1 ENVIRONMENTAL RISK & INSURANCE

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1 Chapter 1 ENVIRONMENTAL RISK & INSURANCE Environmental insurance is now well established and is set for growth with the arrival of new environmental regulations, notably the Environmental Liability Directive, which is expected to dramatically increase the costs of environmental liability ENVIRONMENTAL INSURANCE, ONCE LABELLED as difficult to obtain, data intensive, expensive and lacking cover, has finally come of age. With over 15 years of development and use in the UK and Europe, and 30 in the US, the environmental market has matured and now has both the strength and expertise to respond to today s challenges. In the recent past, environmental insurance was predominantly used to facilitate property transactions by removing the uncertainty of environmental risks from the equation by transferring them to an insurance carrier. However, the emerging trend is for companies to use it to protect their entire portfolio of operations and operational assets. These portfolio programmes are primarily focused on emerging legal liabilities and exposures created by new environmental regulations and the increase in enforcement around the world. One significant example is the Environmental Liability Directive (ELD) which extends environmental liability across the European Union for any damage to the environment, protected habitats and species by a company s operations. These emerging environmental risks are typically not covered under traditional liability coverages. According to the International Underwriting Association (IUA) in a recent report, The gap between traditional insurance cover and the range of liability has become uncomfortably wide and will get wider. The argument that these pollution cases are very rare or inconsequential no longer stands scrutiny, according to Chubb Europe, one of a number of specialist environmental insurers (see box right). ) The Environmental Liability Directive One of the most important factors driving an interest in environmental insurance and risk management in Europe is the European Union Environmental Liability Directive (Directive 2004/35/CE). This is EU-wide legislation that establishes a common framework for the prevention and remedying of environmental damage at a reasonable cost to society. The ELD is transposed into the national laws of each member state. All member states have to ensure their national laws meet the minimum requirements of the ELD, though they may elect to go further in providing more stringent standards and more Coming of age CHUBB ENVIRONMENTAL CLAIMS FACTS N fact pollution cases are on the rise. In 2007 there were I over 800 pollution incidents that had a serious impact on the environment and another 16,300 minor pollution incidents. Behind these figures are companies that are liable to pay fines and, most importantly, cleanup costs. Fines may be small, however cleanup costs are often very large. As an example a company had a major spill and was subsequently fined 15,000. The cleanup costs however were 1.2m. REVIEW QUESTION: Pollution only happens in very high risk industries (True or False?) ANSWER: False The most common sources of pollution in 2007 were: organic materials inert materials and wastes sewage oils and fuels chemicals severe penalties for violations. Some countries have chosen to extend the minimum requirements by extending the definition of protected species or choosing not to put in place optional permit and state-of-art defenses. Because each country is different, any insurance must respond to the specific national law implementing the ELD. The implementing legislation for the ELD only became effective in 2007, and so its impact on environmental events in member nations is only beginning to show. For example, the recent pollution caused by an oil pipeline failure in southern France has resulted in claims against the owner and operator for damage to protected species. Another example, the recent red mud spill at Kondohor in Hungary [pictured, next page] ] has become a focus for debate about the environmental damage caused by this catastrophic Some countries have chosen to extend the minimum requirements by extending the definition of protected species etc. Because each country is different, any insurance must respond to the specific national law... 7

2 Chapter 1 ENVIRONMENTAL RISK & INSURANCE release of impounded alumina wastes, and who will pay the costs of bodily injury, property damage and cleanup. Liability under ELD legislation is also being discussed in this case, but may not be relevant since the owner of the facility where the release occurred has neither insurance that will respond, nor the assets to pay such losses and damage costs. In addition, there is the question of who is going to pay the 472m fine recently imposed by the regional environmental authorities. TONY LENNON AT CHUBB CLAIMS ARE REAL, AND THERE are notifications, mainly for onsite losses. When discussing claims it is important to differentiate, especially in relation to the UK, between the claims experience of long term policies that cover historical contamination only and those policies that cover new pollution arising from ongoing operations. Although the claims experience from the historical policies is very good, the