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3672 P-15 5/3/01 2:56 PM Page 240 240 / Indemnity in Perpetuity: Mining, New Zealand The outcome of this approach was indeed conservative, but the advantage was that the regulators accepted the method and the results it produced with minimal debate. Modeling Results ISR Insurance Component. The results of modeling for the ISR insurance component produced a sum equivalent to the annual insurance premiums that would be paid to realistically cover the occurrence of sudden events. Figure 15.2 shows that two risk issues (pit lake outlet and waste seepage release) were the two riskiest events and accounted for approximately 96 percent of the total project risk for the ISR insurance events. The combined occurrence cost of these events was therefore the risk cost. However, as insurance for sudden and accidental environmental events was widely available, the risk cost was not used directly in the derivation of the capitalization sum. Instead, discussions with WGC’s broker identified an annual premium offered by the insurance industry, and this was used to calculate the ISR insurance component. Even though the risk quotient for the catastrophic tailings release event lay below the risk cut-off, as Figure 15.2 shows this event dominated the exposure profile. From a technical standpoint, this event could be excluded, but it was retained for political reasons. The outcome of the discussions with the insurance industry was that ISR insurance to cover $12 million for catastrophic tailings release was around $45,000 per year (but for the same premium up to $50 million could be purchased). This level of cover would be more than adequate for the riskiest events. The estimated net present value of an annual ISR premium of $45,000 per year, discounted over the 50 years that the potential for a tailings release event was assumed to exist, was $960,000. Gradual Risk Component. Figure 15.3 shows the key information used to derive the gradual risk component of the capitalization sum. Figure 15.3 shows that the riskiest issues (waste collection pond quality and waste rock bypass) contribute to almost 94 percent of the total project risk for all the issues. The calculated risk cost for the events shows a moderate degree of uncertainty where the estimate varies from $2.997 million (optimistic, CL50%) to $5.281 million (pessimistic, CL95%). The planning (CL80%) estimate of the risk cost is $3.977 million. The exposure profile chart of Figure 15.3 shows that the calculated risk cost would also be able to cover the occurrence of all individual issues lower down the risk profile. On the basis of the modeling results, the gradual risk component of the capitalization sum was set at $3.977 million. Public Liability Insurance Component. The public liability insurance component of the capitalization sum was equivalent to the annual insurance premiums 241 Figure 15.2 50,000 45 Pit Lake Outlet 0.128970398 0.008118628 0.011849039 Cost CL 50% 140.92 202.97 11,884.47 Cost CL 80% 248.51 217.54 12,386.75 Cost CL 95% 463.64 233.69 12,869.02 Cost CL 50% Waste Seepage Release Cost CL 80% 0.1 0.00384 0.00005 PROJECT Frequency Waste Catastrophic Fail Cost CL 95% Postclosure ISR Insurance Events Exposure Profile 12.89703979 0.77938824 0.592451958 PROJECT RISK ANNUAL RISK Occurrence cost of insurable (ISR) postclosure events if the risk events occur. Current ISR Cover Current Premium 0 2,000 4,000 6,000 8,000 10,000 12,000 ISR risk ISR risk ISR risk Liability / Insurance 90.39% Riskiest 95.85% Events 100.00% % Cumulative Risk 2:56 PM 14,000 Pit Lake Outlet Waste Seepage Release Waste Catastrophic Fail ISSUE All Costs Expressed as $ x 1,000 POST CLOSURE - RANKED RISK EVENTS 5/3/01 Exposure ($ × 1,000) 3672 P-15 Page 241 242 Figure 15.3 Waste W/rock Bypass COMPONENT Cost CL 50% 2150.081627 770.0979491 784.0646308 648.9016475 29.79944131 1528.396594 55.52840839 GRADUAL ($x1,000) Planning Pessimistic 3,977 5,281 0.418 0.551 0.217101079 0.078455597 0.00784556 0.006468592 0.003 0.00155097 0.000269852 ANNUAL RISK Cost CL 80% 3070.336856 1078.869357 1092.551973 852.4990239 42.98176627 2165.304602 85.87479011 Waste Tailings Bypass Pit Lake Quality Cost CL 80% Cost CL 95% 4351.640244 1526.658937 1541.663213 1097.384336 59.73693642 2983.203382 130.3709727 Waste Pond Quality Sum Amount Req'd 3,977 GRADUAL ($×1,000) 68.17% Riskiest 93.83% Events 96.39% 98.42% 99.40% 99.91% 100.00% % Cumulative Risk Waste Perimeter ARD COMPONENT 0.0096 0.01 0.001 0.00096 0.01 0.0001 0.0005 PROJECT Frequency Pit Wall Pumphouse Cost CL 95% Postclosure Gradual Events Exposure Profile Cost CL 50% Sum Risk Optimistic 2,997 0.321 20.84170361 7.845559687 0.784555969 0.620984847 0.3 0.15509704 0.026985199 PROJECT RISK Occurrence cost of uninsurable, gradual postclosure events if the risk events occur. Waste Coll Pond Quality Liability/Insurance Gradual risk Gradual risk Gradual risk Gradual risk Gradual risk Gradual risk Gradual risk 2:56 PM 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Waste Coll Pond Quality Waste W/rock Bypass Waste Tailings Bypass Pit Lake Quality Waste Pond Quality Pit Wall Pumphouse Waste Perimeter ARD ISSUE All Costs Expressed as $ × 1,000 POST CLOSURE - RANKED RISK ISSUES 5/3/01 Exposure ($×1,000) 3672 P-15 Page 242 3672 P-15 5/3/01 2:56 PM Page 243 Implementation and Risk Reduction / 243 that would be paid to realistically cover third-party claims. No specific issues were identified that would require public liability insurance. However, it was recognized that the trust would be managing land and would encourage public access. It was therefore assumed that the trust would require a standard public liability cover and that the capitalization sum would need to provide for that insurance. Third-party, or public liability, insurance to cover property damage and injury was widely available at the time. Annual premiums of around $5,000 were typically required for policies with $5 million of cover. The net present value amount required to provide these premiums in perpetuity was estimated to be $127,000. Postclosure Base Costs. The estimated annual base costs to cover land management, monitoring, and remedial action averaged around $20,000. The net present value of this annual expenditure in perpetuity totaled $549,000. Summary Table 15.3 shows a consolidated summary of the capitalization sum to be vested with the trust at the time of its establishment at closure. The total sum of $5.613 million would allow the trust to undertake its land management and maintenance responsibilities in perpetuity. Table 15.3 Capitalization Sum Components ($ × 1,000) Component ISR Insurance (premiums) Gradual Risk Issue Costs Public Liability Insurance (premiums) Postclosure Base Costs TOTAL Amount Req’d 2017 Cover 960 3,977 127 549 5,613 50,000 na 5,000 na na IMPLEMENTATION AND RISK REDUCTION When the bond proposal was put to the regulators, the bond strategy and quantum were accepted without challenge. The capitalization bond became one of the matters appealed to the Environment Court by objectors to the extended project, and so the strategy and quantum subsequently underwent legal and technical examination within the court situation. At the hearing, the regulators supported adoption of WGC’s proposal without change. Opponents to the project offered no contrary technical or other evidence that justified making significant modifications to WGC’s proposal. In his decision, the judge chose to round the quantum up to $6 million, and WGC posted a capitalization bond of this amount. 