Expert Commentary

Changing Environmental Insurers: Use Caution

There is a game of reverse musical chairs going on in the environmental insurance marketplace today. There are now more places for a piece of environmental impairment liability (EIL) business to land than the number of pieces that need a home.

October 2016

A large contributor to this phenomenon is a major underwriter of environmental insurance abandoning the site pollution insurance market, putting countless policies and hundreds of millions of premium dollars up for grabs.

With more insurance companies scrabbling for EIL premium dollars, brokers have a wide choice of homes for their accounts. From the early days where there were only a handful of insurers, there are now over 40 insurance companies providing environmental coverage. Greater competition leads to lower premiums. I have heard multiple underwriters complaining recently about greater than 30 percent price reductions compared to the expiring premiums of the company that is abandoning the site pollution coverage line due to a crippling loss ratio.

Most brokers and buyers do not understand how such price reductions might be possible for the replacement underwriter to still make a profit. On the surface, it looks to be an act of kindness by the underwriter. What lies beneath the surface and goes almost entirely unnoticed is that the switch from insurers has the potential to erase 30 years of incurred but not reported (IBNR) losses that would have been covered by the insurance company exiting the marketplace and not being picked up by the new ones. Those legacy losses were incurred during the go-go years of the cleanup of America from 1996 to 2007.

The Design of EIL Policies

The IBNR loss exposures on site pollution insurance policies can take decades to fully develop. The way that EIL policies are designed is that, once a claim resulting from a release of pollutants is reported to the insurance company, all subsequent claims costs incurred indefinitely over time are covered by the single EIL policy that was in place when that first claim was reported. The insured benefits from this coverage development because multiple self-insured retentions (SIRs) are avoided; they won't have to pay the SIR again for a subsequent claim if that claim was caused by the same pollution event.

The insurer benefits because multiple sets of policy limits cannot be stacked up over the years after the pollution event happened and multiple claims resulting from the event become known over time. Having a single policy covering all losses ensuing from a covered pollution event also streamlines claims handling. Involving multiple insurance policies and companies over a loss exposure that can take decades to develop creates unusually difficult claims adjustment challenges even with the most well-intentioned adjusters. Throw in an insurer that needs to reduce the outflow of cash from paid claims, and the insured is going to face a hopeless mess in being indemnified. Overall, having a single policy cover all ensuing losses over time is a good design for the insurer and the policyholder alike.

An Illustration of EIL Policy Operation

To illustrate the concept of a single policy applying to all ensuing losses and the effects of environmental damage loss development, it helps to use an example. Let's set the stage with a chromium plating bath solution being released into a storm drain and finding its way into a trout stream. Plating solutions typically contain heavy metals that are not good to have in a trout stream.

The spill is promptly reported to the Environmental Protection Agency (EPA), which requires that the heavy metals in the stream be remediated. A claim is presented to the plating company's environmental insurance company under their state-of-the-art EIL insurance policy, and the insurer promptly pays for the cleanup costs to remediate the problem. The environmental insurance market pays for the cleanup of hundreds of spills every year just as it has been laid out here.

Three years later, the fishermen who regularly used the stream sue the plating company for creating fish containing high levels of toxic metals. It turns out the fishermen's families have been eating a lot of fish during those years. This became apparent in the form of an unusual birth defect associated with exposure to heavy metals. The birth defect was discovered in six newborns at the local hospital and linked to the mothers eating the tainted fish.

Scientific tests of the stream reveal that the cleanup of the heavy metal residue was inadequate. Due to the election of a new president right after the spill, the budget for the EPA was significantly reduced, so there was no regulatory oversight during the remediation, and there was nobody left to check on the stream after the head count reductions in the regulatory agency. The fishermen's families bring a class action suit against the plating company 6 years after the spill for exposing them and their families to heavy metals.

Twenty-three years after the spill, the six infants with birth defects reach the age of majority at 21 years. Twenty-five years after the spill, these adults bring another legal action against the plating company for all of their future medical costs, loss of income, pain, and suffering.

How does the typical environmental insurance policy respond to all of these late-to-develop claims? The site pollution insurance policy that paid for the original cleanup of the stream then pays for all subsequent claims that developed over 27 years or more, up to the policy limits, with only one self-insured retention being applied.

The site pollution insurance policies in place when the fishermen and the injured children sue the plating company in subsequent years would not respond to those claims. Virtually all claims-made policies require a claim for damages within the coverage period and for a claim under the policy to be made within the policy period or an extended discovery period. Because the chromium plating bath solution spill claim was first reported in the year that it happened, it cannot be first reported again at any time in the future.

Purchasing a site pollution liability policy 20 years after the chromium plating bath solution spill event, which provides retroactive coverage back to the beginning of time, does not overcome the claims first reported requirement in a claims-made policy. The pollution release that leads to the first reported claim can only be first reported once.

This provides an insight into the price reduction phenomenon in the EIL market. Subsequent insurance companies do not need to do anything to avoid liability arising from claims related to a pollution release or escape already reported on another insurer's policy. That is because a claim that was already reported under one policy cannot be "first" reported to another insurance company. So, the new insurers have no exposure to subsequent claims from previously reported pollution events. This reduction in prospective liability without being burdened by IBNR losses allows the new insurers on the risk to drastically reduce prices as the new placements look much more promising to them than the expensive losses created by the go-go years in the cleanup of America decades ago.

