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Pollution Risk Services
7870 E. Kemper Rd, Suite 240
Cincinnati, OH 45249
Phone: 513-489-2793
Fax: 513-489-2794 |
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04/01/2003
Insured Fixed-Price Contracts as a Means To Quantify Costs and Obtain Funds To Clean Up Contaminated Sites: The Kenosha Model |
Generally, the two largest hurdles to cleaning up contaminated sites are: (1) knowing how much the cleanup will cost; and (2) getting the cleanup funds. This article discusses why insured fixed-price contracts (IFCs) are the best way to quantify the cost and, in many cases, to obtain cleanup funds. The cleanup now underway at a 115-year-old closed industrial site in the City of Kenosha, Wisconsin ("the City"), provides a clear picture of how to use IFCs.
The mechanics of an IFC are fairly simple. Under the traditional cleanup model, contractors (hereafter, the "Contractor") give an estimate of the cleanup costs, but the risk of cost overruns are borne by the city or other entity ("the City") that is paying for the cleanup. By contrast, under an IFC model, the Contractor gives a fixed price that is backed up by insurance (the "Insurer") to cover cost overruns, and the Contractor and Insurer assume the risk of overruns. While the City does not have absolute protection against further cost increases, it has the best protections currently available, as set forth more fully below. Those protections include:
an "Experience Account" into which the estimated cleanup funds are deposited and paid out only as the cleanup is accomplished;
insurance that typically doubles the amount of the cleanup funds available; and
an indemnity from a Contractor who is highly motivated to complete the cleanup at or below the estimated cost because the Contractor would be required to cover any costs above the amounts not provided by the Experience Account and the insurance.
Cost Certainty
The first and most obvious benefit of an IFC is that the costs are quantified with the greatest certainty possible. As noted, the cleanup costs are placed in a separate Experience Account. This Account is managed not by the Contractor but by the Insurer. Several large insurance companies including AIG, Chubb, Zurich, Ace, and others provide these policies. The Insurer has a fiduciary obligation to the City to pay out the funds only as the cleanup progresses. Even apart from this fiduciary obligation, the Insurer is financially motivated to limit the payouts because the Insurer wants the Contractor to complete the cleanup before the Experience Account is depleted and insurance is tapped into.
Even if the Experience Account is depleted, the City still has available to it insurance funds that typically cover costs up to twice the amount of the Experience Account. Thus, if at the beginning the Contractor (with the Insurers necessary buy-in) has estimated the cleanup to be $10M, insurance will provide funding to cover costs up to $20M.
Finally, even if the Experience Account and then the insurance are depleted, the City will have a right of indemnity against the Contractor for any additional costs. How deep the Contractors pockets are will vary from case to case. With the Kenosha cleanup, the contractor is a publicly traded company with assets of over $200 million. As noted above, IFCs do not provide the City with absolute certainty. However, this triple-protection method provides more certainty than any other.
Types of Funding
There are three basic funding sources for environmental cleanups, as follows.
Potentially Responsible Parties (PRPs). The most traditional funding source is the current or past property owner(s) and any other PRPs. Unfortunately, sometimes the PRPs are gone or do not have sufficient funds to pay for the project, and oftentimes their duty to pay does not extend to the entire cleanup. (As an example, while the PRPs may be unquestionably required to remove all pollutants, they may not have to demolish buildings or otherwise prepare a site for redevelopment).
Brownfield and Other Grants. A second and increasingly available funding source includes Brownfield and other government grants (both federal and state).
Tax Incremental Financing (TIF). Finally, a third funding source is Tax Incremental Financing (TIF), through which a city or other entity issues bonds that are repaid through the increased property taxes generated as a result of the cleanup.
The Kenosha Model
The City of Kenosha, Wisconsin, is employing an IFC to obtain cost certainty and funding from all three of the above sources. Bottom line, the City will obtain a $10.1M cleanup that will cost the City nothing and will cost the PRPs only $5.1M.
The Kenosha IFC was contracted for in June 2002 and the cleanup must be completed by August 2004. The site is a 110-year-old, 31-acre industrial Brownfield in the heart of the citys residential section, and the Contractors obligations are to demolish the buildings, remove the pollutants, and otherwise ready the site to be used as productive and tax-generating commercial property. As of the March 2003 drafting of this article, the 30 acres of buildings have been entirely demolished (in 9 months) and the cleanup is otherwise on schedule.
The way the City did this is as follows. Briefly, for $10.1M, the City and the PRPs entered into an IFC contract with a Contractor. The Contractor agreed to clean up the entire site, including $4.7M worth of building demolition plus whatever soil and groundwater cleanup the state requires. The Contractor further agreed to purchase enough environmental insurance to cover costs up to roughly twice the estimated cleanup cost. Significantly, following the cleanup the site belongs to the City.
The funds for the $10.1M were obtained as follows.
$5.1 million (50 percent) from the owner and former owner (the "PRPs");
$2 million (20 percent) in Brownfield grants from the government; and
$3 million (30 percent) from bonds floated through Tax Incremental Financing (TIF).
A key element to all three funding sources was the cost certainty provided by the IFC. The IFC cost guarantee helped persuade the PRPs to contribute toward the cleanup since they knew in advance the total amount they would need to pay. Working together, the PRP, Contractor, and Insurer agreed on a price ahead of time that all can live with and that |
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Pollution Risk Services is an environmental services company that specializes in environmental remediation, remedial design, and risk management. By
integrating these disciplines, we are uniquely able to engineer programs that bring certainty of cost and resolution to environmental problems. For more
information contact Brandy Proffitt at (513) 489-2793 or e-mail bproffitt@pollutionriskservices.com.
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