3672 P-15 5/3/01 2:56 PM Page 244 244 / Indemnity in Perpetuity: Mining, New Zealand The extended project consent conditions allowed for the bond (and capitalization sum) to be reviewed annually. These reviews will account for any changes to the operation that might influence the risk assessment inputs and outputs, inflation, plus any other issues that could affect the bond amount. The review process provides WGC with the opportunity to look at and reduce its postclosure risk profile. It is hoped that, over time, this focus will enable the very reasonable capitalization sum to be further reduced. SUMMARY The WGC had a regulatory obligation to estimate and provide a postclosure assurance to indemnify the people of New Zealand against the cost of mitigating potential environment impairment arising from its rehabilitated mine site at any time in the future. Application of the RISQUE method has led to development of a postclosure assurance strategy and determination of an adequate and realistic value to the satisfaction of the regulators. An agreed definition of “perpetuity” was crucial to development of the successful assurance strategy. Using the concept of the time value of money, the risk analyst demonstrated that perpetuity could be defined in financial terms, a solution immediately accepted by WGC and the regulators. 3672 P-16 5/3/01 3:00 PM Page 245 16 CORPORATE REPORTING AND INSURANCE: RESOURCE PROCESSING, UNITED STATES This case study examines: • Application of the RISQUE method to achieve compliance with corporate reporting regulations and guidelines • Balance sheet recovery of contingent liability • Using sound risk management processes to improve the bottom line • Development of insurance strategies BACKGROUND U.S. Corporate Reporting: Staff Accounting Bulletin 92 Regulatory pressure is increasing for public corporations to disclose potential contingent liabilities through the corporate reporting process. Contingent liabilities are losses that can be anticipated to arise if particular events occur. The aim of corporate reporting of contingent liability is to protect the interests of current and potential shareholders by informing them of potential liabilities that could have a material effect on corporate assets and operations and to maintain fairness in the marketplace. In addition to disclosure of the dollar value of contingent liability, the regulators require discussion of uncertainties affecting estimates and how management has handled, and proposes to handle, these liabilities and uncertainties. Reporting Requirements. Legislation has been in place since June 1993, with release of the U.S. Securities and Exchange Commission (SEC) Staff Accounting Bulletin 92 (SAB 92), which requires disclosure of environmental and product 245 3672 P-16 5/3/01 3:00 PM Page 246 246 / Corporate Reporting and Insurance: Resource Processing, United States liabilities. In 1994 the SEC signaled its intention to enforce SAB 92 and to target several types of corporation thought to have significant environmental liabilities. The organizations targeted were operating in oil and gas, pulp and paper, chemicals, and property and casualty insurance companies. SAB 92 is the SEC interpretation of existing securities and accounting regulations and is a “full-disclosure” concept. SAB 92 requires a financial report containing comprehensive disclosure of: • • • • • • Actual assets and liabilities Potential liabilities: present and future Potential recoveries: present and future Secondary and derivative liabilities and assets Footnotes that present detail on methods used to derive the sums disclosed Narrative discussion, in Management’s Discussion and Analysis (MD&A), of the uncertainties associated with events and potential and proposed solutions SAB 92 has several specific requirements in relation to the disclosure of contingent environmental and product liabilities. It requires separate disclosure of a potential liability and a related potential recovery. It is not acceptable simply to disclose the net liability. SAB 92 requires discussion of uncertainty, specifically, the uncertainties affecting the precision of the estimates and the uncertainty associated with a corporation’s legal responsibilities regarding the liabilities. Finally, SAB 92 requires substantial discussion both of the balance sheet impacts of potential environmental events and of management of the potential liabilities. SAB 92 requires that corporations that are publicly traded in the United States must disclose environmental liabilities that are “reasonably possible to occur.” They also must include in the financial statements those liabilities that are “reasonably probable” to occur and have a “material” effect on the assets and profits of the corporation in question. Impacts of Changes. All corporations that are publicly traded in the United States are affected by SAB 92. The ruling not only includes U.S.