Environmental Insurance – Will It Help You Make Money?
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The commercial lenders’ newest hot button is environmental insurance. The product they are talking about usually costs less than a Phase I Site Assessment and can be written in a few days. Is this a way to save time and money? Who is actually protected against loss?
What is the coverage and who is the beneficiary?
Environmental Insurance is a tool developed for banks to manage the loan risk on commercial properties. The bank is the beneficiary. The bank can only make a claim, if the bank as a result of foreclosing on a non-performing loan holds the property and if there is an enforcement action from the state or federal government to clean up an environmental problem. Coverage does not include building components abatement, for example lead and asbestos.
What environmental risk does a bank face on commercial loans?
The Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, amended the Comprehensive Environmental Response Compensation and Liability Act (CERCLA or Superfund). The 1996 amendment spelled out the procedure for a lender to foreclose on an environmentally contaminated piece of property and said that a lender is exempt from clean up expenses, if that lender did not “participate in management” of the property or business prior to foreclosure.
Traditionally the borrower had a Phase I Environmental Site Assessment done as a loan requirement. If a loan was non performing and foreclosure was a consideration, the lender had a second Phase I performed. If the property was clean, the lender foreclosed. If the property had significant environmental problems, the loan was generally written off and the bank took a loss.
Although the 1996 amendment protected lenders from the potential liability of huge remediation expenses, lenders still faced the risk of loosing the loan amount and any associated expenses.
How does the environmental insurance protect the bank?
For the insurance to pay:
1. The bank must hold title to the property as a result of loan default,
2. The cost of remediation must be greater than the bank’s equity in the property after foreclosure,
3. And the property needs to be under an enforcement action.
The insurance company either pays for the cost of remediation above the cost of the equity or pays off the loan balance. Procedures vary by company, but the bank does not have to write off the loan and incur a loss. The insurance covers this loss.
Is the borrower protected?
The insurance coverage is not designed to protect the borrower. In the event the bank has a claim on the policy, through the right of subrogation, the insurance company can take action against the borrower to recover damages.
Is there any other down side for the borrower?
Unless a Phase I Site Assessment is performed the “purchasing borrower” may be assuming “hidden” environmental liabilities.
CERCLA, the Superfund Act, defined an “innocent purchaser” as a person or entity that complied with certain due diligence requirements prior to acquisition and as a result should not be responsible for the “clean-up” liability of a property.
The Phase I Site Assessment is designed to meet part of the environmental due diligence requirements as outlined in CERCLA. If a Phase I is not performed prior to taking title, a property owner may not be able to show that any environmental due diligence was performed, and therefore may not be able to seek the “innocent purchaser” defense under CERCLA.
The potential clean up liability extends to “decision makers” as well as the actual purchase entity, so a corporation, Limited Partnership or Limited Liability Company is not a shield to personal liability.
What are the differences between a Phase I and environmental insurance?
Generally a Phase I is an inspection of the property, a review of the past uses of the property and a review of the general area for known environmental issues and incidents. A good Phase I will also identify potential areas of concern and can recommend preventative actions to avert an environmental event from happening.
Environmental insurance is a transfer of potential environmental risks, post foreclosure, from the lender to an insurance company.
What is the cost of environmental insurance and who writes it?
Policies usually run from $600 to $2,000. AIG, Zurich-America, Reliance/ECS, United Capitol and Kemper Environmental write coverage for commercial properties. The policy for a $2,000,000 loan amount may run about $700 and can be written in as little as 2 days.
What is good about this type of insurance?
The product was designed to reduce lender risk. Like PMI (Private Mortgage Insurance for residential loans) environmental insurance is an inducement to the lender, paid for by the borrower. Environmental insurance is a cost of financing. Having environmental insurance available should encourage lenders to be more accepting of industrial properties and some high-risk retail properties.
A borrower’s knowledge of this insurance may help in loan negotiations with a reluctant lender. Theoretically providing environmental coverage to a lender on some property types should change the risk structure of a loan and reduce the interest rate or at least make it more attractive.
Are there other types of environmental coverage that protect the property owner?
The E&O insurance of the Phase I provider is your first level of environmental insurance.
There are many types of environmental insurance products that provide protection for both the property owner and tenants. Most environmental coverage is not a “stand alone” policy; the coverage is written as an amendment to a general commercial policy. This type of coverage tends to be incident specific, providing clean up if an event occurs that affects your property.
The insurer may require a base line Phase I Site Assessment as well as a thorough understanding of the property, the tenants, and the products used on the property, and the processes performed. In some cases, it is easier for a tenant to get environmental coverage than a property owner, since the tenant/operator has direct control over the operations performed on the property.
Conclusion:
Knowledge is power. Read any insurance policy carefully. Determine the beneficiary and the risks covered. Recognize that some insurance coverage is a cost of financing not protection for the landowner.
A good Phase I Site Assessment creates a record that the purchaser has performed his environmental due diligence. Establishing the groundwork for the “innocent purchaser defense” may be the best insurance you can get.
