The number of abandoned industrial sites across America in need of environmental remediation continues to grow. With local governments striving to curb urban sprawl and eliminate inner-city decay, and with the development of recent legislative and regulatory initiatives, these "Brownfield" sites offer an opportunity for redevelopment. This article explains how environmental insurance and innovative risk management tools help reduce the risk and uncertainty surrounding these projects.
Shifts in the U.S. economy in the years following World War II created a dilemma for American cities and communities. Many older, noncompetitive, and underperforming factories required significant modernization. From the late 1950s through the 1980s, these facilities were relocated to the suburbs rather than attempting to update them for a number of reasons: lower taxes and utility costs, changing labor needs and demographics, and the availability of less costly land. This resulted in the closing of large numbers of industrial facilities in cities across America. Subsequently, technological innovations and the shift to a more service-oriented economy further eliminated the need for industrial plants.
In the 1980s, the dawning of the country's most significant environmental regulations complicated, increased the risk, and ultimately limited the sale, reuse, or redevelopment of these sites. Many seriously contaminated industrial facilities were, or are being, cleaned up under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) or Superfund. CERCLA created the concepts of strict, retroactive, and joint-and-several liability for remediation of environmental contamination.
Even where industry preferred to be near the city, CERCLA and a growing wave of federal and state environmental regulations often made it cheaper to build on "greenfield" areas outside urban centers. In time, many such sites blighted neighborhoods. Factories shut down, local economies suffered, and tax bases eroded. Other local businesses also were devastated by the economic downturn, contributing to the decay of communities.
Many smaller commercial sites—such as former gas stations, dry cleaners, automotive repair shops, and even vacant land where disposal activities occurred—remain abandoned to this day. City governments acquired some of these sites through legal means, such as tax lien foreclosure or condemnation, and were faced with the question of how to put these sites back into productive use while protecting human health and the environment. In the 1990s, these sites were named "Brownfields." The U.S. Environmental Protection Agency (EPA) defines a "Brownfield" as:
abandoned, idled, or underused industrial and commercial facilities where expansion or redevelopment is complicated by real or perceived environmental contamination.
A recent U.S. General Accounting Office study concluded that there are over 500,000 Brownfield sites in urban, suburban, and rural areas of the United States, and estimated that the environmental cleanup and redevelopment costs could exceed $650 billion. With growing pressures on corporate earnings, the wave of mergers and acquisitions, and utility deregulation, industry has been forced to close or sell underperforming or nonperforming facilities, and noncore and stranded assets, creating new Brownfield sites every year.
Evolution of the Brownfields Market
Since the mid-1990s, evolving attitudes, continuing economic evolution and expansion, and innovative approaches are turning Brownfield sites into opportunities. Concern over urban sprawl, economic drivers, and the need for sustainable infill development prompted an opportunity to reuse and redevelop these areas. The remediation of these sites can help a city or community reinvent itself, breathe life into a depressed area, increase tax revenues and related services, create jobs, and improve the quality of life.
New legislative and regulatory initiatives spurred this activity. The Asset Conservation Act of 1996 gave lenders protection against environmental liability in the normal course of debt-financing activities. The Taxpayer Relief Act of 1997 gave favorable tax treatment to environmental remediation costs. The EPA's Brownfields Redevelopment Initiative provided funding for assessment of sites, a previous major cost barrier to entry, and to capitalize revolving loan funds for site cleanup activities.
State Voluntary Cleanup Programs (VCPs) are one of the most significant regulatory initiatives. Currently, about 44 states have passed some form of VCP or Brownfields-type legislation with industrial cities instituting some of the most progressive programs. Among their many provisions, these laws have allowed for risk-based cleanup based on intended reuse or redevelopment, and remedial liability relief for innocent parties voluntarily agreeing to clean up sites. They typically offer "no further action" (NFA), "no further remediation" (NFR), or "certificate of completion" (COC) letters documenting completion of any required remediation and providing (conditional) release from further cleanup requirements. By factoring in the future use of the site, cleanup can be conducted to less than pristine standards.
The level of required cleanup depends on a number of factors, including type of contamination, media involved (e.g., soil or groundwater), and human and ecological health risks. Intended reuse has become a driving factor in determining cleanup standards. For many projects, the cleanup methodology is integrated with the redevelopment, such as an asphalt cap providing both parking areas and an impervious barrier to contain contaminated soil and prevent contamination from leaching into groundwater.
Risk and Uncertainty: Barriers to Brownfield Redevelopment
A number of barriers to successful Brownfield transactions and redevelopment remain; most revolve around risk and uncertainty. Examples of these risks include the following.
Third-party or "toxic tort" liability risks
Many such risks are intertwined, such as the risk of regulatory "re-openers," which could require additional cleanup after the VCP remedial effort has been completed. This constitutes both a regulatory and financial risk.
Toxic Tort Risks. Site owners, sellers, buyers, developers, and contractors all face risks from exposure to soil or groundwater contamination on or emanating from the site. These claims may involve allegations ranging from on- or off-site bodily injury, to property damage from off-site migration, to diminution of property value at adjacent sites.