-based companies registered on U.S. exchanges but also non-U.S. corporations trading registered issues on U.S. exchanges, and non-U.S. corporations trading American Depository Receipts (ADRs) in the United States. SAB 92 therefore has far-reaching impacts on many corporations beyond the boundaries of the United States. The impacts of SAB 92 are also likely to extend, indirectly, to corporations around the world, because regulators in a growing number of countries are showing an increasing interest in introducing similar corporate reporting regulations. In addition, in some countries corporate professional organizations are proactively introducing voluntary corporate reporting procedures. Prior to SAB 92, it was acceptable for corporations to disclose only those liabilities that they knew about and that were current. A typical statement would have 3672 P-16 5/3/01 3:00 PM Page 247 Background / 247 Table 16.1 Impact of SAB 92 Prior to SAB 92 Post-SAB 92 Highly variable reporting practices Disclosure of few, if any, contingent liabilities Tendency to report minimum values Relatively uniform reporting practices All material liabilities are reported Reporting of minimum values is generally not allowed Net value reporting is not allowed Explicit treatment of uncertainty is required Extensive footnotes and MD&A are required in the financial statements Disclosure can potentially have a major effect on the balance sheet Reporting of net value (liability minus recovery) No explicit treatment of uncertainty Little or no MD&A Disclosure had little or no effect on the balance sheet been: “We know of no contingent liabilities that are material.” An important impact of SAB 92 is a shift in the burden of discovery. Now corporations can claim “no material effect” only if they can state: “We have identified and measured all of our contingent liabilities that are reasonably likely to occur, and have determined that none are material, outside of those disclosed here.” As a consequence of SAB 92, corporations must take positive action to evaluate their operations (e.g., through environmental audits), quantify the liabilities (and their uncertainties), and then make a determination as to materiality. Table 16.1 summarizes the impact of the introduction and enforcement of SAB 92 on the characteristics of corporate reporting. The potential consequences of noncompliance with SAB 92 are: • • • • • Increased scrutiny and investigation Notices of noncompliance and violation Fines for violations of reporting regulations Suspension of trading Market effects from news of SEC scrutiny or enforcement actions The following case study was originally based on a confidential assessment of third-party exposure to environmental impairment. The events and liabilities presented here are not the actual results of the assessment; the results have been modified to reflect the risk profiles of typical, large industrial corporations. The name of the corporation is confidential; therefore, the generic “The Company” is used herein to refer to the corporation. Case Study Introduction The Company had substantial financial interests in approximately 10 operating companies at over 30 sites located around the world, in the United States, 3672 P-16 5/3/01 3:00 PM Page 248 248 / Corporate Reporting and Insurance: Resource Processing, United States Australia, Indonesia, Taiwan, and New Zealand. The Company was engaged in mining, mineral processing, and manufacturing. The Company’s corporate risk manager needed to gain a quick, comprehensive understanding of The Company’s environmental and third-party liability with respect to substantial sudden and gradual environmental events. This information was required to restructure the corporate environmental and third-party liability insurance strategy. Prior to this assessment, the corporate risk manager had no way of assessing whether the current insurance cover was adequate. The Company was also required (under SAB 92) to report corporate environmental and contingent liability on the balance sheet. The Company had been a leader in applying new technology to enable it to better manage the environment and its business. RISK IDENTIFICATION Panel Process The Company selected an expert panel to identify the key environmental events at each site that could lead to substantial environmental remediation and/or thirdparty claims. The panel members worked together for one week at the commencement of the project. During that time they reviewed the available information, became aware of the project aims, understood the project methodology, and established the appropriate roles and responsibilities of panel members. After the first week the panel members worked individually on preparation of information in a predetermined format. The role of the risk analyst was to coordinate panel contributions, ensure consistency of approach, and perform subsequent risk analysis. The expert panel consisted of the business manager, a mining industry environmental specialist, a manufacturing industry environmental specialist, and corporate legal counsel. Where additional information was needed for specific events, individual panel members consulted with Company operations personnel. The panel members were generally familiar with many of The Company sites. In cases where the panel members had little or no firsthand knowledge of particular sites, the panel experts compared what they knew of The Company site activities and conditions with their experience of similar activities carried out in similar environments elsewhere in the world. The available information on site conditions varied in quality and comprehensiveness from site to site. Information for some sites consisted of detailed environmental audit reports and backup data. For other sites, a selection of technical reports, such as engineering reports, groundwater studies, and environmental incident reports, were available. In a few cases, the only information available was a brief project summary and background photographs drawn from published annual reports. 3672 P-16 5/3/01 3:00 PM Page 249 Risk Identification / 249 Nature of Risk Events The panel identified 235 key events that were entered into the risk register. Each event was classified as either a sudden or gradual occurrence to assist with the later determination of an insurance strategy. Sudden risk events were considered by panel members to be accidents, generally involving low probability and high consequences (i.e., tanker collision, fire, or explosion). Gradual risk events are representative of the more classic cases of pollution and usually had relatively high likelihoods of occurring. Typical gradual risk events were leakage from an underground storage tank and seepage of leachate from a hazardous waste dump to the groundwater. The panel members estimated the annual frequency of each event, median and high estimates of occurrence cost, and estimates of the most costeffective management steps that could be taken to prevent the event from further occurring. Panel Conclusions The risk events identified by the expert panel included issues such as: • Stormwater discharges to surface water • Wastewater discharges to surface water and sewer • Soil and groundwater contamination from aboveground and underground storage tanks (ASTs and