The insurability of ecological damage
Jürgen Busenhart, underwriting expert with insurer Swiss Re, explains the issues surrounding liability in environmental insurancePublic concern with the environment is increasing. Eco-catastrophes and pictures of dying animals and devastated landscapes have prompted greater efforts to call to account those who are responsible. Yet not infrequently, the legal situation has allowed the responsible party to escape paying compensation, even when its financial situation would have permitted this.
A series of industrial accidents in the 1980s triggered attempts to use civil law as an instrument for settling the liability question in cases where ecological damage resulted in traditional forms of secondary environmental damage such as bodily injury or property damage. The objective of these efforts, grounded for the most part in strict liability, is to protect the property of damaged parties. In these cases, the damage involved a protected legal good, and could be quantified and indemnified according to the principles of legal liability.
In a second phase, lawmakers addressed the problem of historical contamination by adding provisions on soil protection and pollution clean up to existing laws. Their purpose was to obligate industrial operators and landowners to clean up any pollution on their property. These provisions, too, are based on property rights under civil law.
With pure, primary environmental damage, the situation is different, for it involves a free resource of nature which everyone has a right to use and benefit from equally. The principles of liability under civil law do not apply, because private property is not involved. However, special provisions under public law may empower the state, as trustee of all resources of nature, to require polluters to correct ecological damage or carry the costs for doing so. Police law provisions also make it possible to obligate potential polluters to install protections or to comply with minimum ecological standards.Comprehensive proposal
In January 2002, in response to severe occurrences that have caused massive pollution and environmental damage over large areas of Europe in the past decades, the European Commission issued a draft directive on environmental liability. The new proposal is comprehensive in scope. Though focusing on prevention, it also regulates liability and provides for cleaning up new environmental damage. After the European Parliament incorporated several changes during the second reading, the document was returned to the European Commission, which is now to produce a final version for submission to, and approval by, the Council of the EU.
The proposal is based on a liability regime under public law - that only the public authorities are entitled to bring compensation demands against polluters. Below is a partial list of the provisions in the proposal:
- Public authorities are obligated to initiate specific measures for remedying ecological damage.
- Strict liability applies to certain occupational activities presenting a potential hazard for the environment; for other activities, fault-based liability applies. The liable party is the polluter, or the party performing dangerous activities.
- Public authorities are obligated to demand that operators initiate clean up measures, or to initiate them themselves.
- Clean up measures are measures to restore the environment to its natural condition.
- This provision shall not apply to ecological damage resulting from diffuse pollution which is not clearly attributable, and for which it is not possible to demonstrate a causal relationship between the damage and the activities of individual operators. A comparison of this EU proposal with the existing legal situation in the individual member states reveals the following:
- Several environmental areas are already completely regulated. These include soil protection (historical pollution), water, protection of nature, waste (disposal sites, incinerators, etc), classified installations (IPPC, Seveso), dangerous activities/substances, air pollution and air quality, genetically modified organisms, agriculture and forestry, fisheries, and regional planning.
- In contrast, "damage to protected species and natural habitats" and "compensation for interim losses" - as proposed by the Commission - are new for most countries, and the directive requires stricter legislation in these areas.
- Various, sometimes radically different approaches have been used, based on civil law and public law. The directive focuses on the operators in control of dangerous activities, whereas most member states concentrate on the polluter and/or the owner of a contaminated site.
- Introduction of the directive will cause overlaps with existing rules, and may lead to various compatibility problems.
The draft directive provoked intense, at times heated discussion throughout Europe, in political bodies, industrial associations and other stakeholder groups. Expectations were riding particularly high that the insurance industry could slip into a new role as financial guarantor of the new liability regime. In reality, however, the industry will be able to fulfil these expectations only partially. Insurers are fundamentally willing to provide the needed solutions, as the Comité Européen des Assurances (CEA) has always made clear; but this will not be possible until certain underwriting conditions are fulfilled. Unfortunately, the directive - neither the original draft nor as modified by Parliament - would meet these conditions. Most problematic, perhaps, is the liability stipulated for "protected species and natural habitats". These are natural resources of inestimable value: but values that cannot be estimated cannot be insured.Calculating risk
In order to insure environmental liability, a clear set of criteria is needed, allowing the underwriting risk to be reliably calculated. Such criteria must exist for the severity of damage, the type of damage (eg bodily injury, property damage), and the trigger mechanism (cover for sudden and accidental events only; or limited cover for gradual events; or full cover).
