Environmental Liability Risk Transfer: its time has come.

Environmental Liability Risk Transfer (ELRT) is the ability of a company (particularly a publicly owned company - filing reports with the SEC) to transfer its risk for environmental liability to a third party in such a manner as to eliminate the reserve for contingency which is carried on its balance sheet.

The Problem

For some time, the SEC and the accounting profession has required that public companies disclose to investors the potential liability which the company has to remediate property owned (or formerly used) by the company from pollutants. The disclosure requirement is a problem to many companies, as often the potential amount of the cost of remediation (even when the amount is unknown) is an impairment to the company either in a public offering or the obtaining of borrowed funds in a financing.

However, until recently, there have been only the choices of continuing the reserves (and attendant disclosure) or completion of the remediation. Neither choice has been a desirable prospect. The first doesn't solve the problem. Commencement of remediation requires the use of important capital, has an unknown cost and often can take years. Sometimes, in the process of remediation of property from known contaminants, other previously unknown contaminants are discovered and must be remediated at the cost of additional time and money for completion of the project.

The problem has resulted from the requirements in CERCLA (the Superfund law) and other federal and state environmental statutes, which impose upon the potentially responsible party (PRP) the absolute obligation to bear the cost of the cleanup of the property, which obligation continues even if the property is sold to a third party. Since a new owner also has exposure under the statutes to complete the remediation, the PRP gains little in a sale unless there is the assurance of the completion of remediation by the new owner.

The problem is compounded by the fact that the cost of remediation is very often uncertain. Sometimes estimates have varied by many times the original estimate.

Holding the property creates its own problems and continued "pain and suffering" to the management of the company. There is usually a significant dollar cost to continue to hold property. There are always continuing costs. Those costs always include property taxes and insurance, but many times an abandoned plant site requires a reasonably significant number of non-productive employees for maintenance and security. Perhaps most important is the time of the company's management in continuing to ponder the problem.

Companies most effected by environmental contingent liabilities include many Fortune 500 chemical, oil, gas and transportation firms. Most have disclosed liabilities of more than $100 million, and some, like Monsanto and Arco, exceed $1 billion. In total, it is estimated that companies are carrying close to $100 billion of contingent liabilities - a staggering number of illiquid assets.

The Solution

ELRT solves all of these problems. Simply stated, ELRT is the transfer of the liability for remediation (the cleanup itself) to a third party in a manner which assures the PRP that the remediation will not only be commenced, but actually completed. Since the original PRP continues to have the exposure of liability for the cost of the cleanup, to eliminate the dreaded establishment of reserves and/or footnote disclosure in its financial statements, the obligation of any third party must be such that it is satisfactory not only to the PRP, but to its auditor. The method which has been successfully utilized is the obligation of a third party enhanced by commercial insurance to protect against not only known contaminants, but unknown contaminants as well.

Environmental Liability Risk Transfer has been developed by Remediation Capital Corporation (RCC) and Environmental Liability Acquisitions, Inc. (ELA) both of San Francisco. A few other companies have also made efforts to accomplish similar structures.

History of the Development

One recent insurance industry estimate is that more than 80 percent of all of the dollars paid by insurance companies related to claims for environmental pollution is for defense costs; a minuscule 20 percent or less has been expended to do actual cleanup.

This reflects the attempt by the industries who created the claims and those who have willingly or unwillingly insured against the claims, a crude effort at risk transfer. Hundreds of millions, if not billions, are now being spent trying to push this liability from one party to another. Yet the cost to our society and to our economy remains. The hundreds of millions spent on defense do not remediate a single barrel of pollution.

Until now, Environmental Liability wasn't anyone's "Business"; dozens of companies are engaged in remediation. That isn't the issue. For the companies in the United States discussed here which own real estate, not one has the opportunity to make toxically polluted real estate a profit center. Many managers will ponder the size of the loss related to the property, while for years others will be concerned about how his or her management of the problem will be evaluated by a superior, but none of these managers can show a profit to the bottom line by the management of problem. The best result which management can achieve is reduction of the loss.

Environmental Liability Risk Transfer is a viable alternative for a very important reason; the entities engaged in the business have a profit motive and therefore, remediation of the property at the lowest possible cost and in the shortest possible time is imperative - or they don't make money. This gives assurance to all of the parties to the transaction to enable the creation of the ELRT structure.