experience of operational policies demonstrates that today s industrial activities are still causing environmental damage and that the damages caused are more apparent and attract both public and regulator attention more than historical contamination. This is also borne out by the Environment Agency statistics and the number of pollution incidents that are arising every year. 400 times the cost As an indication of what the Environmental Liability Directive really means to regulated entities, the French government carried out a study using incidents from 1996 and 1997 to look at comparative regulatory costs of pre-eld liability and post- ELD costs. In the case of a spill into a river, the costs under the Directive were estimated to be as much as ten times the regulatory damages that were actually assessed in the pre-eld period. In another loss, involving a fire in a warehouse storing pesticides, post-eld costs were estimated to be 400 times the costs actually assessed under pre-eld regulations. Other examples studied in the study indicate that even without significant environmental damage, the effect of this Directive is to increase costs to responsible parties by at least 25%. One solution to the rising costs of environmental liability in the EU nations and elsewhere is environmental insurance, which can provide real protection together with the added advantage of access to expert engineers and scientists to manage control and mitigate losses. Claims paid under environmental insurance policies can often be the difference between a company staying in business or declaring bankruptcy. Indifference, ignorance and complacency cannot be allowed when a cost-effective and financially efficient solution is available. 8

3 Environmental liabilities comprise property damage, bodily injury and cleanup liability, and these liabilities are increasing as there has been a major increase in regulations globally and much greater enforcement by regulatory bodies, with the result that the costs of environmental risks and liabilities on businesses are increasing all the time ENVIRONMENTAL RISKS ENCOMPASS A WIDE array of liabilities, as illustrated in the following academic definition of environmental risk: The economic or administrative consequences of actual or potential, slow or catastrophic release of ef- fluents, emissions, wastes, resource e depletion, etc., arising out of an organisation s activities. For those of us working in the insurance and risk management arena, a more useful working definition of environmental risk is: Actual or alleged environmental damage caused by the release or disturbance of polluting materials from a business activities resulting in bodily injury, property damage or cleanup liability. Discovery of pollution, a pollution condition or a pollution event is typically the trigger for an environmental loss or claim. Pollution is generally categorised as one of the following occurrences: NEW CONDITIONS pollution caused by releases from current operations SUDDEN AND ACCIDENTAL RELEASES pollution that happens within a relatively short and defined period resulting in consequential effects such as a rupture in a pipeline or failure of a tank valve GRADUAL the drip-drip occurring over an expanded period of time such as leaking underground pipes, valves, tanks, etc. PRE-EXISTING CONDITIONS historic contamination caused by prior operations at a facility or site, typically soil and groundwater contaminated by materials used at the facility ON-SITE pollution conditions within the boundaries of a facility or site requiring action to protect work-force or the environment OFF-SITE pollution that is migrating, or has migrated, beyond the facility boundaries such as groundwater plumes or the deposition of airborne releases. Environmental risk Environmental liabilities comprise property damage, including contamination and vapour instruction, for example from industrial chemicals and fuels migrating under building, bodily injury, including physical damage, inhalation of vapours, and ingestion of contaminated produce and mental anguish, cleanup liability and legal defense expense. Regulatory enforcement action includes that taken by a regulatory body or other body delegated authority to intercede to protect human health and the environment from pollution conditions. These bodies can require companies to undertake several actions, which might include an emergency response to a sudden and accidental release to contain and stabilise a release; an investigation and assessment of pollution conditions to determine their potential for impacting human health and the environment and potential remedies to mitigate the impacts; the cleanup, remediation and restoration both off-site and onsite (first party); taking action in relation to the enforcement of regulations with regard to groundwater, rivers, lakes etc or land and soil; or an assessment of environmental damage. Environmental Liability, Legislation and Exposure Over the last 10 years there has been an explosion in environmental regulations, gaining pace year by year. Research by Aon shows that there are currently more than 17,000 separate environmental regulations that address air, water (including groundwater), land and soil contamination. Legal liability for pollution and environmental damage is driven, in