It must also be accepted that insurance cover and legal liability will never be congruent. Though increasing experience will allow the two to approach each other, there will always be gaps. Lawmakers will always define liability more broadly than insurers are willing to define their cover.
Intentional pollution, for example, will never be covered, and there will always be differences with respect to types of damage, triggers or sums insured. Also - particularly in the environment arena - the risk of change, in its technical, scientific and economic aspects, has taken on forms that make it particularly difficult for the insurance industry to adapt. We know little or nothing about the effects that many substances have on our environment.
The underwriting criteria for insurability are as follows:
- Assessability: In order to calculate the potential exposure and a premium adequate to cover it, it must be possible to quantify the probability that damage will occur, as well as its severity. In addition, it must be possible to allocate damage to a particular insurance period.
- Randomness: The time at which an insured event occurs must not be predictable, and the occurrence itself must be independent of the will of the insured.
- Mutuality: A large number of endangered parties must join together to carry the hazard jointly.
- Economic efficiency: Private insurers must be able to charge a premium commensurate with the accepted risk; a premium that allows them to write insurance profitably over the long term.
To assess the probability and severity of an occurrence, insurers depend on their experience and statistics from the past. With ecological damage it is necessary to distinguish between two areas when assessing the occurrence probability: damage that is sudden and accidental, and damage that is not.
For sudden and accidental damage, insurers can usually determine probability using statistics on explosions or fires, for example. Then, by factoring in knowledge about legal liability, statutory regulations on the design and operation of industrial plants, and the properties of known substances, insurers can arrive at a fairly accurate picture of the risk they are underwriting. The joker in the pack is the risk of change, and this should not be underestimated. New knowledge is surfacing all the time as to the effect of various substances on human health.
Normally, such uncertainties are accounted for by adding a surcharge ("loading") to the premium. Yet if a factor is new or unfamiliar - or if it represents a new category, such as ecological damage - calculating its probability is more difficult, even where it would result from a sudden or accidental event. In the past, such damage has just not been insured. Thus, insurers have little or no experience - statistics - for this kind of loss, and it is currently almost impossible to calculate an adequate premium.
However, when an insured "event" is not sudden or accidental, things become more complicated. Here, the insurer may be dealing with emissions that accumulate gradually: at an industrial plant, for example, over years of normal, undisrupted, authorised operation. At first, the event is not recognised as such; and for this reason, it cannot be allocated to a definite point in time. The threat to human health may result from the slow accumulation of toxic substances in a propagating medium such as groundwater. Here as well, insurers do not have the necessary experience because such events have until now been excluded from insurance cover, and are not included in loss statistics. They also lack knowledge as to the effect of many substances on the environment and this, too, makes it more difficult to assess risk. Coming on top of this, liability for ecological damage would aggravate the insurers' situation yet further.A formidable challenge
The question of damage severity is even more complex. Despite an abundance of statistical data, there is still considerable uncertainty in estimating the amounts that will be awarded in future for bodily injury claims, due to cost trends in the healthcare sector and other factors. Similar uncertainty reigns when it comes to estimating the cleanup cost for contaminated waste sites: methods are changing, costs are rising. Ecological damage presents an even more formidable challenge. There is no legal basis for attributing liability and mandating the restoration of ecological quality; and even more critical, to the insurer, is the lack of statistical data for estimating the cost of such measures.
In calculating an adequate premium, long-term profitability is not the only issue: statutory solvency requirements also play an important role. The law requires insurers to charge premiums that, in light of underwriting knowledge, are adequate to cover the risk. For the reasons mentioned above, this is hardly possible for ecological damage using traditional underwriting methods.
In the past, the insurance industry has repeatedly proven that it is willing and able to adapt its concepts and products to its clients' changing needs. In doing so, it has contributed mightily to the development of society itself. This applies even to environmental risks, which are continuously evolving in response to legal, technical, social and political pressures. Insurers have already extended or brought out new covers here: in environmental liability and in cleanup, for example.
It has always taken time for insurers to adapt their covers (or develop new ones) to fit a changing world. This is as true for environmental damage insurance as it is for any other type of cover. In this respect, at least, ecological damage insurance is quite conventional. We may therefore be confident that as soon as a foundation for solid underwriting has been laid, the market will offer insurance products covering, more or less comprehensively, the liability for ecological damage.