Specialty Podcast: What You Need to Know About Environmental Coverage for Multi-Family Housing

Intro (00:00):
You're listening to the Alliant Specialty Podcast, dedicated to insurance and risk management solutions and trends shaping the market today.

Megan Davidson (00:09):
Welcome back everyone to another Alliant Specialty Podcast. I'm Megan Davidson, Vice President of Alliant's Real Estate Group. We work with owners, managers and developers of multi-family housing nationwide. With me today is Bill Nellen. Bill, so glad you can join us today.

Bill Nellen (00:26):
Well, I'm excited too, Megan. I run Alliant's Environmental Practice nationwide, and I'm going into my 12th full year at Alliant, which is exciting. And, you know, in the environmental space we go across a lot of different industry sectors, whether that be Public Entity, Private Equity, M&A, Energy, and it's certainly Real Estate. So, it's great to be here, joining you today, Megan, and to hear more about what you're facing in your industry sector and kind of collaborate on how environmental and pollution liability might intersect.

Megan Davidson (01:05):
Thank you so much, Bill. That's exactly what we're going to be talking about today. And getting really specific, we're trying to dig into the environmental issues that are present in multi-family housing, whether they're affordable or conventional properties. This is typically an area where insurance may not be required, but we know that the risks exist. We see the outfall of that and whether you would choose to insure them or not might be part of the subject of our conversation today. We want to dig deeper into the why of it and the what of it and what you see in your area.

Bill Nellen (01:42):
I would lump environmental or pollution risk into three large categories related to multi-family, generally. Those would be historical liabilities like legacy environmental risk, and basically, that's, what was this piece of property before it was multi-family or habitational? The second basket is operational, so, you know, what could or would happen possibly during the client's ownership, investment or management responsibility at the given multifamily asset? And third and lastly is construction development risks, so during the course of construction, certainly a lot of things to think about. Ultimately, you know, what happens if the job gets stopped because of some pollution conditions that are caused? Or results from construction, whether it's a defect or pollutant that's released during construction. So those are the three that I see. What's facing some of your clients in today's market?

Megan Davidson (02:48):
Well, one of the ones that comes to mind, and it has to do with certainly a development we saw out in the northwest is the issue of legionella. Can you describe for us a little bit about what legionella is, how it can affect an apartment building and what the risk to an owner-operator of those properties might be?

Bill Nellen (03:10):
Wow. Yeah, that's very specific, but I like it because it is one of the, I would say, top five things that could be a pollutant that would impact these types of assets. Legionella is a bacteria and it can cause a serious type of pneumonia. It can be found in the natural environment, but it's usually in pretty low concentrations or diluted, but it can be more widespread and kind of really find a toehold in purpose built water systems such as decorative water features, fountains could be an example or kind of HVAC systems.

Megan Davidson (03:46):
Bill, another area that we've seen as an issue in multifamily properties is the presence of meth inside units, whether it's from making meth or using it. Can you help us understand what the ramifications are for residents of the units affected, nearby units, and what a cleanup entails, as well as the cost?

Bill Nellen (04:07):
Yeah, and I'll take it one step further. That's certainly a societal problem that has a lot of, you know, downside risks to our overall population, both in the United States and I'm sure elsewhere. But ultimately as it intersects with environmental insurance, which is where I'm seeing a lot of things, let's be conscious of the fact that these policies are claims-made policies in most cases and also subject to a deductible. So perhaps there are other lines of insurance that might get triggered too, because you know, certainly some of the chemical compounds that are used in the formulation of crystal meth could be explosive, could be at certain concentrations stick to the inside of structures and require some sort of reconstruction. So if you have an explosion, certainly it would trigger the general liability maybe and the property insurance. But an environmental policy would respond to the cleanup, and we're talking about multi-family mostly here, so you're going to have a population that's a habitation and so if somebody's using this unit not just to sleep, eat, and live then ultimately, that could expose a population of people, which could be tens or hundreds to this toxic airborne contaminant, which could ultimately lead to some type of class action. Or a plaintiff's attorney could get a group of residents together at one structure or multiple ones and it could also have reputational or image damages that could stem from it for the owner operator, investor or manager.