part, by the numerous environmental laws and regulations which are typically administered by government-appointed authorities responsible for environmental protection and compliance. Damages to third parties often accompany events that result in regulatory actions. Another global trend is that these regulations are now being actively enforced by regulatory authorities. As a result, operators of potentially polluting facilities and operations are now more frequently being targeted for regulatory enforcement actions, and are exposed to significant legal liability under national, provincial/state and local environmental laws. Across Europe, EU member states have differing legal regimes that share the fundamental common objectives of the EU Directives, including the Environmental Liability Directive (2004/35/EC), the Water Framework Directive (200/60/EC), Integrated Pollution Prevention and Control (IPPC) (2008/1/EC) and the Directive on Protection of the Environment through Criminal Law (2008/99/EC). Globally, a wide range of regulations apply, with many of them borrowing best practice requirements from the more es- 9

4 The ELD creates a range of new responsibilities and liabilities for operators both within their home country and for any operations which are either trans-border or operate solely outside their home country tablished regimes operating across Europe and North America. Other areas of potential environmental liability include regulatory control over directives such as Seveso II (2003/105/ EC) which apply to facilities that have the potential to cause a major accident, and international treaties and agreements such as The Basel Convention on Transboundary Shipment of Hazardous Wastes and their Disposal. Examples of the potential impact of environmental risks and liabilities on business facilities and operations: Cost of risk identification, assessment and compliance with environmental laws Cost of losses and claims associated with third-party liability Cost to defend third-party claims (even where the party is ultimately exonerated) Cost of cleanup of onsite and offsite releases of pollutants Disruption of business due to the presence of contaminants or requirements for their cleanup Cost of fines and penalties imposed by regulators Unexpected costs to clean up acquired properties or businesses Losses occurring during construction or from completed operations (i.e. discovery of contaminated Chinese drywall in new homes or mould in condominium units) Losses occurring during remediation due to negligent actions of contractors Losses due to improper maintenance of structures or systems (i.e. mould due to failure of an air conditioning system) Cost to meet regulatory requirements in areas of expanded footprint of operations Cost of managing and mitigating risks, including insurance premiums for environmental insurance policies Cost to comply with financial responsibility requirements (i.e. underground storage tanks and waste management facilities) Losses due to intentional releases of contaminants (i.e. bioterrorism or sabotage) Damages to business reputation The financial consequences of many of these environmental impacts can be mitigated by the use of environmental insurance, which responds to a broad range of third-party claims and regulatory actions that are not covered by general and excess liability insurance programmes. Environmental Damage and Restoration > The EU Environmental Liability Directive The purpose of the Environmental Liability Directive (EU Directive 2004/35/CE) was to establish a common framework for the prevention and remedying of environmental damage at a reasonable cost to society The ELD does this by creating, for the first time, a comprehensive liability regime that applies across the EU for damage to protected habitats, species, flora and fauna and liability for pollution of water, groundwater and land. The ELD creates a range of new responsibilities and liabilities for operators both within their home country and for any operations which are either trans-border or operate solely outside their home country. Liability may be strict, where the materials or operations are so hazardous that negligence need not be a factor in determining liability, or fault-based (negligence) exposure. In this context, and relevant to insurance claims, the definition of operator is broad and includes any person or company that operates or controls the damaging operations. In many countries, this will also include a person that exerts decisive economic control over the technical functioning of the operations. The ELD s definition of environmental damage to include protected species and habitats is perhaps the most important development in creating a broad basis for the liability of polluters across the EU. > The EU ELD A definition For the purpose of the Directive the following definition applies: Environmental Damage : (a) damage to protected species and natural habitats, which is any damage that has significant adverse effects on reaching or maintaining the favourable conservation status of such habitats or species. Damage to protected species and natural habitats does not include previously identified adverse effects which result from an act by an operator which was expressly authorised by the relevant authorities in accordance with provisions implementing Article 6(3) and (4) or Article 16 of Directive 92/43/EEC or Article 9 of Directive 79/409/EEC or, in the case of habitats and species not covered by Community law, in accordance with equivalent provisions of national law on nature conservation. (b) water damage, which is any damage that significantly adversely affects the ecological, chemical and/or quantitative status and/or ecological potential, as defined in Directive 2000/60/EC, of the waters concerned, with the exception of adverse effects where Article 4(7) of that Directive applies; (c) land damage, which is any land contamination that cre- 10

