Can Environmental Insurance Succeed Where Others Have Failed - Essay Example

Can Environmental Insurance Succeed where others have failed? Large firms are engaging in production activities often produce waste that poses a threat to the environment. Firms should always be liable for environmental, health and safety risks exposed to individuals working either in the firm or living within the environment. There are many protective measures put in place by firms in order to reduce environmental pollution. It ranges from environmental policies, health policies as well as the safety risk policies. However, these protective measures may not be socially efficient. In such cases, these firms have to be liable to the negative externalities developed due to their actions. Such externalities include loss of well-being of people exposed to pollution or those individuals who are not willing to use unhygienic recourses. In such situations, environmental may levy a post damage fine, directly proportional to the extent of the external damage violated. For smaller firms, this fine may exceed their limited assets therefore making the firm declare they are bankrupt and avoid paying the fine altogether. Environmental agencies therefore came up with a pre-damage risk management process. In this process firms will pay smaller fines frequently for not implementing the obligatory environmental practices (Moore et als, 2012). Examples of such management process include Project Safety Management (PSM) programs, Risk Management Program (RMP), U.S. Environmental Protection Agency (EPA) and also Occupational Safety and Health Administration (OSHA). Since post damage fines are often limited by bankruptcy and, on the other hand, pre-damage process mandates are constrained by monitoring. And, therefore, the best alternative will be to buy environmental insurance policy. The paper, therefore, researches on mandatory insurance for Underground Storage Tanks (USTs) in order to come up with answers if environmental insurance policy succeeds where the traditional policies failed. Pre damage fines could have been the best alternative to address the issue of bankruptcy, but the implementation is constrained by regulatory agencies’ narrow monitoring capabilities. Environmental Protection Agency has limited auditors to do facility inspection in order to ascertain whether all firms have effectively put in practice all the risk management practices. The chance of a firm being found out that they have violated the rules is very low. To make it effective will require increasing the auditors in Environmental Protection Agency, and this will increase the administration cost by a considerable amount. Therefore, as an alternative, the states’ underground storage tank program. (Clean Water Nashville Program, 2015) the U.S. Environmental Protection Agency (EPA) proposes that to address inefficiency due to firms declaring bankruptcy, environmental insurance cover should be a mandate for all firms. Underground Storage Tanks leakages are the most common source of pollution of ground water. Petroleum products and other hazardous contents stored in underground tanks seep into the soil mingling with ground water. This ground water is the source of drinking water as well as water used for cooking, washing utensils as well as used for other house chores. This water is also used for bathing purposes and many other uses. In order to curb leakages, underground storage can be modified by upgrading storage equipments, as well as careful operation. But still there will be leakages, after over 20 years of regulation there is still about 10,000 underground releases every year. Therefore, firms with underground tanks have to find ways of reducing these risks. These ways will help in reducing the number of incidents where a leakage brings harm to people living in the environment. However, these firms with underground tanks implement this regulation that aims at bringing maximum social benefit, as well as the reduction of risks. Therefore, the state has come up with means of reducing these risks. The government formed regulation agency to monitor and impose fine on any company that has failed to adhere to these rules and regulation. The fines will help to raise funds to compensate those affected by the damage as well as help the government in the environment cleanup process. Leakages still occur in spite of the presence of both post damage fines imposed and the significant process mandates. In the United States, most tank owners of small business scale. Therefore, if an Underground storage tank leakage is discovered and a pre-damage fine is imposed, the business will easily become bankrupt. Pre damage fines, as well as process mandates, are available for Underground Storage Tanks business practices. However, limited monitoring recourses in the Environmental Protection Agency have made the agency inefficient for implementing these regulations. (Labatt et als, 2002) argued that Environmental Protection Agency do not inspect Underground Storage Tanks regularly enough to ensure that all the required practices are carried out and adhered to strictly. If environmental insurance policy is made mandate, then the problem of bankruptcy will cease. Because businesses with Underground Storage Tanks will be paying a premium regularly, and, therefore, the insurance firm will pay the fine if the business is held liable. On the other hand, the challenge of monitoring these businesses will not be an issue either because the possession of insurance cover can be easily verified is Environmental Protection Agency. Most importantly, because insurance firms provide differentiated premium based on the Underground Storage Tanks leakages risks, it will provide an incentive for the firms to improve their risk management. Having an insurance cover is also a guarantee that compensation will be available for victims if accidents occur. Limitation of post damage fines Firms are uncertain about the extent of harm their activities poses to different parties. If consumers favor green firms, the firm will suffer losses such as lower profits, higher wages and damage to the employees. In order for firms to lower expected future harms involves an additional cost such as upgrading the facilities on the Underground Storage Tanks. Firms will engage in risk reduction activities if the cost is lower than the expected private benefit of care. This activity is contrary to the regulatory agency that cares for all citizens and, therefore, compares the cost involved for risk reduction with the total harm imposed on all the citizens. This aspect implies that for a firm to select a social efficient risk reduction, a regulatory firm wants to impose costs on the firm external damage