Regulatory Risks. These are of greatest concern to firms that own and wish to sell or redevelop their sites, buyers who transact in or redevelop Brownfields, and to some extent, contractors engaged in the actual cleanup and development work. Again, regulatory re-openers could result from an EPA-mandated cleanup broader than that approved under a state VCP or changing state regulations imposing more stringent cleanup standards to already remediated sites.
Memoranda of agreements (MOAs) signed between EPA regional administration and some state regulators (approximately 15 to date) have mitigated some of this risk. However, the MOAs contain exceptions to these enforcement "passes." Due to strict eligibility requirements, they largely address sites that would be unlikely to face federal CERCLA enforcement actions even in the absence of the MOA.
Waste generation and disposal during remedial actions and undiscovered preexisting contamination are other regulatory risks. Most state VCPs have incorporated limitations on remedial liability to innocent purchasers to a degree sufficient to encourage Brownfield redevelopment, but they do not eliminate regulatory risk altogether.
Timing Risks. Intertwined with financial risks, these involve delays in development and opening that may occur due to discovery and required cleanup of unknown preexisting contamination during remediation or construction activities. Not only are profits at risk, but "soft" costs, such as loan interest, may continue during such delays. Not all timing risks are related to environmental conditions. Failure to pass zoning for intended future use or to secure permits for development activities may cause other timing risks.
Financial Exposures. Lenders remain cautious about providing debt financing on properties with known or suspected contamination, even with the added clarification provided in the Asset Conservation Act. The contamination might impact the borrower's ability to repay the loan, the loss of collateral value, and the potential for remedial and toxic tort liability. Owners who redevelop their own sites and buyers who purchase sites for redevelopment face financial risks ranging from underestimating cleanup costs, to the cost of undiscovered preexisting contamination, to toxic tort liability. The insolvency of an indemnitor is a financial risk faced by both parties.
Many finance, regulatory, liability, and timing risks are being addressed through innovative arrangements by a burgeoning cottage industry of Brownfield development firms. Some firms provide equity funding, others trade an equity position for funding and executing environmental or redevelopment consulting and remediation activities. Traditional methods of dealing with these exposures have included reductions in the purchase price to offset anticipated environmental risks, indemnification agreements, escrow accounts, letters of credit, trust funds, and similar funding mechanisms. These methods lead to protracted, often heated negotiations over indemnification terms and the need to maintain reserves on balance sheets for transactions in which a company's real intent was to cleanse itself of the liability in addition to the asset.
Innovative ways of managing Brownfield risks are available to meet the needs of parties involved in reuse and redevelopment opportunities. Environmental insurance products now play a critical role in many transactions. The following four main products are particularly beneficial to parties involved in Brownfield purchases, sales, ownership, reuse, and redevelopment.
Pollution legal liability
Cleanup cost cap
Secured creditor programs
Owner-controlled environmental insurance programs
Pollution Legal Liability (PLL). This cornerstone product for fixed-site facilities is designed to transfer the risks of cleanup costs for unknown preexisting or new environmental conditions, third-party "toxic tort" liability (bodily injury, property damage, and diminution in value), transportation and disposal of waste materials from cleanup activities, and loss of income/extra expenses caused by pollution conditions. PLL, which each insurer gives a different name, can protect the seller by backing up the indemnification given to, or received from, a buyer. It can also protect sellers from third-party liabilities resulting from their interest in the divested property. PLL can protect the seller from changes in regulations or new regulations that impose new liability for cleanup.
PLL can protect the Brownfield buyer from: cleanup costs or tort liability incurred if a seller becomes insolvent and cannot fund its indemnity; third-party liability and cleanup costs from other unknown preexisting environmental conditions; and the risks of waste materials generated and transported during cleanup. It can also replace lost of profits associated with delays in opening and fund continuing soft costs incurred during development due to environmental conditions. Once the development is up and running, PLL can continue to provide risk transfer for cleanup of new environmental conditions, third-party liability, and even loss of income and extra expenses caused by pollution conditions. PLL also gives an increased comfort level to lenders that environmental cleanup costs, third-party liabilities, and certain timing risk won't adversely affect a borrower's inability to repay a loan.
Cleanup Cost Cap. This coverage, introduced in the mid-1990s and also known as "Remediation Stop Loss," is used to manage the finance risk associated with unexpected cleanup cost overruns. The policy pays for costs in excess of the estimates contained in a remedial action plan (RAP), plus some buffer layer, usually 10 to 20 percent of the budget estimates, which acts as a deductible. Some arrangements include coinsurance once the cleanup costs exceed the budget estimates plus the buffer layer. The policy responds when cleanup costs exceed the RAP estimates plus the buffer due to the discovery of more contamination than was expected, additional types of contamination discovered in the area of concern, or off-site cleanup costs for known pollution conditions in the area of concern that have migrated.
Cleanup cost caps can be used to hedge the finance risk Brownfield developers face from cleanup cost overruns. Owners who redevelop their own sites and developers who purchase these sites find this coverage valuable for its direct financial protection when cleanup cost estimates are exceeded. The product can also be structured to provide contingent coverage for an owner who reacquires remedial liability should the buyer become insolvent and fail to complete the cleanup. Like PLL, a cleanup cost cap provides an extra level of comfort to lenders.
