Analysts believe the other shoe is going to drop eventually the question is when?

“We believe pollution losses will come back to haunt the industry,” said Gerard Altonji, senior analyst for A.M. Best in Oldwick, N.J., who authored Best's report, “Asbestos Wave Continues to Crest; Can Environmental Be Far Behind?”

He noted, however, that unlike the sudden impact of asbestos, pollution losses will bleed into insurer earnings and capital strength over time. For asbestos, attorneys “mass-produced mass settlements,” he noted. With pollution, “it's a slow goThere are a lot of polluted sites out there barely touched.”

“We are focusing more on pollution now,” he confirmed. “In the aggregate, the industry has done a very good job of funding the vast majority of its asbestos exposures in just a few years time. But the pollution side hasn't budged.” Reserving actions that once averaged $1 billion per year (from 1991 through 1998) have fallen into “sleep mode,” with the industry posting total charges under $2 billion for all years since 1999, he reported.

Laurence Eisenstein, a partner for Eisenstein Malanchuk in Washington, agrees that insurers are taking environmental exposures too lightly. “There are not more environmental claims than before, but there's a steady flow that has continued and I don't think it is likely to tail off anytime soon,” said the attorney whose practice of lawyers, ecologists and financial experts focuses on representing policyholders with historic liability coverage issues.

“Environmental is a lot more real than asbestos,” he added. “In asbestos, it's large dollars but large dollars dealing with plaintiffs who may not be injured. In the environmental world, people spend real dollars on real sites that have real contamination.”

Mr. Eisenstein reported that the profile of companies bringing pollution claims has changed over time. “We?re not seeing the Exxons and GMs with 50 sites,” he said. “They've done those.” However, many middle-market and smaller firms with substantial exposures are starting environmental claims processes, he added.

“They're still large claims and there are still lots of them,” he said, noting that the financial driver for small companies is more acute. A small company with one site cleanup costing $10 million doesn't have the resources, he said.

Claus Metzner, a consulting actuary for Milliman USA in Milwaukee, makes a distinction between large dump-site claims and non-Superfund or direct claims, calling the last category “more troublesome.”

The Comprehensive Environmental Response, Compensation and Liability Act of 1980 is the federal law dealing with remediation of large, closed hazardous waste sites typically with many past polluters or potentially responsible parties. (CERCLA is commonly known as Superfund because of a provision setting up a trust fund to pay for the cleanup of sites for which no viable PRPs exist to foot the bill).

Unlike multidefendant CERCLA sites, non-CERCLA claims can arise where there is one defendant like a factory with waste-generating production facilities that didn't take waste off its premises, Mr. Metzner explained. Cleanups of those sites generally would be regulated under state law, he said, noting that courts in various states at various times have changed interpretations of what is covered under insurance policies.

In particular, he noted a 2003 court decision in the Wisconsin Supreme Court Johnson Controls Inc. vs. Employers Insurance of Wausau holding that remediation costs constitute “damages” under general liability policies, overturning a 1994 ruling that they were not.

Beyond the uncertainty of changing coverage rules, he said, “we're seeing ongoing activity that deserves to be looked at?and looked at differently than the dump sites. There appear to be new sites new to the insurer sites coming up.”

“The problem is if you didn?t know about them, you now have a true IBNR,” he said, referring to incurred-but-not-reported losses for unknown situations (true IBNR) rather than unanticipated dollars to be paid out on known cases.

He went on to describe a reserving process that segregates non-dump cases into severe and non-severe ones. While non-severe cases can average $50,000, a lot of them can add up, he said. In the severe category claims of $1 million or more single large cases of $10 million or higher can swing year-to-year results, he noted, recommending that insurers take a long-term view of severe-case exposure.

While actuaries and analysts agree that many insurers have not updated their environmental analyses in some time, they differ on how big an issue this is.

“I don?t see, at this point, pollution threatening to turn into another asbestos,” said Christopher Lattin, a consulting actuary in the Washington office of Tillinghast. “Having said that, I think there are some insurance companiesthat may have ignored the pollution reserve.”

One indication is the survival ratio?a ratio of reserves to average annual payments that indicates the number of years insurers can keep making pollution payments at their current rate, he said. That ratio has dwindled to low levels for some insurers, he noted.

According to A.M. Best, the industry three-year survival ratio fell from 6.9 in 1999 to 5.2 in 2003, as only a handful of insurers hiked reserves and payments continued at an annual level of $1.5 billion.

“If you do the math, you would need a 15-to-18 percent per-year decline in payments for a survival ratio of 5 to be correct,” according to Morgan Stanley?s Mr. Wilt. “There?s nothing to suggest that payouts are going to fall off at that pace.”

Amy Bouska, Tillinghast's p-c insurance practice leader in Minneapolis, doesn't believe survival ratios will be as high as some industry ultimate loss estimates imply. Tillinghast now estimates that the industry ultimately is going to owe $35 billion?a figure that translates into only a $4 billion reserve shortfall. If insurers boosted reserves to eliminate the shortfall, it would push the survival ratio to eight years.

However, if insurers, instead, boosted reserves to cover the $24 billion shortfall implied by A.M. Best's $56 billion ultimate loss estimate, the resulting survival ratio would be about 22 years, she estimated.

Supporting lower numbers, Mr. Lattin said the number of insureds bringing pollution claims to his clients for the first time has fallen dramatically, as have new sites being reported by existing insureds.

Beyond the explanation that the largest sites were discovered in past years, another factor driving favorable trends has been settlement activity, he said. The largest PRPs settled with their insurers years ago through policy buyouts.

