New Insurance Options for Complex Site Cleanups

by Gregory Steinman

Blended finite risk programs offer a new twist on insurance coverage for contaminated sites - a way to smoothly fund the project costs and at the same time cover the full tab for known and unknown cleanup liabilities.

The demolition of the building went as planned. The asbestos and foundation were removed and transported to a disposal site.

Removal of the contaminated soils was the next step. However, the New York City developer was not expecting to discover 12 underground storage tanks, 500 to 1,000 gallons each, suspected to contain heating fuel oil. By law, it had to report this finding to a state regulatory agency, which required removal of the tanks as part of the soil remediation - adding $250,000 to the cost of cleaning up the site.

The trouble didn't end there. When the developer had the tanks removed, oil constituents in the soil volatized into the air, creating a noxious odor. Adjoining businesses claimed that the odor forced them to shut down, adding $750,000 in restitution costs.

The bad news kept coming. During excavation of soil to install barriers that would prevent residual contamination from migrating off-site, workers encountered an unknown contamination plume migrating onto the developer's property. They eventually determined that the contamination was PERC, a solvent used in dry cleaning operations, which presented trouble on two levels - not only did the developer have to report and delineate the plume, but it also had to remediate the constituents.

Due to prolonged remedial negotiations with the state regulatory agency, these activities caused further construction delays and resulted in $12 million in added project costs.

The original contract budget of $20 million grew to $33 million after all of the changes.

Such environmental liabilities present a major risk management challenge to today's construction industry. Prior to beginning a project, it is imperative to identify environmental exposures and implement effective means to manage and mitigate the risks.

In a typical project, the discovery of additional or unknown contamination onsite may expose a developer or contractor to extra costs, damages, and potential litigation in relation to first and third party liability claims for bodily injury, property damage, and remediation expense. The risk of cost overruns is high.

One way for developers and contractors to manage these types of environmental risks is through a formalized self-insurance mechanism, commonly referred to as a blended finite risk program. These blended programs take traditional risk transfer insurance and discounted funding mechanisms for known liabilities and combine the two elements into a long-term project financing commitment.

The program strictly earmarks funds for the cleanup of site contamination liabilities, assuring that money will be dedicated to specific mitigation or remediation tasks, while adding risk transfer coverage for unknown liabilities. The setup is particularly useful on complex, multiyear projects.

While standard blended finite risk programs typically cover costs of mitigating existing or known contamination liabilities, your insurance provider can tailor the plan to include coverage for losses associated with the discovery of unknown environmental liabilities on the same site. Each program can be individually structured to a project's needs.

In the case above, the developer hired a contractor for the $20 million demolition and remediation effort, with the developer assuming full responsibility for additional costs. The developer chose a blended finite risk program.

The program entailed the developer still paying $20 million. It was divided into a "premium" of $16 million to cover the known tasks - essentially an escrow-style pay-up of funds that were used to pay project costs - and $4 million for risk transfer coverage, which provided $40 million in excess limits to pay for unforeseen project costs.

The developer ended up capping costs at $20 million, while the blended program covered the additional $13 million in remediation costs. In other words, the developer had prepared for the misfortune that befell his project.

While there are other insurance options that project participants can use to address these types of problems - such as remediation stop-loss or "cost cap" policies - these plans have limited terms and do not trigger the funding discounts in the blended program.

The funded balance in a blended program has one other advantage - it can satisfy investor, financial institution, buyer, and seller concerns about a project's financing.