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Pollution Liability Insurance
and Catastrophic Environmental Risk
Martin T. Katzman*
Abstract
Public concern with catastrophic consequences of chemical releases into the
environment resulted in the passage of RCRA and Superfund legislation, which
establish financial responsibility requirements. These acts encourage the creation of a
market in pollution liability insurance for purposes of risk spreading, safety regulation,
and victim compensation. This article analyzes policy alternatives for regulating
catastrophic risks, the insurability of pollution liabilities, factors contributing to the
rise and fall of the market, and conditions under which markets could be resuscitated.
Introduction
Threats to human health from chemical releases into the environment are
reported with increasing frequency. While biomedical evidence casts some
doubt on the matter [6; 57], the public perceives chemicals in the environment
as a major cause of cancer and heart disease [80]. Regardless of the locus of
exposure, toxic chemicals may engender a low-probability of long-term injury
to large numbers of victims. In this respect chemicals in the environment are
indistinguishable from those in the workplace or in consumer products (such
as drugs or food additives), although they come under different regulatory
and legal frameworks.
In response to an apparent mass disaster, Love Canal, Congress passed two
acts which introduced insurance as an important instrument of environmental
policy. These acts rely more on market incentives and less on traditional
proscriptive or prescriptive strictures than any other regulatory statutes.
Under the Resource Conservation and Recovery Act (RCRA), owners and
operators of facilities that treat, store, and dispose of hazardous chemicals
must demonstrate financial responsibility for third-party damages. For
sudden accidents, the levels of responsibility are $1 million per occurrence and
$2 million annual aggregate, exclusive of defense costs. For nonsudden
occurrences, the corresponding levels are $3 million and $6 million. The
Comprehensive Environmental Response, Compensation, and Liability Act
(or "Superfund") extends these requirements to transporters (Sec. 108(a)) and
generators of hazardous chemicals (Sec. 108(b)). Several states have raised the
required financial responsibility beyond the federal level. Unless a firm can
meet a test for self-insurability, financial responsibility must be met by
insurance.'
Superfund anticipated a major role for the insurance industry in the
regulation of chemical hazards. Acknowledging the limited ability of
regulators to assess the risks from complex technologies, this act called upon
insurers to advise the President on the appropriate limits of financial
responsibility for generating facilities. These limits were to be established in
the 1985-1990 period.
When RCRA was passed in 1976, several London insurers had been
developing liability policies for nonsudden pollution accidents. By the time
Superfund was passed in 1980, a few American insurers began offering such
policies. Despite the misgivings of many underwriters [77], at least a dozen
primary insurers were offering pollution liability policies by 1983 [49]. In
addition, more than 40 insurers and reinsurers had established a pool [43, pp.
83-85]. It appeared that the Congressional initiative toward market-based
environmental risk management might succeed.
By the end of 1984, the pollution-insurance initiative lay in shambles.
London reinsurers withdrew from the market, carrying along many existing
and prospective insurers. The number of pollution insurers operating
worldwide was about eight, most of whom insured "light risks" like gas
stations and dry cleaning establishments. Only two insured the "heavy" risks,
from which catastrophes are most likely to result. By mid-1985, only one
insurer offered coverage for nonsudden occurrences [19]. Many waste-site
operators were unable to meet the financial tests, so Congress twice extended
the original deadline (January 1, 1985) for demonstrating responsibility [9;
23]. By the end of 1986, two-thirds of waste facilities had failed to obtain
insurance [30], and no progress has been made in establishing financial
responsibility requirements for generators. In response, Congress ordered the
General Accounting Office to undertake a major study of insurability in the
'A facility can self-insure against third-party liability if it passes several tests of financial
strength, such as having tangible net worth greater than $10 million and a current ratio exceeding
1.5 [76].
Pollution Liability Insurance 77
marginal cost of pollution control. Where these marginals are equal, the cost
of pollution-engendered accidents plus the cost of accident prevention is
minimized. The equity criterion is expressed as "the polluter pays." While the
efficiency and equity objectives are analytically distinct, the public finds least
acceptable those technologies where the injuring party does not compensate
the victims of its actions [67].
Alternative regimes of controlling externalities differ in their efficiency,
equity effects, and transactions costs [11; 12]. These latter include the costs of
monitoring behavior, collecting and analyzing information, enforcing
contracts, and imposing sanctions. Under any regime, these costs are far from
trivial.
Under tort regimes, whether the cost of accidents is borne by the victim or
the injurer depends upon liability rules.2 Of the several available common law
theories, negligence and strict liability best internalize risks from chemical
injuries. Regardless of the theory employed, the plaintiff must prove
causation.