USTs); landfill leachates; stockpiles; tailings seepage; drum disposal; waste disposal; PCB releases; chemical, oil, and solvent spills • Pollution from air emissions of heavy metals, particulates, oxides of nitrogen and sulfur, methane, carbon dioxide • Transport and off-site disposal of wastes • Noise • Fuel and chemical transport accidents • Asbestos handling • Degradation of sites of cultural or heritage significance • Chlorine and fluoride emissions • Refinery waste storage • Cooling water discharges • Mine water discharges • Tailings dam failure • Acid rock drainage (ARD) • Concentrate spillage during transport 3672 P-16 5/3/01 3:00 PM Page 250 250 / Corporate Reporting and Insurance: Resource Processing, United States The types of remediation requirements that were considered by the panel included: • • • • • • • • • • • • • • • Documentation of the nature and occurrence of the event Hydrogeological and hydrological assessment Groundwater recovery and treatment Development of alternative water supplies Public relations and community consultation Leak detection and soil remediation (both in situ remediation and dig and dispose) Water and wastewater treatment works design, installation, and operation Monitoring, upgrading of facility and equipment Installation of containment structures Drainage improvement Response plan preparation and implementation Vegetation and soil rehabilitation Spill clean-up Alternative waste management and disposal Dredging (or excavation) and disposal of contaminated sediments Risk Management Criteria During the project, the panel members defined several criteria that assisted with interpretation of the modeling results and provided guidance in developing risk management strategies. The criteria were: • A risk quotient of $20,000 per year was used as the cut-off threshold between the riskiest events and those that posed a low risk. • Risk event occurrence costs of $500,000 and less were considered manageable under operational contingencies and therefore did not require specific management action. • Sudden risk events were considered separately from gradual risk events and were assumed to be insurable. • All gradual events with an annual likelihood of occurrence of less than 0.5 were considered to be risk events (i.e., there was a possibility that the event would not occur in future) and therefore would be potentially insurable. • Similarly, all gradual events with an annual likelihood of occurrence of 0.5 or greater were assumed to occur and were therefore assumed not to be insurable due to their high likelihood of occurrence. 3672 P-16 5/3/01 3:00 PM Page 251 Risk Analysis / 251 RISK ANALYSIS Risk Modeling The main features of the risk model that were specific to this project were: • The costs of consequences of each risk event were divided into two categories, third party and environmental impairment. • Third-party consequences included costs of claims by third parties for human health damage, stock and fishery loss, regulatory penalties, property damage, consequential loss, and some environmental damage. • Environmental impairment consequences included the cost of remediation and reasonable works to prevent, or restrict the impact of, further occurrences. • The risk quotient was calculated using a conservative estimate of the combined cost of all consequences at a conservative confidence level (CL 80 percent). • The events were ranked by risk and risk profiles were generated, which showed both the event risk quotient and the financial exposure to each event. Separate risk profiles generated by the model were: • Sudden events (third party and environmental impairment) • Insurable gradual events (third party and environmental impairment) • Uninsurable gradual events Sudden Events A total of 66 sudden events was identified by the panel. Figure 16.1 shows the risk quotient and exposure profile of all sudden risk events ranked from highest to lowest risk. The profile shows that a relatively small number of risk events have risk quotients that are effectively identifiable on the profile. A total of 20 events have risk quotients above the risk cut-off criteria set by the panel ($20,000 per year); the other 46 events have comparatively minor to negligible risk quotients. Of the 20 riskiest events, 10 have risk quotients above $200,000 per year. The exposure profile of Figure 16.1 shows the 10 or 12 highest-risk events present, on average, approximately $2 million of exposure at the planning confidence level. This compares with an exposure of approximately $3 million for the next 20 risk events with material exposure. For the 12 highest risk events, the representative pessimistic estimate of exposure is approximately $4.5 million compared with $7 million for the next 20 most risky events. 5/3/01 3:00 PM Page 252 252 / Corporate Reporting and Insurance: Resource Processing, United States Risk Quotient (Pessimistic) Optimistic Occurrence Cost (CL 50%) Risk Quotient (Planning) Event Risk Quotient 15,000 3,000 14,000 13,000 11,000 10,000 2,000 9,000 8,000 1,500 7,000 6,000 5,000 1,000 4,000 3,000 Risk Quotient ($1,000 per year) 2,500 12,000 Cost ($ × 1,000) 500 2,000 1,000 0 0 S5-18 Concentrate S3-4 Air S3-5 W/water S1-1 Air S4-11 Tailings S7-21 Escarp S4-13 SO2 S3-10 AST S7-23 Reject S5-14 Ship ore S3-10 Ship in S11-34 Oil S6-19 Ship S3-8 AGT S4-13 Ship S3-10 Rail S3-4 AGT S2-2 St/water S11-34 AST S3-7 Oil S4-13 Acid S7-21 AST S5-18 AST S1-1 St/water S7-23 St/water S3-10 Fuel spill S2-3 Lime S3-7 Chlorine S10-33 Dam S11-34 Dam S7-23 Madden S3-8 Chlorine S7-22 G/water 3672 P-16 Figure 16.1 Sudden event exposure profile showing the occurrence cost of events ranked in order of decreasing risk quotient. The exposure profile of Figure 16.1 also shows that there is considerable uncertainty in the estimates of the potential exposure to sudden risk events. This is illustrated by the large range in value between the optimistic and pessimistic costs, the pessimistic estimate often being two to three times greater than the estimated optimistic cost. Figure 16.2 is a cumulative risk profile that shows the cumulative exposure and the cumulative percent risk for risk-ranked events. This figure shows that the most risky 12 events are responsible for approximately 93 percent of the total risk presented by all sudden risk events. Insurable Gradual Events Panel members identified a total of 73 insurable gradual events. Figure 16.3 shows the risk quotient and exposure profile of all insurable gradual risk events with the events ranked from highest to lowest risk. The risk quotient profile shows that