Oil and Water: Pollution and the Emerging Concerns of Fracking the Farmland

#IRMI2016 1

This session will focus first on the important concept of pollution and remediation legal liability inherent in all agricultural risk. It will conclude with an overview of the problems and opportunities that hydraulic fracturing oil and gas operations in the farmland present to insureds and insurers.

This file is set up for duplexed printing. Therefore, there are pages that are intentionally left blank. If you print this file, we suggest that you set your printer to duplex.

2 Oil and Water: Pollution and the Emerging Concerns of Fracking the Farmland

#IRMI2016

What Is “Fracking”?

• Hydraulic fracturing is a process used in 9 out of 10 natural gas wells in the United States, where millions of gallons of water, sand, and chemicals are pumped underground to break apart the rock and release the gas. • Scientists are worried that the chemicals used in fracturing may pose a threat either underground or when waste fluids are handled and sometimes spilled on the surface. • Most fracking activity is in proximity of or on site of working ranches and farms.

3 “Fracking” Illustrated

Good Neighbor Policy

4 Where Oil and Cropland Intersect

The Risks

• Fracking produces millions of gallons of wastewater. The amount can inundate under-equipped treatment plants. • Pumping hydraulic fracturing fluids, which could contain hazardous chemicals, into the ground along with water and sand at high pressures. The result is a “super-salty brine,” prone to bacterial growth, and potentially contaminated with heavy metals. • Improperly treated wastewater has been found discharged into river basins, polluting the surrounding environment. The potential also exists for fracking fluids to seep into aquifers if a well casing fails, posing a risk to groundwater supplies.

5 Frackquakes

• A team of scientists with the US Geological Survey has found evidence “directly linking” the uptick in Colorado and New Mexico earthquakes since 2001 to wastewater injection, a process widely used in the controversial technique of hydraulic fracturing, or fracking, and conventional drilling. • The study does note that despite the strong and direct link, the findings are not definitive. • The US government announced back in May 2015 that it would track the risks that so-called frackquakes pose and start including them on official maps that help influence building codes.

Does Earthquake Insurance Respond?

• A recent survey of wholesale market placers for earthquake coverage indicated that the earthquake peril covers a defined event whether natural or man-made. • While the science is still evolving, they report no unusual response to “frackquakes” to date. • For eligible prospects, the peril of earthquake is currently available, either by endorsement to a commercial property policy, within a difference-in- conditions policy, or available as a stand-alone policy such as the California Earthquake Authority. • This continues to be recommended as a standard offer on broker/agent quotes and proposals.

6 The Reward

• More than half a million new jobs exist because of shale gas. • This ebbs and flows with the market price per barrel. • There’s a wealth of natural gas in shale rock, some 1,000 trillion cubic tons recoverable in North America alone. • At the 2010 rate of consumption, potential shale resources can last more than 100 years of use. Some even say shale will help the United States become a net gas exporter within the next decade. • It is obvious there is a need to balance the economic advantages with the environmental concerns.

What It Means to Agribusiness Insurance

• Our concern is not the ongoing debate between environmental activists and the energy industry. • The fact of shale oil extraction as environmental risk is the focus for today. • To help focus, we will use this scenario: . First, a case study of a claim against a driller, and then ... . What if the (mythical) Shale Oil Hydrofacturing Company wanted to put a facility on your client’s property and they ask you the all important questions … . What can happen?

7 Insurable?

• Landowners leasing property to oil and gas operations are violations of most standard mortgage agreements, because that is not a risk that the lender is willing to take. • Likewise, homeowners insurance may not cover damages from fracking. For example, a major insurance company announced just last summer that its standard policy does not cover damage from fracking. • This is not unexpected or unusual since the “pollution exclusion” has been court tested and deemed enforceable in standard policy language to date. • As we know from our path through AFIS studies, environmental insurance combines risk management with risk transfer and is not designed to be addressed by standard personal or commercial policies. 11

Split Estate

• Ownership of land and ownership of minerals underground are two separate entitlements. • A split estate happens when a person owns the surface of a piece of land but not the resources underneath—oil and gas, for example. • That means a private energy company, or even the government in cases of publicly owned mineral rights, is authorized to march onto private (or public) property and start drilling. The most offensive part is that a landowner can do nothing to stop them. • Even if there is no split estate, some counties and cities stipulate “setbacks,” which regulate how far a well must be from homes, schools, rivers, and other valuable assets in a community. • These are decided locally and can vary quite a bit: in some places, quite a large buffer zone is required, whereas in others, wells are popping up literally in the middle of school yards.

