Environmental Cost-Cap Insurance Policies: A Phoenix Rebirth.

Over a decade ago, environmental cost-cap policies were a commonly used, valuable tool in the contaminated property transactional toolbox, allowing some complicated, Brownfield parcels to be successfully sold prior to the remediation being complete, by providing lenders and buyers a level of comfort that any environmental remedial cost overruns would be picked up by an insurance policy at some later date, should projected budgets be exceeded.

Alas, the program worked a little too well, and not from the perspective of the insurance underwriters.  

Claims were made, and paid out, on a slew of policies, resulting in large losses for the insurance industry. And, as expected, insurance companies shied from this risk pool, and the availability of this type of transactional policy largely dried up circa-2009/2010. They remained available, but on a very limited basis, generally for larger remedial projects (typically with cleanup budgets in excess of $10 million); for smaller remediation projects, the arena was barren.

But the cost-cap policy, like a phoenix, seems to have been reborn. 

There are currently about a half-dozen bona fide underwriters offering cost-cap policies for smaller-sized environmental projects, in the $1 million - $10 million dollar remedial range.  A few of the insurance companies revisiting this niche market are:  Beazley Group, Axis Insurance, Ironshore (a Liberty Mutual affiliate) and Munich Re, among several others. 

What changed?

Well, for one, the underwriting technical review process has gotten stricter, tightening up the work plans upon which the policies are based and expanding/better defining the numerous exclusions to coverage (i.e., providing narrower coverage). 

Some of the touch-points include better defining and excluding issues relating to:

• Newly identified contamination after the policy is bound;

• Overruns for the selected remedial technique employed as the work progresses; and

• Changes in regulatory cleanup standards during the course of the policy period.  

Also, potential insureds may have to pay the underwriters not-so-small, non-refundable application-related fees to allow the insurance companies to hire third-party environmental firms to perform detailed peer reviews of the consultant and contractor remedial work plans prior to binding, to ensure they are reasonable and defensible. 

All new policies will generally require a written regulatory approval of the remedial work plan from the underlying governing agency prior to binding the policy - this was not as strictly enforced in the past as it is now.

And, as expected, not all underwriters will view the same project through a similar lens, with some trying to expand quite aggressively into this niche market, and others acting in a more conservative vein. And there are certain hot-button contaminant types that are more globally shied away from than others — emergent PFAS issues in groundwater being a prime example (refer to our firm's April 2020 Environmental Takeaways Newsletter for an informative primer on PFAS contamination).

A favorable aspect of these newly available cost-cap policies is that, as in the past, they generally tend to be negotiated on a policy-by-policy basis, allowing for flexibility in negotiating the terms and conditions for your particular project. That does not mean the underwriters are pliable, but it does allow for more give-and-take on clause modification than tradition form policies.

What are some policy standards you can expect to see?

Premiums: Typically in the 12.5% to 25% range and paid in full at policy inception, but can track lower, some as low as 5% (but such a low percentage would tend to be an outlier situation). 

Coverage Limits: Typically, the limits of coverage do not exceed the lesser of the remedial budget estimate, or $10 million (as a common cap), but again, this varies.

Policy Terms: Can run the gamut, but commonly fall in the 3- to 10-year range, depending on the type, complexity, and legacy of the remedial work.  Longer terms can be negotiated.

Deductibles: Usually run in the 15% to 20% range, but again, can be negotiated down to 0% on certain policies. 

Co-Insurance: Cost-deductible co-insurance payments required by the insured are also highly negotiable, from 0% - 25% (most fall in the 15% to 25% range).

Cost-Cap Coverage Folded into other Environment Coverage: Many of these new cost-cap policies come folded into a longer-term (30 year typically) Pollution Legal Limit (PLL) policy, covering claims for third party impacts, toxic tort, and unknown pre-existing conditions — again, with the policy terms and exclusions highly negotiable.

Other Common Policy Conditions: Some policies have: (a) property size limitations (e.g., only sites up to a certain acreage, or remediation areas of a certain size); (b) require regular budget and progress reports from the insured (e.g., every 90 days or once a milestone phase is completed); and (c) require the consultant/contractor performing the remediation to undertake the work under fixed-fee price conditions, to act as a 'partner' in the deal/have skin in the game.

Are there other remedial cost-cap backstop funding options? Yes, here are two examples.

Private Equity: In addition to standard underwriters, we have also seen some private equity firms sticking a toe in this pool — these instruments — also insurance — tend to be more complex and the underwriter's more risk-averse, but the deals are highly negotiable and it is another option to consider if the traditional carriers cannot satisfy the particulars of your transactional deal. Policy limits also tend to run in the $1 million to $10 million range.

Micro-Cost-Cap Escrow Funding: Another emerging trend is not an insurance policy at all, but rather a contractual equity play, whereby remedial funds (analogous to a policy limit) are posted by an equity fund with an independent, third-party agent (typically an attorney trust account). These types of vehicles are available for smaller remedial projects (i.e., with cleanup budgets typically in the under $1 million range) that are looking for some upper-end protection that are not serviced by the traditional insurance marketplace. These funds are typically a backstop to a fixed-fee remedial cost provided by the environmental firm conducting the remediation; they are tapped only if/after the fixed fee is exceeded, and any penalty (similar to a deductible) is paid by either the consultant, the benefactor to the remedial funds, or some combination thereof.  The concept of a co-pay and the initial fee to set up the escrow and secure future access to the guaranteed funds are all highly negotiable in these types of contracts, usually drafted and negotiated by/between environmental counsel for the transactional parties and the equity entity posting the guaranteed funds.

In summary, there appears to be a cost-cap tool back in the transactional toolbox - just be sure you understand the limitations of its use before deciding whether to include it in the terms of your deal.

If you have any questions regarding any of the remediation-related issues above, do not hesitate to contact Glenn Brukardt at glenn.eikon@gmail.com or 908-813-2323, ext. 36.