Ms. Bouska said buyouts explain, in part, why the reserving “black hole” that some analysts and actuaries put at levels as high as $100 billion in the 1990s has shriveled to less than one-quarter of that.

“Up until 1994 or 1995, the insurance industry's response to pollution claims was ?scorched-earth litigation.' We will deny everything, everywhere, all the time,” she said, adding that with varying outcomes in the courts, insurers began to negotiate buyouts, shutting off future claims.

Another factor shrinking the black hole has been a more realistic cleanup approach by the federal Environmental Protection Agency and state counterparts. Risk-based corrective actions and strategies known as “remediation through attenuation” replaced the mentality that sites must be clean enough for people to “eat the dirt,” she recalled.

Mr. Metzner also believes trends have stabilized for CERCLA sites. “Changes in remediation technology may have offset underlying inflation,” he said.

“What we?re seeing through our clients is that this mass tort is developing the way people thought it would,” Ms. Bouska said with perhaps “a few bumps” along the way. Still, there is an open question, she noted: “Are we on track because we're on track? Or are we on track because an EPA funding crisis is slowing things down?”

That?s a key concern for Mr. Altonji and Mr. Wilt, who believe that while lack of funding is impairing EPA?s ability to locate sites and address cleanups, it?s simply delaying the inevitable. “The sites still have to be cleaned,” Mr. Altonji said.

Kevin Bruno, an attorney for Robertson, Freilich, Bruno & Cohen, in Newark, N.J., said many states face the burden of picking up the slack from the federal program being so inactive, even though “states have to have balanced budgets,” handcuffing their ability to undertake more cleanups.

“Quite frankly, I?m surprised that more action hasn?t been taken sooner rather than later in terms of pushing the private sector to clean up the sites [as a consequence],” Mr. Altonji said.

How many yet-to-be-cleaned sites are there? According to an EPA study, “Cleaning Up The Nation?s Waste Sites,” of an estimated 294,000 hazardous waste sites, 217,000 are yet to be discovered.

Digging into the numbers, however, Mr. Lattin said that many are defense sites that don?t impact insurers, and that 736 of the 294,000 are the worst type?the National Priority List sites?with 60 percent of those already discovered.

“They do list a staggering number of non-NPL sites?150,000″?which also impact insurers, “but they are smaller,” he said, with the EPA estimating the cleanup cost to be $30 billion, compared to $32 billion for remaining NPL sites.

Mr. Eisenstein said that as state and federal “sources of funding diminish, the importance of pursuing insurance increases.” The recovery of “a few million dollars of insurance money was absolutely critical” in one case where he represented a company that has gone out of business. “If there was greater funding available on the federal or state level, maybe people wouldn't be worrying about the insurance.”

He added, “We have more governmental clients than we've ever had before,” explaining that while they may not be seeking insurance directly, they are seeking advice on orphan sites, on how much insurance is worth, and recommendations on finding old coverage.

At the state level, Mr. Bruno sees a different type of growth in spite of budget issues. “When we speak of the ?black hole of environmental liabilities,' most people are really talking about NRD,” he said, referring to natural resource damage assessments against corporations to restore drinking water supplies, wildlife habitats, fishing areas, and other resources damaged by pollution. (See related story, page XX.)

Listing NRD claims among potential pressure points for insurers, Mr. Altonji also believes the erosion of the absolute pollution exclusion in post-1986 general liability policies is an issue. “More jurisdictions are finding ways around the exclusion,” he said, reporting an Arkansas appellate court ruling (Anderson Gas & Propane vs. Westport Insurance) that said the exclusion didn't apply to damages caused by an underground storage tank that leaked in 2000. (The EPA includes 125,000 USTs in its estimate of 294,000 hazardous waste sites.)

The inclusion of “new pollution” occurring under post-1986 policies where exclusions fail to hold, Ms. Bouska noted, is a key difference between Tillinghast?s $35 billion estimate of industry losses and Best's $56 billion figure. Mr. Altonji confirmed the Best figure “implicitly” includes those, although they weren?t clearly delineated when the figure was derived in 1997.

USTs are regulated under the Resource Conservation and Recovery Act, which applies to all operating transport, storage and disposal facilities (unlike CERCLA, which applies to closed sites).

Peter Mintzer, a partner in the Seattle office of Cozen O'Connor, reports “heightened activity,” generally, in the RCRA corrective action claims area. “There?s very little case law about recovering RCRA claims under general liability policies or new pollution legal liability policies,” he added.

Another “hot topic,” according to Mr. Mintzer, is liability for investigation and cleanup of underwater sediments. Especially in the Pacific Northwest, where there are port districts and shipyards, he said, industrial operations occurring over the water or immediately adjacent to it result in blast grit, paint chips and other waste products depositing in the water and settling in the sediment below.

In spite of budget constraints, regulators are paying more attention to these types of cleanups, which can involve dredging thousands of cubic yards of contaminated sediments, and are much more expensive and time-consuming than traditional upland cleanups. For a single site to have a sediment cleanup cost of $5 million would be fairly small, he said, noting that a Superfund site with a sediment issue could cost $20-to-$100 million.

Mr. Eisenstein sees yet another trend undeterred by state or federal budgets growing environmental activity beyond U.S. borders. “Environmental laws are starting to catch up to U.S. laws,” he said, reporting “a decent amount of activity in Canada” and emerging activity in Europe. Because cleanups are just starting, the large companies in Europe are going to be targeted first, he noted.

Another wrinkle is that pollution exclusions on non-U.S. liability policies frequently were not instituted until much later. “We have seen clients with no pollution exclusions until the early 1990s,” he said.

Reproduced from National Underwriter Edition, April 8, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.