Environmental Risks and Insurance: Looking Back and Forward

The US public is much more aware of the human impact on the environment than it has ever been. In North Dakota, 10,000 people camping in the winter to protest a new oil pipeline is a testament to that relative new awareness and concern. This environmental awareness also translates into less tolerance for pollution and polluters. Less tolerance translates into more claims for environmental damages in the courts.

Clean Water Act

Correspondingly, environmental risks are expanding to Main Street businesses and farms at an unprecedented pace. In 2016, the Clean Water Act was expanded to encompass nonpoint source pollution. A point source is a drain pipe. A nonpoint source could be a farmer's field or a water drainage district. One water drainage district can involve hundreds of farms, the board of directors of the water drainage district, and everybody who sold fertilizer to the farms. Combine that with public intolerance and industrialized agriculture, and the environmental risks in farming are entering a new world that farms are unprepared to deal with.

That one change in the Clean Water Act, a decades' old environmental protection law, sets federal environmental protection laws on a collision course with decades' old state "right to farm" laws. In the simplest terms, right-to-farm laws are not right-to-pollute laws, and federal law prevails. Nine-figure pollution damage claims in this area have already been made. Most of the parties involved in the farming sector do not have a speck of useful insurance coverage in place for environmental damages to soil and water today.

Environmental Insurance Capacity

There was a glut of environmental insurance capacity in 2016, and that will be here in 2017 as well. The supply of environmental insurance products exceeding demand has been the case since at least 1988, so that is not a new situation.

The constraint in the marketplace that leads to poor market penetration in the environmental insurance product line has always been in the product distribution channel where insurance producers are not educationally equipped to help their customer base manage environmental risks. The reactivation of the Society of Environmental Insurance Professionals in 2016, a not-for-profit educational organization dedicated to the advancement of knowledge on environmental insurance, and webcasts from multiple providers on environmental insurance and risks hold promise in creating the venues for insurance producers to become more proficient in the coverage line.

The smaller end of the environmental insurance marketplace is less than 3 percent market penetrated. For example, there are 2 million farms without adequate insurance for fertilizer-caused contamination to ground and surface waters. There are over 2 million condo and apartment buildings that do not have adequate coverage for mold or Category 3 water damage today. There are significant sales opportunities for insurance producers in both of these sectors.

2016 Environmental Milestones

The following are some of the environmental risk milestones from 2016.

• The city of Des Moines, Iowa, needs a new water treatment because farm fertilizer spread on fields—in some cases, decades ago—has made its water supply too unsafe to drink. The city would like the nonpoint polluters upstream to pay $175 million for the new plant. Those "polluters," which include county board members in three counties upstream from Des Moines on the Racoon River, are finding out firsthand why the Supreme Court justice from Wisconsin said in 2014 that the liability insurance policies sold to farms for pollution losses were "useless."
• A city in Alabama that draws in drinking water from a river is suing a long list of manufacturers in Georgia for contaminating the river with chemicals. Included in the list of damages the city seeks compensation for is lost revenue due to its inability to sell its drinking water to its residents. The damages claims being made by the city are for economic damages due to reduced revenues from the sale of water.
• AIG, the company that basically invented commercially viable environmental insurance in 1980, exited its pollution legal liability coverage line in February 2016. AIG will no longer renew those policies. Although there was no official reason provided for exiting the site pollution insurance product line that I am aware of, the general consensus in the marketplace is the exit was driven by poor loss ratios in the coverage line. As these nonrenewed AIG policies are being replaced at sometimes 40 percent price decreases, not enough attention (apparently, none) is being given to formerly reported claims under the AIG pollution legal liability (PLL) policies. Environmental impairment liability (EIL) claims sometimes take 20 years to fully develop from the date they were first reported. There is a little quirk built into an AIG PLL policy (and others) that requires perpetual renewal of the coverage with AIG for incurred by but not reported claims to be covered. It is hard to renew a policy if the insurer will not sell it. Hence, the incurred but not reported losses might not be covered at all unless specific attention is paid to this loss exposure within the replacement coverage.
• At least four new managing general agents entered the marketplace to sell environmental insurance in 2016, adding to an already oversupply of environmental insurance products and distribution points. Oversupply is leading to lower premiums, which, in some sectors, were already likely too low to begin with.
• The glut of environmental insurance products has made matching the environmental insurance product to the needs of the customer even more difficult for the insurance brokers. In some industry sectors, such as fire and water restoration contractors, the fundamental coverage defect rate between the general liability and environmental insurance is still above 80 percent in the policies sold to this class of business.
• For unknown reasons, claims adjusters seem to be denying losses that have been paid for years under exceptions to pollution exclusions. This emerging trend is especially noticeable in the oil and gas insurance sectors. For decades, insurance companies in this sector have sold general liability (GL) policies showing "pollution" coverage on the declarations page. The "pollution coverage" on these GL policies is actually a series of exclusions related to pollution. Under certain circumstances associated with the pollution event, exclusions to the pollution exclusion can lead to a covered loss, or an uncovered loss, depending on which claims adjuster's view is taken. In 2016, there seemed to be an unusual number of claims denied for pollution based on the perspective of the claims adjuster, sometimes in midlevel layers of excess placements, even when the insurers below and above the contested coverage layer had paid for pollution damages. In my experience, depending on exclusions to exclusions is not the best way to insure for pollution damage losses. It is better to have the pollution coverage within an insuring agreement. Pollution exclusions are hard enough to understand without adding into the mix pollution exclusion exclusions. It is no wonder there is emerging coverage litigation in the arena.
• For unknown reasons, the insurance companies that sold GL insurance between 1980 to 1986, and have been paying for pollution claims over the past few decades under those old GL policies, have started to investigate what kind of primary environmental insurance was available to cover pollution-related losses after 1986. The legacy GL insurers would like to debunk the myth that GL insurance buyers could not buy meaningful pollution coverage after 1986. If the legacy GL insurers can show the primary environmental insurance was available but not purchased after the "absolute" pollution exclusions were added to GL policies, those insurance companies could free up billions in incurred but not paid pollution claims. Of course, that means that the responsible parties would have to pay the environmental legacy claims out of pocket if they have not purchased primary pollution insurance.
• The biggest change I experienced in 2016 was a tenfold increase in expert witness work on environmental insurance-related topics. More requests for expert witness support work were presented to me in 1 year than in the past 10 years combined. The litigated pollution insurance damages in the cases I did work on exceeded a billion dollars. Our research/report production team produced 90,000 words in expert reports with well over 15,000 pages of supporting documents, all detailing the availability of environmental insurance after 1986 and the workings of environmental insurance in custom and practice.

