Practical Uses of Environmental Insurance How To Increase Shareholder Value And Reduce Risk

1. Practical Uses of Environmental Insurance How To Increase Shareholder Value And Reduce Risk Presented to The 14th Annual Advanced Contract Risk Management In Upstream Oil And Gas Conference By: Joseph Naylor, Senior Counsel Joe.Naylor@enbridge.com Enbridge Energy Company and David Dybdahl, CPCU, President dybdahl@armr.net American Risk Management Resources Network, LLC.

2. Presentation Outline • History of insurance coverage for environmental risks • Modern Policies: Specialized environmental risk policies currently available; advantages and disadvantages • Considerations for negotiation of an environmental policy • Specific Example – Use of environmental insurance in the purchase and sale of a company.

3. Modern Environmental Insurance • Specialized insurance coverage written specifically to cover environmental risks • Useful to fill the insurance coverage gaps created by pollution exclusions in traditional insurance policies. • Continuously available since 1980, but still not widely utilized.

4. History Of Insurance Coverage For Environmental Damages And Claims • It is important to understand the historical coverage for environmental losses in traditional insurance policies to appreciate benefits of the new specialized environmental insurance products.

5. Commercial General Liability (CGL) • Environmental Liabilities become apparent beginning in the 1970’s • Standard Business Insurance Policy: Commercial General Liability (CGL) • CGL Insures Against Third Party Liability for Damages (not otherwise excluded) • Exclusions on the CGL for environmental damages evolved over time.

6. CGL Policies Prior To 1970 • CGL Introduced in 1941; Coverage was generally broadened up to 1970 • Provided coverage for Damages Caused by an “Accident” • Policies were Accident or Occurrence Based, rather than Claims Made Based coverage

7. 1970 Qualified Pollution Exclusion • A exclusion was added to the GL policy that was designed to exclude claims caused by pollution, except where caused by events which are “Sudden and Accidental” • Problems determining what is sudden and accidental (See Primrose Operating Company, 382 F.3d 546)

8. 1986 “Absolute” Pollution Exclusion • Excludes Coverage for Damages “Arising out of the actual, alleged or threatened discharge, dispersal, release or escape of pollutants” • The “sudden and accidental”exception to the pollution exclusion was dropped • “Pollutants” are broadly defined • Can lead to overbroad reading of exclusion and denials of coverage (See CBI Industries, 907 S.W. 2d 517)

9. Time Element CGL Endorsement • Also Known As: Time Element Pollution Coverage, • Coverage is created through an endorsement to the CGL policy to provide coverage for pollution events that fit within specific time parameters. • There is a significant difference between environmental coverage as an exception to an exclusion versus coverage provided within an insuring agreement. • Confusion on this point is common and leads to confusion about the efficacy of modern environmental insurance.

10. Time Element Pollution Coverage • Typical Time Element Coverage “Triggers”: • Incident must be “Sudden and Accidental” • Incident must be Detected when it Occurs (or Within a defined Short Time Period Thereafter) • Incident Must be Reported to Underwriter Within a Specified Time Period (120 hours – 30 days) • This coverage is common in the CGL sold to oil and gas risks.

11. Modern Environmental Coverage • By about 1990, Environmental risks became more quantifiable • Insurers offered new products specifically designed to cover pollution-related events. Coverage in true environmental Insurance is provided within the insuring agreement portion of the policy • Environmental insurance policy forms are not standardized and can be modified. • Buyers need to be keenly aware of differences in the over 140 environmental policies forms that are available.

12. Basic Types Of Environmental Insurance • Site Specific (EIL) • Contractors Operations (CPL) • Professional Liability (Errors and Omissions) • Clean Up Cost Cap • Packages of these policies are also sold Contrary to popular belief litigated claims on these policies are in fact rare.

13. Environmental Impairment Liability (EIL) • Sold under many brand names including: • Pollution Legal Liability (PLL) • Premises Pollution Legal Liability (PPL) • Premises and Remediation Legal Liability (PARLL) • Unique Features: • Responds to loss arising from pollution conditions on or emanating from an insured facility. • Covers third party bodily injury and property damage losses. • Also insures remediation and defense costs. • Can insure prior acts, pre-existing conditions and superfund liability.

14. PL Policy Coverage Triggers • Generally written on a claims made and reported basis. • Multi year policy terms are available. • Known contamination at time of application are not covered.

15. Contractors Pollution Liability Insurance (“CPL”) • Also sold under many different brand names. • Provides coverage for pollution-related losses arising from described operations of the named insured • CPL coverage is important because most contractor CGL policies contain absolute pollution exclusions. • These exclusions can eliminate all coverage for any claim associated with a “pollutant”. • CPL is designed to fill the coverage gap in a contractors CGL policy.

16. Cleanup Cost Cap Coverage • Also known as “Remediation Stop Loss Coverage” or “Cost Containment Coverage” • Covers Remediation Costs which exceed budgeted costs • Covers the costs incurred to complete the insured remedial action work plan. • Used extensively by the US Army to facilitate fixed priced remediations. • The U S Army estimates their clean up costs decreased by 30% and time frames accelerated with the use of this insurance.

