With the UK preparing to transpose the Environmental Liability Directive into law, what can insurers and their clients learn from the experience of others who are further ahead of the game?
Ana Paula Nacif with Post Magazine reported in an article published on 27 November 2008 that after months of consultation, the Environmental Liability Directive is finally set to be transposed into UK law in December, according to the Department for Environment, Food and Rural Affairs - despite the original deadline of 30 April 2007 being long gone.
Even though some believe that DEFRA's timetable is still a tad optimistic, the insurance industry in the UK has been looking closely at the experience of other European countries to try and make sense of how the changes ahead will affect the market.
The ELD furthers the concept of the 'polluter pays' through the introduction of compensatory and complementary remediation. The aim of compensatory remediation is to make up for environmental loss during the period between the damaging event until primary and complementary remediation reach the baseline condition - that is the environmental condition prior to the damage. This means that compensatory remediation is required both when primary remediation is possible and when it is not.
According to Glen Donaldson, head of environmental liability at Crawford & Company, this poses a significant financial risk to many businesses in the UK. "This is recognised in the ELD whereby member states are asked to promote and encourage the use of appropriate insurances and other alternative financial security instruments to offer some protection to businesses."
In fact, some countries, like Spain, have decided to go the extra mile and make financial provision compulsory in some cases, whether insurance or otherwise.
According to Tony Lennon, European manager for Chubb Environmental Solutions, the Spanish government requires all companies to carry out an environmental risk analysis. If their exposure is below EUR300,000 (GBP255,231), companies do not need to make a financial provision although they are, of course, still liable. If their exposure is between EUR300,000 and EUR2m, providing they can demonstrate they have a robust environmental management system, they are also off the hook. However, if their exposure exceeds EUR2m, they must have a financial provision irrespective of whether they have robust environmental risk management or not.
But many UK companies are not even aware of their exposures, let alone any financial provision they may need. Mr Lennon suggests that perhaps Defra, in trying to not antagonise companies, downplayed the potential liability the new directive would bring. "They underestimated the new exposures, which made people think they didn't need to worry."
Directive, what directive?
As an example, he cites two seminars he attended in November on behalf of trade associations. "Most of the 40 delegates hadn't heard about the directive before seeing the invitation. The reality is that the vast majority of UK industry is simply not aware of it."
David Barr, UK environmental practice leader at Marsh, agrees a lot of work still needs to be done. "In other European countries there is a lot of interest and uptake in this kind of environmental impairment insurance; in the UK it is a different story."
He explains that in other countries companies are used to buying insurance that goes beyond general liability. "They think of insurance programmes from an operational point of view, whereas the UK has been more a transaction type of market. But we are seeing the market becoming more operationally focused here as well."
Apart from raising awareness among potential customers, insurers and brokers operating in the UK also need to keep an eye on what is happening in the rest of Europe.
Cases have already been brought under the ELD in countries, such as Germany, Portugal and France, that should shed light on how insurers are handling such claims. But the market is far from having a clear picture.
"We need to remember that environmental claims, especially complex ones, will take a long time and require a lot of investigation and research," explains Simon White, environmental branch manager at XL Insurance. "So, although we know some cases have occurred, it will take time for them to go through the whole process. We will start to see proper European examples coming into the public arena as and when these are resolved."
Mr White adds that there has been a significant change in attitude in some of the countries that have implemented the new legislation. "There is now a duty of care, so potential polluters need to report to the regulator if they have caused or are likely to cause pollution," he explains. "That wasn't there before. No incident is too small as they can escalate quite quickly; that's one of the problems with pollution, so we are seeing more notifications."
If polluters have a duty to report, regulators have a duty to enforce the legislation. "Historically authorities could take the company's behaviour into consideration and decide on a course of action," explains Mr White. "The directive took that away from them and they do have to enforce the legislation."
But, as member states have a certain level of flexibility as to how they implement the ELD, the legislative landscape is uneven.
Some countries have less developed environmental law, while others already have a wealth of existing legislation that will either be replaced or amended. "Therefore," says Wayne Harrington, environmental risk manager for the UK and Ireland at Ace, "we cannot expect a flood of specific ELD-related claims immediately. But the number of reported incidents and regulatory responses will certainly increase in the short-term as these changes take hold."
Such differences in approach pose difficulties to insureds, insurers and reinsurers. "Environmental impairment doesn't necessarily stop at the country's border," explains Juerg Busenhart, senior product manager at Swiss Re. "So in certain cases they will be faced with different legislation. Even with the directive introducing a level of uniform liability, at the end of the day they are faced with different liability schemes, which make it difficult to put in place trans-European insurance solutions."
Search for a solution
Also, with ELD cases already in the pipeline on the continent, it could be years before a solution is finally reached. "The directive deals with the results of environmental impacts, such as contamination, and remediation can take a long time - up to 50 years," says Mr Busenhart. "So it is difficult to make an assessment of costs and the likely timescale involved."
Anna Nilsson, environmental underwriter manager at AIG, agrees, adding that all the member states are currently looking at each other to find out how they are handling the new legislation. "Although there have been some cases, it will take time until the market fully knows how to interpret and handle them."
Establishing the appropriate course of action and the amount of resources needed following an incident is one of the tricky issues regulators, insurers and policyholders will have to grapple with. And a lot of research has gone into establishing ecological equivalents and calculating natural resource damage, says Graeme Merry, environmental specialist at Heath Lambert.
One such research project is Remede, which draws on both US and EU member state experience. The project's case studies cover resource, habitat and value equivalency approaches and come from six different countries - the Czech Republic, Germany, Poland, Spain, Sweden and the UK.
