Articles / Publications

Environmental Claims Journal, Vol. 14, No. 1, Winter 2002

INTRODUCTION - THE SEPARATION OF ENVIRONMENTAL AND CONSTRUCTION INSURANCE

Despite common roots and similarities in operations, traditionally there has been a separation of environmental contracting and general contracting resulting in the two practices being handled by different segments of the insurance industry. Even though many of the larger environmental remediation firms grew out of general contracting operations, the two have not been viewed as having overlapping exposures.

An environmental firm is hired to identify and characterize contamination, develop and execute a plan for remediation. Construction contractors are engaged in the traditional development of improvements to land, including structures, roads, bridges, and other tangible elements of real property. As a result, the risk management and insurance needs of these two segments of the contracting industry have been addressed through different mechanisms.

In part, the separate paths for risk management of environmental and construction exposures were dictated by the exclusion of pollution risks from property and liability insurance policies starting in the 1970s. As the policies of standard insurers excluded more and more environmental risks over the year, a separate market emerged to handle the pollution risks associated with environmental consulting firms and remediation contractors as well as those of industrial accounts with environmental exposures. Insurance companies also set up separate divisions to underwrite and service environmental exposures. These units did not typically handle insurance policies for general and trade contractors.

Things began to change as environmental projects grew from the simple characterization and cleanup of historic contamination into brownfield conversions of industrial properties, military base closure, and reuse and large-scale infrastructure projects where environmental work is a part of larger construction activities. With this shift there has often been a lack of coordination between the risk management needs of the environmental parts of the work and those related to the more traditional construction activities.

Trends toward single contracts for the delivery of completed projects (i.e., design-remediate-build projects) have tended to erase the distinction between environmental remediation and construction work from the owners' and contractors' perspectives. It is now common for one firm to be responsible for the design, construction, operation, and maintenance of a complex infrastructure or industrial project. If remediation is required, the project specifications often make the general contractor responsible for that aspect of the work. Frequently the general contractor opts to “self-perform” what is perceived to be low-hazard environmental remediation hoping to either manage budgetary constraints or to meet stringent project delivery deadlines. In light of these changes in construction projects involving contaminated sites, it is becoming unclear where the responsibility of the general contractor ends and that of the remediation contractor begins. This is especially true where the general contractor performs or subcontracts for the necessary site cleanup as a part of the general contractor's responsibilities.

Where construction is done on property that has been contaminated by historic operations, the work of the general contractor must often be done around that of a remediation firm. Some elements of a treatment process may also have to be accommodated in the plans for the completed structure. The design of the improvements may encompass elements of environmental control such as where parking structures are used to cap contaminated areas in places where removal of contaminated soil would otherwise be required.

Risk management considerations in design/remediate/build projects are considerably more complex than those involved in nonenvironmental construction. Where multiple contractors are involved, there is a need to coordinate the protection of different insurance policies into a comprehensive program of coverages that addresses environmental, professional (errors and omissions) and contracting risks. Because these coverages are typically written by different insurers and handled by brokers with varying degrees of expertise, the coordination of risk management needs is considerably more challenging than in traditional construction projects.

Insurance brokers normally handle construction business in a separate division or department from the units that deal with standard manufacturing, commercial, and institutional risks. Larger brokers have quasiindependent construction practices that deal with major construction companies, engineering, and design firms. The people that work in these divisions are normally skilled at handling the risk management needs of contractors, including the placement of surety programs to support contracts where performance and payment bonds are required. Within these construction divisions, specialists are employed for wrap-ups, transportation projects, international business, and other areas where higher skill levels are required to service accounts.

Few insurance brokers have any environmental expertise that can be utilized to provide competent environmental risk management assistance for accounts with construction exposures. Small brokers do not have a frequent need for this type of specialized skill, and the cost of staffing of an environmental unit would be difficult to justify. Larger brokers are developing specialized units to address the needs of the environmental industry, but frequently neglect to make the services of the specialists employed in the environmental unit available to the general insurance or construction divisions on an integrated basis. This lack of communication between environmental practices and other parts of the brokerage system exists in the large firms today and manifests itself in a lack of coordinated expertise able to address the complex issues that transcend multiple disciplines like construction and environmental practices.

