Capturing Environmental Captive Risk

FOR MANY companies and risk managers, environmental risk creates a 'black hole' of uncertainty within their risk profile. Because of this uncertainty, risk managers have either passively assumed environ­mental risk or chosen to transfer this risk through the use of insurance.

What companies have struggled with when addressing environmental risk is the question of how to knowingly retain envi­ronmental risk in an efficient manner while protecting the company from catastrophic environmental losses.

This article seeks to help companies and their risk managers quantify environmental risks for their business, determine what en­vironmental risks should be retained within the captive and decide how to appropriate­ly structure such a programme to provide the most efficient management of environ­mental risk.

Risk quantification

While there are no perfect guidelines for what factors a company should use to quan­tify its operational and historical environ­mental risk, there are twelve key risk topics that a risk manager can apply to help quan­tify the company's environmental risk.

With only a few minor exceptions, the information needed by the risk manager to identify and quantify a firm's environ­mental risk is readily available through the public domain or within the firm's legal, or environmental, health and safety depart­ments.

Fire/explosion potential - By reviewing the Material Safety Data Sheets (MSDS Sheets), a risk manager can determine the chemical's risk of fire or explosion. MSDS sheets can be found at each manufacturing location as required by OSHA.

Raw materials - Each firm that uses haz­ardous materials in the US is required to tell the government about the use of these materials by filing a SARA Title V report. By reviewing this report, the risk manager can determine the top ten most-utilised materials and then review the MSDS sheet for its hazardous properties.

Waste materials - Each manufacturing facility has a manifest for hazardous mate­rials which can be reviewed to determine what materials are being disposed of and where they are being disposed of. In ad­dition, the US Environmental Protection Agency (USEPA) maintains a database of this information called ECHO as a point of reference.

Surrounding environment - Computerised mapping programmes such as Google Maps and Google Street Views allow a risk manager to easily and quickly identify high hazard locations around a facility. High hazard facilities can include schools, public housing, and water supply operations.

Site history - Historical uses of the property can indicate potential legacy environmental issues. Property usage for activities such as foundries, gas stations, chemical manufacturing or use of solvents in the manufacturing process increases the potential for environmental impacts in the future. This information can be obtained through interviews with long-term em­ployees, Sanborn maps and historical city directories.

Regulatory environment - Interviews with members of the environmental health and safety staff as well as the legal staff can in­dicate whether regulators will or can create a potential source of environmental claims. The USEPA's National Enforcement Trends report can also serve as a guide to focus enforcement actions of the USEPA for a specific year. A poor regulatory rela­tionship will result in a debit adjustment.

Historical claims/lawsuits - Review of de­tailed historical loss runs can identify his­torical chemical exposures that could result in potential environmental claims. Claims from workers due to exposure to chemicals can be a marker for potential third-party exposure claims. In addition, historical cleanups that have occurred at the sites, neighbour complaints, and notice of violations serve as warning flags for future claims and lawsuits. These types of markers should result in a debit adjustment.

Groundwater conditions - Typically avail­able through the environmental health and safety department or the firm's envi­ronmental consultant, knowledge of the depth to groundwater, the quality of the groundwater, and natural barriers between the surface and groundwater aquifer can indicate the risk that contaminates can enter the water supply. A facility located in an area with shallow groundwater, water of good quality or in an area where ground­water is used by others for drinking water would result in a higher risk of environ­mental losses and would thus result in a debit adjustment.

Soil conditions - Typically available through the environmental health and safety department or the firm's environ­mental consultant, knowledge of whether the soil is sandy and porous or containing clay with limited porosity. This informa­tion can indicate the risk of contaminants spreading throughout soils very quickly or remaining contained by the clay soil.

Management practices - Good environ­mental practices, including good materials handling practices, good disposal prac­tices, written spill response plans and envi­ronmental training dramatically improve a company's risk of loss. Good management practices will result in a credit adjustment.

Air emissions - By reviewing the company's air permits, a risk manager can determine what contaminants are being released into the air and if those materials are hazard­ous. Large quantities of greenhouse gases, carcinogens, and materials that cause res­piratory issues being released into the air would result in a debit adjustment.

Tankage - Large volumes of chemicals and materials that are hazardous can create a significant risk at a facility. Simply put, the more material stored and the more haz­ardous the nature of these chemicals, the more risk this carries. This consideration should be contemplated along with natural hazards such as flood, hurricane and earth­quake. Large storage tanks in areas that are susceptible to natural disasters will result a debit adjustment to the premium.

Captive premium calculation

Based on the risk factors, a risk manager can then classify each location based on the risk classification of ‘Low Risk', 'Me­dium Risk' or 'High Risk' and assign a basic premium per location of US$5,000, US$8,000 and US$12,000 respectively.

This raw number is then multiplied by the number of locations within that category (see Example 1). After calculating this classification subtotal, the premium is then modified by the twelve factors. A factor of 1 through 10 is assigned with 1 receiving a 10% credit, 10 receiving a 10% debit and a 5 being neutral or no debit or credit assigned.

This process can be accomplished through the use of a basic spreadsheet. 

These subtotals are then totalled for a basic US$1 m per incident/US$lm policy aggregate limit policy with a US$100,000 retention. Of course, the rating can be modified to provide a credit for a large number of locations as well as for increased limits greater than US$1m.

Inefficient captive programme structure

Now that we have determined how to cre­ate the captive premium, it is imperative that we discuss what types of risks do not fit into a captive structure and how to use this structure to protect the company from catastrophic environmental losses.

The reality is that certain risks either don't fit into a captive structure or there are federal financial assurance guidelines.

Underground storage tanks - Storage tank environmental liability coverage pricing has reduced dramatically. On average, an underground storage tank can be insured for premiums of US$300 to US$500 per tank and this premium includes a certifi­cate of financial assurance to comply with state and federal laws.

If a company maintains its underground storage tanks in a manner that is com­pliant with federal and state guidelines, underground storage tank losses can be minimised and predictable. Unless the risk has hundreds of storage tanks, including underground storage tank risk within the captive makes very little business sense.

Non-owned disposal sites - The traditional environmental insurance markets will accept this risk for a cost of US$150 to US$300 per location. The minimal costs coupled with the fact that companies have to rely on third parties to dispose of their waste materials and often these disposal companies are beyond the control of the originator of the waste, mean that liability is much more difficult to control. We would suggest that this risk be transferred to the environmental impairment liability markets.

RCRA financial assurance coverage - The Resource Conservation and Recovery Act forces some industries to prove that should they create an environmental incident that harms third parties, the company can make the third party whole.

This law forces specific policy wording and a special certificate to be provided to the state environmental regulators. Because of the specialised policy wording and certificate, again we would suggest that this risk be transferred to the environmental insurance market.

Efficient captive programme structure

By placing the first layer of environmental risk into the captive, a company can then secure excess environmental impairment liability limits for a significant premium reduction. We would suggest that a layer of US$1 m to US$5m be accepted by the captive to secure the greatest premium sav­ings from the environmental impairment liability marketplace.

These premium savings can then be used to buy excess limits of at least US$1 m on an aggregate basis. Excess limits can be secured through a direct placement or through the reinsurance markets.

Jeffrey Hubbard is senior vice president, Environmental Practice Leader for Alliant Insurance Services