the risk posed by the insurable gradual events is substantially greater than that posed by the sudden events. The profile shows that 50 risk events, approximately two-thirds of identified insurable, gradual risk events, have risk quotients that are greater than the $20,000 3672 P-16 5/3/01 3:00 PM Page 253 Risk Analysis / 253 500,000 100% 450,000 90% 400,000 80% 350,000 70% 300,000 60% 250,000 50% 200,000 40% 150,000 30% 100,000 20% 50,000 10% 0% S5-18 Concentrate S3-4 Air S3-5 W/water S1-1 Air S4-11 Tailings S7-21 Escarp S4-13 SO2 S3-10 AST S7-23 Reject S5-14 Ship ore S3-10 Ship in S11-34 Oil S6-19 Ship S3-8 AGT S4-13 Ship S3-10 Rail S3-4 AGT S2-2 St/water S11-34 AST S3-7 Oil S4-13 Acid S7-21 AST S5-18 AST S1-1 St/water S7-23 St/water S3-10 Fuel spill S2-3 Lime S3-7 Chlorine S10-33 Dam S11-34 Dam S7-23 Madden S3-8 Chlorine S7-22 G/water 0 Cumulative Risk Cumulative Cost ($ × 1,000) Cum Pessimistic Occurrence Cost (CL 95%) Cum Planning Occurrence Cost (CL 80%) Cum Percent Risk Quotient (Planning) Figure 16.2 Sudden event cumulative graph showing the progressive contribution of risk events to total risk and occurrence cost with events ranked in order of decreasing risk quotient. per year risk threshold. The six most risky insurable gradual events have risk quotients above $600,000 per year. In addition, the top 20 risk events have risk quotients greater than $200,000 per year. Figure 16.3 also clearly indicates that approximately one-third of insurable gradual risk events (22 events) show negligible risk quotients of less than $20,000 per year. The exposure profile of Figure 16.3 shows that risk events within the group of the most risky 18 or 20 events generally present more exposure than events within the next 20 or so most risky events. At the planning confidence level, approximately 10 of the most risky 20 events present approximately $6 million exposure compared with approximately $1 million for many of the next 20 risk events. In addition, a representative pessimistic estimate of the exposure for 10 of the most risky 20 events is approximately $10 million compared with $3 million for the next 20 most risky events. The exposure profile of the figure also shows that there is considerable uncertainty in the estimates of the potential exposure to sudden risk events. Figure 16.4 is a cumulative risk profile that shows the cumulative exposure and the cumulative percent risk for risk-ranked events. It shows that the most risky 20 5/3/01 3:00 PM Page 254 254 / Corporate Reporting and Insurance: Resource Processing, United States Pessimistic Occurrence Cost (CL 95%) Optimistic Occurrence Cost (CL 50%) Planning Occurrence Cost (CL 80%) Event Risk Quotient 3,000 15,000 13,000 2,500 12,000 11,000 10,000 2,000 9,000 8,000 1,500 7,000 6,000 5,000 1,000 Risk Quotient ($1,000 per year) 14,000 Cost ($ × 1,000) 4,000 3,000 500 2,000 1,000 0 0 G5-15 Oil G10-33 ARD G3-9 Oil G3-9 Lagoon G10-33 Dam seep G3-8 Waste G7-27 Dust G6-19 W/w marine G7-21 Quench G3-10 Metals G10-33 W/water G7-20 Potable G5-18 Dust G5-15 Dust G6-19 Saline G7-24 Quench G9-31 Dust G5-15 Spills G7-23 Leachate G7-25 S/water G9-31 Potable G3-8 Waste G9-31 Dip G7-20 S/water G7-23 Leach Mad G9-32 UST G5-14 Dredging G3-4 UST G4-13 UST G11-34 Tails leak G3-7 Pot liner G11-34 Industrial G7-23 UST G2-3 Stor tank G3-7 UST G5-18 AST G11-34 Domestic 3672 P-16 Figure 16.3 Insurable gradual events exposure profile showing the occurrence costs for events ranked in order of decreasing risk quotient. events are responsible for approximately 82 percent of the total risk presented by all insurable gradual risk events. Uninsurable Gradual Events Uninsurable gradual events were identified as those events with some uncertainty of occurrence but with likelihoods so high (greater than a 50 percent chance per year) that it can reasonably be assumed that they would occur. Figure 16.5 shows a combined risk and exposure profile of the 96 uninsurable gradual events. The risk quotient posed by every one of the uninsurable gradual events is greater than the $20,000 per year risk threshold that was selected to define the riskiest insurable events (both third party and environmental impairment). The lowest risk quotient of the uninsurable gradual issues was $90,000 per year. The figure shows that the shape of the risk profile is very similar to that of the exposure profile, mainly due to the way in which the uninsurable risk events are defined. There is little difference between the risk quotient and the exposure to 5/3/01 3:00 PM Page 255 Risk Analysis / 255 Cum Pessimistic Occurrence Cost (CL 95%) Cum Percent Risk Quotient (Planning) 500,000 100% 450,000 90% 400,000 80% 350,000 70% 300,000 60% 250,000 50% 200,000 40% 150,000 30% 100,000 20% 50,000 10% 0% G5-15 Oil G10-33 ARD G3-9 Oil G3-9 Lagoon G10-33 Dam seep G3-8 Waste G7-27 Dust G6-19 W/w marine G7-21 Quench G3-10 Metals G10-33 W/water G7-20 Potable G5-18 Dust G5-15 Dust G6-19 Saline G7-24 Quench G9-31 Dust G5-15 Spills G7-23 Leachate G7-25 S/water G9-31 Potable G3-8 Waste G9-31 Dip G7-20 S/water G7-23 Leach Mad G9-32 UST G5-14 Dredging G3-4 UST G4-13 UST G11-34 Tails leak G3-7 Pot liner G11-34 Industrial G7-23 UST G2-3 Stor tank G3-7 UST G5-18 AST G11-34 Domestic 0 Cumulative Risk Cum Planning Occurrence Cost (CL 80%) Cumulative Cost ($ × 1,000) 3672 P-16 Figure 16.4 Insurable event cumulative graph showing the progressive contribution of risk events to total risk and occurrence cost with events ranked in order of decreasing risk quotient. third-party and environmental impairment liability at the planning level of confidence because all of the uninsurable events have very high likelihoods of occurrence (greater than 50 percent per year). The exposure profile of Figure 16.5 shows that there is substantial uncertainty in the estimates of the potential exposure and substantial financial exposure to uninsurable gradual risk events. Four events each present in excess of $20 million of exposure (planning confidence level) to environmental impairment liability. A pessimistic estimate of exposure to each of the top two events is approximately $80 million. Approximately 15 events each exhibit exposures of between $5 million (planning level of confidence) to $10 million (pessimistic confidence level). Furthermore, an additional 20 events could, from a pessimistic perspective, each incur $10 million liability. These events, however, present less exposure at the planning confidence level (approximately $3 million to $5 million). 