Risk Management

Better Accounts of Future Cleanup Costs

''There isn't much of a carrot associated with reporting,'' but perhaps Section 302 of Sarbanes-Oxley will provide a stick.
David KatzSeptember 9, 2004

Until recently, difficulties in predicting cleanup costs haven’t mattered much to senior finance executives. That’s because, under Securities and Exchange Commission rules and Financial Accounting Standards Board dictates, they’ve had the latitude to report the cheapest cost estimates. “There isn’t much of a carrot associated with reporting,” says David Dybdahl, president of American Risk Management Resources Network, a Chicago-based environmental insurance brokerage firm. “You increase your environmental reporting and you decrease earnings.”

If there’s not a carrot, perhaps Section 302 of Sarbanes-Oxley will provide a stick. Some say that Sarbox 302, which directs CFOs and their bosses to personally sign off on their companies’ financials, could cause top executives to demand more scrupulous accounts of future costs from their environmental managers. “The stakes are higher under Sarbanes-Oxley,” says John Nevius, an attorney who represents corporations for Anderson, Kill & Olick in New York. “The consequences if you get it wrong are greater.”

While pollution insurers hope that pressure for more accurate reporting will translate into corporate demand for their products, one area of environmental insurance is hot right now. As it has for a number of years, experts observe, this coverage is playing a key role in the transfer of polluted land via mergers, acquisitions, divestitures, property sales, and outright donations.

Environmental coverage can be used as a way to get the buyer and seller to agree on future cost estimates. Unlike unsold polluted sites, for which the true cleanup costs won’t be known for many years, “in a merger or sale, the buyer forces the actual reflection of the expected costs,” according to Dybdhal.

Despite the often wide range of estimates for future cleanup costs on a site, the buyer and seller have to lock in on a fixed price, says Dybdhal. Exacerbating the problem is that in preparing their estimates, the parties tend to perch on polar extremes. “The seller will always gravitate toward the best-case scenario…to maximize the sales price,” he adds, while the buyer will hire engineers to scour the terrain for the gloomiest possible outcome.

The purchase of insurance by the seller can help bridge the gap between the two estimates by covering the contingency that the seller’s estimate is too low. Environmental impairment liability insurance, for instance, “provides comfort to buyer and seller that a third party will come in and deal with any unknowns,” says Robert Colangelo, executive director of the National Brownfields Association in Chicago. (For more, see “Turning Point for Pollution Insurance.”)