THE POSSIBILITY OF COORDINATED ENVIRO-CONSTRUCTION SERVICES

Many construction projects are, in reality, a combination of traditional construction and environmental work that must be coordinated not only from a standpoint of site activity, but also with regard to insurance and risk management needs. Sites where environmental remediation precedes construction are becoming more common as brownfield projects are undertaken to revitalize blighted urban areas. Closure and conversion of military bases and government-owned manufacturing facilities also involve remediation on a large scale, particularly where hazardous chemicals were a part of historic operations. Construction of airports, subway and light rail systems, shopping centers and superstores, bridges, tunnels and highways, arenas and stadiums, public and private entertainment facilities, and many other large-scale projects typically involve remediation of contaminants or work on sites that are impacted by historic pollution. The unique insurance and risk management needs of these projects present an opportunity for people with construction experience to expand their activities into this new class of enviro-construction activities, but the segmentation of services among larger insurance brokers has left a gap in knowledge between environmental and construction risk management services. A facility that can bridge this gap is required to address the new risk management challenges created by the convergence of construction and environmental risks.

The development of a comprehensive insurance and risk management program for contractors that combine environmental with general construction services is a complex task that requires skills that are not commonly found in either the environmental or construction practices of even the world's largest insurance brokers. These contractors are seeking broker assistance in the following areas:

1. Identification of Risks

Contractors expect their insurance brokers and risk management consultants to understand both the environmental and construction risks associated with their operations. This knowledge of the client's business allows the broker to ask the questions necessary to determine what environmental and general construction exposures must be addressed in the design and implementation of an insurance and risk management program. Only a broker that has had experience with both environmental and construction exposures will be able to perform this task competently.

2. Understanding of Relevant Contracts

Construction and environmental projects are driven by the contracts that are executed between the contractors and the parties hiring them to do the work. In order to be of assistance in the development of risk management programs, brokers must be able to assist in the review of other contracts that are commonly a part of environmental work, including regulatory orders for site cleanups, contracts for remediation services, real property purchase and sale agreements, project-specific loan agreements (often with personal environmental indemnity and recourse provision), and private contracts between and among parties to transactions. Where required, the broker must be able to tailor the risk management program to meet or support the obligations imposed upon the contractors by allocation of risk indemnity provisions of these contracts and agreements.

3. Quantification of Risks

The broker should also be capable of providing the contractor with assistance in developing estimates of the potential magnitude of environmental, professional, and other construction losses associated with the work of the contractor. These estimates may be based on actuarial data (to the extent that information is available) or on the broker's experience with similar accounts and with work that involves similar exposures to loss. A maximum loss exposure may be calculated by the broker through a systematic assessment of possible costs, including physical damage to real and personal property, cleanup of contamination, bodily injury, business interruption, and natural resource damage, along with defense costs for third-party claims. The broker should also be familiar with the impact of mitigation strategies that can allow the determination of a range of possible costs for the contractor's exposures as they relate to a specific project.

4. Understanding of Environmental Liability Exposures

In order to fully assess the environmental risks associated with a project where both construction and remediation work is involved, the broker should have an understanding of environmental laws and regulation, as well as the tort and contract law principles that can result in the imposition of legal liability. Familiarity with the specific environmental risks that are involved with a construction-environmental project requires broad experience on the part of the broker with accounts that provide professional and construction services in the environmental industry.

5. Knowledge of Environmental and Construction Coverage Forms

The broker should have a thorough understanding of the more than 25 different types of environmental insurance coverage forms that are available in the market today. Brokers that are not regularly involved in working with, modifying, and manuscripting language for environmental market policies will not be familiar with the subtle changes necessary to fully protect the contractor's exposures. They will also be unfamiliar with the types of modifications that are acceptable to the underwriters in tailoring coverage to the needs of the contractor. The broker should utilize a checklist of mandatory changes to preprinted coverage forms and be able to add those changes required to tailor the insurance policies to the specific risks of the project being insured.