5/3/01 3:00 PM Page 256 256 / Corporate Reporting and Insurance: Resource Processing, United States 90,000 90,000 80,000 80,000 70,000 70,000 60,000 60,000 50,000 50,000 40,000 40,000 30,000 30,000 20,000 20,000 10,000 10,000 0 G3-6 Fluoride G4-13 Slag G4-13 Gw waste G5-15 Chemicals G3-9 Waste G3-8 Seepage G3-9 Air G7-21 Oven G3-9 Wastewater G3-7 Waste G5-14 Septic G5-17 Effluent G3-4 St/water G3-5 St/water G3-6 Sanitary G3-10 Kaolin G4-11 Leachate G7-24 Noise G7-23 G/water G10-33 Mercury G7-24 Dust G7-23 Discharge G8-29 Sw pile G7-27 Oil G7-25 Methane G9-32 Dust G5-14 St/water G9-32 Dip G9-32 Acid G7-20 Oil G1-1 St/water G2-2 Fire 0 Risk Quotient ($1,000 per year) Event 3P and Remed Occurrence Cost (Pessimistic) Event 3P and Remed Occurrence Cost (Optimistic) Event 3P and Remed Occurrence Cost (Planning) Risk Quotient (Planning) Cost ($ × 1,000) 3672 P-16 Figure 16.5 Occurrence costs of gradual, uninsurable events shown at three selected confidence levels with events ranked in order of decreasing risk quotient. STRATEGY DEVELOPMENT Where possible and cost effective, risk treatment can be achieved by transferring risk through insurance. Where risk transfer is not an option, risk reduction strategies need to be developed. Usually, there are a number of options and methods for reducing the likelihood of occurrence of the risk event to negligible levels, the exposure of the events to sums that can be taken up as operational contingencies, or both. The strategy developed by the risk manager in this case study was confidential and was based on different dollar values from those presented here. The following risk reduction strategy is therefore an example of how the results of the RISQUE method can be interpreted and used to develop strategy. Transfer of risk via insurance can be achieved using a wide range of instrument types and opportunities. Where purchased insurance is preferred over self-insurance, cover is possible using instruments such as: • Sudden and accidental insurance, including industrial and special risk insurance (ISR) 3672 P-16 5/3/01 3:00 PM Page 257 Strategy Development / 257 • Finite risk insurance • Third-party insurance • Environmental impairment liability (EIL) insurance The event types and exposures that were evaluated in this case study were required by the risk manager, presumably because of the nature of insurance cover readily available to The Company. The nature of cover was therefore apparently dependent on whether the risk events were sudden or gradual. In addition to the risk and exposure profiles of Figures 16.1 through 16.4, various risk relationships were specifically generated and used to assist with strategy development. The risk relationships considered the cumulative cost for events, cumulative risk quotient for events, event prevention cost versus occurrence costs, and cumulative prevention costs compared with cumulative occurrence costs for risk events. The costs and types of insurance cover to be discussed are provided for illustrative purposes only and are based on general current practice within the insurance industry but are not based on quotations. The types of cover described and the indicated rates to determine premium cannot be used or relied on for any other purpose. Furthermore, the insurance options are based on a rudimentary understanding of the insurance industry and instruments. An experienced insurance broker would be able to generate a more sophisticated and appropriate strategy and also take advantage of specific market conditions. For example, an occasional bargain becomes available when substantial amounts of coverage move in and out of syndication for short periods of time and require placement. Taking advantage of the occasional bargain can represent large savings. The basic strategy developed for insuring sudden and insurable gradual events was similar, and was to obtain a standard insurance policy plus a cap insurance policy. The standard policy would cover the conservative but realistic planninglevel estimate of occurrence cost for all of the riskiest sudden events (those with a risk quotient greater than $20,000 per year). The cap insurance policy would cover the much less likely chance that the actual cost of claims would be greater than the planning cost (as represented by the pessimistic level estimates of cost). Under this strategy it was assumed that the cost of obtaining cap insurance would be less expensive than for normal insurance. Insurance of Sudden Events For purposes of the case study, it was assumed that ISR insurance would be readily obtained for the sudden risk events. ISR insurance covers first-party remediation and third-party claims for personal injury, property damage, consequential loss, fishery and livestock losses, and environmental damage. Liability associated with statutory penalties was excluded because transfer of risk for penalties is illegal in most countries; therefore, penalties are usually excluded from most policies. 3672 P-16 5/3/01 3:00 PM Page 258 258 / Corporate Reporting and Insurance: Resource Processing, United States The ISR insurance strategy summarized in Table 16.2 is based on interpretation of the risk and exposure profile of Figures 16.1 and 16.2, which show a plot of the cumulative relationships between cost of occurrence of risk events and overall risk presented. The strategy assumes the deductible (or excess) on the policy to be $500,000 per event as The Company would be able to absorb risk costs up to this value within its operating contingencies. A representative estimate of the exposure cost (planning confidence level) for each of the 12-highest risk events is approximately $2.0 million. The planned cover of $2.5 million per event should also be adequate to cover the occurrence of any one of the risk events contained within the risk profile. Cover is provided for 10 events, as it is considered extremely unlikely that all 12 events would occur. Figure 16.2 shows that the estimated planning cost of the riskiest sudden events is approximately $25 million, which means the total cover should be adequate to cover most occurrences. The figure also shows that the riskiest events are responsible for around 93 percent of the total sudden event risk. Therefore, the standard ISR policy covers the vast majority of the risk presented by the riskiest events. As current standard rates for ISR insurance appear to be around 0.3 to 0.8 percent per year, a standard policy premium rate of 0.6 percent per year has been assumed, giving an annual premium of $150,000. Figure 16.1 shows that a representative estimate of the exposure cost (pessimistic confidence level) for each of the 12 riskiest events is between $2.5 million