5 ates a significant risk of human health being adversely affected as a result of the direct or indirect introduction, in, on or under land, of substances, preparations, organisms or micro-organisms. Where environmental damage as defined above does occur, the ELD specifies a number of potential obligations to address such losses depending on the scale of the damage and response to primary remediation, as outlined here: PRIMARY: Any remedial measure that returns the damaged natural resources and/or impaired services to, or towards, baseline condition COMPLEMENTARY: Any remedial measure needed to compensate for the fact that primary remediation does not result in full restoration of the damaged natural resources and/or services COMPENSATORY: Any action taken to compensate for interim losses of natural resources and/or services that occur from the date of damage until primary remediation has achieved its full effect INTERIM LOSSES: Losses that result from the fact that the damaged natural resources and/or services are not able to perform their ecological functions or provide services to other natural resources or the public until the primary or complementary measures have taken effect. It does not consist of financial compensation to members of the public. The concept of environmental damage and the definitions adopted by the ELD are increasingly used by countries outside the EU and particularly for those countries that are members of the OECD (Organisation for Economic Cooperation and Development) which holds the ELD as an exemplar regulation for protecting the environment (Environmental Liability for Damage to Natural Resources). EU ELD Some Key Points: New types of definitions of losses and damages have been introduced for the first time across the European Union Some liabilities created by the ELD include non-pollution environmental damage An assessment of coverage for ELD liabilities under general liability is needed The definition of operator needs to be reviewed and possibly restated in insurance policies Operators bear responsibility for actions taken regarding an imminent threat of environmental damage The ELD was implemented in 2007, and liability can be retroactive to that date Liability may be strict or fault-based. It depends on a company s operations and other factors An at-fault party is responsible not just for cleanup but for remediation and restoration of natural habitats and species Some incidents may be cross-border. Complicating matters, different countries have implemented the ELD with differing definitions and broader mandates, making application of the law and liability (e.g. joint and several) of polluters more complex The monetary value of a loss and its concomitant restoration actions is very difficult to assess Financial assurance/security is selectively (to be) required by operations that have strict liability in a number of countries: Portugal (from January 2010), Spain (expected clarity 2011), Greece (expected clarity 2011), Bulgaria (from January 2011), Czech Republic (2013), Hungary, Slovak Republic (2012) and Romania. Natural Resource Damage (US) NRD A predecessor to the ELD in the US is the assessment of Natural Resource Damages (NRD) which is applied under a number of US laws. These regulations are defined as Damages recoverable at sites where injuries to natural resources have occurred as a result of releases of hazardous substances or oil or as a result of natural resource injury related to implementation of a response action. They have been in place since the 1990s and provide a source of reference and a priori experience to the wider implementation across Europe of liability for such damage, specifically in the area of environmental resource equivalency to determine both the extent of damage and restoration mechanisms and targets. Future Directions Environmental regulations will continue to develop in Europe and other nations where European countries conduct industrial operations. The effects of new regulations can often take several years to become apparent, depending on the speed of implementation and the aggressiveness of enforcement by regulatory authorities. In those countries with a history of strict enforcement of environmental laws, the body of environmental regulation and law will continue to grow, and also will be further integrated into other aspects of general behaviour. This is demonstrated by the growth in the number of businesses registered under the ISO Environmental Management Programme. Elsewhere, regulations and enforcement will lag behind the US and EU as societies and governments become more sophisticated and governed populations demand more effective environmental governance. 11