- Reinsurers were reluctant to risk capacity in such new, uncharted territory.
- Few insurance brokers understood the exposure, the client's needs, the
regulatory issues, or the products. In time, as historical underwriting
data grew, more underwriters hired environmental professionals for their
underwriting units. Results proved favorable, and capacity and variety of
available environmental coverages increased dramatically.
In the last 10 years, the environmental insurance market has experienced
double-digit gross premium growth. Long-term market participants have been underwriting
environmental exposures profitably, given the greater underwriting experience,
historical data, and knowledge in handling environmental claims.
The Role of Environmental Insurance in Today's Market
Environmental insurance has developed from its roots as a compliance-driven
product to a tool for managing environmental risk and for protecting shareholders
from the financial consequences of environmental liabilities. Where the initial
market comprised corporations purchasing coverage primarily because it was a
regulatory requirement, major corporations today are choosing these products
and using them as financial tools to address a variety of business needs.
Environmental insurance now plays a major role in a variety of business transactions
and financial engineering situations. In mergers and acquisitions, it protects
the acquiring company from unanticipated costs overruns associated with known
cleanup obligations, as well as the discovery of unknown, pre-merger pollution
conditions. And, in the disposition of surplus corporate assets, environmental
insurance often substitutes for the selling corporation's indemnification.
In Brownfield redevelopments, developers use environmental insurance to guarantee
that a project's financial success won't be derailed by a number of known or
unknown environmental conditions, including those that cause delays in project
completion. In state and federal Superfund cleanups, environmental insurance
is used in virtually every situation where an environmental contractor guarantees
to perform the required remediation on a fixed-price, "at-risk" basis. In many
cases, these products facilitate transactions that have favorable tax and accounting
treatment, often the insured's ultimate strategic objective.
While much demand for environmental insurance and risk services has been
focused in North America, international markets are beginning to experience
the same trends that triggered U.S. environmental market growth. Europe and
Australia have both seen significant developments of environmental regulatory
initiatives and enforcement, and increased social awareness of environmental
issues.
2001 State of the Market
Although the commercial insurance industry generally experienced a hardening
of terms and conditions in 2001, environmental insurance appears to have been
less affected than most lines. Environmental premiums in 2001 were only 2-4
percent higher than 2000, a modest increase relative to most other casualty
insurance lines.
Meanwhile, environmental insurance markets continue to leverage the dynamics
of high-growth potential against an otherwise hardening market. While the conditions
in the overall property and casualty (P&C) market have had some effects on the
environmental market, most environmental insurers continue to offer significant
capacity, broad and flexible policy terms and conditions, and multiyear policy
terms. Even though pricing has been somewhat affected, it remains relatively
aggressive. Most industry experts expect this trend to continue in 2002, with
some slight twists that have entered the market psyche due to evolving environmental
risks.
Market capacity offered by any one insurer for a single environmental transaction
ranges from unchanged from 2001 to a 50 percent reduction, with a few of the
major markets offering $100 million per loss, and some offering $150 million
or more in the aggregate. A few primary markets have reduced their capacity
from $100 million down to $50 million. Even as reinsurance costs rose across
all lines of coverage, total market capacity for environmental products remains
in excess of $500 million. And even those insurers who have reduced their primary
capacity are, generally, able to obtain facultative reinsurance that allows
them to offer $150-$200 million for a single program. In addition, a number
of specialty markets, and some traditional P&C insurers that see opportunity
in this area, continue to add market capacity.
Broad policy terms and conditions for environmental products continued to
characterize the environmental insurance market in 2001. Rather than imposing
coverage limitations, most markets are seeking higher retentions and relatively
modest price increases in an attempt to maintain underwriting profitability.
In this case, the markets may be concerned that demand would be jeopardized
if restrictions affect the products' applicability in strategic and financial
contexts. However, there are some exceptions, as discussed below.
Possible Problem Areas
The nature of environmental risk is continually changing, and the market
continues to evolve accordingly, albeit cautiously in some cases. One example
is the steady growth of mold-related claims, especially in construction and
habitational settings. The initial responses of most insurance markets to severely
limit (often via sublimit) or exclude coverage are giving way to increased underwriting
expertise and scrutiny, and creative methods of providing coverage.
Multiyear policies remained popular with 10-year policy terms a typical maximum—and
even a standard for fixed-site, traditional risk transfer products, like pollution
legal liability. Due to reinsurance restrictions, some insurers have reined
in policy terms beyond 10 years; others continue to offer them on a case-by-case
basis. At least one market is restricting to 5-year policy terms associated
with new environmental conditions (i.e., after coverage is bound).
In the spirit of maintaining the "deal facilitation" focus that the products
have built into the legal and real estate communities, insurers have become
creative in dealing with reinsurance restrictions on policy term length. Examples
include guaranteed renewal terms, extended reporting periods, and "rolling"
renewals. The September 11 attacks had widespread influence on the insurance
industry, including the environmental insurance market. The catastrophic losses
being reported by reinsurers have led to restricted reinsurance capacity for
all lines of coverage worldwide.
Markets and Capacity
More than a dozen insurers provide various pollution-related insurance coverages.
However, six of them are considered "major" markets, offering significant capacity,
extensive underwriting experience, technical expertise, and product flexibility.
Below is a summary of these insurers and their respective capacity available
for any one transaction.
While any individual market typically does not provide limits of more than
$100mm, except on a facultative reinsurance basis, higher limits may be obtained
by layering the capacity of multiple insurers. Additionally, it should be noted
that global reinsurance capacity is in excess of $500 million for any one placement.
Premium volume is expected to continue to increase at an annual rate of 20-25
percent as environmental products continue to become a more meaningful component
of many business transactions. Insurance companies will continue to compete
aggressively for market share, in terms of coverage depth, innovation and flexibility,
price, and capacity. Markets able to continue providing comprehensive, innovative,
and adaptable products and financial stability will continue to dominate the
environmental insurance market.
Part 2 of this article takes
a look at what affect the events of September 11 and new environmental concerns—mold
and bio-terrorism—are having on the environmental insurance market.
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