therefore imposing fines based on observed damages. Such fines raise the firms anticipated cost for meeting external damages. Such costs may be high because of large external damages and because the probability of the harm being detected is low. When the firm is caught, the cost will be much greater than its limited assets, and, therefore, these firms declare bankruptcy. Limitations of Process Mandates or pre-damage fines To address the issue of bankruptcy; regulatory agency made it a mandate for firms to reduce safety and environmental risks. If a firm is found out that it is not reducing its safety and environmental risks then, a pre-damage fine is imposed on the firm. The post-damage fine is relatively lower than pre-damage fines and poses minimal risks when it comes to making firms bankrupt. Therefore pre-damage fine improve small firms risk reduction incentives. If firms’ processes are regularly audited, it will provide economic incentives for firms to take responsibility for risk reduction (Labatt et als, 2002). But the agencies for implementing and enforcing these processes have limited recourses, Occupational Safety and Health Administration (OSHA)concentrates mainly on notorious firms known to have serious environmental problems. The rest of firms with Underground Storage Tanks are rarely inspected. Given that post damages fine is low and the low monitoring capability of regulatory agencies, firms rarely implement Occupation Safety and Health Administration rules and regulations. (Moore et als, 2012) argued that risk management do not guarantee risk reduction. 2007 report pointed out that only 36 percent monitored ground water; 15 percent monitored surface water control while 7% monitored methane. This process shows that there is a lot of inefficiencies when it comes to monitoring underground tanks in United States. Mandated taking of Environmental Insurance Cover Because of the limitation of the two traditional programs an alternative will be that it should be made a requirement that firms must take environmental cover. This requirement can help the issue of small firms as well as the issue of monitoring inefficiencies. If the insurance cover is not mandatory, small firms will not take the insurance cover out of their will. A premium that is at par with firms interest in taking an insurance cover is the same as the firms expected loss added to expected external damage. However for small firms the scenario is different. This difference is because if a small firm is fined and the total fine totals all the firms’ assets fewer private losses plus post damage fine, the firm can declare bankruptcy and therefore excused from paying. This excuse implies that the firm cannot purchase insurance at this premium. Therefore, to force small firms to purchase insurance cover, the regulatory agency can revoke the firms’ privilege to operate or impose a pre-damage fine or impose any other costs. The only thing the regulatory agency has to do. Is to confirm that the firm has a valid insurance policy or it has provided enough legal documentation that enough financial resources have been set aside just in case of risk related liabilities. Taking an insurance cover not only addresses the issue of bankruptcy but also provides other gains. With insurance cover, the post damage fine will be reduced if an accident occurs. The cost will also be predictable and is paid slowly in the form of premiums. On the same note, insurance provides funds in order to compensate injured parties for damages. Unlike without insurance where when small firms can declare themselves bankrupt hence not paying some of the fines. The most important point is that insurance can motivate efficient risk reduction because competitive premiums should point out the anticipated sum of social cost (Moore et als, 2012). To ascertain whether a firm has an insurance cover is fairly easy. The regulatory agency only requires firms with Underground Storage Tanks to submit a certificate with an insurance signature on it. This process does not require large costs in both the regulatory agency as well as to the tank owners and operators. If a firm with underground does not have an insurance certificate, it will attract a fine of about11, 000 U.S. dollars. To summarize, environmental insurance has grown to be a well functioning and competitive markets with many insurance companies offering a variety of different premiums (Labatt et als, 2002). In 2009, about 100 insurance companies offered environmental insurance policies for Underground Storage Tanks leakages. The insurance covers have differentiated premiums and in case of an accident the insurer pay the full cost of external damages. These social efficient ways will help in reducing risk exposures. According to (Moore et als, 2012), it is evident that the insuring companies do have an economic motivating factor to provide premium discounts to Underground Storage Tanks owners. In order to point out the lower expected claims payments due to releases of Underground Storage Tanks. Comparison between environmental insurance versus state funds Due to the initial lack of private insurance, state funds was set as an option for FRR compliance. State funds could address the issue of bankruptcy in small firms by acting like classified insurance firms by collecting fees from firms and pay out funds needed when releases occur. However, they don’t function this way instead the government spent hard earned tax without creative incentives to help in reducing risk. Since state funds are subsidized reducing participation cost making it lower than insurance premiums, state funds can force insurance covers out of existence. State fund gives firms with Underground Storage Tanks protection against leaks at zero costs. An operator has to pay a fee in order to be included in the state funds programs. The fee is relatively low and is usually paid for tank registration whether one will like to participate or not. However, this fee has no relationship with the riskiness behind one's effort to reduce risks. In terms of their lack of incentive to reduce risks. State funds redistribute fund of the key players in the market based on needs. This redistribution, therefore, implies that costs of participation in the state fund do not rise with firms’ riskiness of underground storage tank releases but also riskier firms tend to benefit more. In the same note, if the state funds collected are below the amount to be disbursed then the funds can be insufficient to compensate harms occurring. On the other hand, if a firm takes an insurance cover, the insuring company will be liable for; third party compensation as well as cleanup cost if a leakage occurs. Regulatory agency has put a priority for the insurance