Avoid Common Mistakes That Lead to Uninsured Environmental Loss
David Dybdahl | March 31, 2017
History proves that there is a pattern of mistakes made by insurance buyers that lead to unnecessarily uninsured environmental loss. With a few simple corrections, the majority of uninsured environment losses over the past 20 years could have been insured, often at bargain-basement prices.
The most common mistakes made in commercial insurance buying decisions regarding pollution/contamination risks are the following.
- Severely underestimating the dollar amount and duration of environmental loss exposures
- Underestimating the effects of pollution/contamination exclusions in property and liability insurance policies.
- Overestimating the amount and reliability of the coverage provided by exceptions to pollution exclusions
- Not adjusting the insurance specifications in procurement contracts to reflect modern gaps in insurance coverage created by pollution/contamination exclusions
Ninety-five percent of commercial insurance buyers are needlessly uninsured or severely underinsured for any loss caused by, or in some cases even associated with, pollution or contamination. This situation has persisted for decades in the face of an oversupply of environmental insurance.
The pricing for pollution insurance coverage has been so low, on average, for so long, that the leading supplier of environmental impairment liability insurance for fixed sites for over 30 years found it necessary to abandon the business line entirely in 2016. History shows that environmental insurance was not expensive relative to the losses that are paid on average.
Oversupply has created a buyer's market for environmental insurance for over 20 years. In an oversupplied market, which would naturally lead to a low price, how can it possibly be that 95 percent of insurance buyers today are not adequately insured for their environmental loss exposures? Why has historically underpriced environmental insurance been shunned by so many commercial insurance buyers?
Here are my observations gained from 35 years in practice.
- There is a systematic tendency for the managers of a firm to underestimate their environmental loss exposure by a factor of 10. It would take a book to explain why the error factor in estimating environmental loss exposures is so high. I see this tendency to underestimate environmental loss exposures in the expert witness work I do in coverage litigation for environmental damage claims. Through the fact-finding discovery process, I get the benefit of post-loss 20/20 hindsight, sometimes over decades of corporate decision-making, simply by reading the depositions of the witnesses. Underestimating the environmental loss exposure by multiple employees, by tenfold, over years of loss development, is apparently the real number in practice.
- Due to the systematic underestimation of the environmental loss exposure, the perceived need for, and value of, environment insurance by insurance buyers is also underestimated by a factor of 10. Insurance premiums will always seem high if they are benchmarked against a perceived risk that is 1/10 the actual loss exposure.
- A surprising number of insurance buyers and their insurance agents and brokers rely on exceptions to pollution exclusions as the sole source of potential insurance coverage for contamination hazards. This approach to insurance protection is highly unreliable. Pollution exclusions are the most litigated verbiage in the history of the insurance business; no one can be certain how the exclusion or the exceptions to the exclusion will operate until after the loss when the actual environmental damages become known. I know of no other type of insurance coverage that would be this inherently unpredictable and therefore completely unreliable.
- If genuine environmental insurance is purchased, it is common practice to purchase limits of liability that are much less than the limits carried for other causes of liability losses. This is not rational risk management decision-making. The pollution exclusion in property and liability insurance policies creates the need for environmental insurance. There are many examples of eight-figure contamination-related losses and a few losses measured in billions of dollars. There is no reason why the limits between the pollution policy and the overall liability insurance program on the firm should be different. Both are intended to protect the net worth of the insurance buyer.
- Ignoring the fact that virtually all property and liability insurance policies exclude losses arising from contamination also manifests itself in the insurance requirements that companies and public entities use in their vendor procurement insurance requirements. Requiring the proper environmental insurance coverages on vendors is not only an inexpensive way to transfer risk, through the utilization of notice of cancellation requirements in the vendor's insurance policies, risk managers can get an early warning on risky vendors who are going to be canceled or nonrenewed by their insurance companies. By ignoring that contamination exclusions exist in the contractual insurance requirements for vendors, risk managers forgo what can be both cost-free risk identification on a global knowledge basis through the insurance marketplace and risk transfer.
Choosing To Be Uninsured
Environmental losses have a long history of being expensive for any size organization. Why would anyone choose to be uninsured for pollution/contamination losses? It turns out that many insurance buyers did not actually choose to be uninsured for pollution or contamination losses, they just did not understand how pollution exclusions work.
To help sort the current technically uninsured loss exposures out, it is important for insurance buyers to focus in on the contamination hazard instead of "pollution" events. The operative word in the typical pollution exclusion is "contaminant," which has appeared in the most commonly used definition of what a "pollutant" is since 1970. In my experience, the word "pollutant" tends to get people thinking too much about only hazardous waste, which leads to false assumptions on the effects of pollution/contamination exclusions in commercial insurance programs. The false assumptions lead to poor decisions on environmental coverage.
While pollution exclusions have been used for over 40 years, they keep changing. Over the past 15 years, insurance companies have added a host of new exclusions for specified contaminants. These specifically excluded contaminants include the gasses from welding rods, asbestos, lead, silica, fungus, mold, bacteria, and, by default, Category 3 water because of the bacteria that water contains.
The common exclusions for these specified contaminants are essentially pollution exclusion on steroids. Some of these exclusions in liability insurance policies contain "anti-concurrent causation" language straight out of the flood exclusions in property insurance policies. An anticoncurrent causation clause within a specified contaminant exclusion eliminates coverage if the contaminated becomes involved in any sequence to the loss event.