The takeaway for the insurance producers reading this last point is: Why was their insurance coverage litigation on a billion dollars of pollution claims in the first place? There has been a glut of environmental insurance capacity since 1988. There are not a lot of good reasons to have uninsured pollution losses any time after 1997 for anything less risky than the containment operations for the Chernobyl nuclear disaster in the Ukraine.

Professional Liability Effects

Expanding environmental protection laws, combined with a historical surplus of underpriced environmental insurance, is setting up hundreds of insurance brokers for professional liability claims arising from leaving their clients needlessly uninsured for pollution-related losses. In some cases, insurance brokers have their feet being held to the fire for their activities, or lack thereof, 20 years ago, which left their customers uninsured for environmental losses today.

A very much underappreciated design-advantage of claims-made insurance coverage is 40 years of neglect on pollution loss exposures, and the effects of pollution exclusions can be erased by simply purchasing full prior acts EIL coverage today. For insurance brokers, simply recommending insurance of this type should alleviate allegations of neglect in the long-term customer base for uninsured losses.

The departure of AIG in 2016 from the site pollution insurance product line has created the biggest shift in the environmental insurance marketplace since 1987. A former product line manager at AIG tweeted that he estimated there was 300 percent loss ratio on the site pollution product line from placements made more than 10 years ago.

This 20/20 hindsight is showing that environmental insurance has been unrealistically cheap for decades based on these kinds of loss ratios. The reason that the site pollution liability loss ratio affects everyone today, not just the customers of AIG, is that, if the site pollution product line product line really has a loss ratio that bad, it is not reasonable to say environmental insurance is or was too expensive as a justification for not buying the insurance.

History will show it was the insured losses under EIL policies that were expensive, not the premiums charged. From at least 1997 to 2007, environmental insurance for expected and unexpected loss costs, arising from known and unknown pollution conditions at an insured site, was available dirt cheap. Some of the policy terms were 30 years long!

As the pre-1986 GL insurers start to produce solid evidence that there was over a billion dollars of retroactive primary environmental insurance capacity available for purchase, the insurance brokers who did not recommend EIL coverage 25 years ago, or any time thereafter, will be looked at under the microscope for potential errors and omissions by the clients with uninsured losses.

What To Expect in 2017

The public demand for a clean environment will continue to expand, even in the face of a Donald Trump administration. A lack of government enforcement of environmental protection laws would be expected to lead to more private lawsuits.

The environmental insurance product line in the United States will continue to expand at a 10 percent organic growth rate. Most of the growth will come from small accounts where the market is less than 3 percent penetrated.

I foresee increasing pollution losses on Main Street businesses and agricultural risks. Most of these losses will be uninsured. The errors and omissions loss exposure to insurance agents will be light in this sector because the uninsured clients, after the uninsured loss, will not have the money necessary to pursue a professional liability lawsuit against the agent.

With billions of dollars at stake, I expect the legacy GL insurers to continue to perfect the "primary environmental insurance was available" argument to deny losses for post-1986 pollution claims under pre-1986 policies. Unlike the small account market, uninsured pollution claims that could have been insured for 20–30 years under an insurance product line with 300 percent loss ratio will put the larger brokers under the microscope for professional liability losses. This new loss exposure for the brokers will be on long-term customers who depended on the broker's advice on what to insure in cases where the brokers did not go on record recommending pollution insurance in the 1997-to-2007 time period.

Not paying for pollution claims under the exceptions to pollution exclusions in GL policies has been expanding for the past 3 years, and I expect that trend to continue. Those risks will migrate toward true environmental insurance policy forms.

Conclusion

All of this spells more demand for environmental insurance from both the large and small account market. It is a great time to be a specialist in environmental insurance.