Expert Commentary

Navigating the U.S. Environmental Liability Market (Part 1)

In this two-part article, Alan Bressler examines the current state of the environmental insurance market, including the players, capacity, mold, and bio-terrorism.

March 2002

Before the 1970s, the potential effects of industrial activities on the environment were not widely reported. Since that time, however, regulatory changes, social awareness, and a few highly publicized cases against major corporations prompted organizations to take significant strides in managing environmental risks.

Today, in addition to a wide variety of technological, process, and behavioral improvements, corporations are using risk management tools and financing mechanisms developed by a continually evolving environmental insurance marketplace. This article examines the current state of the marketplace, how it got there, and factors driving its growth. Part 2 examines the impact of September 11 and new environmental concerns—mold and bio-terrorism—on the environmental insurance market.

The Development and Growth of the Environmental Insurance Market

In the mid-1970s, organizations that had relied on general liability policies to cover operational risks began to experience the effects of the emerging environmental liability. In the aftermath of incidents like Love Canal in New York and Times Beach, Missouri, new federal and state regulatory requirements began concentrating on hazardous waste treatment, storage, and disposal operations, chemical manufacturers, and the blossoming environmental services industry.

The regulations, along with increased social environmental awareness and activism, helped give rise to the environmental insurance market. Consider, for example, the passage of the Resource Conservation and Recovery Act in 1976. It initiated the requirement that certain types of facilities provide evidence of financial responsibility for certain pollution release incidents at the same time that traditional property and casualty insurers began excluding pollution risk from their general liability policies. This left a handful of insurance markets that were capable and willing to provide specialized coverage for pollution.

The initial capacity of the environmental insurance market was limited by a number of factors.

  1. Among the small number of insurers entering the market in the early 1980s, most attempted to teach traditional casualty underwriters how to analyze and price environmental risks. Yet, the integration of environmental science (engineering, geology, and hyrdogeology) with underwriting analysis was not widely practiced. Compounding this problem was the lack of historical underwriting data on which frequency and severity trends could be established for a wide variety of environmental exposures.
  2. Largely as result of the first factor, the insurance products available initially were narrow in coverage, costly, and cumbersome to apply for and obtain.
  3. The underwriting community generally viewed the market potential as relatively small, based on what was then a limited number of compliance-driven applications.
  4. Reinsurers were reluctant to risk capacity in such new, uncharted territory.
  5. Few insurance brokers understood the exposure, the client's needs, the regulatory issues, or the products. In time, as historical underwriting data grew, more underwriters hired environmental professionals for their underwriting units. Results proved favorable, and capacity and variety of available environmental coverages increased dramatically.

In the last 10 years, the environmental insurance market has experienced double-digit gross premium growth. Long-term market participants have been underwriting environmental exposures profitably, given the greater underwriting experience, historical data, and knowledge in handling environmental claims.

The Role of Environmental Insurance in Today's Market

Environmental insurance has developed from its roots as a compliance-driven product to a tool for managing environmental risk and for protecting shareholders from the financial consequences of environmental liabilities. Where the initial market comprised corporations purchasing coverage primarily because it was a regulatory requirement, major corporations today are choosing these products and using them as financial tools to address a variety of business needs.

Environmental insurance now plays a major role in a variety of business transactions and financial engineering situations. In mergers and acquisitions, it protects the acquiring company from unanticipated costs overruns associated with known cleanup obligations, as well as the discovery of unknown, pre-merger pollution conditions. And, in the disposition of surplus corporate assets, environmental insurance often substitutes for the selling corporation's indemnification.

In Brownfield redevelopments, developers use environmental insurance to guarantee that a project's financial success won't be derailed by a number of known or unknown environmental conditions, including those that cause delays in project completion. In state and federal Superfund cleanups, environmental insurance is used in virtually every situation where an environmental contractor guarantees to perform the required remediation on a fixed-price, "at-risk" basis. In many cases, these products facilitate transactions that have favorable tax and accounting treatment, often the insured's ultimate strategic objective.