17. Negotiating an Environmental Policy • Each Insurer has customized applications keyed to proprietary rating models. • The application becomes part of representations and warranties of policyholder. • Almost all disputed environmental insurance claims are a direct result of a poorly prepared application. • Use of qualified specialized environmental insurance broker is highly recommended. • The insurance industry is devoid of any formal training in this complex line of coverage.

18. Insurance Can Increase Shareholder Value • It can reduce the risk profile of the firm. • Properties can be transferred for a fixed cost without indemnities. • It can facilitate property transfers by getting environmental risks off the table as objectively priced by a third party. • It can help quantify Sarbanes Oxley disclosure requirements on Environmental liabilities.

19. Premiums are tax deductible Interest is earned on loss reserves tax free Insurance uniquely creates a sum certain for a wide rage of possible outcomes If a loss occurs insurance underwriters have “claims” Reserves are not tax deductible Interest on cash reserves is taxed Reserves cannot take into account the probability of events for a worst case scenario. If a loss occurs, uninsured negotiators suffer career limiting events Insurance Companies Have Inherent Advantages

20. The Use Of Environmental InsuranceIn a Property Transfer A Case Study Background: Sale of a company for a fixed price Buyer & seller agree on a fair value of $40,000,000 without environmental “issues” There is an Environmental Remediation Plan for $1,000,000 Buyer’s due diligence raises “potential worst case environmental liabilities” valued at up to $24,500,000 How much will the company sell for? $39,000,000 or $15,500,000

21. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY RemediationRisks 12 Expected Cleanup $1,000,000 costs, 99% confidence over 2 years 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

22. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY RemediationRisks 12 $5,000,000 Excess Remediation Cost, 1% chance of being incurred over 5 years beginning in year 2 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

23. Liability During RemediationRisks 12 Third Party Claims during remedial operations. Potential cost of $5,000,000 over 10 years, no estimate of probability 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

24. Environmental LegacyRisks 12 Discovery of new sources of contamination on the property. Discovered in year 3, it takes $2,000,000 over 5 years to remediate, no estimate of probability 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

25. 12 The facility used an old dump that became a superfund site. Discovered in year 3, it is expected to cost $100,000 per year for 15 years = $1,500,000, no estimate of probability 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Environmental LegacyRisks Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

26. Environmental LegacyRisks 12 Ongoing Operations: $10,000,000 Loss Potential could be incurred in any year after purchase, no estimate of probability 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY

27. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Environmental Impairment Liability Insurance 12 • Purchase EIL Insurance • $10,000,000 limit, 10 year term, $300,000 premium • Non owned disposal sites • On and off site clean up of unknown pollution conditions 11 10 9 Risk Gone 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

28. Non-owned Disposal site exposure 12 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Purchase EIL insurance with non-owned disposal site coverage Risk Gone

29. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Discovery Of Unknown Contamination 12 Purchased EIL Insurance with on site coverage for unknown pollutants 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 Risk Gone 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

30. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY After The Purchase Of EIL 12 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

31. Contractors Loss Exposures 12 Purchase Contractors Pollution Liability Insurance 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Risk Gone Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

32. After The Purchase Of CPL 12 $70,000 for term of policy - 3 years 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

33. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Cost Cap Insurance($5,000,000 limit $1,100,000 self insured retention) 12 Cost Cap Insurance 13% of $5,000,000 = $750,000 premium, term of policy - 3 years 11 10 9 8 7 Risk ($000,000) 6 5 4 Risk Gone 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property – Key, shaded areas show risk over time, not expected cost

34. ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY After the Purchase of Cost Cap Insurance 12 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property -- Key shaded areas show risk over time, not expected cost

35. Structured Settlement Annuities 12 • Purchase An Annuity or Finite Risk Policy • $970,000 Cost 11 10 9 8 7 Risk ($000,000) 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Time in Years Property Value $40,000,000 -- Clean up cost estimates between $1,000,000 and $6,000,000 Chemical Manufacturing Property -- Key shaded areas show risk over time, not expected cost ENVIRONMENTAL RISKS ASSOCIATED WITH THE TRANSFER OF PROPERTY Risk Gone

36. Risk Limits Insurance Policy Premium Expected clean up cost $1,000,000 Annuities $970,000 Excess remediation $5,000,000 Cost cap or $750,000 costs remediation stop loss 3rd party claims $5,000,000 Contractors Pollution $ 70,000 during remediation Liability Discovery of new $2,000,000 Environmental $ 300,000 contamination on Impairment Liability property Superfund liability at a $1,500,000 Environmental Included non-owned disposal Impairment Liability site Environmental loss from $10,000,000 Environmental Included ongoing operations of the Impairment Liability plant TOTAL COST $24,500,000 $2,090,000 Using Insurance Tools To Facilitate A Property Transfer

37. Result • The full $24,500,000 of environmental contingencies are funded for a total premium cost of $2,090,000. • The sales price $40,000,000 - $2,090,000. • The Sarbanes Oxley disclosure exposure for the seller is minimized. • Buyer is also protected from assuming and recognizing contingent liabilities on its balance sheet. • And the negotiators are not exposed to career limiting events!

38. CONCLUSION • • With insurance the company sells for $37,910,000. • • The transaction needs to be set up with the anticipated use of insurance to be successful. • • It requires specialist knowledge to fit • the insurances together. • Effective use of modern environmental insurance can increase share holder value.