Anthony Kaufman, Senior Associate
Published by Brownfield Insurance March 2009

Environmental contamination and liability concerns affect nearly all commercial and industrial property and business transactions.  High quality and defensible cost estimates are essential for negotiating, deals, settling litigation, tax appeals, modeling investment returns, securing financing and insurance, and complying with regulatory disclosure requirements.  Environmental exposure and liabilities are difficult to determine, and frequently owners, sellers, and investors must develop such estimates based on incomplete data and limited knowledge of site and contaminant conditions.  Even in the absence of complete and detailed data regarding each environmental issue that may be associated with a site or portfolio, there are tools available that offer effective and defensible means of estimating environmental cost and exposures.  

ASTM Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters (ASTM Standard Designation E-2137) identifies several standardized, hierarchical approaches for estimating costs for situations where probable outcomes can and can not be assigned.  These include (from most to least preferred):

•When probable outcomes can be assigned
 •Expected Value Approach - Reflecting statistical expectation based on  probability-weighted outcomes and cost contributions;
 •Most Likely Value Approach - Reflecting costs for a single expected or likely response outcome; and

•When probable outcomes can not be assigned
 •Range of Values Approach - Reflecting cost ranges for various outcomes without assigning probabilities; 
 •Known Minimum Value Approach - Reflecting minimum costs for only those most certain activities to be incurred

A preferred method is the Expected Value Approach for cost estimating wherein various response outcomes to environmental or contamination issues are identified, costs and probabilities are assigned for the various components of the response outcomes, and the sum of the probability-weighted costs are used to generate a defensible estimate of likely costs (expected value) necessary to address the environmental problem.  The responses and probabilities typically are identified on a decision tree or branched decision diagram that is utilized to complete the estimate.  The decision tree approach alone is best suited for sites with limited complexity and range of outcomes.

In situations of greater complexity involving multiple and interdependent possible response components, such as might be associated with multi-site portfolios or multi-media contamination, a more sophisticated Expected Value Approach to estimating liability is available through the use of Monte Carlo computer simulations.  Monte Carlo simulations utilize probabilistic, statistical models to assess multiple environmental responses, costs and probabilities in various combinations and outcomes.  The type and variety of various potential elements or steps (risk events) involved in solving the underlying environmental contamination concern are identified, and assigned probabilities and costs.  The computer simulation processes sequences of these risk events in various combinations and does so by running through thousands and even tens of thousands of iterations of potential combinations of the steps that yield various potential response outcomes.  The simulation assesses the range of potential risk events and outcomes, and does so in a manner that reflects the underlying probabilities and costs assigned to both individual components and the aggregate probability of various combinations that lead to a given outcome.  In this way, a wide variety of possible outcomes and associated costs are modeled, and the result is an estimated cumulative cost distribution curve which identifies the probability of incurring specific costs necessary to address the underlying environmental problem. 

For example, a multi-site portfolio may have 10 properties each with three confirmed environmental contamination issues and five potential contamination issues for which the need and extent of remedial actions have not yet been determined.  There is a very wide range of yet to be determined possible response requirements that may or may not be incurred in addressing each of these issues.  The engineering tasks that may be necessary to address each issues (starting with a triggering event such as a reportable spill or regulatory inspection, and continuing with a various types and degrees of environmental investigation, treatment system design and remedial responses) are described and laid out in either a spreadsheet or decision tree format for each issue.  Costs and probabilities of the various steps are assigned, linkages between the events are defined and the data input directly into a model to run the Monte Carlo simulation.  The model provides a cumulative probability cost distribution curve that identifies the likely needed expenditures to address the issues.  The real utility of the simulation is that it can take a wide variety of cost and probability data for a wide range of possible activities and outcomes and combine it into a single model that can be run thousands of times under thousands of various combinations.  The result is the estimated cumulative cost distribution curve.

This approach requires expertise of the estimating team to leverage limited knowledge of actual site and environmental conditions with their knowledge and experience to complete the basic input data for the models.  With the proper team in place and successful use of the simulation, the result is a clear and defensible cost estimate that identifies the uncertainties, estimates cost consequences of various outcomes and the likelihood of such outcomes, and allows all project stakeholders to understand the risk and costs to which they may be exposed. 

Mr. Kaufman is with EWMA’s Headquarters Office in Parsippany, NJ.  He specializes in environmental assessments and remediation.  For additional information or to discuss your concerns please contact Mr. Kaufman at 800-969-3159 ext. 190 or Anthony.Kaufman@ewma.com.