6. Afford Access to Insurance Alternatives

The broker should be familiar with creative risk transfer and alternative risk management solutions, including captive insurance companies, insurance and remediation trusts, surety bonds, and various financial transactions that might create tax advantages for their clients. The broker should have access to internal resources or established relationships with outside consultants, attorneys, and accountants to provide the skills required to properly address the risk management process. For example, specialized skills may be required to conduct negotiations with regulators, develop sophisticated funding mechanisms and develop accurate estimates of remedial costs. The broker should understand the capacity available in the domestic insurance market, have access to foreign markets if necessary, and know how captive insurance subsidiaries can be utilized.

7. Prepare Market Submissions

Confidentiality and nondisclosure agreements are commonly executed for the contractor's insurance submissions due to the sensitive nature of the information required to develop an insurance proposal for an environmental project. The broker typically will need to discuss the environmental characterization of the site, the proposed remediation alternatives, the status of the various parties to manage cleanup and development costs. The broker must also maintain close working relationships with the underwriters active in the environmental and construction areas in order to obtain the maximum results in structuring a comprehensive insurance program for an enviro-construction project. This relationship will allow the broker to maximize the combination of coverage and pricing that is required for a successfully placed insurance program.

8. Negotiate and Facilitate Coverage

In order to provide comprehensive protection for all risks identified for a specific project, the construction, professional and environmental insurance policies must address a broad range of exposures. The broker should confirm through a process of negotiations with underwriters that all required risk management objectives have been met. The final program should then be presented to the contractor. Often the process of reviewing the insurance and risk management program involves meetings with not only the contractor, but also with the contractor's client, attorneys, accountants, financing sources and other parties working on the development of the project. Environmental regulators may also be involved in a review and approval of environmental insurance programs. Once the approval of these parties has been obtained, the broker should instruct the selected insurer to bind coverage in accordance with the specifications of the written insurance proposal. Evidence that coverage is bound should then be provided to the contractor and other parties that require proof of insurance prior to the commencement of work at the project site.

9. Communication of Financial Benefits

The broker should be able to clearly explain the financial benefits of the selected insurance and risk management alternative to the contractor and other parties involved in the project. The broker may be required to explain the insurance program and its benefits to contractor's client, including inside and outside counsel, accountants, and financial officers.

10. Provide Ongoing Policy and Claims Assistance

The broker should monitor changes to construction and environmental exposures and alert the client if modifications to the insurance policies or other risk management mechanisms are needed. Changing environmental statutes, tax laws, or legal developments are few examples of areas that the broker should monitor to assure that the client's exposures to loss and/or liability remain protected. The broker that has had experience with prior environmental claims will be most sensitive to the needs of the insured and will be able to provide advice on the proper presentation and handling of claims associated with the current project.

NEW TYPES OF RISK ASSOCIATED WITH ENVIRO-CONSTRUCTION PROJECTS

The need for this increased level of service on the part of the broker is driven not only by the merging of environmental and contruction projects, but also by the different requirements placed on contractors as a part of this class of business. While insurance has always been purchased to protect the parties involved in construction projects from the risks associated with the development of site improvements, the protection that is required in environmental-related projects also includes not only risks arising from contaminated soil and groundwater, but also losses caused by cost overruns on site remediation. Because many risk managers are unfamiliar with environmental exposures, there is a greater need for broker assitance to assure adequate attention to the insurance that will be required. The projects are also more complex in terms of the contractual and legal issues encountered in sorting out responsibility for various aspects of project design and management. In addition to the standard construction contract, typically there will be a remediation contract (standard form or fixed-cost), consent order, or other agreements with regulators that govern the cleanup, and private agreements between purchasers and sellers that include allocation of risk provisions, indemnity agreements in-cluding recourse for environmental issues, and specific requirements related to insurance coverages. Some contracts also include demolition of existing structures, including abatement of asbestos-containing building materials and the construction of infrastructure or other site improvements.

