Flight into the unknown

With increasing political focus falling on the issue of biodiversity and the penalising of those causing environmental damage, Lynn Rouse considers the likely implications for the insurance industry

Protecting biodiversity and penalising those causing its damage and destruction are areas attracting increasing political focus. Only last month, Paris hosted a conference, involving leading scientists and policy makers, to help inform politicians and decision-makers about these issues ahead of 2010 - the date by which continuing global efforts aim to curb the loss of biodiversity. Taking stock of current knowledge and associated controversial issues, the conference also highlighted the link between biodiversity and sustainable development.

Closer to home, there has long been a UK Biodiversity Action Plan in place, created after the Convention on Biological Diversity was established at the 1992 Earth Summit in Rio. And 2007 brings the deadline for the UK government to implement the European Union Environmental Directive, including its decisions on whether damage caused under permitted emissions levels and by those emissions not currently considered harmful should fall outside the directive's scope (see box).

This directive is aimed at the prevention and rectifying of environmental damage, specifically damage to habitats and species protected by European Commission law, and to water resources and land contamination. Furthermore, the UK government is expected to deliver its new revitalised sustainable development strategy this spring.

Political footsteps

In light of these moves, liability insurers should be on their guard: where political focus falls, new legislative steps tend to follow.

"From what I understand, the sustainable development strategy will be the number-one priority of the UK's presidency of the EU," comments Phil Bell, technical manager, liability, at Royal and Sun Alliance. And Tony Lennon, European manager of environmental solutions at Chubb, agrees that political momentum is gathering: "We have got the environmental directive and will have a new sustainable development strategy - it is all coming together under the common theme of protecting the environment."

As far as the UK's sustainable development strategy is concerned, environmental insurance experts certainly expect references to be made about protecting biodiversity wherever possible. "We know that the EU is looking at biodiversity as part of the environmental liability directive so you would expect some form of response in the UK national strategy," says Marcus Drew, assistant vice-president, environmental at AIG Europe.

Some have likened the political momentum gathering behind biodiversity to that of climate change a decade ago. Bearing in mind the legislative requirements that have now been imposed on companies relating to climate change and emissions, should industries operating today be concerned at this parallel?

"From an insurance perspective, biodiversity could actually have a far more immediate impact than climate change," points out Mr Drew. "The atmospheric pollutants that appear to be causing climate change are diffuse - we know they're there but it's difficult to pin down the exact source or the exact effects, which limits the application of insurance."

The problem of diffuse pollutants also applies to acid rain, as Mr Lennon explains. Referring to the example of previous difficulties in attributing Scandinavian forest damage to the UK power industry, he says: "It wasn't possible to identify specific power stations because the cause and effect were separated by thousands of miles. Looking at biodiversity, however, the impact caused by manufacturing over a long time will be much easier to attribute to local activities - there will be more closely defined polluters to investigate."

Pollution solution

Mr Drew agrees: "It should, in theory, be easier to pinpoint a source of pollution that is affecting a natural resource as the two would be in a far closer proximity - insurance becomes more applicable as the risk becomes more quantifiable.

"Aptly enough, the EC is looking specifically over the next two years at developing its understanding of biodiversity and, ultimately, making industry more responsible for the pollution it causes. New legislation will be required to reflect this, although how that will be interpreted by the member states (and to what degree interpretation is allowed) remains to be seen."

Current environmental regulations focus on establishing liability for short-term accidental damage and historical contamination, thus UK environmental impairment liability policies reflect this and do not explicitly cover biodiversity, linked as it is with gradual, accumulative damage. This is only right, according to Jurg Busenhart, co-author of Swiss Re's report The Insurability of Ecological Damage. "The tendency is for insurance cover to be in line with legal liabilities - insurers always try to harmonise solutions with the legal system."

Much of the demand for EIL, therefore, stems from those involved in property transactions wanting protection against pre-existing contamination, rather than by companies with forward-looking concerns surrounding their operational sites. However, Mr Drew adds that changes are detectable. "The market for operational environmental insurance is growing, albeit slowly at the moment."

One of the difficulties that insurers will face going forward, especially if legal liabilities are extended, is trying to convince insureds that the processes they are carrying out today could be creating the pollutants of tomorrow. For example, a report published late last year by F&C Asset Management highlighted the fact that two-thirds of FTSE 100 companies deemed to be in a 'high risk' zone were not taking substantive action to manage their biodiversity risks. It concluded that this should be a worry for investors.

Mr Lennon, for one, is concerned by the preoccupation of industry with historical contamination issues. "They are only worried about what was done to the land last century, when they could be causing tomorrow's contamination today. This is the message we have to get across. When you ask clients about their potential pollutants going forward, they are dismissive, saying they are quite happy and can manage it. It is a dangerously blinkered view to believe that what they are doing today is beyond reproach."

He believes, therefore, that any new regulations should focus on "strongly encouraging" companies to carry out detailed assessments of their potential for causing damage. "First and foremost, industries need to properly identify their risks, which a lot of companies are poor at doing."

So what will happen if the government's strategy places far stricter requirements on companies relating to biodiversity damage?

Research and development

Mr Drew expresses his own hopes about the UK's response: "One would hope this leans toward effective permitting of industrial facilities - with the emphasis on prevention of incidents rather than penalties after the event - increased resources for environmental regulators in order to police the strategy and some research and development on the effects of industry on natural resources."

Mr Bell adds: "I think it is likely there will be business incentives, with an increasing focus on this issue as well as greater penalties should companies cause damage. The real problem, however, is that biodiversity has not got an economic value (see box, below) and, therefore, it is not possible to set a premium and allocate reserves for it. Insurers do not know how many claims there will be or how much they will cost."

