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Legacy of Liabilities: A new environment of accountability


Rules boost interest in cover, asset disposal

As companies identify, quantify and report their environmental cleanup obligations under new accounting guidance, risk managers can play an important role in protecting their companies from the resulting risk, experts say.

After years of underreporting environmental liabilities on most corporate financial statements, companies now are required to report the current fair market value of future environmental cleanup and disposal costs associated with the retirement of assets such as property, manufacturing plants and equipment.

Such asset retirement obligations might include the removal and disposal of underground storage tanks, the abatement of an abandoned site that contains asbestos, or the cleanup and restoration of leased facilities.

Financial Accounting Standards Board Interpretation 47, which clarifies FASB 143, "Accounting for Asset Retirement Obligations," became effective for all companies at the end of 2005.

As more companies—through teams including legal, accounting, real estate and environmental expertise—seek to identify and assess their FIN 47 obligations, they may open themselves up to a host of financial reporting exposures, including having to restate prior year financial statements, which could trigger shareholder lawsuits, experts say.

At the same time, companies with significant FIN 47 obligations may seek to divest some of these assets, which could raise significant environmental liability issues.

In either case, risk managers can help solve the issues with environmental insurance, experts say.

Risk managers need "to remain very close to both the legal and environmental engineering community within their firms so they can stay abreast of the issues as they continue to develop toward what we think will be a situation of much more disclosure in this arena," said John Reynolds, chief executive officer of Willis Environmental North America in New York. "And the impact on companies can be rather dramatic based on the level of properties they have in their own portfolios."

"It's a great opportunity for risk managers to look across the risk of their organizations and provide solutions to an issue that might typically be thought to be outside their domain," said David Bennink, managing director for Aon Environmental Services Group in New York. "While it may be an accounting issue, risk managers can work with the accounting people to see if they can get some of the environmental liabilities off the balance sheet or, at a minimum, get a qualified footnote on the balance sheet."

Indeed, experts note that due to pollution exclusions in most directors and officers liability policies, risk managers not only can help protect the integrity of their FIN 47 reporting obligation via environmental insurance, but also seek to address the D&O exclusion.

"I think the risk manager has got to be talking to the CFO's office and the general counsel's office to ascertain what they may need once they have settled on what the FIN 47 disclosure is going to be," said Joe Boren, chairman and CEO of AIG Environmental in New York.

If, for example, a company were to report a $250 million FIN 47 exposure, it could purchase environmental cost cap coverage and be in a position to tell its shareholders, and especially its skeptical shareholders, that the company has purchased additional environmental insurance in case the exposure turns out to be more than the $250 million, Mr. Boren said.

At the same time, risk managers can help assure shareholders that—despite its best efforts to identify all of its pollution exposures with respect to its asset retirement obligations—the company has purchased additional pollution liability insurance to respond to a currently unknown environmental problem at the site or facility, he said.

In addition, "the risk manager is going to want to make certain his D&O policy will respond if there are any actions for a challenged disclosure," Mr. Boren said.

Indeed, C. Gregory Rogers, president of Advanced Environmental Dimensions L.L.C., a Dallas-based management consulting company that specializes in environmental financial reporting strategies, noted that risk managers can address the D&O pollution exclusion by purchasing a so-called "carve back," or endorsement, on their policy.

And to the extent that companies have the proper process, procedures and controls in place to adequately report their FIN 47 obligations, as required by the Sarbanes-Oxley Act, they can convince underwriters that they are a low risk, he noted.

In those cases where companies are "having to make a major disclosure on the books or in an SEC report, I think it would be appropriate to talk to the risk manager and have them look at the environmental insurance industry and see what they might be able to do to resolve some of those issues," said Scott Deatherage, an environmental attorney in the Dallas office of Thomson & Knight L.L.P. In many cases, companies will want to move those potential liabilities off their books through an asset divestiture, he said.

Indeed, insurers and brokers say many companies today are looking to divest assets due to the potential future environmental liability associated with them.

But now that they have to account for potential future liabilities on their current balance sheets under FIN 47, the liabilities in some cases exceed their net worth and companies therefore are looking to move—or at least significantly reduce—their potential exposure.

"You'd be surprised at how many companies own a litany of real estate assets that they've acquired in acquisitions in the past" and not sold because of the potential environmental exposure, Aon's Mr. Bennink said. "We're working with some clients now that literally have hundreds of surplus real estate assets."

"When corporations perceive that their environmental liabilities are significant, the reaction may be to divest or sell their property," said William Hazelton, senior vp with ACE Environmental Risk in New York. "Typically in the environmental insurance marketplace, when there is a purchase, sale or divestiture, the potential to buy an environmental insurance product significantly increases."

ACE Environmental is "able to tailor our standard environmental insurance products to reflect the risks being transferred in purchase/sale agreements to make sure that the parties taking on the liability, a buyer or seller or both, is covered," Mr. Hazelton said.

Environmental brokers and insurers say there is sufficient capacity to handle the environmental insurance demands that might arise due to FIN 47.