Boutique or specialty brokers that have experience with environmental placements and significant relationships with underwriters may be retained either as consultants or brokers on projects that combine environmental with general construction activities. A niche environmental broker may work with the client's existing broker to provide outsourced environmental services and may then be appointed as the broker or co-broker for any insurance placements required as a part of the project risk management program. The skills highlighted above are those that should be sought in the appointment of a specialty broker either as a consultant or on a stand-alone basis.

The insurance products that are utilized for environmental risks may also be unfamiliar to risk managers that have concentrated on construction account work. The following is a list of some of the exposures that are typically insured in large-scale environmental projects:

• Cost overruns for remediation expenses
  
• Re-openers under regulatory order
  
• Changes in regulations that require additional remediation
  
• Discovery of new contaminants (onsite/offsite)
  
• Third party claims for bodily injury, property damage, or cleanup costs (onsite/offsite)
  
• Contractual liability
  
• Natural Resource Damage claims
  
• Diminution of property values (subject to third party properties)
  
• Loss of rents or business interruption due to contamination
  
• Payment of remediation expenses (Finite and blended finite/risk transfer)
  
• Professional risks related to site characterization and devel-opment of remedial action plans
  
• Risk of release during the remediation due to the work of contractors
  
• Completed operations for remediation work

Each construction project, by its nature, has unique risk characteristics that are not common to other projects. Frequently, the introduction of environmental work into construction projects also brings additional scrutiny by professionals including lawyers, accountants, environmental consultants, and engineers hired by the parties to the transactions. Many times the issues that are raised in the reviews of these individuals are ones of first impression (from their perspectives). Their lack of experience with environmental matters can result in projects becoming bogged down by executive indecision. The expertise of a specialty broker will assist in addressing these professional concerns by bringing experience and independent knowledge of insurance and risk management issues to the process. This will allow projects to move forward and meet time-critical milestones.

The size and scope of enviro-construction projects, along with the presence of unique risks related to environmental exposures also may require oversight by financial executives that are not commonly involved in nonenvironmental construction projects. This complexity makes the sales process for risk management products and services more difficult, and brokers that are inadequately prepared will not make it past a first meeting with the prospective account. Even where strong relationships have been forged with customers, the risk management of environmental construction projects may involve a broker qualification process prior to engagement of the risk management team.

Examples of Enviro-Construction Projects

The types of projects where environmental and construction risks converge is extremely broad. The opportunities might be best understood from a review of examples of cases where enviro-construction skills have been a part of the risk management process. The following case studies provide examples of projects where a combination of environmental and construction risk management was required to successfully address all significant exposures:

1. Construction of New Facilities at an Existing Airport
   
   When the port authority that owned a major airport facility decided to construct a new international terminal, the request for contractor proposals included far more than a standard construction project opportunity. The successful bidder was required to provide design services to execute a basic concept that had been created by a leading architectural firm. In addition to the design-build services, the bidder was also required to include a proposal to operate the terminal for a period of 25 years following construction. The site on which all work was to be conducted was, like all airports, contaminated by leaks from fueling system piping and historic spills of fuels and solvents. Remediation was already in progress to clean up underground aquifers, but the contractor was responsible for any other contaminants discovered during the course of construction as well as abatement of asbestos in existing structures prior to demolition. An option allowed the bidder to also provide financing for the project as an alternative to the bond issue that was proposed as a source of funds by the port authority. Altogether, this project represented a potential 29-year relationship between the contractor and the owner. This new design-remediate-build-operate-finance project required a consortium of parties to successfully execute the various components. This risk management process involved the creation of a new risk management department that will stay in existence after the construction work is completed. Insurance for construction services was provided through an owner-controlled insurance program (wrap-up or OCIP) that included not only general liability and workers' compensation but also environmental insurance to address both known and unknown contamination.
   