The Problem:A Hidden Coverage Flaw for IBNR Claims

As long as the insured had EIL coverage in place that would cover the original pollution release or exposure they are OK on subsequent claims from the same pollution event, right? That policy will pick up coverage for that first pollution condition and then any subsequent claims thereafter. The buyer is free to move coverage as they please so long as they keep it continuous.

But what if there was a way that the insurance company could unilaterally shut off their obligation to pay for developing subsequent claims for claims that have already been reported? That would be pretty scary, wouldn't it? I'm here to tell you that such a thing exists—whether intentional or not. A rarely unrecognized provision that can be found in some, but not all, claims-made environmental policies can leave major coverage holes that cannot be repaired if coverage is ever discontinued with an insurer.

Many EIL insurance policies contain a "lifetime renewal commitment to us, but we have no commitment to you" provision. The wording in various claims-made environmental insurance policies resembles the following.

Coverage under this Policy for such subsequent claims shall not apply, however, unless at the time such claims are first made and reported, the insured has maintained with us or any other subsidiary or affiliate Pollution Legal Liability coverage substantially the same as this coverage on a continuous, uninterrupted basis since the first such claim was made against the insured and reported to us.

Essentially, this provision requires that the insured continuously renews their policy with their insurer to maintain coverage for any subsequent claim related to a claim already reported on one of the insurer's policies. I like to refer to it as the "Perpetual Renewal" provision. If you're thinking "Wow, that sounds one-sided," you're right.

Theoretically, under an EIL product with this design, all an insurance company has to do to cut off coverage for developing environmental claims over time is figure out a way to not renew the policy. That is extremely easy to do in the excess and surplus lines insurance marketplace where renewals are not guaranteed at all. Or, if it's determined to drop the insured, the insurer could simply charge an outrageously high renewal premium (making it unaffordable and impractical for the insured to continue coverage with them) or, perhaps, exit the site pollution market entirely. Having this type of provision in a policy presents a coverage gap that many insureds are simply unaware of.

What's worse for insurance consumers is that the perpetual renewal obligation of the insured to maintain coverage for IBNR claims gets buried in parts of EIL policies where nobody looks for it nor where most insurance professionals would expect to find it. The section where the perpetual renewal provision appears is not entitled "If You Report a Loss and You Want Us To Pay for Developing Claims over Time You Need To Perpetually Renew with Us, No Matter What We Decide To Do with Your Premium or Coverage." Such a statement, although technically accurate, would certainly be frowned upon by the insurer's marketing folks. For one thing, it's kind of a downer concept, and, second, it's simply too long to be a section header.

Finding the Perpetual Renewal Provision

After reviewing numerous policies in the marketplace, here are a few examples of the policy sections where the perpetual renewal provision was located:

  • Third bullet within the "Discovery of a Pollution Condition or Claims Arising from Each Incident" section
  • The "Related Claims" bullet within the "Limits of Liability and Deductible" section
  • Under the "Non-accumulation of Limits" bullet of the "Limits of Insurance and Deductible" section
  • One of the many bullet points under the "Reporting, Defense, Settlement, and Cooperation" section
  • Final paragraph of the pollution legal liability insuring agreement

It seems that there is no rhyme or reason for the placement of this provision within EIL policies. Because of this, an awful lot of the replacement EIL policies are being placed with no regard to the effect of the renewal provision. Replacing a site pollution policy that has been with the same insurer for a decade requires more than just making sure to include the same coverage lines and matching retroactive dates. Brokers and insureds need to be even more careful if there has been a reported claim at any point in the past with the insurer whose policy is being replaced by changing to a different insurance company.

If we go back to our example from earlier, let's imagine the original EIL policy the plating company had in place contained the perpetual renewal provision. Had they moved their coverage to another insurer at any point between the first claim for cleanup costs and the lawsuit filed by the fishermen and their families, there would have been no coverage for damages or defense costs related to the other two lawsuits. The original insurer would deny coverage for the suits because the plating company did not maintain continuous coverage with them, pulling the trigger on the perpetual renewal provision. The new insurer would deny coverage because the original claim was first reported to the previous insurance company and could not be "first" reported to them and therefore would not trigger coverage.

This fatal design flaw cannot be fixed by maintaining a retroactive date on the renewal policies. Recall that an EIL policy only applies to claims arising from a first reported claim from the pollution release. The damage is done the minute the fatal placement error is made, and it is irreversible.

The Solution

One way to avoid an unfortunate situation like this is to never get into one like it in the first place. There are policies out there in the marketplace that do not contain the perpetual renewal provisions. A policy that does not give the insurer unilateral control to shut off coverage for IBNR losses is immensely more valuable to the buyer as it won't leave them uncovered for subsequent claims should they ever have to or decide to move coverage.

Unfortunately, an awful lot of insurance buyers who have had a pollution loss reported under an EIL policy some time over the past 30 years are going to lose their coverage for IBNR losses because it is impossible to renew a policy when the insurer is abandoning the product line. It is sometimes possible to endorse a replacement EIL policy with an endorsement proclaiming a new claim from a previously reported pollution loss will be covered by the current EIL policy. However, in practice, these endorsements are underutilized. It will be interesting to see how this plays out in the EIL realm as those policies are placed elsewhere and unrealized subsequent claims start rolling in.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do 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.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week, including links to free articles from industry experts. Discover practical risk management tips, insight on important case law and be the first to receive important news regarding IRMI products and events.

Learn More