Why Real Estate is Not Risk-Free When It Comes to the Environment

Environmental risk is rarely top of the list for real estate investors but is something that should not be ignored.

Property owners, developers and tenants face a range of exposures, some of which seem quite innocuous but can have expensive consequences. For example, a property may have a back-up electricity generator to ensure that heating systems, IT servers and other critical infrastructure continue to function in the event of a power outage. In all likelihood, this generator will be run on petrol or diesel which will be stored in a tank onsite. This poses a genuine environmental threat. In one case a client with a low-risk property portfolio had a diesel leak at one of its office buildings, which resulted in contamination of a nearby waterway. The costs of cleaning up the riverbank and water remediation, together with mitigation expenses, came to around £130,000, a not insignificant sum.

But this is really just the thin end of the wedge. In another example involving an office building in Europe, the insured was an investment fund that owned the property. The building was fitted with vinyl flooring tiles, secured by glue. This glue started to decompose, releasing solvents into the air. Office workers became unwell, reporting headaches and nausea. This resulted in the cessation of operations and the need to find alternative accommodation until the problem was rectified. The client incurred costs of around €500,000 in business interruption and bodily injury claims.

Heightened Risk

History has shown that when financial pressures increase, as they have done in many sectors over the past couple of years, environmental protection tends to slip even further down the list of businesses’ priorities. They may not apply for the necessary permits or dispose of hazardous chemicals or hydrocarbons in the correct manner. When tenants go into liquidation, they may not shutdown their operations correctly, potentially leaving the landlord on the hook for hefty clean-up costs and responsibility for any environmental damage left behind.

Many property owners opt to remove uncertainty around potential environmental exposures by taking out insurance but there are some common misconceptions here. First, it is unlikely that adequate, if any, protection for environmental exposures will be covered under the terms of a property policy. And second, acquirors of real estate assets who have taken out a Warranty & Indemnity (W&I) policy to protect themselves against risks associated with the transaction will need to read the fine print carefully as losses stemming from environmental claims are typically excluded from this type of insurance. 

Flexible Protection

The solution lies in an environmental impairment liability (EIL) insurance policy, which covers risks arising from property owners’ past or current operations, or for which they retain a legal liability. Cover includes claims for clean-up, bodily injury and property damage arising from pollution and we have seen an uptick in demand for this type of product over the last 18 months. This is in due to a growing awareness of the risks, as well as the benefits of this type of insurance. 

When buyers are looking for protection for multiple sites, the economies of scale add up and they can often recharge the premium to their tenants. Policies have become increasingly flexible, something which is a key consideration as no two businesses are the same in their approach to real estate and property management, or in their appetite for risk. Those in engaged in significant re-construction of sites may mix EIL with redevelopment cover and will need an insurer that is able to dovetail the two during the redevelopment phase then revert to basic cover once work is complete, whilst ensuring there are no gaps in cover. 

Real estate investors often acquire a property with a view to holding it for around three to five years and then moving it on to turn a profit. However, as a previous owner, they will retain some liability and it is now easier than ever to adjust cover to reflect updates to a portfolio. The greater flexibility of today’s insurance also extends to those with international portfolios, allowing policy holders to bring protection for assets held in multiple countries under one master policy.

Best Practice

Ultimately, insurance protection should be married with best practice when it comes to risk management. Property owners need to have a good understanding of their tenant base and make sure that lease agreements are correct and that they have the right licencing protocols in place. It is not uncommon for issues with sub-letting to arise, so it is vital to ensure a solid understanding of and compliance with terms of the lease. Having a good property management agent who understands the risks and has experience of handling incidents that may lead to environmental contamination should also be a priority. Good communication and information sharing is vital to make claims handling as smooth as possible. 

Given the heightened focus on environmental, social and governance issues, the spotlight on those who do pollute, even if it is inadvertently, is unlikely to soften. Property owners need to understand the environmental risks they face, how to mitigate against them and ensure they have the right protection in place should the worst happen.

More Information

For more information, please contact cliona.byrne@aig.com  

 

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