and $7.5 million. With the standard policy providing up to $2.5 million per event, cap insurance cover of up to $5 million per event should be adequate to cover the very conservative cost of any one of the risk events contained within the risk profile. The figure shows that the estimated pessimistic cost of the riskiest sudden events is approximately $50 million, which is equivalent to the planned cap insurance cover. Premiums for cap insurance have been assumed at half that for the standard cover (i.e., 0.3 percent per year), meaning the annual premium for this policy is $150,000. Under this strategy, the total liability covered by sudden event insurance will be $75 million. Table 16.2 ISR Insurance Strategy No. of Events Deductible/Event Maximum Cover/Event Total Cover Estimated Maximum Exposure Premium —Rate —Cost Primary Policy Cap Insurance 10 $0.5 million $2.5 million $25 million $25 million 0.6% per year $150,000 per year 10 — $5 million $50 million $50 million 0.3% $150,000 per year 3672 P-16 5/3/01 3:00 PM Page 259 Strategy Development / 259 Insurance of Gradual Events For purposes of the case study, it was assumed that EIL insurance would be readily obtained for the insurable gradual events. A summary of the strategy is given in Table 16.3. As with ISR insurance, this strategy was developed from interpretation of risk and exposure profiles and plots of the cumulative relationships between risk event occurrence costs and overall risk. The reasoning behind the strategy was similar to that used for the ISR insurance cover. Because of the higher risk associated with the EIL insurance component, the assumed premium rate for the standard policy is 6 percent per year, which is 10 times greater than that assumed for the ISR cover. The total liability covered by EIL insurance will be $120 million. Table 16.3 EIL Insurance Strategy No. of Events Deductible/Event Maximum Cover/Event Total Cover Premium —Rate —Cost Primary Policy Cap Insurance 10 $0.5 million $6 million $60 million 6% per year $3.6 million per year 10 — $6 million $60 million 3% $1.8 million per year Management of Uninsurable Gradual Events Interpretation of Results. Ninety-six risk events were identified as being effectively uninsurable. The total estimated cost (at the planning confidence level) of third-party claims and environmental remediation for all of the uninsurable, highlikelihood gradual risk events was $480 million. A pessimistic estimate of the combined financial liability for the uninsurable risk events was approximately $740 million. Clearly, The Company needed to reduce the financial exposure by carrying out risk reduction actions that either would effectively prevent the events from occurring or would reduce the cost of the consequences should those events occur. For each of the uninsurable risk events, the expert panel considered the most cost-effective risk reduction measures that could reasonably be taken. A profile of the cost of the identified prevention measures and the concomitant financial liability for each uninsurable risk event is plotted on Figure 16.6. Both sets of cost estimates are presented at the planning level of confidence. The profile shows that most of the prevention costs are substantially lower than the costs that would be incurred if the events occurred. Figure 16.7 shows more clearly the relationships between prevention costs and occurrence costs for the riskiest 26 uninsurable risk events. It shows that the two 5/3/01 3:00 PM Page 260 260 / Corporate Reporting and Insurance: Resource Processing, United States Estimated Prevention Cost (CL 80%) Event 3P and Remed Occurrence Cost (Planning) 80,000 80,000 70,000 70,000 60,000 60,000 50,000 50,000 40,000 40,000 30,000 30,000 20,000 20,000 10,000 10,000 0 G3-6 Fluoride G4-13 Slag G4-13 Gw waste G5-15 Chemicals G3-9 Waste G3-8 Seepage G3-9 Air G7-21 Oven G3-9 Wastewater G3-7 Waste G5-14 Septic G5-17 Effluent G3-4 St/water G3-5 St/water G3-6 Sanitary G3-10 Kaolin G4-11 Leachate G7-24 Noise G7-23 G/water G10-33 Mercury G7-24 Dust G7-23 Discharge G8-29 Sw pile G7-27 Oil G7-25 Methane G9-32 Dust G5-14 St/water G9-32 Dip G9-32 Acid G7-20 Oil G1-1 St/water G2-2 Fire 0 Risk Quotient ($1,000 per year) Risk Quotient (Planning) Cost ($ x 1,000) 3672 P-16 Figure 16.6 Prevention and occurrence costs of gradual uninsurable events ranked in order of decreasing risk quotient. events with the highest financial exposure (both air pollution issues) present an exposure of around $75 million each, and the estimated planning cost to prevent each event is approximately $30 million. It is easy to conclude that The Company should invest $60 million to reduce an imminent financial exposure of around $150 million, which represents good value for the environmental dollar. If the funds were unavailable for both prevention actions to be carried out immediately, then the fluoride emission event should be addressed first as it is more risky and more likely to occur. Figure 16.7, in conjunction with Figure 16.8 (which shows a comparison of the cumulative prevention and occurrence costs of all the uninsurable events), shows that for a relatively small additional cost ($5 million), the total exposure of $228 million associated with the top four events could be reduced. Additional gains in reducing financial exposure could be made by spending a further $5 million (total of $70 million) to lay off $260 million, which is the exposure to the top eight uninsurable risk events. Figures 16.7 and 16.8 would be used to develop a rational, cost-effective risk reduction strategy for the uninsurable risk events. 5/3/01 3:00 PM Page 261 Strategy Development / 261 Estimated Prevention Cost (CL 80%) Event 3P and Remed Occurrence Cost (Planning) 100,000 100,000 90,000 90,000 80,000 80,000 70,000 70,000 60,000 60,000 50,000 50,000 40,000 40,000 30,000 30,000 20,000 20,000 10,000 10,000 G3-9 Wastewater G3-10 Gw nursery G3-6 St/water G5-18 Sewage G5-17 Air G7-21 Oven G3-9 Air G7-24 Oven G3-8 Air G5-15 Leachate G3-8 Seepage G4-13 Soil waste G3-9 Waste G10-33 Leachate G7-27 S/water G5-18 Leachate G4-13 SO2 G5-15 Chemicals G3-10 Gw waste G4-13 Effluent G4-13 Gw waste G4-13 Slag G4-13 Particulates G3-7 Air G3-6 Leachate 0 G3-6 Fluoride 0 Risk Quotient ($1,000 per year) Risk Quotient (Planning) Cost ($ × 1,000) 3672 P-16 Figure 16.7 Prevention and occurrence costs of the riskiest gradual uninsurable events ranked in order of decreasing risk quotient. Strategy for Uninsurable Risk Events. The general risk reduction strategy would be to: • Immediately create a management reserve of $480 million. This is the planning level estimate of exposure for all uninsurable events. It is considered reasonable to use only the planning confidence-level estimates, because the 80 percent confidence level is conservatively high and the uncertainty of cost variation is mitigated by the relatively large number of events that are assumed to occur. For example, for every occasion where a cost greater than average is incurred, it could reasonably be expected that another event would incur a cost below the median. • Plan ultimately to spend approximately $111 million to reduce $480 million of exposure. • For the next reporting period, budget to spend $70 million to reduce the $260 million of exposure to the eight riskiest events. • In the subsequent reporting periods, budget to spend $41 million to reduce the remaining $220 million of exposure associated with the remaining uninsurable events. 