The burden of proof is not an insurmountable barrier to recovery for
damages from commonplace mechanical hazards. If a construction worker is
struck by a falling brick or a pedestrian struck by a car, the injury is
immediately apparent. When chemicals cause harm through their mechanical
or acute biological characteristics, such as the explosion of a natural gas plant
in Mexico City, they can be treated in the same legal and insurance framework
as mechanical accidents. The defendant and plaintiffs can be easily identified;
the causal links between defendant's behavior, the accident, and the damages
are clear; and the injuries are immediately manifest. Usually, courts can
determine the cause of the accident and apportion blame in a reasonable
manner.
2Under the assumptions of the Coase theorem, liability rules are irrelevant in determining
optimal risk management. Two critical assumptions are zero transactions costs and the
replaceability of losses by financial expenditure [11; 12; 16]. These conditions hardly hold for
pollution damages.
3Two mechanisms of intergenerational chemical injury exist. Chemicals may mutate male or
female zygotes prior to conception, as has been alleged by Vietnam Veterans exposed to Agent
Pollution Liability Insurance 79
Under traditional tort law, a statute of limitations prevents the filing of a suit
more than three to five years after an accident. Because of the time lags
between chemical release and human response, conventional statutes of
limitations prove an insuperable barrier to recovery.
Third, a given chemical may affect humans through multiple pathways.
Furthermore, a given biological response, such as lung cancer, may result
from alternative sources, such as occupational exposure to asbestos or
smoking. The multiplicity of potential pathways causes two problems in
establishing liability: identification of the defendant and proof of causation.
Under traditional tort law, the plaintiff must identify one or more specific
defendants. The source of exposure determines whether the victim can seek a
remedy through the workers' compensation system, a product liability suit, or
through appeal to environmental protection statutes.4 Even if the locale of
exposure were identified, it might be virtually impossible to identify the
specific defendant whose molecule caused the plaintiff's exposure. This is
clearly the case with exposure to hazardous waste sites, where many
companies discard identical chemicals.
Proof of causation depends upon presenting sophisticated biomedical
evidence, most of which is indirect or analogous in nature. Epidemiologists
have difficulty in sorting out health effects of lifestyle (especially diet and
intake of stimulants), occupational, and environmental exposures to
chemicals. Toxicologists are uncertain about long-term human responses to
low, intermittent doses of chemicals, especially when they act in concert.
The latency period between exposure and manifestation of illness
obfuscates the search for causality. The latency period increases opportunities
for further confounding causes to intrude. Furthermore, the quantity of
evidence (including eyewitnesses) decays over time. Not surprisingly, expert
testimony about causality is rarely conclusive.
Advances in biomedical measurement may exacerbate rather than abate the
legal problem. As lower and lower concentrations of chemicals in the
environment become measurable, the number of chemical hazards for which
human exposure can be measured, and hence the number of alternative
explanations of an injury, increases. As techniques for diagnosing such vague
symptoms as malaise improve, the potential number of measurable adverse
health effects increases as well [41].
Orange. Chemicals may also cause birth defects by upsetting fetal development, as was the case of
pregnant mothers who ingested thalidomide.
4Federal environmental statutes do not provide for victim compensation for personal injury or
private property damage. The statutes, however, allow private individuals to initiate "citizen suits"
against polluters that violate these statutes. The remedy can be an injunction or a payment. An
increasing number state of environmental statutes extend the rights of individuals to recover for
personal damages. If the defendant violates a statute, it is negligent per se in a tort action [43, pp.
42-43].
80 The Journal of Risk and Insurance
5Borel v. Fibreboard Paper Products Corp., 493 F.2d 1076 (5th Cir. 1974) has been called a
"bill of rights" of asbestos workers. It permitted workers to sue suppliers to their employers,
without identifying one specific defendant whose asbestos caused disease. In Sindell v. Abbott
Laboratories, 26 Cal.3d 588; Cal. 607 P.2d 931; 163 Cal.Rptr. 132 (1980) plaintiff ingested
diethylstilbestrol (DES), a drug that was intended to suppress miscarriages. A large number of
daughters of these mothers developed cervical cancer during puberty. The courts apportioned
damages according to the pharmaceutical companies' market share of DES.
PollutionLiabilityInsurance 81
additional basis that enterprises may be better able to spread the costs of
injuries than plaintiffs, the theory has become widely adopted in the areas of
workers' compensation, product liability, and hazardous chemicals [31; 46;
59; 74].