In order to specifically cover biodiversity, or elements of it, Mr Drew says the challenge for insurers is, "being able to quantify biodiversity by establishing baseline conditions, previous incidents, and understanding the full cost of restoration and prevention, among other things. This is not just a challenge for insurers but also for environmental experts, environmental regulators and industry".

He continues: "Some elements of biodiversity damage will always be extremely difficult to insure, if not impossible. The value of more intangible elements - such as views and landscapes or areas of land rich in biological species that would be difficult to repopulate - is very subjective and cannot be adequately measured or quantified."

In addition, Mr Drew points out that there is a lack of data establishing the effect that industry is having on the ecology of the environment - especially the gradual impact over time. "We lack an understanding of not just the pollution risk but the cost of prevention and restoration."

Wildlife protection

There are already difficulties in dealing with biodiversity risks faced by those involved with environmental clean-up activities. Under existing legislation in the form of the Wildlife Countryside Act 1981, preventative assessment work must be undertaken prior to any environmental clean-up, explains Alan Dobson, divisional director of Quest Gates' environmental claims unit.

This demands that the consultant or contractor should assess the presence of protected species before undertaking any work that may affect or disrupt the habitat of a protected species. If they are present, relocation is required. "Relocation must be undertaken by a licensed handler to avoid hefty fines," he says. "For example, if gold-crested newts are disturbed or handled by non-qualified personnel, or their habitat destroyed, there is a maximum fine of £5000."

Consequently, Mr Dobson explains: "To extend an environmental restoration project to deal with restoration of natural habitats will undoubtedly result in increased claims spend, not least due to the fact that this is a specialist area and the work involved is particularly labour intensive."

Experts are not aware of any current legal cases that explicitly refer to biodiversity damage but this is not to say the issue remains unexplored.

"One of the areas we have been aware of in the UK relates to the discharging of low levels of oestrogen from sewerage treatment works and the effect this is having on fish stocks," explains Mr Lennon. "What is happening is that they are almost changing sex to the extent that it is becoming difficult to spawn. One could argue that is some evidence of biodiversity damage."

So what action should EIL underwriters and other insurers be taking now regarding potential risks of damage to biodiversity? "Unfortunately, specific quantification of biodiversity and the associated legal liability is not advanced enough yet to start commenting on possible wordings and exclusions in respect of biodiversity," says Mr Drew. "What insurers can and should do now is to make sure that they are involved in the consultation process on biodiversity and ecological damage so that our views can be taken into account when the time is right."

The fact that government, industry and society as a whole will be increasingly called upon to protect and preserve biological diversity appears to be a given. Where the question marks remain is the extent to which legal liabilities could widen in the future.


The directive was adopted on 21 April 2004 and member states have three years to implement it. Preparations for its transposition and implementation in the UK are in hand. The plans (subject to change) are as follows:

i) Up to September 2004 - identification of implementation issues within government and informal engagement with external stakeholders.

ii) Autumn 2004, autumn 2005 and summer 2006 - public consultations on options, proposals, and draft legislation, respectively.

iii) November 2006 to April 2007 - making regulations.

iv) May 2007 - directive implemented.

The proposal, which does not cover 'traditional damage' - economic loss, personal injury and property damage - has the following characteristics:

- Based on the 'polluter pays' principle, polluters bear the cost of remediating damage caused or of measures taken to prevent imminent threat of damage.

- Liability met by remediating damage directly or reimbursing competent authorities that take action.

- Strict liability would apply in respect of damage to land, water and biodiversity from activities regulated by specified European Union regulation.

Fault-based liability would apply in respect of biodiversity damage from other activities.

- Defences would exist for damage caused by acts of armed conflict and natural phenomenon, from compliance with a permit and emissions that at the time authorised were not considered to be harmful according to the best available scientific and technical knowledge.

- Where an operator is not liable, the member state would have subsidiary responsibility for remediating that damage.

The main issues that emerged from negotiations, plus the EU's related decisions, are detailed below:

- Financial security Whether or not it should be compulsory and the form it should take - left to member state discretion.

- Permit defence/exclusion Whether damage arising from activities operating within terms of authorisations (plus activities whose emissions were not considered harmful at the time) should fall outside the directive's scope - left to member state discretion.

- Subsidiary responsibility Whether or not the state should automatically be responsible for remediation where the operator could not be identified - left to member state discretion.

- Nuclear and shipping damage - excluded from directive's scope. Source: Quest Gates


The following is extracted from Swiss Re's report The Insurability of Ecological Damage, published in November 2003.

Damage to the environment often infringes upon the rights of individuals, causing property damage or bodily injury. In dealing with this issue, European legislators have used civil liability as their instrument of choice. The thrust of the resulting laws, based for the most part on strict liability, is to make polluters pay for the damage they cause. Such laws generate substantial risk and insurers have responded by offering fairly comprehensive environmental liability covers. These can only apply, however, where damage is quantifiable - where it can be indemnified by a certain sum of money.

With pure ecological damage, the situation is different. An ecological good is a public good - it belongs to no one and damage to it does not affect anyone's property rights. Thus, civil liability does not apply.

Insurance underwriters have no way of calculating the probability or size of potential losses - to date, therefore, insurers have not been able to offer cover for these risks.

Ecological damage is primary environmental damage directly affecting the water, air, soil, flora or fauna. Ecological damage always involves a free resource of nature.

Against this background it is difficult to fit ecological damage into the current legal liability context. Questions arise such as: when a free resource of nature is damaged, who is entitled to compensation; who has the right to sue; who is responsible for ecological damage; how can we put a value on ecological damage?

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