Environmental Insurance: A Brief Overview

David A. Franchina
Kennedy Covington Lobdell & Hickman, L.L.P
Charlotte, North Carolina

The environmental insurance market has undergone a tremendous change over the past decade. Ten years ago, insurance to cover environmental risk was unavailable at almost any cost. Today the environmental insurance market is a billion-dollar industry led by a handful of major insurance carriers. As attorneys and risk managers continue to become aware of the specialized benefits of environmental insurance, the industry is expected to continue its growth. A variety of real estate transactions, redevelopment projects, mergers and acquisitions, and financing packages can benefit from the added protection environmental insurance affords. While environmental assessments may be inaccurate, and an indemnity agreement is only as strong as the indemnitor’s finances, environmental insurance can provide reliable, long-term protection from unexpected and substantial environmental liabilities.

There are three primary types of environmental insurance policies offered by carriers: pollution legal liability, stop-loss, and secured lender policies. While there are a variety of other specific policies offered to contractors, professionals, and businesses with particular needs, these three main types of policies play an important role in the most common business and real estate transactions.

Pollution Legal Liability Coverage

Pollution legal liability policies insure against unknown pollution conditions at covered locations; they are generally provided on a claims-made and reported basis. These policies insure against risks associated with operations and activity performed on specific locations; coverage is generally available for bodily injury, property damage, and cleanup costs arising out of conditions existing as of the policy inception date. (Some policies will cover post-inception date conditions as well.) Legal defense costs are also covered under these policies. Typically, pollution legal liability policies exclude existing known pollution, contractual liability, underground storage tanks, and penalties resulting from legal noncompliance. Terms usually last one to five years, but policies have been issued for up to thirty years or more. The cost of such policies depends upon the extent of the coverage provided, but it is often affordable in the context of larger transactions.

Stop-Loss/Clean-up Cost Cap Coverage

Stop-loss/clean-up cost cap policies cover cost overruns for remediation of contaminated property, typically due to newly discovered contaminants; they do not protect the insured against bodily injury or property damage claims. Generally, the estimated cost of remediation is calculated as the self-insured retention, with an additional five to ten percent buffer added above that figure. The stop-loss policy then covers any expenses incurred in remediation above that amount. The cost of the policy is typically three to four percent of the estimated clean-up cost annually.

A stop-loss policy will cover remediation of off-site pollution that originates within the covered area. Changes in a government agency’s requirements for remediation, resulting in increased costs, are also covered. Legal costs associated with the cleanup are normally excluded. The term of the policy depends upon the estimated time for clean-up.

Secured Creditor Coverage

Traditionally, notwithstanding statutory liability protection, lenders are exposed to environmental risk when loans are secured by real estate. Environmental contamination requiring government-mandated remediation, or leading to private suits for bodily injury or property damage, can be so financially burdensome that borrowers can be forced to default on their loans. In addition, environmental contamination can diminish the value of real estate held as collateral to secure a loan.

Lenders may protect themselves with secured lender insurance policies. These policies are provided on a "claims made and reported" basis. Secured lender policies cover the lender to the lesser of cleanup costs or the outstanding balance of a secured loan after the borrower has defaulted on the loan. (As such, the typical insurer’s underwriting includes an evaluation of the quality of the loan contemplated by the lender.) A lender’s policy should also insure against third-party claims from bodily injury and property damage.

Secured lender policies protect the lender against mistakes in environmental site assessments ("ESA"). They are also marketed by carriers as less-expensive alternatives to ESAs, since some lenders will use them in lieu of ESAs to address potential environmental risks on a loan.