15 February 2023
Building Resilience: Real Estate and Environmental Impairment Liability
The UN’s World Metrological Organisation’s State of the Global Climate Report, unveiled at COP 27, has been labelled a “chronicle of climate chaos” by UN Secretary-General Antonio Guterres.
The report delivers the damning news that global temperatures have risen 1.15°C since pre-industrial times, while the last eight years look set to be the warmest on record. The accelerating sea level rise, unprecedented glacier mass losses and record-breaking heat waves are the alarming consequences of climate change and lay bare the need for urgent global action.
At the end of October, the UK government issued an update on its progress towards environmental targets, which stated: “The Environment Act will deliver the most ambitious environmental programme of any country and help support our international commitments to protect 30% of land and ocean by 2030.”
In response to the macro-environment, the evaluation and reporting of environmental, social and corporate governance (ESG) criteria is becoming increasingly important for real estate organisations. Nearly two-thirds (60%) of respondents to CBRE’s 2021 Global Investor Intentions Survey stated that they have already adopted ESG criteria as part of their investment strategies. As part of the ESG agenda, companies need to show how they will consider, manage, mitigate and protect themselves against a range of environmental risks.
An important component of ESG is that a company should have a strategy to ensure the sustainability of its business and have demonstrable measures in place to be resilient. In addition to increasing environmental and social performance, it can add value to a company and protect its financial performance.
How can Environmental Impairment Liability (EIL) insurance support ESG in Real Estate?
Traditionally EIL has mainly been used in single property transactions to insure against potential claims and regulatory liabilities arising from pre-existing pollution conditions (historic contamination). Increasingly, however, real estate owners and investors are acquiring EIL to cover their operational risks and/or property portfolios.
Change is a constant, whether it is a change in law, new scientific discovery, new technology, increased awareness, or simply a change in who or what is next door. It is not just environmental risks themselves that change over time. People’s perceptions also evolve, making the challenges of effective environmental risk management and protection even greater.
Top Environmental Risks for Real Estate
• Climate change risk
• Emerging contaminants
• Waste crime
• Historic contamination
• Site development pollution risks
• Operational pollution risks
• Knotweed & other invasive plants
• Asbestos
• Electromagnetic frequency (EMF)
• Radioactive substances
• Natural resource/biodiversity damage
• Legionella disease
Landlord and landowners can face residual liability for pollution caused by tenants and contractors (especially following insolvency of the polluter) and liability for pollution caused by trespassers and illegal occupants. There are a number of multi-million pound claims in the UK on landlords for this type of scenario ranging from individuals to blue-chip pension funds.
Recently there has been a shift in clients’ focus (especially amongst real estate developers and investors) from onsite liabilities (clean-up costs, etc.) to the realisation of the potential impact of offsite third-party claims and the need to mitigate against them. In addition, landlords and investors are increasingly considering how an environmental claim may impact tenants’ operations in terms of shutting them down or delaying their operations, resulting in loss of rental income and third-party business interruption claims.
Many of the risks listed above are insurable with a specific EIL policy, but the coverage available and cost are highly dependent on a range of factors, such as the quality and extent of technical information and structure of contracts.
EIL can protect business operations from interruption caused by pollution/ contamination and cover property investment income, such as loss of rent, to protect landlords and lenders/investors. This can be combined with contingency plans showing robust and demonstrable management and mitigation of risks.
Policies can cover directors and officers of insured parties, multiple insureds and their benefits can also be assigned to a new purchaser and investors. Cover can be obtained for ongoing commercial/ industrial activities, thus protecting a company’s business operations and employment.
Reputational risk and the ability to respond proactively to an incident and effectively manage the ensuing communications and public relations issues can be important factors for companies. Some policies can extend to include crisis management and emergency response costs.
EIL can help to facilitate transactions and loans/investments, by transferring known and unknown environmental liability risks in an open and transparent way for a known cost to an environmental insurer – thus showing management of the risk and adding value.
EIL has a positive role to play
As expectations around compliance with environmental regulation expand, real estate organisations need to stay on top of the evolving risk landscape. For real estate, resilience in ESG terms relates to risk management and business continuity in response to disruption, such as pollution, extreme weather or the pandemic.
In the event of a significant environmental claim the company responsible (the ‘polluter’) may become insolvent and be unable to pay, in which case the liability is likely to transfer to the landowner/landlord/employer.
Real estate organisations are discovering that, irrespective of the contractual and technical risk mitigation measures they implement, not all risks can be ‘engineered out’ and some residual environmental risks will most likely remain with the site owner/ operator, if the ‘polluter’ no longer exists.
With a combination of risk assessment planning and a properly structured EIL policy stakeholders can be provided with protection to support both the sustainability of their business and protection of the environment.
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Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.