New Breed Of Company Buys Contaminated Sites For Cleanup

• Chemical companies can get environmental liabilities off their hands by shifting the problems to others who will insure against risks

Ann M. Thayer, C&EN Northeast News Bureau

E verybody wants their problems to go away. If you can't solve them yourself, what better way

is there than making them somebody else's—even for a price. But who will­ingly takes on others' problems?

Environmental Liability Acquisitions (ELA) not only wants some of the chem­ical industry's biggest headaches—con­taminated properties—but also thinks it can make a profit from them. The San Francisco-based company looks for properties to acquire, develops third-party remediation plans, provides insur­ance for the process, and hopes eventu­ally to clean up and sell the land.

The company's business premise is not yet proven. Although the three-year-old firm has acquired its first properties, none have been cleaned up and turned around for a profit. Still, ELA is work­ing actively to obtain even more con­taminated sites.

Opportunities abound. Chemical com­panies accrue tens, even hundreds, of millions of dollars to cover contingent liabilities and probable environmental remediation costs on properties they own or lease. And they are spending nearly the same level annually on actual cleanups.

"ELA saw an opportunity from a fi­nancial viewpoint to move the environ­mental solutions forward," says James Brimhall, ELA's cofounder and presi­dent, who argues ELA's somewhat coun­terintuitive business plan. "And in fi­nance, the contrarian philosophy is the profitable philosophy."

Brimhall comes to this business with a financial background. Prior to his 1991 founding of Remediation Capital Corp., ELA's predecessor company, he spent 12 years creating financing pro­grams as an executive at two West Coast investment firms. His ELA co-founder, Tim Glass, has experience in the remediation business and handles ELA's environmental operations as chief operating officer.

The market needs are at least three­fold, Brimhall explains. Instead of wide­ly varying estimates, companies want to quantify their likely cleanup costs and be assured they won't vary. They also want to receive value for assets that may be unproductive drains on earnings and that are buried under environmental problems. And, they would like to re­move the liabilities from their balance sheets by shedding the properties.

About half of ELA's proposed trans­actions involve real estate. In the other half, only the environmental liability may be acquired—for example, for a property where a chemical finn has been a tenant. In these cases, ELA issues a re­mediation guarantee contract. In either case, ELA is designated as the party re­sponsible for cleanup and has insurance to guarantee the cost.

One of ELA's first three transactions in­volves a former Monsanto Chemical de­tergent chemicals plant in Carson, Calif. The property, which was on the market for $6.6 million, was acquired by ELA as part of a $10 million transaction. But ELA did not pay anything for the property.

The Monsanto deal is considered "upside down" since the environmen­tal liability exceeds the real estate val­ue. In such cases—which are about 30% of those ELA sees—the land may be used to finance part of the deal. Without affecting cash flow or earn­ings, this "off-balance-sheet" approach allows a company to receive cash con­sideration for property that it might otherwise have difficulty selling.

"If a company has a facility that is

closed, and it is worth $5 million but would take $10 million to clean it up," says Brimhall, "they don't want to spend $10 million now and five years later sell it and get $5 million back."

Because of the liability and associated expenses such as taxes, insurance, and maintenance in carrying a property, "they'd just as soon spend $5 million now and have us take it," he says. Up to 20% of proposed deals are "rightside up" and ELA may have to pay for the property.

In addition to affording some certain­ty in remediation costs, Jeffrey Felder, Monsanto Chemical's director of site op­erations, sees other benefits. "One— which we could accrue even without the deal—is returning the property to the community for use."

A minor consideration, he adds, is putting these projects into the hands of people looking to do the cleanup. "Al­though Monsanto and others like us are capable of conducting remediations our­selves, and we do, it does well to focus our efforts where we get the most value and focus other people's [efforts] where they get the most value."

Monsanto was obliged to clean up the California site under a state administra­tive order, says Felder. Because of ELA's small size and limited assets, the deal was designed so that if ELA went bank­rupt, "Monsanto would be better off for having done the deal," he notes. Unlike a previous deal in which Monsanto sold property to a remediation company, the transaction with ELA differs in having insurance coverage.

ELA provides "environmental liability acquisition insurance" to cover the clean­up of known contaminants. Once the property has been cleaned and has re­ceived regulatory letters of closure, prop­erty transfer liability (PTL) insurance is is­sued. The insurance carries a postreme-diation rider that the property is clean and will meet current and future regula­tory standards, and covers future clean­up of any unknown contaminants.

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BUSINESS

BUSINESS

ELA's coverage is underwritten by Zurich American, Schaumberg, 111., and American International Group, New York City, two of the largest companies offering environmental insurance, says Brimhall.

Although insurance premiums gen­erally are deductible as a business ex­pense, ELA and its clients are not yet certain whether the premiums covering certain types of remediation insurance are. The uncertainty is tied to an under­lying and not yet clearly resolved issue about whether cleanup costs are ex­penses or capital improvements.

If they are capital expenditures, which increase a property's value, not only is there no tax benefit to chemical firms, but land is not a depreciable asset. In looking at chemical industry balance sheets, it is clear that companies are di­vided on how their environmental ex­penditures are expensed or capitalized. The issue can be avoided altogether by getting rid of a property or a liability.

