General Insurance Spring Seminar 19-20 May 2003 Scarman House

1. abcd General Insurance Spring Seminar 19-20 May 2003 Scarman House

2. Session G (Plenary) Assessing, Managing and Insuring Pollution Risk Dr Simon Johnson Dale Lee (FIA)

3. Introduction and Agenda • The Pollution Problem and How Insurers have been caught • Legal Background - UK • Underwriting Practices • FRS12 and pollution liabilities • Case Studies • Summary and Questions

4. The Pollution Problem and How Insurers have been caught

5. The Pollution Problem • Gradual Seepage of pollution into the environment over many years • Headline problems such as Love Canal increased public awareness and prompted action • In late 1970's claims began to hit premises/operations coverage under Comprehensive General Liability (CGL) policies • In USA CERCLA passed in 1980 - 'polluter pays' strict and retro, joint and several liability on PRP's • Superfund tax where no PRP or emergency clean up • London market hit on excess layers and reinsurance • Insurance risk not assessed and legal environment changed

6. Claim Triggers and Components • Triggers - Exposure, Manifestation, Continuous, Injury in Fact - 'All Sums' • Remediation costs - Design and implementation of (normally) long term clean up scheme. NB - scheme could fail • Third party bodily injury and property damage • Defence costs. Primary policies often costs in addition with 'duty to defend'. • Coverage disputes leading to Declaratory Judgement (DJ) costs

7. Insurance Market Reactions • Do not write pollution business - absolute pollution exclusions - most common reaction • Design a separate new policy to cover pollution risk - i.e. a new insurance product • Consult experts to understand the risk technically and legally - each site is unique • Assess the risk financially • Historical - Ongoing differentiation • Pollution present as at date of inception - historical risk • Pollution deposited after date of inception - operational risk • Clear policy wordings - claims made clear triggers

8. The Legal Background - UK

9. UK Environmental Legislation • Some key dates: • Upto 1990 • miscellaneous Acts e.g, Alkali Act & Public Health • Statutory Nuisance etc. • Environmental Protection Act 1990 (EPA) • Environment Act 1995 • Implementation of Part IIA of EPA 1990 in April 2000 • 2003+ - influence and impact of ‘new’ EU Regulations

10. Framework of Contaminated Land Law in England & Wales EU Draft Directiveon Environmental Liability Historical Contamination Part IIA EPA Waste Management Part II EPA Redevelopment (Change of Use) T&CPA 1990 Water Pollution WIA 1991 WRA 1991 (Amendments due) Industrial Activities Part I EPA (PPCA 1999) Civil Liability & Human Rights Act

11. Contaminated Land - A Lawyer’s Definition “Land which appears to the Local Authority to be “contaminated” because: 1. Significant Harm is being caused or there is a significant possibility of such harm being caused; or 2. Pollution of controlled waters is being or is likely to be caused

12. Part IIA EPA 1990 • First time Contaminated Land has been specifically legislated • Remediation Notice served on ‘Appropriate Person’ • Appropriate Persons fall in two categories • Class A - Caused or Knowingly Permitted If no Class A can be found then • Class B - Current owner/occupier • Complex rules for exclusion and allocation of liabilities • Few Sites Classified (so far) - about 50

13. Current Underwriting Practice

14. Underwriting Philosophy • Gradual Pollution risks • experience rating - site specific assessment • use of experienced qualified environmental professionals • information intensive - adherence to industry good practice • site specific consequence analysis • assumed maximum event probability over policy period

15. Environmental Policies • EIL - new and old gradual and sudden and accidental pollution conditions • CLI/PLL/PARLL - site specific contaminated land insurance (some new as well as old pollution conditons) • CPL - Contractors Pollution Liability • Cost-Cap/Stop-Loss - for clean-up schemes • Property Portfolio and secured lenders

16. Policy Cover & Triggers (CLI) • Claims made Policy • typically up to 10/12-years • Policy responds to: • Notice under Part IIA of EPA 1990 • any other Regulatory or third party notice alleging liability • Policy indemnifies insureds against: • Regulatory liability - clean-up costs (including own site) • Third Party liability - including bodily injury • Legal and Technical Defence costs • Loss of rent receivable/Business Interruption

17. Risk Assessment - Sources, Pathways and Receptors From ICE Design and Practice Guide - Contaminated Land 1994

18. Is Land Contaminated? • Published guideline levels • background levels • target levels • intervention levels • Quantitative Risk Assessment • RBCA - partly quantitative • models - e.g. Risc Human, CLEA, etc.

