Environmental insurance is paramount to the successful completion of a brownfield development. We asked Rick Craig, National Environmental Practice Leader at Beecher Carlson Insurance Services to give us all of the “down and dirty” details associated with obtaining environmental insurance.
Q: Who needs environmental insurance
(types of projects, developers, etc)?
A: There are two main questions every developer should ask themselves when considering environmental insurance:
- Was a Phase 1 Environmental Site Assessment conducted to determine
the prior use of the Property and the presence of any Recognized Environmental Conditions (RECs)?
- If financing is necessary and there are RECs, is my lender going to require environmental insurance as a condition to the loan?
In the case of contaminated properties, environmental insurance is almost always a lender requirement. However, developers and owners are often unaware of the many “hidden environmental risks” that can lead to environmental liability and the requirement by their lender of environmental insurance. What often appears to be an innocuous commercial real estate project may have a number of these hidden risks requiring coverage.
For example, former farm land that has not been in operation for the past 20 years would be considered by many to be a “greenfield” possessing no environmental liability. The reality however is that residual metals and contaminants may still linger in the soil from the use of pesticides, herbicides and fertilizers. Add to this the fact that when $1 million or more in financing is needed, any and all lenders are going to require a Phase 1 site assessment. When it is discovered that RECs exist, borrowers are either asked to obtain environmental insurance or oftentimes pass on the financing opportunity altogether.
Q: Is environmental insurance mandated by state and/or federal law?
A: You would not drive a car without auto insurance and the same goes for environmental insurance for building on a potentially contaminated property. However, unlike auto insurance, environmental insurance for real estate developments is not typically mandated by any government agency. It is the responsibility of the developer to determine if they should or need to obtain environmental insurance.
In any case, if a developer encounters trouble during construction, such as discovering buried oil drums or contaminated soil, they do have a legal obligation to investigate and report any contamination issues to the appropriate regulatory agency. This is one more reason for a developer to consider purchasing environmental insurance.
Q: Who is responsible for environmental issues that arise?
A: Despite the absence of state or federal environmental insurance requirements, there are numerous local, state and federal environmental regulations that impact any buyer or developer of contaminated property. The most important is a federal law was enacted in 1980 to safeguard the public from “abandoned” contaminated sites. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as “Superfund law”, among other things places the responsibility for clean-up of a property on the shoulders of all parties involved in the chain of title, whether their involvement is past or present. There are thousands of examples of developers and other buyers inheriting someone else’s mess and being forced to clean it up.
Q: Are there any new product types in environmental insurance?
A: While different insurance carriers offer a range of policies that are constantly changing, the two main products for real estate transactions and development remains to be Pollution Legal Liability (PLL) and Remediation Cost Cap (Cost Cap). PLL is the most widely used product in conjunction with property transactions as it allows developers and their lenders to arm themselves for the possibility of unknown clean-up issues arising during construction. On properties with known environmental clean-up obligations, Cost Cap can be used to “cap” a developers’ risk of cost overruns. From a lender’s perspective, having the borrower acquire PLL and/or Cost Cap on a property with known contamination protects against their worst case scenario of a borrower going into default and the lender needing to foreclose, thereby putting themselves directly in the chain-of-title. While PLL and Cost Cap don’t protect against credit risk, they certainly provide the means for borrowers and lenders to prevent unforeseen environmental expenses or cost overruns from causing a loan to go into default.
Q: Have more incentives been added for acquiring environmental insurance since the boom of the green movement?
A : There are really two aspects to the “green” movement when it comes to real estate and development. One is the more established set of various tax, funding, and regulatory incentives designed to promote the development of Brownfields. What could be more “green” than recycling an old industrial plant? That’s essentially what redevelopment of contaminated property is. The more recent “green” trend is more about sustainability of developments. More and more it appears that “green” requirements are being written into the planning and permitting process for commercial construction, not particularly to provide new incentives such as tax benefits, but to assist planning and building departments in adding “green” language/requirements into plans. Planning and building departments are simply updating their plans and permits with new codes. For example, for a permit to be issued for any new development or renovation project in Downtown San Francisco, green product codes and requirements are written into building permits that mandate the use of sustainable materials, energy efficiency, and reduced carbon footprints.
Q: What is typically the budget for environmental insurance on a brownfield project?
A: The perceived risk, limit of liability, deductible amount, and length of policy are all factors that go into the premium calculations of the insurers. While there is no “typical budget” for a brownfield project since they all have unique risk characteristics, it is common for a brownfield developer and its lenders to seek a long-term policy of 5-10 years with $3 million or more in limits. Premiums for these types of policies begin at about $50,000.
Q: What is the process of obtaining insurance?
A: The most efficient and cost-effective process for obtaining environmental insurance is as follows:
- Retain an experienced insurance broker specializing in environmental insurance.
- Collect all available environmental due diligence information regarding the site (e.g. Phase I or II Environmental Site Assessment reports, environmental regulatory correspondence, etc.) as well as any draft purchase and sale and environmental indemnity agreements.
- With your broker’s input, agree with your lender as to the required limit of liability, maximum deductible and length of policy term.
- Direct your broker to approach all available and financially sound environmental insurance markets.
- Your broker will obtain quotes and should prepare a detailed comparison of coverage terms, conditions and pricing.
- Select your first choice and get approval from your lender.
- Coverage is typically bound at closing of transaction.
Q: What does the market for Environmental Insurance look like?
A: The market continues to grow although it has leveled off from a substantial expansion period in 1998-2004. The good news for buyers of environmental insurance is that it is now a “buyer’s market,” with very few exceptions. There are more insurance companies offering environmental insurance products than ever before. Just this year we have seen Great American join the ranks of major carriers offering pollution products. Availability of certain products however, namely remediation cost cap, has dropped dramatically with a corresponding rise in premiums and deductibles.
The biggest wildcard in the marketplace is the ultimate fate of AIG Environmental, who is by far the largest writer of environmental insurance and one of the few cost cap providers. As of this writing the subsidiaries which AIG Environmental utilizes to “write” their policies are a part of AIG Commercial Insurance Group, Inc. (AIGCI). Senior Management at AIG has emphatically stated that AIGCI is not for sale and would be a part of the core of smaller, yet still very sizeable and financially strong “new AIG”. Notwithstanding this uncertainty, our outlook for the foreseeable future is to “expect more of the same” with prices, terms and conditions for most products stabilizing, but not necessarily hardening, as the environmental insurance market continues to mature.
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