"These projects are expensive and time-consuming," emphasises Mr Merry. "In the UK, the regulator will be trying to fit the directive's requirements around what is already in place, so there is a degree of uncertainty about how this will be done."
Enforcement is crucial if this certainty is to be achieved and, according to Mr Merry, has been limited with the existing legislation to date. "Until more examples of enforcement come through and companies start facing significant costs, it will be hard to get people's attention."
Although these grey areas remain, it seems the wider market is changing to gear up for new demand. While environmental liability insurers insist this will remain a specialist market, recent moves could prove otherwise. For example, earlier this month Axa launched a new environmental solution designed to cover ELD exposures (Post, 20 November 2008, p3).
Despite this interest from mainstream carriers, others argue that years of environmental liability experience cannot be underestimated. "A lot of expertise is being drawn on from the US experience," says Ms Nilsson. "These are very complex deals that involve not only clean-up costs but also complementary and compensatory remediation."
And, according to Mr White, the ELD takes environmental risk to a different level and general liability policies were never designed to cover environmental exposures to this degree. "We are not trying to reinvent the wheel; we are looking at practices that have been established for a long time, whereas the general liability market doesn't have that experience."
Growing cover gap
Traditional insurance markets have provided an element of environmental liability cover - namely, third-party liability for sudden and accidental pollution - but there has been a long-standing gap in terms of gradual pollution and first-party losses. And, as regulations continue to become more complex, this gap will continue to widen, explains Alexander Pohl, senior project manager for environmental risks at HSBC Insurance Brokers.
He also believes that capacity may drive market changes. "The problem is that, at present, there is not sufficient capacity in the specialist environmental insurance market to insure all affected installations across Europe," he says. "This would require billions of pounds of capacity. So, arguably, is it likely that traditional insurers and pools will need to become involved if insurance is chosen as the mechanism to provide financial security under the ELD."
With environmental liabilities focusing people's minds, some in the market have discovered that certain environmental covers can be found in unlikely places.
Christoph Mocklinghoff, leader of Marsh's environment practice in France, explains that some general liability policies that cover product liability have an element of environmental exposure cover related to that. "This is interesting as the specialist environmental market never thought about covering product liability."
There may already be some overlap and Mr Mocklinghoff explains that policies are evolving to respond to clients' needs. "We are developing complete policies that give both general and environmental liability cover."
He adds that the directive is likely to have a significant impact, citing a landmark decision on the sinking of the Erika ship that could set a legal precedent.
When Erika sunk in 1999, it caused a major oil spill and, in January this year, the Criminal Court of Paris fined the world's fourth largest oil group, Total SA, EUR375,000 - the first time a French court has handed down a conviction for environmental damage.
Mr Mocklinghoff says lawyers are "using the spirit of the directive" to make the company pay for damage. "It's not over yet as they launched an appeal on the basis the directive was not enforced at the time of the accident."
Dampened demand
Wherever happens in France, the UK market will have plenty of challenges of its own. Whether these will translate into more business for brokers and insurers remains to be seen. As Mr Merry points out: "Over the years the expectation was that various pieces of environmental legislation would raise awareness and trigger interest in insurance cover for this type of liability.
"By and large, this hasn't materialised. To a certain extent, people are happy to rely on the existing limited cover they have. They haven't taken into consideration that the situation regarding environmental liabilities has changed a lot."
This situation is likely to change further yet. In 2010 there will be a review across Europe under the ELD into financial security mechanisms to ensure sufficient funds are available to address pollution caused by companies, particularly in the event of insolvency.
According to Nigel Wallis, partner at law firm O'Connors, some large UK companies - especially those with operations in other European jurisdictions - are weighing up their options, with some deciding to set up captives to protect themselves. "With the trend towards balance sheet transparency, brought about by the Companies Act, some companies want to make sure their risks are managed."
Being prepared to deal with new exposures may well be a good idea. As Mr Pohl concludes: "Companies need to keep in mind that the ELD is just the first of a number of new and increasingly stringent environmental regulations that will challenge businesses over the next few years."
US experience
The Environmental Liability Directive's 'environmental remediation' requirement has similarities with the 'natural resource damages' concept in the US. The following case study illustrates how the legislation is applied and how much such claims can cost.
Case study of a US NRD claim
A ruptured pipe at an oil processing facility resulted in around 22,000 litres of waste oil entering a river. The river is used for recreational purposes and has sensitive environments and the emergency response included containing and recovering the oil.
Nearly 16 miles of riverbank were impacted and nearly 100 oiled birds needed cleaning. An additional number of birds died as a result of the oil.
Following the clean-up, the polluter and its insurer hired an NRD expert to conduct a detailed site remedial investigation, which involved reviewing and categorising the ecological damages.
Based on this assessment the impacted ecosystems along the riverbank required either further cleaning or actual removal. The shoreline banks needed flushing and the extensive cleaning process had to be constantly monitored. The ultimate ecological restoration included the replanting of reed beds and other vegetation along the river.
The cost for the emergency response; subsequent pollution; NRD assessments and characterisations; the actual remediation itself, as well as the ecological and species restoration/rehabilitation - similar to the ELD's 'primary remediation' and 'complementary remediation'; and legal costs have so far reached $2.5m (GBP1.6m).
On top of the above actions, aimed at restoring nature back to its baseline condition, the NRD concept assesses interim loss to the environment as a result of the pollution incident. This claim for NRD (compensatory remediation) is currently expected to be in excess of $250,000.
Source: XL Insurance.