While the plaintiff no longer has to identify specific acts of negligence,
recovery still depends upon a formidable proof of scientific causation. Courts
have customarily phrased the question of causation in particular terms: " Did
Chemical X cause the specific injury of Plaintiff A, yes or no?" Because of the
statistical nature of epidemiological and toxicological evidence, this question
is generally unanswerable. In the face of scientific uncertainties and
conflicting expert testimony, the court may ignore the problems of isolating
the harm-causing substance, tracing the pathway from the polluter to the
plaintiff, and showing the etiology of the disease. Instead, it may simply ask
whether it is more likely than not that the plaintiff suffered a particular injury
as a result of presumed exposure to the defendant's chemical hazard.
Suppose, for example, one tumor normally occurs per 10,000 people, but
among the exposed plaintiffs, the incidence is three tumors per 10,000. The
court may reason that the chance that the plaintiffs' injury was caused by the
hazard exceeds 50 percent; i.e. the odds are two to one. Clearly, the court
cannot identify the one in 10,000 that would have incurred the tumor, but it
may spread two full awards over three plaintiffs. Obviously, the application of
such an insurance principle overcompensates one plaintiff and undercompens-
ates two. If one accepts the Rawlsian veil of ignorance as a reasonable premise
(no victim knows whether or not he or she would have had the tumor any
way), the result is not necessarily unfair. In any case, the increasing
acceptance of such statistical evidence reduces the burdens of proof on the
plaintiff.
The Problem of Financial Responsibility
Winning in court does not guarantee recovery. The mortality of businesses
is often higher than the mortality of their victims. In several cases, the
polluting business had been dissolved before the injury was discovered, and
the plaintiff had no defendant to sue. Furthermore, losses to victims may
exceed a firm's ability to pay, and the victim cannot recover the award.6 As a
consequence of bankruptcy limits to liability, a business has no incentive to
reduce the probability of accidents for which losses greatly exceed its net
worth [46; 64]. Losses to third-parties from such accidents do not inevitably
translate into corporate losses, and thus there may be significant external costs
to private management of catastrophic risks.
Financial responsibility requirements permit successful plaintiffs to recover
from increasingly more severe accidents. While such requirements are central
to worker compensation and automobile liability systems, they are relatively
6In Ohio v. Kovacs (U.S.S.C 83-1020), the U.S. Supreme Court unanimously ruled that an
industrial polluter can escape an order to clean up a toxic waste site under the umbrella of federal
bankruptcy.
82 The Journalof Risk and Insurance
7In correspondence, Emilio Venezian suggests that mobile risk managers can be induced to
consider long-term losses by making retirement compensation contingent upon future accident
losses. For example, suppose losses in 1995 result from an event in 1985. The individual managing
the risks in 1985 will suffer a reduction in pension payments.
84 The Journalof Risk and Insurance
Definiteness of Loss
Losses which cannot be publicly verified lend themselves to counterfeit
claims. Property damage caused by chemical hazards, including contamina-
tion of ecosystems, can be publicly validated. So can personal injuries, like
tumors or birth defects. Until recently, public policy toward hazardous
chemicals has focused exclusively upon such injuries.
Recent biomedical evidence, however, opens the possibility that human
exposure to chemicals in the environment results in increased sensitization;
i.e. a lowered threshold of morbidity response. Moreover, morbidity may also
take the form of a diffuse malaise, analogous to the debilitation associated
with lead poisoning. In Ayers v. Jackson Township,8 plaintiffs argued that a
contaminated municipal water supply was responsible for malaise, rashes, and
general anxiety. Although the trial court rejected malaise and rashes as
evidence of injury, it awarded the plaintiffs $2 million for emotional stress
and $8.2 million for lifetime medical monitoring. These portions of the award
were overturned on appeal, but there is no guarantee that future courts will
not recognize malaise or anxiety as compensable. Indeed, in Jackson v.
Johns-Manville, a Federal Court of Appeals upheld an award for anxiety over
probable future illness.9
8N. J. Super. L., 461 A.2d 184, 189 N.J. Super. 561 (1983).
954 U.S.L.W. 3100 (5th Cir. 1986).
PollutionLiabilityInsurance 85
'"If one's prior probability of a meltdown is 1/30,000, as taken from the well-known study by
nuclear engineer, Norman Rasmussen, then the probability of 1 meltdown in 500 hundred-reactor
years is only 0.015. If one's prior probability is 1/1060, as revealed in premiums of the nuclear
liability pool, then the probability of one meltdown in 500 reactor-years is .27 [79]. While
Three-Mile Island was not a meltdown, it came close and makes the insurers' prior appear more
plausible than that of nuclear engineers.