While much demand for environmental insurance and risk services has been focused in North America, international markets are beginning to experience the same trends that triggered U.S. environmental market growth. Europe and Australia have both seen significant developments of environmental regulatory initiatives and enforcement, and increased social awareness of environmental issues.

2001 State of the Market

Although the commercial insurance industry generally experienced a hardening of terms and conditions in 2001, environmental insurance appears to have been less affected than most lines. Environmental premiums in 2001 were only 2-4 percent higher than 2000, a modest increase relative to most other casualty insurance lines.

Meanwhile, environmental insurance markets continue to leverage the dynamics of high-growth potential against an otherwise hardening market. While the conditions in the overall property and casualty (P&C) market have had some effects on the environmental market, most environmental insurers continue to offer significant capacity, broad and flexible policy terms and conditions, and multiyear policy terms. Even though pricing has been somewhat affected, it remains relatively aggressive. Most industry experts expect this trend to continue in 2002, with some slight twists that have entered the market psyche due to evolving environmental risks.

Market capacity offered by any one insurer for a single environmental transaction ranges from unchanged from 2001 to a 50 percent reduction, with a few of the major markets offering $100 million per loss, and some offering $150 million or more in the aggregate. A few primary markets have reduced their capacity from $100 million down to $50 million. Even as reinsurance costs rose across all lines of coverage, total market capacity for environmental products remains in excess of $500 million. And even those insurers who have reduced their primary capacity are, generally, able to obtain facultative reinsurance that allows them to offer $150-$200 million for a single program. In addition, a number of specialty markets, and some traditional P&C insurers that see opportunity in this area, continue to add market capacity.

Broad policy terms and conditions for environmental products continued to characterize the environmental insurance market in 2001. Rather than imposing coverage limitations, most markets are seeking higher retentions and relatively modest price increases in an attempt to maintain underwriting profitability. In this case, the markets may be concerned that demand would be jeopardized if restrictions affect the products' applicability in strategic and financial contexts. However, there are some exceptions.

Possible Problem Areas

The nature of environmental risk is continually changing, and the market continues to evolve accordingly, albeit cautiously in some cases. One example is the steady growth of mold-related claims, especially in construction and habitational settings. The initial responses of most insurance markets to severely limit (often via sublimit) or exclude coverage are giving way to increased underwriting expertise and scrutiny, and creative methods of providing coverage.

Multiyear policies remained popular with 10-year policy terms a typical maximum—and even a standard for fixed-site, traditional risk transfer products, like pollution legal liability. Due to reinsurance restrictions, some insurers have reined in policy terms beyond 10 years; others continue to offer them on a case-by-case basis. At least one market is restricting to 5-year policy terms associated with new environmental conditions (i.e., after coverage is bound).

In the spirit of maintaining the "deal facilitation" focus that the products have built into the legal and real estate communities, insurers have become creative in dealing with reinsurance restrictions on policy term length. Examples include guaranteed renewal terms, extended reporting periods, and "rolling" renewals. The September 11 attacks had widespread influence on the insurance industry, including the environmental insurance market. The catastrophic losses being reported by reinsurers have led to restricted reinsurance capacity for all lines of coverage worldwide.

Markets and Capacity

More than a dozen insurers provide various pollution-related insurance coverages. However, six of them are considered "major" markets, offering significant capacity, extensive underwriting experience, technical expertise, and product flexibility. Below is a summary of these insurers and their respective capacity available for any one transaction.

While any individual market typically does not provide limits of more than $100mm, except on a facultative reinsurance basis, higher limits may be obtained by layering the capacity of multiple insurers. Additionally, it should be noted that global reinsurance capacity is in excess of $500 million for any one placement.

Premium volume is expected to continue to increase at an annual rate of 20–25 percent as environmental products continue to become a more meaningful component of many business transactions. Insurance companies will continue to compete aggressively for market share, in terms of coverage depth, innovation and flexibility, price, and capacity. Markets able to continue providing comprehensive, innovative, and adaptable products and financial stability will continue to dominate the environmental insurance market.

Part 2 of this article takes a look at what affect the events of September 11 and new environmental concerns—mold and bio-terrorism—are having on the environmental insurance market.

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.

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