While commercial real estate portfolios are not commonly thought to have significant environmental exposure, properties intended for use as office space, warehousing, distribution and light assembly can incur environmental liabilities. This is not surprising if you consider the proliferation of environmental legislation and litigation, coupled with growing environmental awareness, over the past 20 years. The far-reaching effects have created environmental liability issues for facilities and properties — from the obvious landfills and hazardous waste disposal sites to seemingly benign commercial and industrial properties/facilities.

To protect against liabilities from owned or leased premises, most owners of real property rely on the Comprehensive General Liability Insurance policy. But the advent of the absolute pollution exclusion in 1986 made the term "comprehensive" misleading. Real estate owners and developers are increasingly discovering a large gap in their insurance coverage for environmental loss which can have a material effect on their bottom line.

Environmental issues can negatively impact a real estate firm's balance sheet in two ways. First, environmental issues can delay and even prevent property transactions from moving forward — one party may be reluctant to accept environmental risk. Secondly, the lender’s fear of environmental impairment may impede financing.

Common Environmental Exposures

Some common environmental exposures faced by real estate owners and developers include:

• Soil and groundwater contamination by improper handling or disposal of dry cleaning solvents;
• Investigation and defense of claims due to local or regional soil and groundwater contamination;
• Sick building syndrome, i.e., carbon monoxide buildup from poorly maintained heating, ventilation or air conditioning systems; Former, unknown waste disposal areas such as landfills and lagoons; and Unknown leaking underground storage tanks and piping.

Often, environmental exposures have costly consequences for real estate owners and developers who have gaps in their insurance coverage. For example, a large warehouse was leased to a tenant performing fabrication of galvanized heating/cooling ducts for installation in new building construction. No manufacturing occurred at this location — only the fabrication of ductwork. Occasionally, the tenant used a small amount of solvent to clean metal surfaces, but this was not common practice. This type of operation typically has a low potential for environmental damage to the premises. A building with historical use as a textile manufacturing plant was adjacent to the warehouse. When it was discovered that soil and groundwater beneath the textile plant were contaminated with solvents, a costly cleanup began.

To recover some of the cleanup costs, the owner of the textile plant sued the owner of the adjacent warehouse for contributing to the contamination through their use of solvents. The property owners submitted the claim to their Comprehensive General Liability Carrier and received an unexpected response — the claim was denied based upon the absolute pollution exclusion. To avoid liability, the warehouse owner was forced to hire an environmental consultant to conduct an assessment of the condition of this property. Without insurance, the property owner also had to pay for legal counsel to defend the claim. The total cost of the consultant's work and the legal fees amounted to $190,000.

Another example of how environmental issues can negatively affect a firm's bottom line involves a real estate limited partnership. One of the holdings of the partnership was a warehouse facility that stored swimming pool supplies. When a forklift operator at the facility accidentally ruptured several five-gallon containers of chlorine, the spill followed a floor drain to the outside of the building. As the material was being cleaned-up, some piping was found that lead to four underground storage tanks. Used by the previous property owner for the storage of gasoline, the tanks had been improperly abandoned. Two years later, the partners sought to sell the property, but were unable to do so because of the potential liability imposed by the underground tanks. A Phase I Assessment was performed to determine the property’s potential for contamination. During the assessment, the existence of the tanks was discovered. Removal of the tanks according to state regulations was recommended. During removal of the tanks, substantial soil and groundwater contamination with petroleum products was found. Remediation expenses and consultant fees totaled $650,000. The general liability carrier refused to indemnify the partners, citing the absolute pollution exclusion.

The Role Of Pollution Coverage

Commercial property owners are increasingly discovering the far-reaching implications of the absolute pollution exclusion. "Pollution" is an elusive concept and can apply to such obvious examples as toxic chemical spills, as well as more unusual events such as an accidental release of beverage byproduct from a brewing company or grease from a restaurant. Whether obvious or not, the preceding examples of environmental exposures have the potential to cause significant financial loss. The environmental insurance marketplace has seen an increase in submissions for pollution legal liability coverage from real estate firms for portfolios which contain commercial properties previously thought to have no environmental exposure.

Available coverages include a Pollution Legal Liability policy which provides coverage for liability arising from sudden and gradual pollution conditions that emanate from covered locations. A Pollution and Remediation Legal Liability policy provides coverage for loss, remediation expense and legal defense expense under one policy for sudden and gradual pollution conditions on, at, under or emanating from covered locations. These policies respond to the high costs associated with claims like those discussed in the preceding examples.

For real estate firms seeking environmental insurance coverage, the leading insurance carriers can tailor coverages to meet specific needs. For instance, some insurers calculate policy premium on a square-foot basis, allowing simple calculation for existing holdings, as well as adding additional locations. Some insurers can also provide coverage for pollution conditions which occur at divested locations.

Another reason real estate firms are opting for pollution coverage is that it is more affordable than ever before, with the cost decreasing over the past five to seven years. The policies available today afford broad coverage and can be tailored to the specific needs of your client. Specialty products are also available, such as Remediation Stop Loss coverage for those locations which are undergoing remediation. This feature provides coverage if remediation costs exceed a pre-set level. Also, policies can be customized to provide coverage for locations with existing environmental concerns such as low-level soil and groundwater contamination.

Integrated Environmental Risk Management

A combination of risk management tools is an effective way to minimize the impact that environmental liability has on commercial property developers. In addition to specialty coverages, some environmental liability insurers provide an integrated approach to risk management by offering loss control and risk management services to further reduce risks and claims management to help contain the costs of liability issues.

Unless real estate firms address the environmental liability issues associated with their commercial property portfolios, they are not dealing with the complete picture of risk. Fortunately, real estate firms can protect their bottom line with the specialty products available in today’s environmental insurance marketplace.