Sudden decline

Robert Martin and Marcel Steward reflect on the uncertain future of Sudden & Accidental pollution insurance and the possible alternative insurance of the future


There are rumours in the UK insurance markets that a claim has been lodged against the pollution cover afforded by a general liability policy1, and that this claim is so large that it could lead to this remaining element of environmental impairment insurance being withdrawn from general liability policies.

Over the next two pages we will examine how this cover came into existence, whether the clauses actually provide any real cover, and the alternative insurance for the future.
The development of Sudden & Accidental (or Sudden & Unforeseen) clauses in general liability policies in the UK and Europe followed the pattern established in the USA, and possibly the experience there of the Superfund legislation.

In the 1980s, American businesses began to face Superfund-related liabilities and sought protection from their comprehensive general liability (CGL) policies. In some cases the insureds faced clean-up obligations at sites involving the continuous discharge of pollutants dating back to the 1800s. Effective from the early 1970s through to 1985, insurers sought to protect themselves by exclusions in CGL policies barring coverage for bodily injury or property damage arising out of discharge of certain pollutants, unless such discharge was sudden and accidental.

Some courts found the terms unambiguous, but others have interpreted the exclusion as ambiguous, finding in favour of coverage for gradual pollution. Starting in 1986, many insurers began to include absolute pollution exclusion in their CGL policies. While specific wordings varied from carrier to carrier, exclusions generally applied to bodily injury or property damage caused by discharge of specific pollutants at specific sites. These absolute exclusions have been upheld by most courts.

Valerie Fogleman's Environmental Liabilities and Insurance in England and the United States on Environmental Insurance2 details the withdrawal of cover for environmental liabilities from general liability policies in the UK. Summarising this, the cover for losses arising from pollution began to become limited in public liability policies from the late 1980s, when. the standard pollution exclusions drafted by the Lloyd's Underwriters Non-Marine Association were generally used.

As a result of the Environmental Protection Act 1990, clauses to restrict cover under professional indemnity and general liability policies to Sudden & Accidental or Sudden & Unforeseen incidents were also introduced - insurance companies being fearful that their 'losses occurring' wordings could leave their policies open to gradual pollution claims. Thus, rather than the clauses being extensions of covers afforded under general liability and public liability policies, they are a limitation imposed by the insurance companies in an attempt to safeguard themselves from a 'tail' of claims for gradual pollution. So why is there concern over the coverage and why is there now talk of it being withdrawn, not only in the UK but in other countries such as Belgium?

What is the problem with Sudden & Accidental?
As exclusion clauses, if they do operate in the manner the insurance company intended, cover is in place by default.
It is easy to see how the word 'unforeseen' favours the insurer. For instance, if a company regularly stores some toxic chemicals it is not unforeseen that spillages will occur. Similarly, the debate over 'accidental' or 'deliberate' is also likely to be short. However, what is 'sudden' and what is 'gradual' can sometimes be less clear, depending on whether the definition is triggered by the cause or the effect.

For example, let us imagine an underground pipe, which delivers chemicals from an underground storage tank to various buildings on the site, has burst; a leak has occurred and contaminated the groundwater. This water flows onto a neighbouring farm where the sheep have drunk some of the water; and their meat causes illness for those who eat it.

When the pipe is examined it is seen to have rusted. Did the incident result the instant the pipe burst, or was it caused by the corrosion? Was it a slow leak, such that the chemical saturated the ground before passing into the ground water, or was there an immediate flow? Was the pollution triggered the instant the water crossed onto the neighbour's land, or did the water gradually migrate onto his premises over time, say when the water table reached certain limits?

Depending on the specifics of the case, the interpretation of 'sudden' or 'gradual' will determine whether or not cover is provided by the general liability policy wording.
Environmental Impairment Liability (IAL) policies that have been developed for non-USA environmental risks, in a market that is primarily based in London, provide cover for 'pollution events', i.e. both Sudden and Gradual incidents.

It is a relatively new market, having only come into existence following the EPA1990 and not having written meaningful covers until the mid- to late 1990s, when it was driven to respond to the boom period for M&A activity.

As there are very few underwriters who participate and few brokers who specialise in this niche market, a number of misconceptions and misunderstandings surround it. While some of these have a root in the reality of the early years of the operation of the market, a number are merely propagated by the ill-informed, based on the hearsay of others.

