Capital Markets Financial Solution White Paper

Below are excerpts from a white paper that was prepared by Greg Schilz, Managing Director, Aon Environmental Services Group.

Environmental Liability Indemnification – A Capital Market Solution

Southport Re, a Delaware limited liability company provides capital market solutions to the problems of cost overruns related to environmental remediation and liability Southport’s approach utilizes a “loss portfolio transfer” mechanism vs. a traditional risk transfer insurance product.  Southport refers to their solution as an Environmental Liability Indemnification agreement.

Paying for the Costs of Known and Unknown Conditions

The Southport program is designed to address concerns of the owner of a contaminated site or a portfolio of sites. Southport Re seeks to indemnify clients for “qualified expenses” to be paid by the client with regard to environmental liabilities or specific remediation projects for which the client is liable and has established reserves to pay for the expected costs. The Indemnification Agreement is designed to pay for the costs of both the known and unknown conditions, subject to the limits of the policy, as a result of the remediation liability. These costs can include;

• Cost overruns due to newly-discovered contaminants.
• Excess volumes of known conditions.
• Cost overruns due to changes in regulatory requirements.
• Inflation risk.
• Errors or inefficiencies in the remediation work plan.

Covering Large Long Tail Environmental Liabilities

One unique feature of the Southport program is that the length of coverage, policy term, has no set minimum or maximum time period for the term of the program, The program will be as long as necessary to complete the remediation or the limits are exhausted, whichever occurs first.

How the Southport RE Liability Indemnification Works

In order to facilitate the transaction, Southport will establish a bankruptcy-remote Delaware Trust. The owner who is conducting or is required to perform a remedial action deposits the cleanup funds into the Trust. Southport also contributes cash or assets into the Trust as additional security for the cleanup liability.  The Trust then enters into a reimbursement agreement with the owner to reimburse “qualified remediation expenses” over the lifetime of the remediation project.

Remediation Expenses Covered

Qualifying expenses associated with the remediation project include two types of costs:

• Expense Type A – Anticipated remediation costs underwritten on the basis of the project scope of work, budget and timeline
• Expense Type B – Amounts required to address other specified costs associated with or rising from remediation efforts, including inflation, changes in regulatory requirements and total or partial failure of the remediation technology.

Trust Oversight

An independent trustee will oversee the operations of the Trust. The trust is constructed so asset maturities are matched with anticipated disbursement needs for the environmental remediation project. The policy will be structured with annual sublimits that will track with the expected annual costs of remediation.  The sublimits will be greater than the expected annual costs and will increase proportionally over time if there are no costs exceedances in the early years of the program.

Termination Policy

The Client will be able to terminate the Environmental Liability Indemnification Agreement at any time.  Accordingly, the Trust will establish a hypothetical or notional experience account whereby the client, upon termination, will be entitled to a potential refund of part of the initial deposit paid. The amount returned is equal to the trust fund balance less margin fees and qualifying expenses.  Expenses for the administration of the trust are paid out of the deposited funds.

Focus on Large Long-Term Liability

Southport is interested primarily in long-term projects that are expected to take 10 years or longer to complete.   Southport has capacity to transact deals with remediation liabilities of up to $250 million and can consider more when structured or spread out over multiple transactions and or policies. They will consider either single-site projects or portfolios of projects as a part of their product offering. The Southport Re product works best with long-term remediation and monitoring projects with protracted cash flow requirements.

Discounts Built into Southport Re Approach

Southport’s ability to aggressively discount the future value of liabilities is the key to their success in attracting clients who normally use more conservative rates to calculate the future value of such long-term liabilities.

Fronting Policy Options

Southport owns several insurance companies, which could front the “policy” that is supported by the financial trust.  This is especially important where regulators or other third parties require a rated insurance policy to support the owner’s financial assurance obligation for remediation or closure/post closure care responsibilities. The additional cost of the fronting policy will be separately priced.

Liability and Property Purchase Options

In addition to the loss portfolio transfer option as described above, Southport has the capability to consider the actual purchase of the underlying real estate asset or target company if that is a desired outcome of the client. This option requires much more detail and needs to be addressed separately if this is the client’s goal.

Underwriting Process:

The details of the underwriting process include:

• Annual and cumulative limits for remediation costs are established based on the anticipated funding requirements
• Changes in regulatory standards mid-way through an approved Remedial Action Work Plan must be addressed through a modification of the policy. Otherwise, changes in cleanup standards are excluded
• In evaluating the Remedial Action Work Plan, Southport will consider plans that have not been approved by regulators

Phased Approach to Closing

Southport takes a phased approach to closing. They look first to financially engineer the project. Once there is consensus on the financial terms and capital required, Southport will then provide a proposal for stage two, which includes the environmental engineering. The environmental engineering underwriting process includes an evaluation of the Remedial Action Work Plan, in terms of both Scope of Work and costs, and the expected payouts on worst-case best-case and most-probable outcome scenarios.   There will be a charge for the environmental engineering and further underwriting of the project required to reach a bindable offer from Southport. These costs will be offset by the transaction if and when completed. If no deal is reached Southport Re will retain the funds.

Summary

Southport Re offers an  integrated and customized financial approach to resolving large,  long-term  environmental liabilities. Their solutions help to reduce costs while mitigating environmental risks associated with the liabilities. All of Southport’s  solutions are based on  sophisticated funding mechanisms and provide attractive alternatives for certain client projects.  The solutions create  favorable balance sheet treatments and offer the potential to  greatly reduce or remove liabilities from the balance sheet.

TBLS serves as the environmental technical advisor to Southport Re. For more information or to be introduced to Southport RE, please contact Frances Schlosstein at fschlosstein@thetblsgroup.com, (646) 431-7605.