8 Insurance Company Position

Concern Among Insurers

So What Do We Tell Them? Recent Company Discussion

• “After months of research and discussion, we have determined that the exposures presented by hydraulic fracturing are too great to ignore. Risks involved with hydraulic fracturing are now prohibited for general liability, commercial auto, motor truck cargo, auto physical damage and public auto (insurance) coverage.” (Insurance company position statement)

9 Developing Risk

• Insurers covering fracking risks are still few and far between, and such coverage is relatively new, since coverage litigation involving fracking has been rare. • Given the dramatic increase in fracking and the likely entry of new insurers, coverage litigation is sure to grow. (A report on industry status to date)

Uneasy Neighbors from Catskills to Cascades

10 The Crop Above, the Oil Below

“We’ve got 12,000 wells in the Bakken, and they each take up six acres,” said Mark Trechock, former director of the Dakota Resource Council.

Some Agricultural Concerns

• Contamination of the soil: The detrimental combination of soil acidification and deoxygenation disrupts plant cell growth, which makes it difficult to grow even the hardiest crops. • Accumulation in the food chain: All of these toxic components introduced into the soils make their way up the food chain as plants absorb toxins, primary consuming animals eat the plants, and secondary and tertiary consumer animals eat those animals. • Water use: Between 60 and 80 percent of the water used in fracking remains underground where it can potentially leak into and contaminate underground aquifers. The remaining 20–40 percent of the water returns to the surface, where it can poison nearby water sources if it is not dealt with properly. • Fragmented farmland: When access roads cut across farms or well pads are constructed within existing farm fields, productive farmland is fragmented. In addition to taking away parcels of usable farmland, fragmented farmland requires much more work to cultivate than contiguous farmland.

11 Risk Management

• Oil and natural gas producers have developed multiple ways to obtain the water necessary for wells that are hydraulically fracked. • Building ponds and reservoirs to capture rain, recycling water, and contracting with public works and farmers are some of the innovative ways the industry is obtaining, monitoring, and regulating water usage in areas. • Casing is a process that is regulated by the many states for each hydraulically fractured well site. • Well casing acts as a protective barrier between hydraulic fracturing fluid, oil, and natural gas that flows through the well and the fresh water aquifers. The process involves sealing the drilling well bore in multiple layers of cylindrical steel pipes encased in multiple layers of cement.

What Can Happen!

• Fetid, flammable, polluted drinking water in Pennsylvania homes near natural gas drilling sites was contaminated by methane escaping from flawed fracking wells, a new study shows. • Research makes a direct link between tainted drinking water and leaky gas wells in the Marcellus Shale. • Scientists saw the same connection in Texas above the Barnett Shale, they reported September 15, 2015 in the journal Proceedings of the National Academy of Sciences. • “This does provide pretty strong evidence that it’s a well integrity problem and not a fracking problem,” said lead study author Tom Darrah, a geochemist at Ohio State University in Columbus.

12 Insurance Concerns Case Study

Anything Can Happen, and Usually Does

• A typical fracking case may allege bodily injury or property damage arising out of contaminated groundwater (methane or other pollutants such as fracking fluid). However, there have also been cases involving air pollution, nuisance and trespass, well blowouts, disposal of fracking fluids, earthquakes, and corporate malfeasances by directors and officers. • Take a look in your customer’s filing cabinet, and any policy you pull out may have difficulty with a “pollution exclusion.” • Here’s what happened in one case….