19. Common Contaminants of Concern • Organic materials • fuel oil, petrol, diesel, tars, phenols • solvents e.g. TCE • Metals • e.g. lead, arsenic, mercury • coper, chromium, nickel, zinc • Others • PCBs, pesticides, dioxins/furans, cyanide, corosives

20. Information and Documentation • Phase 1: Desk Study • hazard identification (potential for contamination) • Phase 2: Site Investigation • intrusive sampling, testing and analysis • risk evaluation • Phase 3: Remediation • design of remedial startegy, setting objectives • remedial works • validation

21. Known Contamination - Long-term Risk • Missed Hot Spots • require both a pathway and receptor - low risk /cost events • Residual concentrations • residual levels recorded, land assessed (risk) as suitable for specified use in the insurance contract • principal sources removed, reduced at clean-up • residual levels and risk of contamination for many common contaminants should reduce with time • low probability of retrospective clean-up being required • can re-assess suitability for use • any residual contamination requires pathway and receptor to complete the pollutant linkage

22. Unknown Contamination - Long term risk • Unknown, unidentified and unexpected • Identificati post-inception of insurance unlikely: • expert assessment minimises unknown risk • re-development risk excluded • no known problems to date (many sites have been in a contaminated condition for many years) • Unknown contamination risk - low as most investigations test for a wide range of expected or possible contaminants

23. Approaches to Remedial Action • The Source e.g. removal, treatment or neutralsation • The Pathway e.g. interception or removal • The Receptor e.g. modification or removal Most remediation schemes address either the Source and/or the Pathway

24. FRS12 and Pollution Liabilities

25. Introduction to FRS12 • New accounting standard effective for accounting periods ending on or after 23 March 1999 • Specific guidance on when / how to set up provisions • Potential for major impact on the balance sheets of many companies : some additional provisions likely to be required; some existing provisions may be disallowed • Extensive disclosure requirements • Specific relevance to companies with contaminated land and other pollution liabilities and exposure

26. FRS 12 Provisions A provision should ONLY be recognised when: • An entity has a present obligation (legal or constructive) as a result of a past event (an “obligating event”); and • it is probable (more likely than not) that a transfer of economic benefits will be required to settle the obligation; and • a reliable estimate can be made of the amount of the obligation (extremely rare that this is not the case) - but may be difficult where costs are volatile

27. The Obligating Event Key points: • Constructive obligation arises where the event creates valid expectations in other parties ( through an established pattern of past practices, published policies etc) that the obligation will be discharged • No provision allowed for costs required for futureoperations i.e. the past event must exist independently of an entity’s future actions • Changes in law or public company announcements may create an obligation that did not previously exist. Trigger point for new law is when enactment is “virtually certain”

28. FRS12 Insurance • FRS12 provides insurance opportunities • Long term protection against: • Inadequate provisions • Emergence of contingent liabilities as FRS12 provisions in future • Other liabilities • Insurance provides support to long term management of balance sheet provision over time

29. FRS12 Case Study • UK chemical company purchased a US company with a polluted site • Site requires long term management of pollution problem • Clean-up costs represent a balance sheet provision • Company wanted to control provision over time • Detailed environmental consultant reports including initial cost estimates and annual cost estimates for planned activities • Consultants reports used to build a model of costs during the policy period

30. FRS12 Case Study continued • Likelihoods, timing and amounts modelled to give a distribution of the cost of the liability • Long term real rates of investment return modelled using Vasiceck model based on historical investment data • Deductible adjusted annually - a key feature • Deductible can be set at e.g. 80%, 100%, 150% of the provision • Client set deductible at confidence level at which prefer to retain risk • Pricing provides for premium structure - risk premium, capital loading, expenses, investment risk • Client benefits from valuation control over time