Deed restrictions placed on a proper­ty's future use at the time it is trans­ferred may affect the cleanup scenario and ought to affect insurance coverage, says Felder. Firms like ELA also may enjoy lower insurance premiums than do chemical companies, he suggests, because they are not viewed as culpa­ble for the contaminated property.

"The most difficult thing for ELA was convincing the insurance industry to test this program. And this is still a test pro­gram—it is not established/' stresses Brimhall. Direct competitors are few, he adds, noting that he is not aware of any companies that have completed similar transactions. "The company is being watched daily by insurers. We have to convince them that we can estimate this risk and that we can manage it."

Several years ago, the insurance in­dustry shied away from environmental coverages because of huge uncertain risks and large potential liabilities. To­day, the market for environmental insur­ance is about $500 million in premiums or between 0.5 and 1% of all insurance coverage, says Paul K. Freeman, chief executive officer of ERIC Group, an En-glewood, Colo.-based company that de­velops environmental insurance prod­ucts. But selected areas of coverage have been showing double-digit growth.

Insurance for remediation contrac­tors and property transfers are proba­bly sold most often, says Freeman, for lower limit rather than for huge cata­

strophic coverages. PTL insurance pro­tects owners, purchasers, and lenders against liability that may arise from more than 150 state and federal envi­ronmental statutes. ERIC wrote about 200 PTL policies last year for about $4.5 million in premiums.

The newest type of insurance, what ERIC calls "remediation stop loss," guarantees the cost of cleanup. A typical three-year, $1 million policy costs about $20,000, says Freeman. Higher coverages of $4 million to $5 million might have premiums of $300,000 to $400,000 or more. The policies carry deductibles, similar to those in automobile insurance, that range from 25 to 50% of the estimat­ed cleanup expense.

With a limited, but growing, actuarial history on environmental claims, Free­man says only a small number of firms are trying to deal with the underwriting questions. At least two issues are faced: defining the risk as insurable and find­ing a market willing to pay the required premiums. Through computer modeling and engineering reviews, ERIC designs and prices coverage underwritten by Zurich. Another major player in envi­ronmental insurance is Reliance Nation­al Insurance, Exton, Pa.

The insurance deductible in part cre­ates ELA's potential margin for profit. If ELA exceeds the estimated remedia­tion costs, it is responsible for payment. "The way we make money is by com-

Companies carry large environmental liabilities

$ Millions

Air Products & Chemicals

Arco Chemical Cytec Industries Dow Chemical DuPont W. R. Grace Hoechst Celanese Monsanto Rohm and Haas Union Carbide

1993 environmental remediation liabilities

Accruals for future3 Expenditures6

$ 30

42 231 226 522 160 149 266 191 265

$ 32c

na 18 69

126 44 34 53 57

149c

a Includes estimated liabilities at year-end for sites falling under the Comprehensive Environmental Response, Compensation & Liability (Superfund) and Resource Conservation & Recovery Acts, waste disposal sites, and company-owned properties or operations, b Does not include capital and operating expenditures for pollution control or waste treatment, c Includes some environmen­tal operating expenses as well as remedial activities. na = not available. Source: Company annual reports

pleting projects successfully, on time, on budget or lower," says Brimhall.

In formulating each deal, ELA builds in a reserve to cover its potential risk and serve as a margin for profit. ELA's 12-person staff evaluates five areas of risk related to a property and its clean­up. Its review is conducted under a con­fidentiality agreement.

The first determination by the compa­ny's technical staff is the nature of the environmental problem. A plan for third-party remediation is formed. Real estate issues, including a property's current and future value, and potential use or devel­opment, are other risk considerations.

Legal concerns, considered the riskiest area, touch on all potential litigation and its likely outcome. And, financial risk analysis looks at the cash flow during the entire process.

Finally, risk management addresses insurance coverage and, asks Brimhall, "What is the probability that our analy­sis is right and where is ELA willing to land within a range of risk?"

After having calculated all the risks, any potential property sale or lease val­ue, and company expenses—including the insurance and cost for remediation by a third party—ELA makes a propos­al. Because of this process's complexity, Brimhall believes ELA is about one and a half to two years ahead of competitors.

Still, one of the hardest aspects of its business has been finding the individu­als within chemical companies who are in a position to evaluate and purchase ELA's services. "Most companies are not set up to deal with us," he says, because the needed people are spread through­out a company's operations.

However, Brimhall says ELA has bid more than 80 proposals to date. ELA's staff can put a proposal together, at an internal cost of $15,000 to $25,000, in 15 working days. But it may take a client six to eight months to respond.

By year's end, three transactions total­ing $25 million will be completed, and another five are anticipated to be final­ized. All, except one aerospace-related property, involve chemical firms.

The incentive to resell properties will drive ELA's cleanup efforts and force it to take a proactive approach to regulators, says Brimhall. Still, it will average about five years before a property is clean and has been sold. "I'm not going to tell you now that the company's right," he says, "because ELA will not know that it has succeeded until 1998-99." Π

16 DECEMBER 5, 1994 C&EN