In reality, EIL has now developed into a significant market, but it is being inhibited from growth by the failure of businesses to recognise their true exposure to environmental risks. Indeed, one could quite justifiably ask why the values shown for Land and Buildings valued at 'the lower of cost and net realisable value' on the balance sheets are not being reduced by the related costs of remediation for historic contamination.

Further complexities
The much-heralded European Environmental Liability Directive is currently being drafted into the national laws of Member States and will become operational in 2007. The final draft did not impose the mandatory environmental insurance that appeared in previous iterations, but it leaves the door open, as there is a requirement for a report back to the Commission on the development of environmental insurance markets in 2010. The degree to which the directive will bring about harmonisation is open to question, with existing penalties in some Member States exceeding those put forward in the directive. Whilst the directive reinforces the 'polluter pays' principle, it does not dictate whether this should be on a joint and several basis, or, say, some form of proportional joint and several basis.

Harmonisation of environmental law across Europe is a necessity, as pollution and contamination do not recognise country boundaries. Misunderstandings also persist in regard to the environmental insurance that exists within general liability policies - those environmental covers which are compulsory in some countries and those which can be achieved. International business necessitates that we strive for simplification and standardisation.

The UK Parliament's Environmental Audit Committee concluded in a recent report that crimes against the environment are perceived as victimless and therefore low priority, especially as the penalties are usually minor. It states that unless the Government takes action there is little hope of progress. It points out that SMEs are responsible for up to 80% of all the pollution and for more than 60% of the commercial and industrial waste produced in England and Wales.

In Europe, a new consultancy report compares the effectiveness of non-criminal and criminal measures on the deterrence of environmental crimes and on protection. The report recommends that there should be an EU-wide minimum penalty for certain breaches of environmental law by companies, and suggests several possibilities, including a suspension of activities for offending companies.

Government-imposed penalties won't drive change in regard to historic/legacy environmental issues. It is also questionable whether governments even wish to take a strong line on such matters. Should they be unable to enforce a clean-up by an owner or user, would this leave the Government themselves liable for the cost of clean-up?

Almost everything we read about environmental matters relates to the future and doing things differently, without mention of the problems inherited by the industrial revolution. Can these legacy risks be transferred to the insurance companies? The development of the non-USA environmental markets has been held back by the Sudden & Accidental covers offered by other underwriting markets, which if withdrawn will cause more firms to look to the EIL underwriters for protection.

More significantly, however, the market has also been held back by the attitude of business to environmental issues and the failure to evaluate their exposures either by valuation of their property assets or recognition of their real or potential liabilities to third parties. The well-documented business failures of Enron and World.com brought about the disclosure requirements of the Sarbanes-Oxley Act 2002, with the mandatory disclosures reaching beyond the USA to world-wide subsidiaries of US-parented groups and to foreign registrants on US stock exchanges. While Europe has favoured voluntary disclosures against their codes of corporate governance, it is to be expected that a significant failure of a major European business enterprise will see a change to the prescriptive approach favoured in the USA.

Looking to the future
While harmonisation of EU environmental laws can bring about a change in attitude, this is more likely to be the long-term game plan. In the short term, it is harmonisation of accounting standards and disclosure requirements that will bring about the added focus needed for environmental issues. With the increased awareness will come the need to remove stakeholders' concerns in regard to uncertainties by the placement of suitable environmental insurance policies. This will create the critical mass the environmental markets need to become financially efficient.

Until this demand is force-generated there will be anti-selection against the markets, with those believing they are low-risk not purchasing insurance and those who are high-risk perceiving the cover is too expensive. The analogy would be for all motor insurance to be made optional. Good drivers who had not had a claim would not believe it worthwhile, while a bad driver with high past claims would deem the insurance too expensive. Just as the good driver can be in an accident either of their own or someone else's making, or could buy a car with a latent mechanical default that emerges and causes an accident, the good environmental risk can be caught out, perhaps by pollution resulting from the use of a property by a former owner or user. An office block built on a former Brownfield site for which the remediation is undertaken, while compliant with current law, is not compliant with tomorrow's law.

Should the demise of Sudden & Accidental coverage happen, it could prove to be a blessing in disguise, because it could provide the necessary impetus for the development of a strong and efficient EIL market.
Robert Martin and Marcel Steward are insurance experts for Aon's Environmental Consutling and Solutions Unit

References:
1 References to general liability policies in the UK also apply to public liability policies as well as to some combined liability policies.
2 Environmental Liabilities and Insurance in England and the United States, by Valerie Fogleman, published by Witherbys

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