company to clean damages. Insurers are mandated on pay for damages even if there was a clear fault on the part of the insured so that there will be funds to compensate the affected parties (Risk Anal, 2011). As compared to state funds, private insurance has an edge inducing more risk reduction incentives than state funds. Introduction of private insurance cover has helped to reduce tank release. Conclusion It is clear that leakage from Underground Storage Tanks poses danger to the environment as well as living creatures such as human beings, fishes, and other organisms. It is, therefore, important for tank owners to ensure that leakage is minimal to minimize harm to the environment. However, the traditional methods of averting harm to the environment by imposing fine on the tank owners have not worked (Moore et als, 2012). Pre-damage fine, as well as post-damage fines, has proved to be inefficient in providing incentives for risk reduction in Underground Storage Tanks. Imposing a post damage fine poses the risk of making firms with Underground Storage Tanks to become bankrupt hence unable to pay damages. Pre damage could be the best alternative but because of inefficiency of regulatory agency. Such as Environmental Protection Agency (APA) and Occupation Safety and Health Administration (OSHA) to inspecting firms with Underground Storage Tanks has made the tank owners to neglect implementing the state regulation. The best alternative could, therefore, be State funds. State funds have been able to address the issue of small firms and also increase the monitoring capabilities of regulatory agency. However, it does not encourage firms put efforts in risk reduction. This encouragement implies that state funds can help in compensating for the damages but does not reduce the risk of leakages occurring. Introduction of environmental insurance cover by private insurance company has proved efficient in addressing the issues of bankruptcy, inefficient monitoring as well as providing an incentive for risk reduction. Currently, Underground Storage Tanks commercial insurance has developed providing premiums of different rates to the general public. Mandatory environmental insurance to the relevant firms may not apply to every environmental risk. According to (Labatt et als, 2002), insurers not only to identify but also quantify risks before offering insurance cover. But also have be in a position to set premium to each firm or a class of firms as reflected in the firms’ degree of risk. Demand for insurance cover must also be large enough at the prevailing premiums to enable insurance companies to cover their operation cost and still make a reasonable profit. Therefore making insurance cover mandatory will increase the demand for insurance cover relating to environmental pollution and related risks that might occur. Generally, there is an insurance market equilibrium which has associated risks. In such an environment, there are several expected costs. For instance, there are homogeneous buyers where the insurer charges the expected claim cost. However, if the insurer chargers less than expected, the average claim costs tend to exceed the average revenues. The insurer is limited by competition from charging more than expected. Another expected claim cost is the heterogeneous buyers whereby there are equal numbers of buyers in a group and the number of buyers is larger enough for the law of large numbers to apply to each group. Classification of risk also offers insurers room for estimating the expected claim cost for different buyers and charge cost-based premiums. This follows naturally from competition among insurance companies. The classification involves bring together consumers who have similar characteristics and charging them a premium or rate that differs from consumers with different characteristics. Therefore, classification goes through risk classes and rates per unit of coverage. However, a controversy arises on whether risk classification is appropriate in the society. Insurance also has limits of risk due to increased costs. An example is administrative and capital costs this usually affects premium loadings. Fraud also occurs when policy holders misrepresent or fail to disclose their risk or file fraudulent claims. There is also adverse selection which arises when policy holders are better informed about the expected claim costs than insurers. Low loadings generally imply higher coverage. For some risk exposures administrative and capital costs may be too high for insurance demand to be substantial. For instance, exposure with low severity, high frequency, correlated exposures, and parameter uncertainty are key factors that increase insurance demand. Exposures may also have high frequency since many administrative costs are roughly proportional to expected losses. Exposures with parameter uncertainty also arise when the true expected losses of insured is known perfectly. Contractual provisions also limit coverage by insurance companies. These include; deductibles which eliminate coverage for relatively small losses. The deductibles also reduce claim processing costs. This is important when such costs are unrelated to the size of the claim. With the potential of private environmental insurance to expand to bigger proportion, it is important to note how environmental insurance can best work when combined with other instruments to encourage all firms to adopt socially efficient risk reduction (Risk Anal., 2013). Considering third party audits like the once required by ISO certification should also be used by government regulatory commission as well as insurance companies to adjust their premiums. Otherwise, I can conclude confidently that environmental insurance has done well where other traditional methods have failed in reducing environmental risk by being able to provide compensation for injured parties hence enabling small firms not becoming bankrupt. Insurance firms are also able to provide incentives for firms to adopt socially efficient risk reduction methods.   References Clean Water Nashville Program: Clean Water Nashville program. (n.d.). Retrieved on 28 Feb. 2015 from http://www.cleanwaternashville.org/ Labatt, S., & White, R. R. (2002). Environmental finance: A guide to environmental risk assessment and financial products. Hoboken, N.J: J. Wiley. Moore, L., & Freehill, H. S. (2012). Environmental risks for major projects: Jurisdictional comparisons. Thomson Reuters. Risk Anal. (2011). Can environmental insurance succeed where other strategies hae fail? The case of Underground Storage Tanks Retrieved on 28 Feb. 2015 from www.pubfacts.com/detail/20807380/Can-environmental-insurance-succeed-where-other-strategies-fail?-The-case-of-underground-storage-tank Read More