In understanding ELRT, it is important to understand the problems faced by executives responsible for directing decisions about their companies' environmental liability:

Cost: No one can tell how much the remediation will cost - and very few corporate executives are willing to commit to an unknown to their CEO or Board of Directors. Cost estimates can vary by as much as 1000 percent;

Risk: When a company commences the cleanup of environmental liability, in addition to the cost, it still has all of the risk associated with the cleanup;

Time: The length of time required to complete remediation is usually uncertain. As a result, managers are reluctant to begin the effort;

Contingent Liability: Even the completion of the remediation effort doesn't relieve the PRP of contingent future liability.

ELRT solves each of the problems listed above, as well as other issues which face management. ELRT can take one of two principal forms.

Property Transfer ELRT

In addition to other problems facing management is the ownership of the contaminated land; What is going to be done with it? How will it be carried and managed during the uncertain period of time required for the remediation? In many cases management has no future intended use for the property, but concerns about the responsibility for environmental liability and the necessity of managing and being the cleanup effort, usually make the property unmarketable.

The Property Transfer ELAT is an effective solution for this circumstance. The following are the essential facts in a contract between which was signed in December 1993, between Remediation Capital Corporation [managed by Environmental Liability Acquisitions, Inc. (ELA)] and Monsanto Company.

Monsanto transferred its 11-acre Carson, California site (adjacent to the San Diego Freeway) to ELA; ELA agreed with Monsanto to environmentally remediate Carson (to the point at which the lead regulatory agency issues a "no further action letter"). No further action means it conforms to cleanup requirements as of that date, according to the relevant Federal or State statutes.

ELA obtained a policy of insurance in limits agreeable to Monsanto insuring the completion of the remediation of the Carson site. This policy is called "Remediation Guaranty Insurance or RGI" and insures Monsanto that the remediation obligations of ELA will be performed. If ELA fails to complete the remediation of the Carson site, up to the limits of the policy, the insurer will pay for any further remediation work required as a result of any known contaminants. The RGI policy remains in force until there is a satisfactory completion of the remediation. The coverage under the policy gives Monsanto similar protection to that which would be provided by a completion bond.

The risk of the presence of other contaminants is also a risk to Monsanto. A second policy, Property Transfer Insurance (PTI), is also issued and names Monsanto as an insured. Again the dollar limit of coverage is in an amount agreed between ELA and Monsanto; the coverage provides two separate types of protection: first, against the presence of any unknown or undiscovered contaminants; second, against any further remediation required with respect to known contaminants after a "sign off" and the termination of the RGI coverage. In addition, the PTI coverage can be endorsed in favor of a transferee of the Carson site; thus the name Property Transfer Insurance. The PTI coverage is for an initial period of 5 years and can be renewed.

As a result of this transaction Monsanto received the following benefits: Monsanto has no further liability; up to the limits of the RGI and PTI policies, the obligation to remediate the property has been transferred from Monsanto to ELA.

Monsanto no longer has the struggle with the determination as to the dollar amount of disclosure it need make for the contingent liability.

Monsanto management can stop devoting time, money, personnel and other resources to the Carson site.

Instead of the Carson site being an eyesore to the community, the Carson site will, as promptly as is economically possible, be returned to economic use.

The profit motive, when applied to the business entity with the economic risk of the remediation, and the continuity of the business of accepting the transfer and assuming the economic risk of the environmental remediation, enables insurers to issue coverage without the concern of the so-called "moral risk" which would be inherent if the owner were to seek coverage to cap its own cost of remediation.

Risk Transfer Without Property Transfer

The risk transfer is achieved without the transfer of the property. There are many instances in which an owner simply cannot or will not dispose of its property. In that case, the same benefits, including the insurance coverage, can be provided for a fixed fee.

Summary

The issue is not to reconsider the obligations of a PRP to remediate its property. That issue has been addressed by CERCLA and all of the other federal and state environmental laws. Clearly, the public now expects both the commercial entities responsible for the pollution and landowners to clean up the environment. The important question is how the effort should be spent. ELRT offers most companies a very sensible solution. Environmental risk outsourcing is a concept whose time has come.