Dominic Thomas looks at how EU environmental legislation will affect UK SMEs

Given the significant amount of environmental legislation that has come into effect in Europe and domestically in recent years, one could be forgiven for thinking that there is an equally substantial and well-established insurance market, not least because of the often substantial costs involved in cleaning up pollution or contamination.

Surprisingly, although there are some established players in the market, they are few in number and the market as a whole is relatively small.

According to Willis, around £60m of premium income was written in the UK environmental market in 2004, compared to over £1bn in the US. By further contrast, general liability premium income in the UK for the same period was over £5.7bn.

Environmental insurance is of course a young market and, like all young markets, it takes time for insureds to recognise their exposure and for insurers to build up the necessary understanding of the market they intend to enter.

Even taking this into account, progress has been slow, particularly considering that the existing players (primarily AIG, XL, Chubb and newcomers Ace and Quanta) not only write environmental insurance in the US, but also most have had a substantial presence in the UK for many years.

There are, however, indications that the market may be entering a period of significant expansion, fuelled by a number of factors.

Contaminated land

Research carried out by Davies Lavery with environmental officers in a number of London boroughs has revealed that although Part IIA of the Environmental Protection Act (1990) came into effect in 2000, most local authorities have taken years to establish their contaminated land registers and identify contaminated land within their regions.

This was due to a lack of manpower and financial resources, as well as a lack of specialist knowledge and difficulties in identifying ownership of land.

However, that task is now being accomplished, as evidenced by the number of contaminated land sites identified by September 2004 (78, up from 33 in 2002). An increase in enforced remediation is likely to follow.

The first attempt at legal interpretation of section 78F of Part IIA of the 1990 Act took place in May 2005, in Circular Facilities (London) v Sevenoaks District Council.

The local authority served a notice to remediate contaminated land on the property developer owner, naming them as the "appropriate person" to carry out the remedial works. The owner denied that it was the appropriate person and, although it lost at first instance, on appeal the case was remitted for retrial (which has not yet taken place).

The significance of this case is not the outcome, but that it is the first attempt at legal determination of who constitutes an appropriate person for the purposes of remediating contaminated land under section 78.

It was widely predicted that there would be an upsurge in the number of landowners facing large remediation bills following the introduction of the 1990 Act.

While this did not materialise, this case may suggest that local authorities are beginning to flex their muscles.

The Environmental Liability Directive due to come into effect on 30 April 2007 with the aim of preventing and/or remedying environmental damage to habitats and species protected by EU law, as well as damage to water resources and land contamination which present a threat to human health.

Polluter liable

It is the polluter who will be held liable for the prevention or remediation costs and liability will be strict where the polluter was carrying out "hazardous" activities as defined by the Directive. In other words, a polluter can be held liable even where no fault is established.

The Directive does not cover damage to third party property or personal injury but it will nonetheless impose serious financial burdens upon companies for which existing liability insurance may well not provide cover.

In its original form, the Directive had also aimed to impose compulsory environmental insurance across member states in respect of any liability under the Directive.

Implementation was postponed indefinitely in 2004, following intense lobbying from industry and pressure groups and concerns over whether the insurance industry in Europe had the capacity to provide cover.

However, it was anticipated at the time that compulsory insurance schemes for companies would be implemented six years after the Directive came into force (therefore by 2013 in this country).

If the political will remains (and environmental concerns still have a very high profile) compulsory environmental insurance for companies will bring about a massive growth in the market.

The availability of a wide variety of environmental insurances, includes: cover for land involved in property or corporate transactions; brownfield site development; cover for known contamination; and for professionals and individual homeowners.

European expansion

In the highly developed US market, there are many more established insurers writing environmental insurance. It does not take any great leap of imagination to appreciate that as the European market develops, there will be opportunities for them to expand over here. In fact, that is precisely what is happening, with Quanta Europe opening in London early in 2005 and Ace setting up its environmental operation at the end of 2005.

These factors should ensure that the environmental insurance marketplace expands significantly in the years to come. However, it will also require an appreciation by businesses of the exposures they now face and the relative inadequacy of their existing insurance arrangements.

Many businesses, for instance, still believe that they have cover for pollution or contamination under their liability insurance cover, when for many years now that protection has been heavily restricted.

Most liability policies exclude cover for sudden, accidental and unforeseen incidents. Therefore, historic contamination or pollution taking place over time (for example, a slow, undetected leak from an oil tank) will not be covered.

Furthermore, liability insurance covers liability to third parties. By definition, and with few exceptions, it does not cover the cost of cleaning up an insured's own land. Nor, for that matter, would it cover the costs incurred in preventing damage to third party property. So any containment works to insured land to stop the escape of a pollutant would not be recoverable.

Criminal penalties can also be levied by the relevant enforcing authority - for example, failure to comply with a notice to remediate land - and criminal penalties will not be covered by existing insurances.

Brokers will play a major part in bringing these deficiencies in cover to the attention of businesses, but public perception too will play its part.

To adopt a parallel, directors and officers' (D&O) insurance was initially purchased by a minority of businesses, but following the raft of company legislation in the late 1980s and subsequent litigation concerning directors' duties and liabilities, it was appreciated that directors' personal accountability now required separate insurance protection.

Portfolio review

D&O insurance is now a well established and substantial part of business protection. The same pattern is likely to develop for environmental insurance.

The regulatory structure is now in place and the litigation interpreting the legislation is reaching the courts. Given the financial exposure at stake, prudent businesses will be reviewing their property and insurance portfolios.

Do not expect a revolution in the uptake of environmental insurance in the immediate future.

However, there are sufficient insurers with sufficient expertise now operating in the market to service a level of demand that must and will increase significantly over the coming years.