86 The Journal of Risk and Insurance
"According to Dick Drain, of Alexander Howden Ltd., the London reinsurers of pollution
liability collected $10 million in premiums worldwide, and indemnified one insured for $50
million over the past five years. Source: personal communication at annual seminar of
Dallas/Fort Worth Chapter of RIMS, Oct. 1984.
Pollution Liability Insurance 87
the issuance of the policy. The inspection is funded outside of the premium
and paid for even if the policy is not issued. This report can be used to satisfy
government regulations of the site's safety.
In the period 1980-1984, when insurers began competing in this line, their
policies differed in several respects. All covered liabilities for bodily injury and
property damage to third parties, the cost of legal defense of a claim, and off-
premises cleanup of a preventive nature. Some policies covered on-premises
cleanup of a preventive nature, where there was an imminent off-premises
hazard. All policies excluded injuries to employees (who are covered under
workers' compensation), first party damage, damages resulting from willful
violation of government regulations, and costs of routine cleanup.
The CGL and EIL policies are quite different in their regulatory
implications. The CGL policy is forward-looking, because incidents that
occur in the future as a result of behavior in a given policy year are covered by
that year's policy. The risk analyst and underwriter thus look at the future
stream of losses resulting from this year's actions. Risk-based premiums thus
have a deterrent effect on current loss-prevention and -protection decisions.
The EIL policy is backward-looking, because it is activated by claims made
in the policy year resulting from past actions. For firms which were heavily
engaged in handling chemicals (or which shared facilities with such firms),
current premiums are not easily affected by current risk management
practices. Chemicals released into the environment several decades ago may
already have initiated latent diseases. While the past cannot be undone, some
of the consequences can be. If firms are capable of remedial action, such as
cleaning up older waste sites or purifying damaged aquifers, current bahavior
can affect current liability.
Claims-made pollution liability policies are less risky for insurers than
occurrence-based ones. In underwriting a claims-made policy, the insurer is
not making a commitment into the indefinite future, when liability rules,
medical detection technology, and jury awards may differ from today's.
Furthermore, under a claims-made format, even if an insured switches
insurers from year to year, which insurer must indemnify the insured is
unequivocal.
The claims-made format also imposes risks upon the insured. Suppose an
insured undertakes a hazardous operation for a single year only. An insured
may secure an EIL policy for hazardous operations this year, without any
guarantee that coverage would be available in the future when damages may
become manifest. While an EIL policy may be written with a tail, the insured
cannot be sure that the tail is sufficiently long.
These considerations suggest that there may be great mutual advantages to
long-term, monogamous contracts between insureds and insurers. If the term
of the contract is long enough, say more than 10 years, the distinction between
Pollution Liability Insurance 89
'2A long-term monogamous contract on a specific facility might include annual adjustments
for loss experience or for changes in interest rates. It might be voided if a facility were
downgraded below regulatory standards or if were expanded.
90 The Journalof Risk and Insurance
insured may have shared a waste facility or who releases a similar product into
the environment.
Several solutions to the problem of joinder from future actions on the part
of the insured are emerging. First, many hazardous-chemical handlers now
favor the establishment of standards of care through regulation [20; 471. Even
though adherence to statutory standards is no defense under strict liability,
tough regulations can reduce the frequency and severity of future damages
resulting from the behavior of chemical handlers as a group [64]. Both
insureds and insurers have an incentive to monitor adherence to such
regulations: the insured in order to prevent a "free-rider"from creating a peril
whose cost can be spread to deeper pockets; the insurer, because coverage
lapses in the event of willful violation.
Second, the larger chemical manufacturers are leading the voluntary
clean-up of abandoned sites [15; 22; 54; 72]. A voluntary clean-up is a rational
risk management strategy if the cost to these firms is less than the present
value of their future damage.
Third, a waste-management industry has developed, which is specialized in
transporting, storing, and disposing of waste. Many manufacturers are
excavating chemicals buried on their own sites for relocation to these
specialized sites. The spinoff of hazardous waste provides the generator with a
dual buffer against joint and several liability. The waste management firm and
its insurer bear the first two tiers of liability. Offsetting this advantage is the
possibility of liability for damages cuased by another party. The advantages
appear to offset the disadvantages, for the waste-management industry is
growing faster than the amount of waste generated [43, p. 16].
Statutes of Limitations
In developing the EIL policy, the intent of the insurance industry was to
segment the market between liabilities from occurrences which were sudden
and those which were gradual. The former segment, which includes
conventional, mechanical accidents, would continue to receive coverage under
the traditional CGL policy, with its pollution exclusion. The latter segment,
which includes latent pollutant damages, would be covered under the new EIL
policy.
