1. “Straight Risk Transfer” Policy — Like most liability insurance, risk transfer closure/ post-closure policies simply involve a premium payment to an insurer in exchange for the insurer assuming a specified risk. Closure/postclosure policies are written on an annual renewable basis (with the insurer having limited cancellation/nonrenewal options) with a limit of liability equal to the required financial assurance obligation. There are three key cost elements of the risk transfer structure:

• The insurer may seek collateral in the amount of 25–75 percent or more of the obligation. The amount of collateral required is determined by the financial strength of the owner/operator, the type of facility, and the years to closure.
• Annual premiums for closure insurance fall in the 1.5–3.5 percent of the required limits. (Limits required will be the same as the financial assurance obligation.)
• As the closure/post-closure work progresses toward completion, the financial assurance obligation amount decreases. If the reduction is approved by the governing agency, the insurer may, over time, reduce the collateral it requires and the premium will decrease as well.

At least three insurers — Great American, Zurich, and XL Environmental—offer straight risk transfer for closure/post-closure financial assurance, although their premiums and collateral requirements may vary significantly.

2. “Fronted” Program — A fronted program uses the same methodology as a risk transfer program with one major difference. In a fronted program the insurer provides its “paper” but does not offer any risk transfer. Rather, the insurer is providing an insurance policy with the specified limits and coverage— backed up by its own financial strength and rating—to post financial assurance to the regulatory agencies. The risk of loss is transferred back to the insured by a written indemnity agreement with the insurer.

Thus, the insurer is “fronting” for the insured, and taking the credit risk that the insured may not be able to honor the written agreement and repay any losses the insurer incurs. The amount of collateral required will depend on the limits that must be posted, the nature and duration of the obligation, and the strength of the insured’s financials. Several insurers are willing to provided “fronted” financial assurance policies. Premiums are often significantly less than premiums would be for a third-party liability policy.

3. Finite Risk Program — A finite risk program is essentially an insurance policy that the owner/operator funds with an insurer. The owner/operator pays the net present value of the financial obligation into a “commutation” fund held by the insurer. The insurer then issues a long-term insurance policy designed to cover the entire closure/post-closure period.

To set up the finite risk program, insurers will charge a premium of 2–5 percent of the obligation. This premium is driven primarily by cost and task uncertainty in the closure/post-closure cost estimates, the timing of the closure/postclosure expenditure as well as the financial position of the owner/operator.

Because the financial assurance obligation that must be demonstrated is discounted to present value, this mechanism allows the owner/operator to pay in less than the full obligation amount. It also allows the owner/operator to draw on the funding in the insurance policy as it performs the closure/post-closure. Chartis and Zurich offer this option, but again, pricing and terms vary. Sometimes an insurer may be more inclined to offer the financial assurance if the insured has other lines of coverage with the insurer, but it is by no means a given.

Environmental Third-Party Liability Insurance — Federal and state regulations also require posting of specified limits of financial assurance for bodily injury and property damage caused to third parties by “sudden” and “non-sudden” accidental occurrences. Multiple insurers offer this coverage, although their level of interest varies. Some may require collateral in addition to premium, depending on how they view the financial strength of the insured. Premiums may range from 1–2.5 percent of the limits required.

Determining the Right Financial Assurance Mechanism(s)

Owners/operators faced with financial assurance requirements need to explore the cost of the various instruments as well as their impact on their credit line, particularly if they have a large portfolio of TSDFs or solid waste landfills. Depending on an insurer’s or surety provider’s interest, the difference in cost to owners/operators can be hundreds of thousands of dollars in premiums, and millions of dollars in precious collateral.

The optimal financial assurance program may include the use of several mechanisms in order to achieve compliance. Determining how to structure a program is a dynamic exploratory process that requires assessment of the viability, structure, and cost-benefit based upon:

• owner/operator balance sheet and rating of long-term debt;
• bond capacity, rate, and collateral requirements;
• line of credit capacity and rate • current financial assurance structure, if any; and
• strength of insured’s relationship with insurers and regulators, and strength of an insurer’s relationship with regulators.

Why Environmental Insurance for Financial Assurance?