   Now in the course of construction, this airport project has experienced a number of environmental incidents where insurance has responded. These included releases caused or contributed to by construction activities, the discovery of new contaminants that were not found in site characterizations, and releases from newly constructed extensions of the underground fueling system.
   
   It is expected that this model will be utilized for other major infrastructure construction projects. Similar environmental issues could be encountered in the construction of bridges and tunnels, light rail and subway systems, arenas and football stadiums, and major roadways. Environmental insurance will be required as a component of the risk management programs for these and other construction projects.
   
   Environmental premiums for this project were modest (Approximately $350,000 for the 10-year term of the work), but the protection provided by this program has already had an important impact on the project by allowing work to progress despite environmental incidents, and without an immediate need to determine fault and assess contractors additional costs for remediation.
   
   
2. Construction of Office/Commercial/Industrial Complex on Brownfield Site
   
   A high-tech company mogul decided to construct a new complex for his business on the last remaining waterfront property in the vicinity of his firm's existing headquarters facility. The property is a composite made up of a former forest products facility (with wood treatment by creosote), a ship repair yard, and an abandoned facility that had processed coal tar from manufactured has plants. Contamination includes some very difficult material to remediate, including the break-down products from the coal tar plant that are found not only in soils but also in sediments along a mile of shoreline. Unwilling to risk his own fortunes on this venture, the executive has enticed the city where this property is located to take on the task of purchasing the land and remediating it prior to the development of his industrial/office/commercial complex. The city will also build his buildings (to his specifications) and lease them to him for a 20-year term.
   
   The city is struggling with the task of characterizing the contamination at the site in order to seek proposals for remediation. Under tight time constraints to complete the entire facility within a 4-year time period, the construction planning is already underway despite considerable uncertainty about the work that may be required to remediate the contamination. Preliminary plans will require the placement of structures and parking lots to match areas of contamination so that the construction will become part of a containment system. All work will have to be coordinated so that construction can be conducted concurrently with the removal of contaminants and the installation of pump and treat groundwater remediation systems.
   
   Insurance is being developed to cap the cost of cleanup as well as address the environmental risks associated with remediation and construction of new buildings on the property. This insurance will have to stay in place for the entire term of the lease (20 years) to provide protection to the property and people working there. Bid specifications are being prepared to seek proposals for coordinated services for design, construction, and management of the facilities. Environmental work will also be included in the bid specifications. Insurance and risk management programs will need to combine construction and environmental protection for more than $200 million of remediation and construction costs. The proposed premium for this environmental insurance program is more than $4 million for the 20-year term of the project. It is also likely that the insurance company will be paid in advance for the expected costs of remediation and till manage the remediation project by paying these costs as claims in a finite funding program.
   
   
3. Remediation and Development of Oil Contaminated Property
   
   A major oil company operated a terminal and tank farm in a coastal area of California. Spills from loading and unloading, leaking pipelines and a fire that destroyed the tank farm more than 30 years ago have left the town where these facilities are located contaminated with hydrocarbons. After the owner ignored regulatory requests to investigate and remediated the condition, the state brought an enforcement action against the company that resulted in a cleanup order that requires the excavation and removal of soil in a large area of the town. The expected cost of remediation is $150,000,000. Land values in the areas have escalated to the point where the remediated site will have a significant market value, but this can only be realized if proper entitlements are given for land use. Local officials, angered by the recalcitrant behavior of the oil company refuse to give them the zoning needed to unlock this value. A developer is being sought to be a partner in the development of this site. The project will include remediation of a large portion of the property that is not addressed by the current consent order, development of a master plan for land use that will maximize real estate and income opportunities and construction of improvements on more than 600 acres of prime coastal land.
   
