Environmental risk consultant Allister Meal of risk and insurance services firm Marsh explains the options available for insuring against environmental damage
The use of insurance and alternative risk transfer for environmental liabilities has changed dramatically in the last few years. The market for environmental insurance policies has grown considerably, and there is now a range of specialist environmental impairment liability (EIL) insurance policies to protect against losses from environmental risks resulting from both historic and new pollution conditions.
The main types of policies include liability for pollution conditions associated with one or more sites, contractors pollution liability, and remediation cost cap. These policies can potentially offer limits up to £60m pounds or even, in some cases, in excess of £100m. The policies can be on an annual or a multi-year basis, up to a normal maximum of ten years in respect of historic conditions and 3-5 years in respect of new conditions.
In addition to this expanding EIL market, there has also been a growth in alternative financial solutions. One of the main reasons for this is that a pure insurance solution will not normally cover issues such as known pollution liabilities.
But there are ways of dealing with these issues through an alternative risk transfer (ART) mechanism that can potentially be more financially beneficial than simply creating an internal fund.
A key distinction is between known risks and known liabilities. Insurance can usually help with known risks. However, with known liabilities, it is more likely to be necessary to look at some sort of alternative solution.
The most financially beneficial solution is often a tailor-made blended finite risk programme, which combines risk transfer with risk financing. These can range from
straightforward finite risk solutions focusing on timing risk and cash flow through to more complex programmes.
For example, there may be a divestment programme where there is a mix of known liabilities and risks and unknown risks. In such a case, the insurance market will cover some elements and – where they cannot provide insurance cover – there will be a risk financing element.
In other words, a blended solution is saying: Let’s insure what we can and provide some sort of financial protection against what we can’t in the most appropriate and effective way. This means that the solution can be mixed and matched in different ways to provide tailor-made protection.
Blended solutions may spread cash impact over multiple years. Higher policy limits and longer periods than those available through environmental insurance alone may also be key elements.
In relation to historic pre-existing conditions, the longest cover period available in the insurance market is ten years. However, some companies may require protection over a longer period, and the financing element can mix with the insurable element to provide longer policy periods as well as higher limits.
One of the main elements of coverage is changing legislation, and on the risk financing side there is a much greater option to cover regulatory uncertainty through access to longer policy periods and more flexible policy wordings.
Another area where blended solutions may provide coverage is where there is a transfer of a company or an acquisition in which a warranty or indemnity is provided, but where due diligence cannot be carried out on some parts of the warranty or indemnity. For example, if a company has a long industrial history, it may have owned sites it no longer possesses but where it may have some residual liability.
Such risks would probably be uninsurable in the market if the details of these former sites was completely unknown, but could potentially be covered with a blended solution.
A company that does not have known liabilities, but is looking for environmental cover for potential future problems is perhaps more likely to be satisfied by the traditional EIL market rather than needing to turn to an ART solution.
But this depends on the size of the deal, what information is available and – more importantly – the potential costs of obtaining sufficient information to get the risk transfer solution. For a large multinational deal, the cost of obtaining sufficient information on all sites may be prohibitive, in which case a blended solution may be the answer.
Role of the environmental broker
The quality and extent of information on the risks and liabilities is crucial in the environmental field. Environmental insurance is underwritten on a technical not an actuarial basis, so the better the quality and presentation of underwriting data, the better the results in terms of insurability, terms and conditions, and premium costs. This is where the broker plays a key role.
The more information there is, the more risk can be transferred. If there are complete unknowns or risks that cannot be properly underwritten, then the risk financing route may be more appropriate. Or, if the extent of the liabilities cannot be properly determined without significant spending on investigations, then once again the risk financing route may be more appropriate.
It important is to remember that alternative risk financing solutions are not a one size fits all package. It may be appropriate for the risk transfer and financing elements to sit side by side; though they will remain interrelated in part.
The key is to understand the organisation and how and why it wants to manage its liabilities. Again, this where the broker comes in, but it is important to stress that there is a critical need for this to be done by specialists working in the field. Not just brokers in generic terms, but people with specialist knowledge of environmental insurance and environmental risk management and the ability to understand what the risks are and how solutions can best be structured around them. The broker adds value by bringing together the insurance and financing elements, and this requires a team with insurance, risk management and financing experts, all with specific environmental knowledge.
The market and the users
It is important that the people involved in underwriting and risk financing are specialists. It is vital that the insurer has a technical understanding of the issues and where there are known liabilities, it is important that the insurer has tried and tested claims handling and claims management experience.
In general, blended solutions are being used by medium to large organisations and by acquisitive companies, or those that are going through financial restructuring or divestment programme on certain parts of their business. Increasingly, lenders are also looking at environmental exposures when making investment decisions. As a result, a number of environmental insurance and/or ART deals are being driven by lenders.
Communication is vital
In addition to the continued growth of the market, blended programmes, combining risk transfer and risk finance, are increasingly being used. However, these solutions require a good understanding of environmental information and of the actual risks and liabilities that the solution has to deal with.
Communication is vital, as the underwriters that are providing the risk transfer element may offer more restrictive insurance if they know there is also a funded element. It is important in such a case that the risks are properly assessed so that the risk transfer does as much work as possible and the funding part can be as small as possible. This is key to the success and cost effectiveness of blended solutions.
The role of the specialist environmental broker is crucial to the success of these solutions in ensuring the best presentation to insurers and negotiating the most appropriate and financially beneficial risk solution for its client.
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