THE LONGEST EXCLUSION
It’s not okay to ignore this (significant) part of the general liability policy
Why is it that the longest exclusion in the general liability (GL) policy is totally ignored in insurance program designs by so many insurance practitioners, lawyers, and lenders? In my mind, the answer has as many facets as a diamond. As a full-time specialist broker in environment insurance for more than 35 years, I’ll share some thoughts on why this irrational behavior has endured for decades and explain why it’s such a bad idea to ignore pollution exclusions in insurance program design and in contracts.
It is common practice in the insurance business to fill coverage gaps created by GL policy exclusions by purchasing insurance policies that address the excluded causes of loss. For example, everyone knows the GL policy excludes losses arising from the maintenance, operation or use of automobiles. That means they know they should write an automobile liability policy on commercial accounts that have autos. Many states even require that it be purchased by the owners and operators of trucks and automobiles. In another example, everybody in the commercial insurance business also knows the GL policy excludes losses arising when an employee is injured. So, everyone knows to place workers compensation on accounts that have employees. Again, this insurance also is required by law.
Many insurance practitioners operate under the false assumption that pollution exclusions apply only to hazardous waste or industrial polluters. The reality is they essentially apply to losses arising from any material that can irritate or contaminate something and cause damages.
Insurance specifications in contracts also highlight the importance of filling coverage gaps created by exclusions in GL policies. This knowledge of what to do commonly is reflected in the insurance specifications in procurement contracts. In addition to GL insurance, virtually every insurance specification also requires vendors to maintain automobile liability and workers compensation insurance.
But it is unusual today to see in a procurement contract a well written insurance specification for the appropriate type of environmental insurance. Simply asking for “pollution coverage” is not a well written insurance specification. The term “coverage” is too broad to carry specific meaning.
Ignoring the big one
Exclusions for losses arising from automobiles and injury to employees are relatively short, only taking up a few column inches in the GL policy. Yet everyone knows to pay attention to them and to fill the resulting coverage gaps in insurance program designs. General Liability policies have contained pollution exclusions since 1973, and everyone seems to know of them. The modern pollution exclusion (f.) in the GL policy takes up an entire page. It makes no sense that insurance practitioners routinely fix the short exclusions and ignore the big one.
Pollution and contamination claims tend to be very expensive and insurance buyers would not normally choose to be uninsured for expensive losses. Yet most buyers are, indeed, needlessly uninsured for these types of losses. Many are unaware of this situation because they do not understand the effects of pollution exclusions on their insurance coverage.
So why does everybody ignore pollution exclusions?
In my experience, the number one reason is a severe underestimation of or lack of understanding about what an excluded pollutant may be. Many insurance practitioners operate under the false assumption that pollution exclusions apply only to hazardous waste or industrial polluters. The reality is they essentially apply to losses arising from any material that can irritate or contaminate something and cause damages.
Pollution exclusions have never been limited to hazardous waste. As a point of reference, this is the 1971 version of the “Contamination and Pollution” exclusion endorsement with a sudden and accidental pollution exception that was intended to be used in the GL policy at the time:
“It is agreed that this insurance does not apply to bodily injury or property damage arising out of the discharge, dispersal, release or escape of smoke, vapors, soot, fumes, acids, alkalis, toxic chemicals, liquids or gases, waste materials or other irritants, contaminants or pollutants into or upon land, the atmosphere or any watercourse or body of water; but this exclusion does not apply if such discharge, release or escape is sudden and accidental.”
In 1973, the Insurance Services Office (ISO) incorporated the wording from the pollution exclusion endorsement into the new Comprehensive General Liability policy under Exclusion (f.) Pollution, which was introduced as the industry standard GL policy form in that year. The original pollution exclusion and the pollution exclusions in common use today do not limit the definition of what a “pollutant” may be to hazardous waste.
It is surprising what the courts have decided through coverage litigation may or may not be an excluded pollutant. Carbon dioxide can be considered a pollutant in a GL policy; so can manure. In general, if an insured has materials on site that, if the material escapes or disperses from its intended confinement and could irritate or contaminate someone or something, claims arising from that event could be an excluded loss due to a pollution exclusion. A contractor’s operations leading to the release or escape of irritants or contaminants that result in bodily injury or property damage can lead to excluded claims as well.