31. Case Studies

32. Case Studies 1. US Inward Investor 2. Regeneration: Cokeworks 3. Former Industrial Site 4. Retail Development 5. Retail Portfolio 6. European Chemicals Company

33. Case 1 - American Inward Investor • Distribution Depot • US investor • UK FTSE 350 vendor • £7.5m Indemnity by vendor - 12 years • Contamination risks • Legal exposure • Solution : Indemnity back to back Risk Transfer

34. Case 2 - Regeneration: Cokeworks • Setting: Former colliery/cokeworks • Objectives: Regeneration of site to produce a development platform for light industry. Remediation involved excavation and disposal on-site into a number of engineered cells leaving the rest of the site ‘clean’. • Problem: Need to provide protection to future site owner against failure of engineered cells. Area of cells to be subjet to monitoring but otherwise used as managed public open space. Solution: a long-term bespoke transferable environmental insurance policy for the current owner

35. Case Study 3 - Former Industrial site • Setting: Site cleared but residual contamination from fill materials across site plus hotspots. Fill heavily contaminated with metals, hot-spots of hydrocarbons. • Problem: Proposed redevelopment for warehousing and distribution. Remediation of hot spots plus encapsulation (engineered cover) of fill. Residual contamination from fill and any ‘missed’ hot-spots. • Deal Driver: Transfer of liability. Funding requirement. Deal stalled. Solution: Environmental Insurance to protect ‘new’ owner having bought with information and facilitate the deal and allowed ‘new’ owner to obtain institutional funding

36. Case Study 4: Retail Development • Setting:Former gasworks site - South of England Town Centre. Non-food and food retail development, multiple occupancy. • Problem: Residual contamination both known and unknown in a highly sensitive groundwater environment. • Deal Driver: Indemnity required of purchaser from seller (and original polluter). Residual liability as new owner/occupier. Solution: Bespoke Environmental Insurance covering the Indemnity risk as well as the liability of the new owner. 12-year policy, £5m Limit of Indemnity

37. Case Study 5: Retail Portfolio • Setting: Portfolio of both in-town and out-of-town retail outlets across the UK. • Problem: potential exposure to environmental liabilities, particularly on older sites and out-of-town sites on remediated brownfield land. • Driver: Protection of asset value; corporate governance; corporate reputation; and balance sheet protection. Solution: Bespoke Portfolio Environmental Insurance for a 3-year fixed term allowing new properties subject to agreed due diligence to be added automatically to the policy

38. Case Study 6: Chemical Plant • International chemical company selling a business in Germany • Located on large polluted industrial complex with numerous other businesses • Transaction involved sale of factory • Site ownership remained with client • Client was contributing to on-going clean up costs across the whole complex • Under Sale and Purchase Agreement Client retained liability for long term environmental exposures • Client required professional valuation of liabilities for tax purposes

39. Case Study: Chemical plant (2) • Client is exposed to the following liabilities • Clean up costs arising from buyer choosing to increase the capacity of the business • Business interruption costs arising from increasing capacity of the business • Volatility of client contributions to scheme costs including increases arising from insolvency of other contributers • Failure of buyer to meet financial obligations as specified in the Sale and Purchase Agreement • Client's contingent liabilties under the Sale and Purchase Agreement

40. Case Study: Chemical plant (3) • Provision was assessed using a model of the exposures including: • Volatility of long term clean-up costs • Economic factors • Credit risk of other businesses on the complex • Added Value to client approximately E20m

41. Summary • Insurers have been caught in the past as the pollution risks were not assessed on a site or project specific basis and by experts • Uncertainty about contaminated land liabilities and exposure gives rise to unacceptable risks to companies, organisations and individuals - change of law and risk perception • Risk Management is key to maximising environmental and pollution opportunities • Aim to maximise value and minimise long-term environmental exposure • A multi-disciplinary strategic management approach is recommended, using technical, legal, financial, insurance and commercial management skills • Effective Risk Management requires broad Environmental Consultancy and Insurance Service support