To make sure we start out on the same page, I would like to point out that virtually every business operating today faces either a direct or indirect environmental exposure. Businesses with direct environmental exposures are quite obvious, i.e. chemical manufacturers, environmental remediation contractors, hazardous material transporters, etc….
Businesses with indirect environmental exposures are not quite so obvious, like a financial institution with a mortgage on a property where environmental contamination has just been discovered. Even though the financial institution had nothing to do with the contamination, they still hold the mortgage and are facing an indirect environmental exposure. Should the bank foreclose on the contaminated property if the owner can’t make payments? Are there monies to address the required cleanup? Government issued fines and penalties? Are third party bodily injury or property damage claims possible? Legal costs? Note: The worst environmental damage occurs slowly, seeping into the ground or water over time, and may go undetected for decades.
Environmental exposures can have a significant impact on a financial institutions ability to collateralize property. Today’s transparent business environment (SOX, FIN 47, SAB 92 Ruling…) requires financial institutions to change their strategy because just meeting lender liability due diligence is not enough. Financial institutions must fully understand “who they are doing business with” and the environmental issues impacting their operations.
Historically, financial institutions have depended upon a Phase I/Phase II environmental site assessment in order to meet their lender liability environmental due diligence while at the same time determining a property’s collateral value. Note: Research conducted by Environmental Risk Managers, Inc., shows that roughly 50% of Phase I reports are inaccurate. To address this issue the government has updated environmental due diligence now called All Appropriate Inquiry or AAI
We know that All Appropriate Inquiry (AAI) is only a snap shot of the properties condition at the time an environmental professional conducted the inquiry. During the life of a loan, AAI does not address daily operating exposures, changes in business processes, operations or materials used, neighboring properties causing an indirect environmental loss….
To address the potential indirect environmental liabilities faced by financial institutions, there is a risk transfer product offered by the environmental insurance industry called Secured Creditor Coverage (SCC). SCC was designed expressly for financial institutions that hold or invest in loans backed by commercial property to fill gaps created by traditional environmental due diligence and much more.
SCC provides collateral value protection in the event of a loan default and a newly discovered pollution event at the covered location. When this occurs, SCC can pay out one of two ways. First, the insured receives the outstanding loan balance and extra expenses. Secondly, the insured receives the lesser of the outstanding loan balance and extra expenses or the estimated cleanup costs. In either case foreclosure is not required prior to making a claim.
SCC allows a financial institution to be more competitive on loans they would once be forced to pass-up due to environmental uncertainties plus:
- Increase loan portfolio value.
- Offers first party cleanup costs for claims made after the lender has foreclosed on a covered location.
- Covers third party bodily injury and property damage claims, including defense costs, caused by a pollution event during the policy period.
- Shields assets by protecting collateral and insuring environmental liability arising from collateral properties.
- Accelerates the loan process. Note: For financial institutions with in-house environmental departments, SCC provides valuable tools to assist in expediting and securing loans. For financial institutions that outsource their environmental services, Secured Creditor Coverage can assist by expanding your environmental services and reduce costly outsourcing.
- Reduces costs by minimizing or eliminating traditional environmental due diligence processes.
- Allows financial institutions to better manage cash flow in the event of a claim.
- Coverage is offered on a single transaction or master portfolio basis.
- Multi year policies, up to the term to maturity of the insured loan.
- 10. Assignment of interest, freely assigned to successor lien holder.
- 11. Wavier of subrogation against borrower in possession. Note: Pursuing borrowers for recovery of losses when they default on a loan can jeopardize the status of additional loans held with the financial institution, often making a bad situation worse.
- 12. Has the ability to enhance a pool’s credit rating. Rating agencies have recognized that environmental insurance can add credit support to commercial mortgage pools.
- 13. Expert claims handling service.
14. Allows the Insured to select their own legal representation.
15. Increases financial institutions stock value.
Any financial institution that feels they do not have an environmental exposure as a secured creditor, I would like to point out that AIG, the largest insurance company in the country, once offered SCC. However, AIG had so many claims and paid out so much money that AIG is no longer offering SCC.
(Note: This document is designed to educate financial institutions on Secured Creditor Coverage and how it assists in proactively addressing potential environmental liabilities. For specific contract language you should always refer to the actual insurance policy and/or endorsements)
environmental Strategist Risk Tip For Financial Institutions
As the above competitive environmental intelligence illustrates, in a transparent business environment you have to find out: “Who You Are Doing Business With?”
For example: Vendor Exposure; For an environmental engineer to do environmental work for a bank the environmental engineering firm has to be pre-approved.
One approval process has involved getting a certificate of insurance as evidence the engineers have professional E&O insurance should they make an error or omission in performing environmental due diligence. Some financial institutions on the advice of their legal counsel have gone a step further and they will have their attorney’s review the actual professional liability insurance policies to assure appropriate coverage within the policy exists.
The financial institutions intent in going through this pre-approval process has been to make sure there is appropriate financial support backing the environmental engineer should they create a financial liability while performing their professional services.
The flaw with both of these approaches? The financial institution has done step two and three and forgot to do step one, review the warranty insurance application filled out by the environmental engineering firm to get their insurance. An environmental insurance policy will only be issued after the insurance carrier receives a signed warranty application.
A warranty insurance application states the insured has correctly filled out the application and if at the time of a loss it is determined the application is not filled out correctly the insurance carrier can deny coverage. Financial institutions first and foremost, have to make sure the insurance application is correctly filled out, because if it’s not, the certificate of insurance and/or the insurance policy may not be worth the paper they are written on.