Closing rifts over environmental liability

Risk & Insurance, July, 2003 by Brad Maurer

Risk managers deal with claims and loss in the context of insurance. Business managers view environmental cost as the investments they make to comply with environmental laws. How to close the divide.

you're a corporate risk manager and you've learned, for the first time, that your firm just acquired a very small company. You don't know it yet, but you've just been handed a time bomb. That "minor" acquisition is carrying with it a big and unwelcome bonus: a trail of legacy asbestos and environmental liability claims that will be yours to deal with for many, many years. And you never saw it coming.

Well, you should have.

The consequences of buying and selling assets can have a material impact on the financial well being of your company. It's critical, then, for risk managers to know about such potential liabilities and for companies, at the board level, to address environmental issues today both for their existing assets and for assets they grow into.

Divergent Views of Risk

More often than not, neglect of environmental cost issues results from a lack of communication between corporate colleagues who view the world of risk quite differently: the corporate risk manager and the business manager.

Typically, risk managers deal with claims and loss in the context of insurance. Environmental liability for them is an anomaly-albeit a large enough problem to divert their attention from their normal risk management matters. They view environmental loss as those claims they receive and then submit to a standard insurer with whom they have to do battle for coverage. Environmental loss puts them in a precarious position as the amount of the loss is usually significant. However the administration of the claim is unlike standard insurance--demanding special knowledge about the applicability of standard insurance to environmental loss. Theirs is a reactive position and they're usually the last to know about an environmental claim.

Ask risk managers what environmental costs are and they'll talk about a tort suit brought by a victim of a product, like asbestos; or one brought by the Environmental Protection Agency to clean up something the company polluted in the past; or a citizen's action arising from a spill or release.

Business managers view environmental cost as the investments they make to comply with environmental laws. To them, environmental cost is the price of acquiring and the capital cost of developing, say, a piece of property. Like the earlier underground storage tank example that increased the acquisition cost of the property, if a bad environmental condition exists, unbeknownst to them, they have to invest more in the environmental compliance of that property than they may have expected.

These are two different points of view.

Risk managers tend to be notified of acquisitions long after they've occurred, whereas business managers know about these things up front--as far back as the due diligence period, when they're examining the assets and, more importantly, the liabilities of these companies.

Departmental Crossover

The key message here is that environmental cost concerns cross many departments within a company. It stands to reason, then, that companies should address the matter in a an integrated way. Risk managers should partner with business managers in providing risk control and risk management to the underlying business.

They shouldn't just be reactive, especially with environmental issues that tend to exacerbate over time. And the same goes for the business managers. They should talk with their risk managers when they're going into acquisitions.

That's how risk managers and business managers should assess the situation. However, what are the broad trends each is responding to, and what's been the response of the insurance market?

Three Trends Emerge

I see three major trends in the asbestos and environmental liability area:

First of all, companies have under-reserved or turned a blind eye to their environmental liabilities. This will change, given the U.S. Justice Department's aggressive stance toward corporate officers and managers for criminal liability for knowing violations of environmental loss in the wake of the recent corporate governance scandals.

Second, we're seeing a de-federalization of environmental law enforcement, with more and more states taking the lead for cleanup response and waste release regulations.

Finally, there's the "brown fields" phenomenon--the recycling of former industrial land into non-industrial uses.

Suffering Rum "Bipolar" Disorder

As for market response, the insurance companies have been, shall we say, bipolar when it comes to environmental issues:

First, there's the standard property-casualty insurance market, those carriers writing general liability and regular business insurance and that take the stance that they simply don't insure environmental cost.

This began in 1972 with the "sudden and accidental" pollution exclusion, and continues right up to the most recent "absolute total" exclusions.