Environmental risk management moves beyond the traditional underwriting methods

Mark Fackler, president, AZLAND Risk Management

As published in Scotsman Guide's Commercial Edition, May 2007.

Real estate lending institutions, fiduciaries and capital-market players are rethinking the ways they approach environmental risk management. This is because of 2006's Environmental Protection Agency's All Appropriate Inquiries (AAI) final rule for qualifying certain landowner-liability protections.

Many environmental-consulting firms are predicting higher due-diligence costs related to AAI's new, more-comprehensive requirements for Phase I environmental site assessments. As a result, environmental-risk managers are looking into alternative methods of transferring or mitigating those risks while remaining competitive in the market.

Historically, traditional environmental due diligence or environmental-insurance policies for lenders have managed real estate environmental risk. A combination of both approaches can result in a risk-management product that emphasizes their strengths.

Lender insurance

In case of a mortgage default or discovery of pollution on the property, modern environmental policies for lenders pay one of two things. They pay the outstanding loan balance or the lesser of the following: the outstanding mortgage balance or environmental cleanup cost for the loan term.

Historically, lender environmental-insurance products have been underwritten by reviewing three things:

• An electronic environmental-regulatory database;
• An environmental questionnaire, which the borrower fills out; and
• An internal, proprietary underwriting system.

An environmental professional does not perform site reconnaissance. This saves time in the process.

Advocates for environmental insurance emphasize the quicker turnaround, transfer of risk and protection from future impacts that insurance provides.

Traditional due diligence

Environmental due diligence requires a thorough site reconnaissance by a trained environmental professional. Advocates of this underwriting method question the accuracy of some aspects of lender insurance. Specifically, they have issues with environmental-database products and the borrower questionnaire.

These traditional-due-diligence advocates question if insurance underwriters can adequately underwrite a property's risk without a site reconnaissance by a trained environmental professional. They also argue that this is more difficult without independent verification of facts stated by the borrower.

Further, they have concerns related to mold, asbestos, lead-based paint, wet-lands and radon risk. Environmental due-diligence professionals typically measure these risks in their site assessments.

Examining them closely

While both approaches have their strengths, brokers should be aware of their limitations.

Insurance policies for lenders typically do not protect the property-owner from environmental conditions. Brokers must contact their insurance agents to inquire if owner coverage can be added. Further, insurance underwriters are limited by the inaccuracies of database-mapping programs, the availability of data and the possible biases in the borrowers' disclosure.

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