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.