   The oil company also seeks to remove the liabilities for past pollution from its balance sheet. To achieve this, a finite insurance program will be required as well as the creation of special-purpose corporation to take title to the land. The finite policy will contain a commutation provision to allow a return of funds that are not required for the cleanup to the site owner. Environmental insurance will be provided to cap remediation expenses at $150 million and also to provide long-term protection against third party claims. On top of these programs, all future construction activities will be insured and performance under the contracts will be bonded. Insurance premiums, including the finite placement will be in excess of $127 million.
   
   
4. Military Installation Conversion to Private and Public Use
   
   The General Service Administration has declared a former army ammunition manufacturing facility to be surplus to its needs. The site is contaminated with a variety of common solvents and exotic materials related to the manufacturing of rocket propellants. More than 100 areas of contamination have been identified on the 9000 site and it is estimated that cleanup will cost more than $40 million. A developer has come up with a plan to develop the site for commercial and residential use, and has offered to take on the task of remediating the entire site in return for title to the land. The state must take title to the land a give the Army a promise to clean it up under federal Base Realignment and Closure rules. The developer will then agree to assume the state's obligations and provide indemnity for any environmental liability arising from the project. This complex transaction involves several contracts among the parties as well as a 100-page consent order between the state environmental regulators and the developer that specify the process for remediation of the site.
   
   The developer will rely on insurance to provide financial guarantees as well as protection to the parties with potential liability exposures related to the site. This includes more than $300 million of financial guarantees and insurance including protection against environmental exposures, cost overruns, and performance under the cleanup and construction contracts.
   
   The complexity of the risk management program involved in this project is beyond the imagination of most brokers, even where substantial skills in both construction and environmental insurance are available. Understanding the allocations of risk in the various documents and the interaction of the contracts and agreements required a risk matrix that mapped liability provisions, indemnity agreements, insurance requirements, and other promises related to construction and environmental risks. The end result of the risk management analysis was the development of a combination of several insurance policies with terms as long as thirty years and limits of more than $150 million per occurrence. Protection was provided for more than a dozen entities including several federal and state agencies as well as the developer and contractors performing work on its behalf. Project financing is now being arranged to begin remediation work and construction of the site improvements. Environmental insurance premiums, not including finite policies to assure completion of the cleanup and surety bonds, are in excess of $4 million.
   
   
5. Highway and Bridge Construction on Privatized Beach Access Road
   
   A coastal county advertised for bidders to construct 19 miles of highway and a new bridge to provide additional access to coastal areas that were suffering economic decline due to overcrowding of the only road leading to the beaches. The bidder was required to design, build, and operate a toll highway and bridge that involved construction in sensitive wetland areas where historic uses had left significant contamination. Remediation of any required contaminants was a part of the Scope of Work for the project. The successful bidder ran into trouble with project financing when the life insurance company lending the money required environmental insurance, including coverage for a delay in commissioning related to the discovery and remediation of pollutants in the course of construction.
   
   Insurance was written in a single policy to provide protection against cost overruns on expected remediation, third party claims arising from pollution conditions, releases caused by construction activities, delay in completion and loss of income expected to repay debt as of a fixed date, as well as prospective releases from future activities for a period that matched the term of the loan (20 years). This environmental insurance was required in addition to the normal construction coverages that were done in a project wrap-up program. Environmental policies had a premium of $450,000.

CONCLUSION

The convergence of environmental and construction activities in a single contract for services has resulted in a opportunities for contractors that have the skills to manage both tasks to pursue new and unique project work. In order to take advantage of these opportunities, contractors must assure themselves that the risks associated with the environmental portions of the work are properly addressed by insurance and risk management programs. This will often require the placement of new insurance to address the environmental exposures associated with the specific project in which remediation services are to be provided. Many brokers, including those with contracting expertise, do not possess the skills required to construct a comprehensive program of insurance and risk management for both the environmental and contracting risks of these complex enviro-construction projects. Specialty firms have emerged that are capable of providing both consulting and brokerage services for projects where both general contracting and environmental services are to be provided. These firms may fill the gap in the service profiles of existing brokers or serve as single project brokers where enviro-construction projects are undertaken by a contracting account.