Secured Creditor Programs. These programs are gaining acceptance among both traditional lenders and nontraditional sources of debt financing—on a portfolio and single-loan basis and as a tool to manage risk in securitization of loan pools. In the context of Brownfield financing, secured creditor programs protect lenders from loss of principal loan balance, cleanup costs, or third-party liability.
Two forms of the product exist. In the traditional product, the policy pays for the lesser of the principal loan balance outstanding or the cleanup costs when a loan default occurs and pollution conditions exist on the property used as collateral. A more recent version provides for the repayment of the principal loan balance only in the event of the default and pollution condition triggers. Many lenders prefer this coverage form since foreclosure of the property is not a requirement, and most lenders would prefer not to enter the chain of title due to environmental regulations. Secured creditor programs give the lender assurance that, at worst, the principal loan balance will not be jeopardized due to borrower default and contamination to collateral.
Owner Controlled Environmental Insurance Programs (OCEIPs). Like traditional owner controlled insurance programs (OCIPs), OCEIPs protect project owners from third-party liability due to the operations of all contractors on a project. OCEIPs can be written as stand-alone programs or in conjunction with a traditional OCIP's commercial general liability (CGL), auto, workers compensation, and other insurance coverages. In an OCEIP, both contractor's pollution liability (CPL) and environmental professional liability (environmental errors and omissions) are combined to protect the project owner from third-party environmental claims due to the operations of all contractors, or the acts, errors, or omissions of all consultants and environmental engineers on the project.
The program covers the owner as primary named insured, and each contractor, consultant, or engineer is added to the policy as an additional insured. Coverage for third-party claims for bodily injury, property damage, or cleanup costs is provided for all parties. The program also covers cleanup costs on the project site for the owner due to the operations, acts, errors, or omissions of these firms, as the owner is considered a third party relative to the negligence of the contractor or consultant.
As respects both the remediation and construction portions of the redevelopment process, an OCEIP is an excellent tool for managing the risks associated with Brownfields redevelopment. More so than in traditional OCIPs, the quality and consistency of coverage for the owner is vastly enhanced by an OCEIP. Unlike CGL, auto liability, or workers compensation insurance, where most contractors and engineers have Insurance Services Office, Inc. (ISO), or ISO-type standardized policy forms, every insurer that offers CPL and environmental E&O has its own manuscript policy form.
In the absence of an OCEIP, the project owner is faced with widely varying degrees of coverage and exclusionary language when relying on additional insured status under the contractor's, consultant's, and engineer's policies. Like traditional OCIPs, there are typically significant cost savings to the OCEIP approach; these increase with the size of the project. The following diagram is an example of how PLL, a cleanup cost cap, and an OCEIP may be integrated to form a solid wall of protection for those redeveloping Brownfield sites.
Phase I, II Remedial Design and Development of Cleanup Plan
Remediation of Site
Property Transfer, Redevelopment, and Continued Use
Pollution legal liability for cleanup of undiscovered preexisting pollution, third-party liability, waste transport/disposal, and project delay and soft costs
PLL as Post Remediation Warranty Insurance added for the buyer to protect against regulatory "re-openers"
Cleanup cost cap policy added
Pollution legal liability for cleanup of unknown preexisting, new conditions, third-party liability, regulatory "re-openers," and loss of income/extra expense for owner
These four products have the ability to mitigate many, if not most, of the regulatory, liability, timing, and financial risks faced in Brownfields transactions, reuse, and redevelopment. There is currently a tremendous amount of flexibility in the environmental insurance market, as well as adequate capacity, which allows these products to be customized to address the needs of most Brownfields-related risks. Of course, to make financial sense, a Brownfields developer still must have a detailed understanding of local real estate market needs, capacity, and drivers, as well as a ready source of debt and/or equity financing. At the end of the day, these are still real estate development transactions subject to all of the normal business risks associated with sites where no known contamination exists.
With local governments striving to curb urban sprawl and eliminate inner-city poverty and decay, and with the development of recent legislative and regulatory initiatives and innovative risk management tools, the market for Brownfields redevelopment has never been stronger. While environmental insurance is not the panacea for Brownfield risk, it has become a valuable tool that can eliminate enough uncertainty to encourage many projects to proceed.
Reuse or redevelopment of these sites is one of the most important issues facing cities and communities today. Brownfields initiatives are gaining momentum across the country, and environmental insurance is right there, helping to pave the way.
Alan Bressler is a senior vice president of the Marsh Environmental Group. As a member of the Group's Corporate Client Development practice, his responsibilities include setting and executing corporate strategy for sales and delivery of environmental products and services, acting as a corporate technical resource, developing new environmental product and service offerings, and training and education. Mr. Bressler was one of the nation's first insurance brokers to specialize in the environmental insurance market and now has 12 years' experience in environmental risk management, insurance, and strategic consulting for major industry. He received a BS degree in Risk Management and Insurance from Florida State University.
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