Megan Davidson (05:39):
You mentioned earlier that you were curious about things that we see on the non-environmental side and what some of those challenges are. And one of those challenges that we see in particular is water intrusion and there's a carryover into the environmental division when mold is involved. So, if there's a covered cause of loss, for instance, there's - fire sprinklers go off and subsequent mold, we can typically get our property carrier to pick up coverage. However, there are other areas where mold might be present, where there's not a covered cause of loss under a property form. So, I'm curious as to how an environmental liability policy might respond to a mold claim.

Bill Nellen (06:29):
Yeah, that's a great question. I would love to expand on that a bit further. What we have to be careful about on the off-the-shelf environmental policies, and let's be honest, there are a lot of intricacies to placing environmental insurance that clients need to be aware of because generalists in the insurance world might be excellent brokers and casualty lines or property lines, but would need a bit more assistance related to environmental. That's why it's kind of a specialty risk area that Alliant has chosen to invest in. So ultimately the question would come, we might not know what the cause of loss is, and it might not be a point source or time element issue, but it could be something that happened gradually over time. And what I would urge people to look at is the retroactive date on the policy because a carrier's going to try to do things even as complex as dating when the mold growth occurred. We've seen situations, certainly, I can think of one in the hospitality area where there was an excess of $5 million loss related to business interruption and loss of rents purely because they had to take many hotel rooms out of service because there'd been a catastrophic issue over time where all the plumbing fixtures in various bathrooms and appetences to the structure were leaking, and that just caused widespread mold growth throughout interstitial areas of the structure.

Megan Davidson (08:01):
Wow. So, in addition to just the damage to the property itself, based on the mold, what are some of the health concerns that might be faced by folks that are coming into contact with mold?

Bill Nellen (08:16):
Yeah, so first I'll handle that by talking about the actual health effects. But let's be honest, and I'm sure you see it with your clients, there's this phenomenon associated with people being litigious and having the idea of social inflation where claims might be spurious in some ways just to drive up cost. But to the first point, yeah, I mean it can certainly cause skin irritation at the right concentrations as well as breathing and difficulty in circulatory issues, respiratory issues, various medical effects. And like I said earlier, you know at a volume of people who are exposed not just one family or one couple, but ultimately if you have a whole building that people are breathing this in 8 to 12 hours a day, it could get pretty serious pretty quickly, and there are various types and forms of mold. But this social inflation issue, I've seen a lot of claims on a frequency basis where they're either individual units affected, or buildings or structures where individuals have had some sort of adverse financial consequence. And certainly, let's be honest, we've seen a lot with the COVID-19 pandemic as well as job losses and the current recessionary environment that we're in right now where individuals have faced some sort of financial difficulty and they may use mold in addition to other things to try to get out of leases and try to get out of having to fulfill their obligations under these lease agreements.

Megan Davidson (09:50):
Super helpful, Bill. Thank you. I'm going to pivot for a moment and bounce back to something you said at the very beginning. You were talking about three areas where environmental can factor in and with a competitive real estate market out there, we know lenders often update their requirements and that environmental problems not previously considered may lead to negotiation breakdown. So, can you tell us a little bit more about how environmental coverage can factor into making real estate transactions happen?

Bill Nellen (10:25):
Yes, thank you, and maybe I should add that as a fourth bucket, which I would call transactional risk. But that goes across all industry sectors, whether it's M&A, Private Equity, Public Entity, or anything really. But ultimately in the Real Estate environment, and financing in particular, when individual properties or portfolios are being leveraged with debt, there's a term of art, whether it's a hazardous materials indemnity in a loan covenant or something similar, where a buyer or the borrower is being asked to put up some sort of collateral, tangible financing assets, whether those be personal assets or the assets in a fund, where they have to indemnify the lender for any environmental risks. And frankly, some of those even go past the term of the loan, so past the maturity or the payoff of the loan where after 2, 3, 4 years, the borrower is still on the hook in the event that there's some sort of adverse effect to the real estate asset itself or devaluation or diminution in value of the real estate asset. And you can buy pollution, legal liability insurance. There's also a type of policy the lender can buy and make the borrower pay for, but ultimately a borrower can buy a PLL policy (pollution legal liability) policy and get a limit that's agreeable to both the borrower and the lender and ultimately put that into place and then they have some sort of confidence that there's a certain cost to lay that risk off on a third party as opposed to bearing the brunt of that risk themselves or as a limited partnership.

