Exposure to environmental liabilities represents a significant risk to any business operating in today’s global economy. Failure to address these risks may subject a business, its management, and its outside directors to potentially adverse and material financial, legal, and commercial consequences.
The emergence of the global economy and an increasing awareness of the fragility of the global environment have resulted in the rapid development of environmental legislation in countries and regions throughout the world. One broad, far-reaching example of a legal framework for addressing environmental pollution is the Environmental Liability Directive (ELD) of the European Union (EU).-1This legislation, implemented by the EU in April 2004, was transposed into the domestic laws of the EU’s 27 member states by July 2010.-2Over the past two years there has been a prodigious amount of activity within the EU to interpret the meaning of the complex directive, measure the effectiveness of its implementation, and evaluate the multitude of legal, technical, and economic issues that have been raised by both the regulated and regulatory communities throughout the EU.
The purpose of this article is twofold: (1) to present a brief overview of the ELD with an emphasis on those features or components that will present significant challenges to the business community, and (2) to identify some potential insurance-related issues related to the ELD that have also arisen in the context of US environmental insurance coverage.
Overview of the ELD
The ELD establishes a common administrative framework of liability-3across the EU member states aimed at preventing and remedying environmental damage.-4Under the ELD, "environmental damage" is defined as:
- Damage to protected species and natural habitats (referred to as “biodiversity damage”) if it has “significant adverse effects on reaching or maintaining the favorable conservation status” of the habitats and species concerned
- Damage to water resources (including groundwater, rivers, and other surface water bodies) if it “adversely affects the ecological, chemical and/or quantitative status and/or ecological potential” of these waters
- Contamination of land if it creates a significant human health risk
The scope of the current ELD does not include nuclear-energy-related damage or oil pollution caused by oil spills in marine waters. However, the EU has proposed the regulation of offshore oil and gas activities.-5
Liability under the ELD is imposed on all “operators” (which include individual persons or companies) that conduct business within the EU, even if the parent company is located outside of the EU (for example, a United States firm with European operations). The liability may be strict or fault-based. Operators subject to strict liability (regardless of fault or negligence and without any limit on financial liability) include those engaged in risky or potentially risky operations or activities identified in Annex III of the ELD.-6Operators subject to fault-based liability are those that have damaged the environment through a deliberate action, omission, or negligence. With a few exceptions, there is no retroactive liability under the EU prior to the transposition date of the ELD for each member state.-7For those situations involving multi-party causation, the ELD provides for either joint and several liability or proportionate liability.-8Finally, the ELD does not supersede the existing framework of environmental legislation already in place in the member states. Consequently, operators could be subject to potential environmental liability under multiple legislative mechanisms including the ELD.
Remediating environmental damage
The ELD broadly prescribes a framework for restoring or remedying environmental damage to its “baseline” condition.-9This framework specifies three levels of remediation (primary, complementary, and compensatory),-10the remedial objectives for each level of remediation, valuation techniques to determine the scale of remediation, and the criteria for evaluating reasonable remedial options using best available technologies.
Prevention and remediation costs
The ELD requires that the operator will bear the costs-11for the preventive and remedial actions undertaken in response to environmental damages. However, there are three defenses available to the operator (if allowed by the individual member states) whereby the operator may avoid these costs:
- Damage caused by a third party through no fault of the operator
- Damage resulting from compliance with an order or instruction from a public authority
- Damage occurring through a previously permitted process or activity, or one that was not considered likely to cause damage based on the state of scientific and technical knowledge at that time (i.e., the “state of the art” defense)
Article 14 of the ELD requires member states to take measures to encourage the development of appropriate financial security instruments-12for operator use in guaranteeing one’s liabilities. An October 2010 ELD review by the EU Commission-13noted that the member states had taken somewhat limited action and that in most cases the local ELD markets had developed at the insurers’ initiative. The Commission’s report noted that insurance was the most popular instrument to cover environmental liability. The Commission also reviewed the need for an EU-wide mandatory financial security mechanism but concluded that because of the lack of practical experience in the application of the ELD, there was insufficient justification for introducing a mandatory system. The Commission will reexamine the need for a mandatory financial security system before or during 2014.