Beyond Hazardous
There is a persistent perception with insurance buyers that somehow pollution exclusions are limited to hazardous waste. Pollution exclusions have never been limited to hazardous waste. In practice, pollution exclusions have been used to deny coverage for claims arising from contaminated sandwiches. To develop effective strategies to insure environmental risks, the focus needs to be on the contamination hazard and not be limited to hazardous waste. Few insurance practitioners do this.
Many significant environmental loss exposures have no hazardous waste or materials involved with them at all. For example, a condominium or hotel will be adversely affected by exclusions in its property and liability insurance policies for losses involving a speck of any type or amount of fungi/mold/bacteria. A specially crafted environmental insurance policy designed to fill the contamination coverage gaps will cover first-party losses, including restoration cost, loss of rents, and extra expenses in addition to covering potential third-party liability and defense costs.
Without environmental insurance, these property owners have significant gaps in insurance coverage for a very common cause of loss in apartments, condominiums, and hotels—water intrusion. More than 95 percent of condominiums and hotels have significant coverage gaps for contamination claims in their property and liability insurance programs today for no real reason. For less than 10 percent of the property premium subject to a minimum premium of $3,500 per year, most of these properties could be properly insured today. On large property schedules of apartments, premiums are commonly around $10 a door.
Antique Insurance Specifications
The pollution exclusion in the general liability (GL) insurance policy is the longest exclusion in the policy form. After years of uninterrupted use, it would be reasonable to think the stakeholders in commercial insurance would have adapted to the existence of pollution/contamination exclusions by now. However, this is rarely the case.
Very few insurance specifications in procurement contracts and loan covenants even reflect the existence of pollution exclusions. In my experience, many of the lawyers drawing up the insurance specifications in contracts must be relying on insurance specifications that are decades old. Thirty years ago, no one was paying attention to pollution/contamination exclusions. But things changed a few decades ago in the insurance business, and the professional drafters of contracts apparently did not catch on.
For example, any time I see an insurance specification in a contract requiring broad form property damage coverage in a GL policy, I can tell no one at the firm requiring the GL coverage from a vendor has upgraded their insurance specifications. Since 1986, the Insurance Services Office, Inc., commercial general liability policy automatically includes broad form property damage liability in its standard form. There is no need to specify a coverage extension for what has been automatically included in GL insurance policies for more than 30 years.
Not surprisingly, a 30-year-old insurance specification would not have corrected for the evolution of pollution exclusions over the last 30 years either. Antique insurance specifications, especially in loan covenants, explains a lot about why the vast majority of commercial buildings, condos, hotels, plumbers, and 2 million farmers are needlessly uninsured for pollution/contamination losses in the normal course of their day-to-day operations.
Avoiding Common Mistakes
With this background, what should insurance buyers do to avoid the common mistakes that lead to uninsured contamination losses?
- Do something more than nothing to address pollution/contamination exclusions in property and liability insurance policies. Remember, 95 percent of commercial insurance buyers do nothing.
- Imagine the worst-case environmental loss exposure and multiply it by 10, then assume it will take years of loss payments to finally play out, and then decide if self-insurance is a good idea. Remember, insurance premiums are tax deductible.
- Against this loss exposure, evaluate the current coverages provided in both the property and liability insurance policies to cover a pollution contamination loss if it occurs.
- An easy and low-cost method to transfer loss exposures is to shift risk onto the vendors through the insurance requirements in contracts. Shifting risks to vendors is common practice through the use of insurance requirements and indemnity agreements. In my wholesale insurance brokerage operation, we see a lot of insurance requirements that our customers must meet in contracts. I am continually amazed to see insurance requests that are so completely naive and off-base when it comes to pollution/contamination risks. Banks for some reason are particularly bad at writing insurance requirements for their borrowers. My advice here is for readers to get some professional help in writing the insurance requirements in contracts. The contract lawyers apparently need some help in this area from the insurance practitioners. Be sure to require the appropriate environmental insurance in contractual insurance requirements. This does not happen very often in actual practice. Even when there is a state-of-the-art insurance specification for pollution/contamination in place, the actual liability policies sold to the vendors rarely meet the insurance specifications, regardless of the representations the agents and brokers make on the insurance certificates. The solution is to specify and verify the environmental insurance on vendors.
- Purchase a high-quality environmental insurance policy from an insurance company with the resources to support the coverage line. There are over a hundred different environmental insurance policies for sale today. No two are exactly alike, and coverage may vary considerably and, those variations are often unrelated to the cost of the insurance. It takes a specialist to match the needs of the insurance buyer to the insurance provider.
Conclusion
The environmental insurance market is the solution to the most common mistakes made by insurance buyers on environmental/pollution/contamination risks. Ignoring the effects of pollution exclusions and the environmental insurance market over decades is the root cause of needlessly uninsured and litigated environmental damage and contamination claims today. Environmental insurance has been available in an oversupplied marketplace since 1986. It is time to pay attention to the effects of pollution exclusions and environmental insurance; the practices of the past 30 years are not working. There is no rational reason for so many pollution/contamination loss exposures to be uninsured today.
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