It is interesting to note a few observations about the coverage litigation associated with pollution exclusions. The only time there is coverage litigation over a claims issue is when the insurance company and insurance buyer are not in agreement on how the insurance coverage should operate. Pollution exclusions are the most litigated words in the history of insurance. In coverage litigation both sides create arguments to convince a judge or jury that their position on the coverage is the correct one. This means that the language in the pollution exclusion itself must not have been clear to all of the stakeholder’s pre-loss. Coverage litigation is a natural outcome of ignoring the existence of pollution exclusions in insurance programs.
Fear of addressing
The second most common reason pollution exclusions are ignored in insurance programs is producers resist addressing topics where they’re not proficient. Unfortunately, environmental risks and insurance topics are relatively complex, and it is difficult to become proficient in the subject matter. This leads producers to avoid discussion on environmental loss exposures, pollution exclusions and forms of environmental insurance needed to fill gaps. Producers get into trouble because ignoring the existence and effects of pollution exclusions doesn’t eliminate the customers’ loss exposure to pollution-related claims.
Failure to address the environmental loss exposure and the effects of pollution exclusions in insurance program design is largely responsible for the relatively high number of litigated insurance claims associated with pollution losses. In almost all litigated coverage cases, if the insurance buyer had purchased the appropriate type of environmental insurance before the loss event, there would be no need for litigation.
Ignoring the existence of pollution exclusions in procurement contracts and loan covenants is harder to explain. Someone has ignored pollution exclusions when there is no requirement for environmental insurance in an insurance specification. Apparently, there is no commonly used reference book for lawyers and loan officers that provides guidance on how to write a technical specification for any type of insurance. Therefore, it is not surprising to see procurement contracts and loan covenants that do not mention environmental insurance of any kind.
What is strange is that lenders always want to be insured for their security interest in property where they hold an outstanding loan. When I see a loan document insurance specification that does not require environmental insurance for a commercial building, I wonder if anybody has informed the lender that the property policy’s fungi or bacteria sub-limit could reduce the collectable insurance amount for water loss from a broken drain pipe from the full policy limits to the mold/bacteria sub-limit, which is commonly as little as $10,000 on a $20,000,000 building. A broken drain pipe on a high-rise building can quickly cause a multi-million dollar loss, especially if loss of rents and additional living expenses are considered.
I also wonder if anyone let the borrower or lender know that a GL policy would offer no coverage—or defense—in the case of a breakout of Legionnaires disease associated with the HVAC system in the building or that bacteria in the drain pipe water is a specifically excluded contaminant in both property and liability policies today.
In either case, the borrower would be severely underinsured or completely uninsured in these claims examples. As a result, the lender could end up with the keys to the building. But lenders don’t want keys; they want solvent borrowers who pay off loans. That’s why they require borrowers to maintain property and liability insurance over the course of a loan.
Chances are no one has ever explained to the building owner or lender beforehand the likely effects of the pollution/fungi/bacteria exclusions. Surprises like this lead to coverage litigation.
Such surprise and potential litigation could be avoided with a good set of insurance specifications that acknowledge property and liability insurance policy coverage restrictions for losses associated with contamination. It has always surprised me that lenders are so poor at requiring borrowers to fill the insurance coverage gaps created by pollution/fungi/bacteria exclusions, when they are so good about requiring proof of insurance on any property the bank has a security interest in. It makes no sense.
The solution to pollution exclusions is environmental insurance coverage. There are two basic environmental insurance policy types. One insures specified locations and one insures losses arising from a contractor’s operations. The environmental insurance market place is overflowing with redundant capacity with over 50 underwriters of environmental insurance products and pricing is at an all-time low.
It’s a risky practice to ignore the existence and effects of pollution exclusions, especially when there are coverage solutions available at very reasonable prices for any risk ranging from a single underground storage tank to an atomic bomb plant clean-up contractor.
This is the first in a short series of environmental insurance articles by David Dybdahl, CPCU, ARM, MBA, president of American Risk Management Resources Network, LLC, a wholesale brokerage firm specializing in environmental insurance placements. Dybdahl has provided expert witness testimony in more than $2 billion of litigated environmental insurance coverage matters. He can be reached at email@example.com or (608) 836-9567. For more information, visit www.armr.net.