The risk of landowners having to pay for the clean-up of their land and meet third party claims for pollution emanating from their sites - even where they were not the original polluters - has increased as a result of environmental legislation.
Environmental Liability Insurance

The changing risks

Other parties, such as funders, developers and tenants of real estate are also facing increased risks, largely due to increasing contractual allocation of environmental liabilities in property transaction and development agreements. In this article, Gallagher’s Environmental team look at the insurance options available to protect parties against transaction-related pollution liabilities.

Whilst the frequency of environmental claims and regulatory actions for contaminated land clean-up remains relatively low, when they do arise, the costs and losses can be significant, especially when rental loss, consequential losses, legal costs and management time costs are taken into account.

Environmental due diligence has consequently become a routine exercise during property transactions. However, whilst the Phase I and/or Phase 2 assessments conducted by consultants provide important information, they are rarely conclusive (often due to tight timescales, access limitations, etc.) and usually indicate some residual environmental risk associated with known and unknown historic contamination at the property.

This residual risk is frequently transacted along with the real estate, increasingly by means of extensive environmental provisions contained in sale/lease agreements. The traditional approach has been to ‘take a view’ on this residual liability, and negotiate a price reduction based on a best guess estimate of the liability and/or to rely on the professional indemnity insurance cover of the consultant.

However, neither approach provides much in the way of effective long-term protection against potential environmental claims and regulatory actions or the blighting impact of pollution on an asset’s future marketability. In addition, disagreements between seller and buyer on the potential risks and costs of environmental liabilities frequently occur and can result in deals stalling, or ultimately collapsing. Yet there are potential solutions available for your clients conducting these transactions.

The role of insurance in deal closure

Environmental liability insurance is increasingly being used to facilitate property transactions, by providing robust financial protection against known and unknown environmental risks and enhancing the value of assets for a defined price that can be factored into the transaction value.

In doing so, the environmental risks are transferred to an insurance company that is strictly controlled by a regulatory authority, and has a strong credit rating. Opportunities in environmental insurance are at an all-time high with new insurers increasing competition on costs, providing wider cover and offering greater capacity. A further comfort is the fact that the insurance industry is one the most regulated industries for the transfer of liability; few other companies have specific requirements to keep long-term financial reserves in place for potential environmental liabilities. This means that transferring these risks to the insurance market is a robust and reliable solution.

Case Study

Our pension fund client was purchasing a large retail park, constructed on a former industrial site. The site had been extensively investigated and remediated prior to development, but the environmental due diligence revealed concerns over the extent of unknown residual contamination at the site and, in particular, the long-term risks associated with historic solvent contamination migrating from the site in groundwater. Under the terms of the sale agreement, our client was required to assume all environmental liabilities associated with new and historic contamination at the site, so the transaction was stalled, owing to the environmental concerns raised by the due diligence.

Gallagher’s environmental team was able to negotiate and place, at short notice, a long-term environmental insurance policy covering both the known and unknown historical contamination risks associated with the site. Policy coverage included liabilities assumed under the sale agreement and loss of rental income. The total cost of the policy was a tiny proportion of the transaction value, but provided the protection necessary to enable our client to successfully conclude the transaction.

Range of benefits

Crucially, environmental insurance policies can provide cover which includes protection against change in law. Polices can cover thirdparty and regulatory claims and can include consequential loss, property damage, bodily injury and remediation costs, technical and legal defence costs. Cover can be extended to both the vendor and the purchaser, funders and tenants with relative ease.

Significant commercial benefits that your clients could gain from an environmental insurance policy may include:

  • Achieving maximum asset value for sales
  • Long-term policies that can be transferred with site ownership with assignable policies
  • Accounting provisions - insurance cover for a potential liability can improve a company’s profit/loss sheet
  • High credit rating and protection can secure funders and, in some instances, reduce the level of the funder’s risk rating and therefore loan interest rates
  • A long-term and sustainable approach - the insurance remains intact even if a member of the project becomes insolvent
  • Insurance policies are based on financial loss occurring and streamline the process should a claim occur, instead of chasing multiple parties.

Growing awareness of the true financial impact of environmental liabilities, in terms of costs, losses and blighted property values, and the ability to obtain cost-effective long-term protection against such liabilities has resulted in a significant increase in the number of companies routinely using environmental insurance to facilitate property transactions where environmental risks are present.

With capacity increasing in the insurance market for these specialist risks, now is a good time to test the market, and see how this product can be strategically utilised for the benefit of your clients and their transactions.