13 Home Owner versus Driller

• Home owner alleged hydraulic fracturing well driller’s improper casing allowed pollutants to contaminate natural resources in and around their property, causing health issues, loss of use, and various other economic damages. • Sought remediation, property damage, personal injury, future health monitoring, and an injunction to stop drilling. • Defendants included production company owner-operator of wells, drilling company contracted to conduct drilling operations, and oil field service company that oversaw the process. • The concept of joint and several liability brought them all to the courthouse. • The driller tendered this claim to its commercial general liability (CGL) insurer, which also featured an “Energy Pollution Liability Extension Endorsement.” 23

The Prayer and the Answer

• The driller looks to recover north of $100,000 in legal fees and expert witness costs, as well as its $40,000 share in the settlement with the home owner. • The insurer denied any obligation to either indemnify or defend the driller under the policy terms. • The “pollution exclusion” under the CGL policy is unambiguous in it’s terms, precluding any response to a pollution event within the definition. • With that in mind, we look to the “Energy Pollution Liability Extension Endorsement.” • This had five conditions to cover a “pollution incident.”

14 The Devil in the Details: Policy Requirements

1.The discharge is unexpected or intended from the standpoint of the “insured” and 2.The discharge commenced abruptly and instantaneously on a specific time within the policy period 3.The discharge commenced at or from a site location or premises … and 4.The discharge was known by any “insured” within 30 days of commencement of the discharge of “pollutants” and 5.The discharge was reported to the company within 60 days of the discharge of “pollutants”.

Point—Counterpoint

• The driller’s attorney argued that the insurer may not require “slavish adherence” to the policy terms. The driller did not learn of the discharge until a couple of years after it first occurred. It should be entitled to at least a defense or indemnification. • The insurer argued that with this admission, the insured did not meet any of the burden of establishing the conditions under which the endorsement creates an exception to the pollution exclusion. • Advantage: insurance company. • What coverage advice would you give if the drilling contractor was your new potential customer?

15 Any Lesson Here?

• First, while there may be specialty programs available, their policy features may not provide much benefit. • This is no criticism of their underwriters or their policies; this is merely acknowledging that there must be restraints on terms and capacity in any given market. • The important thing is to understand the customer’s operations and bring them to a carrier that can respond to both their risk management and risk transfer needs. • The CGL “pollution exclusion” is court tested and firm. Any exceptions in a company marketing program will be, of necessity, narrowly defined.

Pollution and Remediation Legal Liability

• These are the elements of coverage you must seek to tailor to the operations of your prospect. • This will require partnering with a good environmental underwriter with risk management as a prerequisite for risk transfer. • They should be able to offer loss control, risk mitigation, and claims management service as well as a remediation and liability policy. • You will have to put in the necessary work to understand and explain how risk transfer happens.

16 Operators Extra Expense

• Operators extra expense (OEE) policies OEE policies are named peril policies typically purchased by well-drilling companies to insure against losses arising from well blowouts (named peril), which are typically excluded under CGL and environmental impairment liability (EIL) policies. OEE policies provide coverage for I. expenses incurred for controlling the out-of-control well; II. redrilling and restoring the well; and III. liability for any aboveground pollution. Because the OEE policies provide coverage only on a named peril basis and then only for aboveground pollution, the scope of insurance protection for fracking cases, where most of the damage comes from perils other than a well blowout (well leak) and much of the drilling and ensuing pollution damage takes place below ground, is somewhat narrow.

New Mobile Business Interruption Forms

To protect against both loss of income and extra expense on key units of mobile equipment, such as drilling rigs, Insurance Services Office, Inc., recently introduced two new endorsements for the premises business interruption and business auto policy (BAP): • CA 99052X for attachment to the BAP • CP15062X for attachment to the commercial property form More information is available on these in upcoming mobile business interruption classes.

17 Some of the Challenges

• Definitions. What is a “pollution event”? What is a ”claim”? What are the reporting requirements? • Warranties. A signed application becomes part of the policy a well as any subjectivities (e.g., safety plans, financial statements, employee handbooks, material safety data record keeping). Be sure the customer understands their import! • Claims-made and reported policy. Are prior events covered? Can a “potential” claim be reported? Must service of suit conform to an addressee in the policy? What is the embedded extended reporting period? Can extra time be negotiated and made part of the policy? • If you made the offer to go to market, did you document the insured’s declination? • If you made the offer last year, did you revive the offer this year (and every year unaddressed exposure exists)?

What about Your Rancher or Farmer?