Insurance issues associated with the ELD
Coverage for ELD liabilities is questionable under standard general third-party liability policies (GL). For example, GL policies generally do not intend to cover gradual losses, costs associated with preventive measures, or restoration of natural habitats. Some GL policies are intended to cover only losses arising from civil actions (lawsuits brought by citizens) and not regulatory/administrative actions (remediation under public law). Most importantly, many GL policies are intended to specifically exclude pollution. Many companies operating in Europe would be uninsured or underinsured if they relied solely on GL coverage to absorb losses imposed under the ELD. At best, these companies would find themselves engaged at times in arguments and costly litigation with their insurers.
US insurers' experiences
Although there are differences between the ELD and the environmental regulations promulgated in the United States, such as the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), enough similarities exist that examination of the development of insurance coverage for pollution claims in the United States would be instructive here. In the United States, policyholders struggled for years with policy coverage questions: What is an “occurrence” in the context of environmental contamination? Does “unexpected and unintended” refer to the damage or to the activity causing the damage? Does “sudden and accidental” have a literal and temporal meaning, or can it include gradual releases in the usual course of business? Can a naturally occurring substance be considered “pollution?” Are clean-up costs considered “damages?” These and other questions have posed coverage disputes causing insurers and policyholders alike to expend significant dollars in litigation costs. Moreover, the judicial decisions varied by jurisdiction, resulting in inconsistent application of identical policy provisions and hence forum shopping.
The problem was not that these terms were ambiguous or undefined. At the time that the policy forms were drafted and throughout their litigation, strong arguments were made that these and other similar terms and provisions were very clear. Indeed, subsequent attempts to further define some of these terms posed additional complications with even more uncertain results (e.g., if a policy were to define “pollution” by a list of conditions that constituted “pollution,” insurers might risk unintentionally covering something not on that list).
Insurers writing commercial liability policies in Europe can expect to face similar issues with respect to coverage for ELD exposures and would be well-advised to learn from United States experience—particularly small, local insurers operating within one member state without niche expertise in environmental coverage. The takeaway: expect the unexpected—significant losses have attached to insurance policies that never contemplated coverage for pollution claims.
Insurance mechanisms have been designed to manage pollution-related losses. Environmental impairment liability (EIL) policies, also known as “Pollution Legal Liability” policies, are one of several insurance products that may provide coverage for ELD liabilities. Generally, these policies cover third-party claims for bodily injury and property damage, as well as remediation and business interruption costs, caused by pollution losses resulting from civil or regulatory actions. EIL policies do not offer unlimited coverage for all losses, however. These policies tend to be tailored or customized with varying endorsements and generally exclude coverage for deliberate noncompliance with environmental laws, known preexisting conditions, relinquishment by an insured of operational control to another party, or (in the case of third-party liability coverages) damages to the insured’s own site.
The ELD is broader than CERCLA
For decades the United States has had environmental insurance policies in place specifically designed to respond to insurable pollution liabilities. However, the newness of the ELD—and the lack of case law and loss history in Europe—translates to higher uncertainty surrounding insurance coverage for ELD losses. Quantification of damages to protected species and natural habitats is an area of relative uncertainty. Compensatory damages under the ELD for interim losses may not be easily quantified or even ascertained. The ELD reaches beyond pollution and extends to any type of environmental damage. These complexities will inevitably extend to the insurance arena: Will existing GL policies be exposed to ELD losses? What revisions will be needed to these policies to respond as intended? Will specific new insurance products need to be created to respond to the ELD and, if so, what experience can underwriters and pricing actuaries rely upon when designing these instruments?
Although the evolution of insurance coverage in the United States can be a model for developing coverage, Europe appears to present new and untested issues, as discussed above. It also remains to be seen whether the same principles and outcomes applied in the United States will also be applied to European coverage issues. As the ELD provisions and complexities will most certainly challenge insurers, a careful analysis of insurance policy provisions is needed to determine whether coverage responds to the damages specified. This requires (1) a full understanding of the underlying liabilities, (2) clear definition of policy coverage and exclusions, and (3) determination of the specific and identifiable events that trigger coverage. These issues will need to be resolved in order to manage the rollout of the ELD throughout Europe.
Christine Fleming is a claims management consultant and an actuary in Milliman's Boston office.
Douglas C. Allen is President and Managing Principal of THESEUS CONSULTING, INC., a professional services corporation. Allen specializes in the assessment, valuation, and management of environmental liabilities for commercial matters and transactions involving bankruptcy and restructuring, mergers and acquisitions, insurance recovery and risk transfer, cost allocation and cost recovery, and environmental mass and toxic tort.