The abandonment of traditional statutes of limitation for the discovery rule
means that insurers cannot close their books on CGL policies written without
the 1971 pollution exclusion. An insured that was issued an occurrence policy
with the pollution exclusion can always claim that the leaking may have
occurred prior to 1971. Moreover, courts have tended to ignore the pollution
exclusion by redefining gradual pollution as "sudden" from the point of view
of the insured's knowledge of the damages. Indeed, several insurers have been
ordered to indemnify insureds whose policies contained the exclusion [7]. This
has been justified on the "reasonable expectations of the insured" principle
[1].
In essence, the courts have transformed the CGL policy into a pollution
liability policy with unlimited coverage. Because of the gradual nature of
PollutionLiabilityInsurance 91
pollution, the limits of previous years can be activated ad infinitum once the
coverage of one year has been exhausted.
To obviate further confusion, the Insurance Services Office has tightened
the pollution liability exclusion in the CGL policy. For policies written after
1986, sudden and accidental pollution are not covered under CGL, although
an insured may be given the option to buy this exclusion back. This exclusion
cannot overcome the unpredictability of policies written before 1986. On a
prospective basis, however, this exclusion neatly separates the market for
pollution-related accidents from other risks. Contractual confusion about
whether a particular incident is sudden or nonsudden should be rendered
irrelevant in a consolidated, claims-made EIL policy.
Nevertheless, in the event that harm results from the actions of a defunct
polluter, the courts may require its past EIL or CGL insurers to indemnify the
victims. Courts may justify the conversion of claims-made EIL and new CGL
policies into retroactive pollution liability policies by the legislative intent of
RCRA and Superfund; i.e. that the insurance industry provide adequate
coverage for third-party damages. This specter decreases the insurability of
pollution liabilities.
Indemnity for First-Party Cleanup
Liability insurance policies are intended to be activated by damage to third
parties, not to the insured. Nevertheless, the courts increasingly require CGL
insurers to indemnify polluters for cleaning up their own property on the
grounds of preventing an imminent hazard to third parties [4].
Insurers argue that such rulings rewrite contracts in an arbitrary way, and
that the deep pocket of the insurance industry is being used to finance a social
program rather than to spread risks. Insurers note that this pocket is not as
deep as perceived. The $100-$200 billion estimated cost of cleanup exceeds the
surplus and approaches the annual premiums collected by the United States
insurers, which were $75.5 billion and about $300 billion, respectively in 1985
[3; 13; 39, pp. 16-18].
While the insurance industry has suffered unexpected losses as a result, the
position of the courts may be justified by the same efficiency rationale as the
voluntary clean-up. The insurer might have had to pay even more if the cost of
on-site cleanup were less than the expected cost of off-site damage. In
principle, there is no reason why insurers cannot in the future underwrite
policies that explicitly cover cleanup costs. Insurers do offer retroactive
liability insurance for accidents that already happened, such as the MGM
Grand Hotel fire. Indeed, some EIL insurers explicitly covered on-site cleanup
costs in their contracts [43, p. 86].
In summary, the emergence of chemicals in the environment as a major
hazard has placed strains on the tort process and insurance contracts [Table
1]. The toxic tort law has evolved in response to the inability of plaintiffs to
collect under traditional rules. Conventional CGL policies are unadministr-
able under the new tort rules.
92 The Journal of Risk and Insurance
table 1
Strains on Tort and Insurance Systems from Chemical Catastrophes
Characteristics of Injuries
Mechanical injuries Chemical injuries
Individual victims Mass victims
Defined injurer Multiple injurers?
Definite loss "Fuzzy" loss
Clear causality Multicollinearity
Sudden Latent
Common/uncorrelated Infrequent/correlated?
Characteristics of Insurance
CGL EIL
Exclude gradual pollution Covers gradual pollution
Occurrence Claims-made
Actuarial science Risk analysis
Prospective/deterrent Retrospective/poor deterrent
Conclusions
The modern chemical industry poses risks to the environment through the
entire chemical life cycle. Toxicants may be inadvertently released suddenly or
gradually in the stages of production, transportation, consumer use, or waste
disposal. The passage of RCRA and Superfund reflects federal efforts to
employ pollution liability insurance as a market-oriented tool for controlling
the release of toxicants into the environment. The collapse of this initiative
raises fundamental questions about the insurability of chemical technologies.
13Mr. Jerry Jones, Program Manager, State Board of Control, California Hazardous
Substance Account, personal communication, May 21, 1987.
Pollution Liability Insurance 95
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