In recent history, over 55 percent ($2.1 billion) of all RCRA closure/post-closure financial assurance requirements, and at least 70 percent ($822 million) of all RCRA corrective action financial assurance requirements, were fulfilled with the financial test or a corporate guarantee.Strained balance sheets brought by the economic downturn have forced many owners/ operators to seek alternatives. In doing so, many have discovered the advantages of using environmental insurance. These include the following:

State and federal regulators should also welcome increased use of environmental insurance. Unlike other financial assurance mechanisms, with environmental insurers, regulators should find comfort in the following:

• Underwriters and engineers with environmental expertise have reviewed the technical soundness and financial estimates of closure/post-closure plans of the owners/operators and the insurer’s credit analysts have reviewed their financial strength.
• Insurers are evaluated and rated by numerous rating agencies, just as other financial institutions are.
• Environmental insurers are required by state insurance regulators to post sufficient reserves for coverages they write.
• In the event a policy must be triggered, environmental insurers—because their business is managing environmental risk—may be better positioned to ensure that closure/post-closure and corrective actions are appropriately performed. Insurers also may be able to reduce the cost of closure/post-closure/corrective action because they have significant influence with environmental consulting firms and law firms, and thus may have more purchasing power in terms of the required services.

Despite the advantages to owners/operators and to regulators, there can be some challenges to using environmental insurance. First, as few will argue, insurance policies often have a language of their own, and may require more than one reading, as well as conversations with an experienced broker or the insurer, before they are fully understood. In addition, because each insurer’s policy is different, some regulators may request that the policies be amended to meet specific state requirements.

The financial woes of AIG (now Chartis) in 2008 may also cause regulators to critique environmental coverage more so than other mechanisms. Ironically, this is the case even though in providing the coverage, environmental insurers have scrutinized to the technical feasibility and cost estimates of the landfills or treatment facilities for which they are providing coverage, in addition to reviewing the owner/operator’s financial condition.

This scrutiny is critical to insurers because once they are “on the risk,” they are “on the hook” for providing the financial assurance (and performing closure or post-closure, if necessary) until the insured secures a replacement mechanism. The policy cannot be canceled until a replacement policy or mechanism is filed with the regulators, so insurers are very discerning in the financial assurance risks they are willing to take on.

Another potential concern, particularly given that EPA has indicated it will develop financial assurance regulations for four additional industries, is whether there is enough capacity in the environmental insurance marketplace — and even among other financial assurance providers —t o fulfill the demand that such rulemaking may create.

Within the last year EPA has indicated it will develop financial assurance regulations for hard rock mining, chemical manufacturing, petroleum and coal products manufacturing, and electric power generation, transmission, and distribution. Although there are at least three environmental insurers willing to write closure/postclosure coverage, their terms and approaches vary significantly, and each has limits on the total amount of financial assurance it can offer the regulated community.

Although overall financial assurance capacity of the environmental insurance marketplace is difficult to estimate, it is safe to say it is currently insufficient to fulfill more than a fraction of the regulated community’s annual financial assurance obligations. It remains to be seen if insurers will be willing to provide more capacity to address the increased need that will result from EPA’s financial assurance ruelmaking.

Conclusion

The goal of regulators is to never have to actually use any of the financial assurance mechanisms posted by owners/operators, but to ensure that they are there if needed. With the many company failures, restructuring, and realignments that have occurred and continue to occur, regulators are placing additional emphasis on the importance of financial assurance to prevent closure/ post-closure, corrective action, and third-party claims from becoming yet another burden on taxpayers.

To ensure the most economical means of posting financial assurance, companies and local governments facing these obligations should explore all the mechanisms allowed by the regulations. In many instances, a financial analysis of the cost of the mechanisms, as well as how the mechanisms may affect the entity’s cash flow and credit line, may point to environmental insurance as a very attractive alternative, or an enhancement to a current financial assurance program.

Elizabeth Bannister is a managing director, and Patricia Blau and Janet R. Carl are senior vice presidents in the Environmental Practice of Marsh U.S.A. Inc. They have substantial experience assisting organizations in meeting their financial assurance obligations.

Please note the information contained in this article provides only a general overview of subjects covered, is not intended to be taken as advice regarding any individual situation, and should not be relied upon as such. Statements concerning legal matters are general observations based on the author’s experience as an insurance broker and risk consultant and should not be relied upon as legal advice. Please consult your own qualified insurance, tax and/or legal advisors regarding specific coverage and other issues. Copyright 2010 Marsh Inc. All rights reserved. MA10-10206