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Scrap metal industry faces environmental dilemma.

Scrap Metal Industry Faces Environmental Dilemma

The scrap metal industry recycles metals like steel, aluminum and lead from discarded consumer products. Although this industry serves the national interest by saving energy and reducing environmental damage, about 30 percent of its members have been held liable for cleanup under the Superfund law.

The scrap metal recycling industry provides a growing source of raw materials for the basic metals industry. In addition to reducing the environmental damage from mining, the recycling of metals saves energy. Compared to the processing of metallic ores, the recycling of steel reduces energy consumption by 50 percent and the recycling of aluminum by over 90 percent.

Scrap recycling involves three distinct stages: the collection of scrap metal from dispersed sources, a preliminary cleaning and separation into homogeneous streams and smelting or reuse. In the parlance of the industry, firms operating in the last stage are considered consumers, a group which accumulates many of the unrecyclable toxic wastes.

Through careful management, scrap recyclers can reduce the release of toxins under their control. However, by its very nature, the recycling process shifts the control of materials to other parties downstream. For example, scrap metal dealers specializing in recovering steel and aluminum from automobiles transport batteries to specialized smelters who recover the lead. Despite this shift in control and the fact that in the absence of recycling even more hazardous materials would be released into the environment, recyclers may still be held liable for environmental damages.

Under the Resource Conservation and Recovery Act, scrap recyclers can be held liable for cleaning up the sites that pose an "imminent hazard" to parties off-site. Under the Superfund statute, recyclers can be held liable for cleanup costs incurred by downstream reprocessors or disposers of the residual waste. Under the doctrine of joint and several liability, one firm may be required to pay for the damages of all. Joint and several liability under Superfund is the single most important factor accounting for the virtual disappearance of environmental impairment liability insurance.

Much of the discussion regarding the costs and consequences of Superfund has been based upon speculation supported by little hard evidence. Underwriters have estimated their liability as high as $200 billion, which presents the scrap metal industry with some serious, indirect consequences. Scrap processors are likely to raise their expenditures on loss prevention and loss protection, thereby increasing the cost of recycled metals and reducing the viability of the basic metals industry upon which it heavily depends.

Survey Method

The entire membership of the Institute for Scrap Recycling Industries, 1,705 organizations, was sent a pre-tested questionnaire in the spring of 1988 surveying such items as the quantity of materials handled, methods of disposal, changes in acceptability of scrap types, changes in management practices, changes in capital expenditures as a result of environmental concerns, liability experience and insurance coverage. Liability experience indicates whether or not the firm is currently involved in a cleanup. If so, the survey then probed for information regarding the contaminating substance, the costs for management, legal counsel, site investigations and cleanups at each site affected.

Responses were obtained from 503 members, approximately 30 percent of the membership. Among the respondents, larger firms were over-represented, as were firms that process nonferrous metals. Several statistical tests suggested that firms with liability problems were more likely to respond to the questionnaire than firms without such problems.

Nearly 30 percent of the firms in the sample have been informed by a governmental cleanup agency or private party that they may be liable for cleanup costs at a hazardous waste site. Claims have been filed against over half of those firms classified as consumers. Seventy percent of these cases involve only one site, while one-fifth of the firms are engaged in cases involving two sites. In most cases, the federal government is the claimant either alone or jointly with a state government, while in 10 percent of the cases, the sole claimant is a private party.

Approximately 30 percent of the claims have been for sites owned by third parties, away from the scrap processor's principal base of operations. Most of the claims for third-party cleanup appear to be filed under the doctrine of joint and several liability. On these third-party sites, the average scrap processor estimated that only 12 percent of the contaminants came from his own firm. About 30 percent of the firms were unable to estimate the total cost or their share of the cost for cleanup of the affected site. Of those respondents who were willing to guess, the expected share of the cleanup costs averaged approximately $4,000 per site, with most processors expecting fairly small losses and relatively few expecting large losses.

Of those respondents who presently have claims filed against them, the average estimated cost each expects to incur for cleanup comes to $80 million. When spread out over the entire membership of the trade association, the total bill approaches $275 million. When a firm is informed that it may be held liable for a particular cleanup, the firm may incur a wide variety of transaction costs, including management salaries, legal assistance and remedial investigation of the site in question. Most firms were able to estimate these costs fairly accurately. An extrapolation of the sample results indicates that the industry as a whole spent $17 million on transaction costs in 1987.

Since the cleanup of Superfund sites takes time, the disbursement of clenaup costs is spread out over several years. The overall cost for litigation averages out to $3,500 per firm in the industry. Some transaction costs, such as remedial investigation, may be incurred on a one-time only basis, while managerial and legal costs may be incurred over several years until the cleanup has been resolved.

Only a few of the firms deemed liable have actually incurred cleanup costs. These firms have probably been involved in smaller sites, with fewer parties, where liability is easily allocated with relatively little litigation. For such firms, actual expenditures have amounted to approximately 25 percent of their total expected liability.

For the scrap metal industry as a whole, the actual expenditures on cleanup have been relatively small when compared to transaction costs and the total estimated liability. In 1987, the sample of firms spent only $2.6 million on cleanup, compared to the estimated total eventual liability of $80 million. The industry as a whole spent about $9 million on cleanup, compared to the expected eventual liability of $275 million. These discrepancies may reflect the fact that the larger, more severely damaged sites are still under litigation.