Megan Davidson (12:09):
Can pollution pick up known existing conditions in the current insurance market?

Bill Nellen (12:16):
That's a great question and we see that question being asked all the time, so I'm glad you asked it. Ultimately, environmental insurance can pick up known conditions, known preexisting conditions, the kind of art and the science around environmental brokerage as well as environmental underwriting is how you can handle those under the existing policy. So, a standard pollution policy covers cleanup costs on a first-party and third-party basis, but it also covers property damage and bodily injury costs, which are third-party liability coverages, if anybody's familiar with casualty lines. And so, a carrier who knows that somebody has a known obligation to clean up or remediate a certain condition where there are actionable conditions above some sort of regulatory standard, the underwriter would view that like ensuring a burning building. Ultimately, they might carve out through an exclusion or a manuscript, the actual costs of cleanup for that known issue, but give you the third-party liability costs or coverages for that issue.
And that's important and valuable because of one large reason. Because you're basically ring-fencing your obligation there. You can get engineers who can give you a sum-certain to clean up something based on the volumes of soil that need to be removed, based on the installation of a vapor barrier, based on the installation of a groundwater pump and treat system, or ripping out sheetrock for mold. But what you can't, or is much more difficult, is the kind of thing I call like a black swan type, low probability, but high risk, which would be the severity kind of, case of loss, which would be some sort of class action, some sort of third-party offsite exposure, some sort of legal suit where thousands of hours of law firm teams need to be pulled in. And so, you'd get that coverage for that known condition. And then ultimately, after you do what the obligation is by the regulator for cleanup, they'll remove that exclusion. And then for the remainder of the policy, I mean sometimes these policies run 5, 7, 10 years, you can have full government reopener coverage for those known issues if the regulations change or if the hazard is made more severe or something of that nature.

Megan Davidson (14:43):
Bill, that is super helpful. I think everyone can see why we pull in the experts when we start going down the rabbit hole of environmental liability and environmental coverages. I so appreciate that. Is there anything else you want to add about things you're seeing in your area, potentially any kind of environmental policy and how it might respond to COVID exposures or not?

Bill Nellen (15:07):
Yeah, I think in large part we've seen that COVID, there were certainly a few carriers out there that did not have their language buttoned up relative to exposure to viruses. And I'm not sure those losses have really manifested themselves as far as the carrier taking a financial hit, but certainly, it's caused a significant amount of litigation around those issues that are still ongoing to this day. I would say the hot topics in environmental insurance right now are 10 years of coverage is still available, but the number of markets offering it is dwindling. Carriers are offering defense outside the limits, which is something fairly new. And ultimately, as I've mentioned before, this is just such an exciting and dynamic market that every day the exposures change, the regulatory market changes, and certainly knowing where to go, where to get the coverage, and how to craft a policy is crucial when people are facing these kinds of risks.

Bill Nellen (16:11):
Finally, there's an exposure to something called PFOAS and PFAS, which is an emerging contaminant found in a lot of fire retardants used in various structures, used in various products that we're ingesting and breathing in every day. And I would say there have been cases out there where their public drinking water supplies have been impacted. And so, the market's kind of just sitting on a tipping point right now relative to how they're going to handle those exposures and whether the federal government and state governments will follow with standards relative to cleanup and exposure.

Megan Davidson (16:49):
Bill Nellen, we so appreciate your insight on this really important topic. Thank you so much for spending your time here today. For those listening in, please go to www.alliant.com for more information.