• If they are asking you about the consequences of leasing land to a fracking operation, there are insurance consequences. • It’s clear that their homeowners, farmowners, or ranch owners program will not provide any relief from the “pollution exclusion.” • Their indemnity relief should be a matter of concern between the landowner and competent legal counsel. Most states follow the joint and several liability doctrine so they will most likely be involved in a pollution incident. • They certainly should ask to be brought into insured status on the lessee’s policy.

18 Developing Market—An Overview

• “While a dozen or more large insurers will write EIL coverage for energy companies generally, only five or six will write primary EIL for well owners or contractors with significant fracking operations,” said Jeff Hanneman, managing director with the environmental services group of Aon Risk Solutions in Houston (Business Insurance 4/24/13). • The number of oil and gas companies buying EIL policies has grown in the past 2 years, amounting to 30–40 percent of the industry as a whole, Mr. Hanneman estimated, saying that the total is between 60 percent and 70 percent among Aon clients (Ibid.). • Insurers are selective about the risks they write, and rates depend partly on geography, he said. Underwriters are concerned about companies with operations in the Marcellus Shale, where well sites often are near populated areas, and in Louisiana, with its history of oil- and gas-related environmental litigation, he said.

Capital Happens? What’s Holding It Back!

• According to James Russo of Energi Insurance Services, Inc., “The biggest issue holding back oil and gas drilling insurance coverage options is a shortage of reinsurance capacity …” • The first step for insurers is to break through the wall of misinformation surrounding fracking. In the case of several of the hot topics around this practice, the conventional wisdom only has half the facts. • One of the most overlooked facts about fracking is that the process has been used in commercial applications since 1949. Over more than 6 decades, the United States has led the way in developing technology to stabilize and streamline the fracking process.

19 Energi Insurances Services, Inc., a Peabody, Massachusetts-based industrial reinsurance company that provides specialized insurance and risk management products to targeted market segments of the North American energy states:

• Considerable media attention has been paid to purported groundwater pollution, where fracking fluids or wastewater leaks into aquifers. When done correctly, hydraulic fracturing occurs thousands of feet below aquifers; by properly casing wells and extracting wastewater, groundwater supplies can be completely protected. • Public concern has also been building around the chemicals used in the fracking process. More than 99.5 percent of what goes into fracking wells is sand and water. Leading oil and gas drilling companies are required to disclose pollutants on the FracFocus national chemical registry, enabling the public to learn more about the chemicals in use on sites near their communities. • Many assume the industry is poorly monitored and regulated. Instead, the opposite is true—leading states involved in oil and gas drilling, including Pennsylvania, Ohio, North Dakota, and Texas, have all instituted stringent regulations to ensure that drilling is safe for the general public. Along with the state regulations, associations such as the American Petroleum Institute have created standards and guidelines that promote best practice implementation. 35

Colorado Compromise (8/2014)

• Governor John Hickenlooper unveiled a delicately balanced compromise on local control of oil and gas drilling that would remove all the initiatives on the issue from the November ballot. • Hickenlooper said he would appoint a commission to make recommendations to the legislature on ways “to minimize land-use conflicts that can occur when siting oil and gas facilities near homes, schools, businesses and recreational facilities.” • This is an example of the awareness of balancing the risks and benefits of hydraulic fracturing drilling required of public policy. • An insurance market committed to risk management as well as premium and loss metrics is equally important to help manage the growth of both economies.

20 Emerging Risk, Emerging Market

• Without insurance companies’ active participation, the burden falls on the market and state regulators to separate the good and bad actors—at the expense of the public and the environment. Insurance providers are critical to ensuring that the industry is implementing best practice standards set forth by state regulations and industry associations.

In the Meantime ...

• The risk to ranch and farm owners is real but manageable. • Standard policies offer no exception to the pollution exclusion. • Hold harmless and indemnity agreements for the landowners and carefully negotiated pollution and remediation legal liability policies for the owner-operators is the challenge for the AFIS broker/agent. • Aggregate demand is the ultimate driver in the marketplace. • That only happens if we participate by making offers for coverage and promoting that demand to the companies.

21 Now What Do YOU Do?

• Nothing happens unless we make an offer! • If exposure exists, it must be identified. • Once identified, an offer for risk management and transfer should follow. • If declined, document and repeat each renewal. • That is how aggregate demand is created and how diligent enterprises prosper. • Both AFIS and IRMI are dedicated to help you with the resources to achieve this.