5/3/01 3:00 PM Page 262 262 / Corporate Reporting and Insurance: Resource Processing, United States Cum 3P and Remed Occurrence Cost (Pessimistic) Cum Remed Prevention Cost (Planning) Cum 3P and Remed Occurrence Cost (Planning) Cum Percent Risk Quotient (Planning) 900,000 90% 800,000 80% 700,000 70% 600,000 60% 500,000 50% 400,000 40% 300,000 30% 200,000 20% 100,000 10% 0% G3-6 Fluoride G4-13 Slag G4-13 Gw waste G5-15 Chemicals G3-9 Waste G3-8 Seepage G3-9 Air G7-21 Oven G3-9 Wastewater G3-7 Waste G5-14 Septic G5-17 Effluent G3-4 St/water G3-5 St/water G3-6 Sanitary G3-10 Kaolin G4-11 Leachate G7-24 Noise G7-23 G/water G10-33 Mercury G7-24 Dust G7-23 Discharge G8-29 Sw pile G7-27 Oil G7-25 Methane G9-32 Dust G5-14 St/water G9-32 Dip G9-32 Acid G7-20 Oil G1-1 St/water G2-2 Fire 0 Cumulative Risk 100% 1,000,000 Cumulative Cost ($ × 1,000) 3672 P-16 Figure 16.8 Comparison of cumulative prevention and occurrence costs of gradual uninsurable events showing that the cumulative prevention costs are less than the estimated occurrence costs. DISCLOSURE: SAB 92 Balance Sheet Reporting Individually, the financial liabilities derived from all of the identified risk events are generally not material. However, when the financial exposure is considered in aggregate, each of the classified risk event groups (sudden: $75 million; gradual: $120 million; and uninsurable risk events: $480 million) constitute material contingent financial liability. The Company’s financial statements for the current year would include disclosure of contingent liabilities for that year. For the current-year financial statement, The Company would book an overall contingent liability of $675 million but would recover $185 million through insurance and include $5.7 million for deductibles (premiums). The Company therefore would reserve $495.7 million. It would be able to comply with legislation and state: “We have identified and measured all of the contingent environmental liabilities that are reasonably possible to occur. We have assessed their significance and beyond those liabilities declared here, we know of none that will have a material effect.” 3672 P-16 5/3/01 3:00 PM Page 263 Disclosure: SAB 92 / 263 Corporate reporting legislation requires a description of the contingent liabilities and any associated recoveries and deductibles and justification of the current and proposed actions in the MD&A. Management’s Discussion and Analysis The risk reduction strategy just developed would be discussed in the MD&A. Tables 16.4 to 16.7 summarize the overall risk reduction strategy for the following Table 16.4 Current Financial Year Event Sudden Environmental Impairment Gradual Environmental Impairment Gradual, Uninsurable Environmental Impairment Book Reserve Table 16.5 Risk Transfer or Reduction Costs ($ × million) Recovery ($ × million) 75 120 480 0.3 5.4 — 70 115 — 675 $495.7 million 5.7 185 Liability ($ × million) Risk Transfer or Reduction Costs ($ × million) Recovery ($ × million) 75 120 480 0.3 5.4 70 70 115 260 675 $305.7 million 75.7 445 Liability ($ × million) Risk Transfer or Reduction Costs ($ × million) Recovery ($ × million) 75 120 220 0.3 5.4 40 70 115 220 415 $55.7 million 45.7 405 Financial Year 2 Event Sudden Environmental Impairment Gradual Environmental Impairment Gradual, Uninsurable Environmental Impairment Book Reserve Table 16.6 Liability ($ × million) Financial Year 3 Event Sudden Environmental Impairment Gradual Environmental Impairment Gradual, Uninsurable Environmental Impairment Book Reserve 5/3/01 3:00 PM Page 264 264 / Corporate Reporting and Insurance: Resource Processing, United States Table 16.7 Financial Year 4 Event Sudden Environmental Impairment Gradual Environmental Impairment Gradual, Uninsurable Environmental Impairment Book Reserve Liability ($ × million) Risk Transfer or Reduction Costs ($ × million) Recovery ($ × million) 75 120 — 0.3 5.4 — 70 115 — 195 $15.7 million 5.7 185 three years. Figure 16.9 shows the planned trends over the subsequent nine years in reduction of contingent liability, annual and cumulative costs of recoveries, and the benefit of expenditure in reduction of contingent liability. Figure 16.9 shows the very substantial benefits that would be gained over a period of four years, where the total contingent liability of almost $700 million before starting this exercise is planned to be reduced to approximately $16 million. Recovery Cost ($M) Contingent Recovery Cost ($M) Cumulative Benefit ($M) Contingent Liability ($M) 700 600 500 Value ($million) 400 300 200 100 r9 Ye a r8 Ye a r7 Ye a r6 Ye a r5 Ye a r4 Ye a r3 Ye a r2 Ye a r1 Ye a nt rre Cu ev io us 0 Pr 3672 P-16 Figure 16.9 Planned recovery of contingent liability showing the anticipated schedule of recovery and the ranked, early reduction of liability. 3672 P-16 5/3/01 3:00 PM Page 265 Summary / 265 SUMMARY The case study demonstrates that there are substantial benefits to be gained from utilization of the RISQUE method to comply with statutory corporate reporting requirements or voluntary reporting. Key advantages of the method are: • The approach follows a systematic, transparent procedure to ensure that all of the material contingent liabilities are considered. • The approach is logical and consistent and, therefore, defensible. • Contingent liability is clearly reported in dollar terms. • Compliance with corporate reporting regulations and guidelines is clear and comprehensive. • The focus is on balance sheet recovery of contingent liability. • A diverse range of potential recoveries and risk management options is explored. • Insurance strategies are more likely to be well conceived, cost effective, and genuinely reduce corporate exposure to contingent liability.