Preparing for environmental liabilities in a deregulated power supply industry
The new millennium presents new challenges and an increased pace of deregulation for the power industry. From state to state, regulatory barriers are falling, and utilities must prepare to operate and flourish in a new environment.
Progressive power companies are evaluating their options in three major areas:
- Acquisition or divestiture of assets
- Management of environmental liability issues in current operations or in preparation for deregulation
- International growth
Acquisition or divestiture of assets
When a company decides to acquire or divest its operating assets, the acquiring company may become liable for all of the environmental liabilities associated with the original company's past and on-going operations. Some of these liabilities may be known or reasonably estimated at the time of acquisition, while others may not be discovered until long after.
Even with thorough due diligence on the part of the acquirer, there are many instances, where due diligence is not enough. Paper trails and historical information on prior company operations or uses of sites owned or operated may be unavailable or may only provide limited information. Tracing historical waste disposal practices further complicates the due diligence process.
Also, many times the sale agreement between buyer and seller requires indemnifications on the part of one or both parties for known and unknown environmental liabilities. The requirement that each party accept certain liabilities creates further uncertainty.
There is also the possibility that a firm will be financially unable to carry out its obligations under an indemnification. Finally, in certain instances, if the companies merging have heavy environmental operations, or if one or more sites have known contamination, uncertainty surrounding these liabilities will invariably scuttle a deal.
For known and unknown environmental liabilities, a combination of risk control and risk transfer techniques can help reduce the likelihood of extensive and even duplicative environmental studies that often result in impossible-to-negotiate indemnification language. Insurance coverage for both known and unknown liabilities can be negotiated at the time of acquisition or divestiture, thus protecting the financial interest of the entity under a single program.
Many programs are negotiated with a multi-year term to cover the entity from the time of acquisition, through remediation projects, and on to future operations. Policy terms are generally available for up to 10 years with liability limits as high as US$100 million per occurrence/aggregate. To protect an entity acquiring facilities with known and unknown conditions, Cleanup Cost Cap (CCC) and Pollution Legal Liability (PLL) coverages offer insurance solutions to financial risks that the acquiring or divesting entity doesn't wish to retain.
CCC insurance can protect both parties from cleanup cost overruns and PLL addresses liability arising from insured site activities and liabilities arising from unknown or future conditions.
Management of environmental liability issues in current operations or in preparation for deregulation
To manage current environmental liability issues or fund those items prior to deregulation, fixed site environmental insurance, also known as Pollution Legal Liability coverage, protects entities against environmental liabilities including:
- Exposures arising out of polluted conditions at covered locations;
- Exposures emanating from covered locations;
- Exposures arising out of transportation of the insured's product or waste; and
- Exposures arising out of the disposal of the named insured's waste at non-owned locations.
The policy responds to sudden and gradual pollution conditions that are known or unknown, and pre-existing or future conditions.
Facilities that may be protected by PLL coverages include power generating plants and water/wastewater treatment plants, where the insureds are concerned with pollution. Liabilities include conditions arising from air releases, ground or groundwater releases from storage tanks, and water discharges exceeding maximum allowable contaminant concentrations.
International growth
The same risk management tools can be employed internationally, where environmental liability risks receive increased attention. Large, multinational insurers offer extensive environmental coverage overseas.
Finite insurance
The above insurance products can be purchased within the structure of a finite insurance program. This program has been used with utilities on portfolios to assume aggregate cost overrun exposures; to provide "disclosure enhancements" to environmental liabilities; to provide financial assurance for the acquirer or divesting entity; and to provide tax accounting benefits.
Finite risk has also been used by insureds to transfer all known environmental liabilities in a loss portfolio or single loss transfer. The liabilities may have been self-insured in the past whereas the use of a finite risk approach can provide balance sheet, tax/accounting benefits.
Latest coverage meets demands of industry trends
Whether a power company is acquiring, divesting or seeking to grow internationally, it cannot ignore its known and potential environmental liabilities. Proper management of these liabilities leads to enhanced profitability, and insurance can be a major factor in helping to achieve this objective.
About the author:
Joseph L. Boren is President of AIG Environmental, one of America's leading providers of environmental insurance coverage and services for American International Group, Inc. (AIG). Prior to joining AIG, Boren served in executive positions with Metcalf & Eddy, a subsidiary of Air and Water Technologies Corporation; SCA Services, Inc. and GSX Corporation, both leading solid and hazardous waste service companies. For more information, contact Alex Lau, 212-770-7388, alex.lau@aig.com.
Edited by April C. Murelio