Risk Reduction Response

As a result of increased concern with environmental liabilities, scrap metal processors have undertaken additional loss prevention and loss protection measures. Scrap processors are becoming increasingly more aware that through the purchase of land they can easily incur joint and several liability. In ever increasing numbers, parties purchasing land are being held liable for cleaning up the damage left behind by prior land owners or land users. As a result, land transactions involving scrap facilities can be risky. Sensitive to potential liability, most buyers and sellers now test the soil at the site, and if damage is detected, most buyers require the seller to undertake some form of cleanup. Thirty percent of the buyers and half of the sellers contractually require the other party to retain liability, but the courts may not honor these terms if the liable party is insolvent. In this case, the second party to the contract by joinder may be liable for all damages.

Many scrap processors are seeking to further reduce their risks by making changes in their internal operational practices. The most common change in operations is an increased inspection of inbound materials. A scrap processor can reduce his risk by refusing to accept materials, such as batteries and transformers, that can contaminate at the back end of the recycling process. Reducing inventories of waste will not always reduce liability, since a processor can be held liable for wastes shipped off his site.

A majority of the firms surveyed made capital investments aimed at reducing the likelihood of toxic substances leaking into the ground. Almost half of the firms paved the entire premises, and one-third installed oil retention devices to facilitate cleanup from the spill. Twenty-five percent of those surveyed installed roofing over storage areas to reduce the leaching effects of rainwater on the toxic materials contained in the scrap metal.

Since most of the liability was incurred off-site, the capital investment by downstream parties is also relevant. However, few scrap processors reported inspecting the sites of their downstream customers.

Most firms surveyed reported a change in their relationship with suppliers by refusing to deal with those who continually ship contaminating substances. A majority of firms demand a warranty from their suppliers. Since the magnitude of the liability can easily exceed the net worth of the supplier, the processor may still face a residual liability.

Approximately 20 percent of the firms surveyed believed they were covered for pollution liabilities under either their comprehensive general liability or their environmental impairment liability policies in force from 1980 through 1986. Firms that were liable were more likely to have insurance and to be involved in disputes over coverage. Obviously, firms that are not liable have little need to test their coverage and engage in disputes, while liable firms are more likely to seek coverage.

The relationship between liability and coverage can be interpreted in two ways. Moral hazard may cause sloppy behavior, resulting in liability, while firms handling more hazardous materials with a greater risk liability may be more likely to seek insurance.

Risk Retention Groups

The unavailability of market insurance may lead to the formation of a mutual insurance pool owned by the scrap metal processing industry. The Risk Retention Act Amendments of 1986 encourage the formation of mutuals among firms in a similar industry or producing similar products. Were the members of the scrap metal recycling industry to form a risk retention group to finance off-site Superfund cleanup liabilities, the emphasis of such a group should be on offsite liabilities, since these are beyond the control of the insured. The purpose of such a group would be to finance catastrophic risks that could potentially bankrupt an individual scrap metal processing firm.

Within the risk retention group, individual member firms may be able to purchase a claims-made policy with a deductible and with a term cap of $5 million. Since annual cleanup costs presently average about 25 percent of the estimated total cleanup costs, this policy would probably be a four-year contract. A claims-made policy is workable in indemnifying for claims that are spread out over several years as the cleanup progresses. The $5 million cap is within the losses expected by 99 percent of the firms surveyed.

The loss distribution provides the basis for computing the pure premium that might be charged by the risk retention group. Potential joint and several liability reduces the validity of the site as the unit of exposure. A firm may sell scrap or ship waste to a large number of parties, any of which may inflict liability. As a result, the most relevant unit of exposure is the firm itself.

The scrap metal industry is responsible for reclaiming $9 billion worth of metals each year and expects its Superfund liabilities to equal $750 million. To put this in perspective, the cleanup bill is likely to equal 30 percent of the net worth of the entire scrap metal processing industry. Approximately 20 percent of the firms surveyed expect their cleanup liabilities to exceed their net worth. If these expectations are realized, Superfund liabilities can have an enormous impact on the fate of many individual recyclers and on the recycling process as a whole. In addition to resulting in bankruptcies and industry consolidation, these liabilities may raise the cost of recycling, thus reducing the scrap metal industry's competitive edge over the virgin metals industry.

While the creation of a risk retention group cannot by itself reduce the real costs of Superfund liabilities to the industry, it can reduce the risks to individual firms. A risk retention group helps make the best of a counterproductive liability system.

The creation of an insurance pool to pay for Superfund cleanups may systematically shift the loss distribution to the right. The very existence of a risk retention group may induce moral hazard on the part of environmental agencies. The risk retention group could potentially become a deep pocket, and regulators may find the transaction costs of dealing with a unified risk retention group more tempting than dealing with dozens of small scrap recyclers.

Martin T. Katzman is senior research economist at Oak Ridge National Laboratory in Oak Ridge, TN.
COPYRIGHT 1989 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989 Gale, Cengage Learning. All rights reserved.

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Author:Katzman, Martin T.
Publication:Risk Management
Date:Dec 1, 1989
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