Oil Spill Derailments Pose Challenge For Insurers

by Zelle LLP

Insurance Law360 - March 6, 2014

In the past year alone, five fiery oil train derailments have made front-page news by causing both catastrophic bodily injury and property damage in rural towns across Canada and the United States, including the 74-car freight train crash in Lac-Megantic, Quebec, in July 2013. These rail disasters have resulted in the tragic loss of life, catastrophic bodily injury, the destruction of homes and businesses and pose a threat to the environment.

In the aftermath of these disasters, questions of whether and to what extent insurance policies will respond — and whose policies will respond — are front and center. With experts predicting that oil spill derailments may increase in frequency over the next decade, the insurance industry must be prepared to address this new coverage threat including the coverage issues and potential exposure which may arise from these disasters.

Recent History of Railroad Derailments Involving Oil Spills

Unfortunately, railroad derailments involving oil spills have become more and more frequent over the last five years. In fact, at least 10 times since 2008, freight trains hauling oil across the U.S. or Canada have derailed and spilled significant amounts of crude oil.

In July 2013, the derailment of a 74-car freight train in Lac-Megantic, Quebec, resulted in fires and explosions of the crude oil being carried in multiple tank cars. The wreck caused the death of 47 people, destroyed almost half of the downtown area and may have heavily contaminated the soil and water in the town.

In January 2014, a Canadian National Railway Co. freight train carrying butane, propane and crude oil derailed outside of Plaster Rock, New Brunswick, near Maine's border. The train rail tankers burst into flames no less than two miles from a residential area with 50 homes and 150 residents.

In February 2014, a 120-car Norfolk Southern Corp. train carrying Canadian crude oil derailed and spilled between 3,000 to 4,000 gallons of oil in western Pennsylvania, near the rural town of Vandergrift.

The increase in these train derailments may be tied to the increase in freight trains carrying crude oil from the Bakken oil patch in Montana and North Dakota. Rail-based oil shipments have grown exponentially in part because pipelines fail to keep up with the growing oil supply. According to transportation officials, these shipments are forecast to increase from 1 million barrels per day to more than 4.5 million barrels per day over the next decade. Thus, the risks for the insurance industry seem to be steadily rising.

Too Little, Too Late

Typically, the freight trains carrying these huge crude oil shipments tend to be smaller lines, they are not major, household name railroads. Many times these small lines do not carry enough insurance to pay for the enormous cleanup costs related to these catastrophic derailment events. One report shows that the railway industry lags significantly behind the pipeline industry in value of mandatory insurance.

However, these small lines, like the Montreal, Maine & Atlantic Railway ("MM&A") line, which owned the trains involved in the Lac-Megantic derailment, have alleged they cannot find enough insurance coverage. While cleanup costs for the Lac-Megantic derailment are expected to exceed $200 million, the MM&A line only had $25 million in liability insurance. Ultimately, the MM&A Line’s lack of insurance and inability to clean up the disaster forced it to file for bankruptcy.

The Canadian government responded to these alleged insurance shortcomings by proposing mandatory minimum insurance for rail companies. Specifically, an August 2013 committee report issued by Canada's Senate recommended the Canada Transportation Act be amended to require rail carriers to maintain a minimum amount of liability coverage. The report did not recommend an exact amount, but noted that pipeline companies are required to have a minimum of $1 billion available in bonds, lines of credit, third-party guarantees and liability insurance.

Insurance Coverage Issues Relating to Derailments

Like any major disaster, a number of different types of policies, purchased by various entities, may be called upon to respond to these types of losses.

Numerous types of policies could apply to provide coverage, including inland marine transit coverage and commercial general liability procured by the rail lines, as well as property coverage issued to the oil companies.

Most first-party property policies that contain transit or transportation extensions of coverage exclude loss or damage for property of others transported by vehicles owned by the insured when she is acting as a common or contract carrier. In most instances, a railroad transporting crude oil would be considered a common carrier. Thus, there would be no first-party property coverage for the railroad lines themselves.

For instance, in the Lac-Megantic derailment, MM&A line’s property insurer sought to file a declaratory judgment action in a Maine district court seeking a declaration that the first-party property policy does not provide coverage for losses to the railcars, railroad track and roadbed and for business income and extra expense losses.

Further, the declaratory judgment action had sought to make clear that the property insurer is not liable for claims made by third parties who suffered personal injuries or damage to their property as a result of the derailment. The insurer claimed that the policy only provides coverage for certain locomotives involved in the incident.

Ultimately, the district court denied the insurer’s request to lift the stay in the MM&A line’s bankruptcy proceeding and, thus, disallowed the filing of the declaratory judgment action. However, the MM&A line and its insurer subsequently reached a settlement agreement regarding its property insurance.

However, inland marine transit coverage procured by oil companies may provide coverage for damage to their property. For example, this type of coverage protects against damage to shipments of property which are listed or described in the declaration while such property is being transported by motor, air or rail. Additional coverages also include debris removal and pollutant cleanup which usually contain specific limits of liability. Oil companies may be able to recover the value of the costs of the thousands of gallons of lost crude oil in these derailments.

Although first-party property coverage may respond to these railroad derailment spills, the largest insurance coverage claims from these spills may arise from third-party liability insurance related to the cleanups and bodily injuries. In the wake of the Lac-Megantic spill, governmental agencies have reported that railway companies only have access to approximately 30 to 40 companies that are willing and able to offer Class III railway liability insurance. Typically, the limits in third-party liability policies issued to short line railway companies that haul this crude oil range from $5 to $50 million in the aggregate. Based upon the amount of damage arising from these spills, exhaustion of these policy limits could occur quickly.

The people and businesses in the towns affected by these railroad oil disasters may look to the railroad and oil companies’ CGL insurance policies for coverage relating to the environmental impact and bodily injury losses. Like in most liability matters, numerous coverage issues may arise including whether the bodily injury and property damage resulting from the railroad derailment was caused by an “occurrence.” Specifically, was the train derailment an accident?

Further, a pollution exclusion contained in the CGL policies may bar coverage for such railroad oil spill claims where the environmental contamination in the towns was caused by heat, smoke or fumes from the oil fires. Finally, it may be a point of contention whether the railroad was named as an additional insured in the oil company’s liability policy. —By Seth V. Jackson, Zelle Hofmann Voelbel & Mason LLP


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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