Financial Assurance Mechanisms
Companies that need to provide financial assurance or proof of financial responsibility must figure out how much financial assurance is necessary.
Once a company knows how much coverage they must provide, they will need to figure out which of the several Financial Assurance mechanisms is most appropriate. These mechanisms are options for covering the costs associated with closure, cleanup, accidents or other contingencies.
There are many options to choose from when deciding how to provide your financial assurance. Each of these options is a “mechanism.” Some of those options cost more than others, but all of them are equal as far as the law is concerned.
A financial assurance trust fund works like a trust fund for a child: you put money into an account and a Trustee invests and manages the money. If there are expenses, the Trustee can pay them if they’re allowed. On the plus side, using a trust fund is very simple: you don’t have to think about it and it’s all taken care of. On the down side, if your trust fund loses money in the market or your expenses go up unexpectedly, you’ll need to add money to the trust fund to keep it up to date. You’ll also need to pay the Trustee to manage the trust fund—most Trustees charge about 4% of the total in the account every year, so you need to make more than that on your investments to keep ahead of expenses. The biggest downside is the pay-in: you’ll need to pay all of the money into the trust fund on day one! That means you can’t use that money for other things, like payroll or improving your facility. If your cost estimate is very large, you might not even be able to fully fund your trust, which means you won’t be allowed to use this option. If you choose to use a trust fund, you must use the exact language that is in the law without changing any words in the trust agreement at all. The trust agreement itself is called an “instrument” and is the document that actually sets up the trust fund. Ecology has forms you can use to make sure you’re using the right words in your instrument.
Using a letter of credit is a popular option for financial assurance. The form (available from Ecology) is fairly short and simple. It promises that the bank will pay the amount of the letter of credit if and when the Department of Ecology says it is due. Banks generally charge an annual fee of between 2% and 5% of the face value for a letter of credit. That means a letter of credit for $100,000 will usually cost $2,000 to $5,000 per year to maintain. The language for a letter of credit used as financial assurance is mandated in the law and cannot be changed, even if your bank wants different wording. A "standby" trust agreement is also required for this form of financial assurance.
Insurance is a very popular option for third-party liability financial assurance. It is rare for closure, post-closure, or corrective action financial assurance. For third-party liability, insurance works like a car or homeowner’s insurance policy. The facility pays a premium and the insurance company agrees to pay a claim if one occurs during the policy period.
Using insurance for closure, post-closure, or corrective action is more complicated and more difficult to find. Most insurance companies don’t write these policies anymore. Some may sell a "fully-funded" policy, which is sort of like a combination of a trust fund and a bond. With fully-funded policies, the facility pays into a clean-up fund over a number of years (plus a yearly premium to the insurance company). Companies that would like to use a trust fund but can’t afford to pay everything up front might like to use insurance instead. When it is time to close the facility, the facility owner will have to pay for closure. After closure is finished, the facility owner will get their money back from the insurance company. That means the owner will have to pay for closure twice, but they get their original money back if they comply with the terms of their insurance contract.
If a facility would like to use insurance for financial assurance, Ecology has to approve the terms of the policy. This type of financial assurance does not need a standby trust agreement. To prove you have met the requirements, you’ll need to submit a short form with mandatory language. Like the other financial assurance forms, Ecology can give you a copy.
The financial test is basically a form of self-insurance. It is limited to the biggest and most financially stable companies. Almost all companies that use the financial test to meet their financial assurance obligations are traded on the stock exchange. Smaller companies probably won’t qualify to use this option. The financial test requires a company to meet very strict financial performance standards. If a company is so healthy that there’s virtually no chance they’ll go bankrupt in the next year, they can use this test to meet the legal requirements for financial assurance. Companies that use this option must submit a mandatory form along with a copy of their audited financial statements for the previous year and a special report from their accountants. Getting the extra report from the auditor costs extra, but the rest of the forms are free.
The corporate guarantee is almost the same as the financial test. The big difference between the two is which company meets the financial test requirements. If a company is part of a larger corporate family, the company can have their parent company pass the financial test instead. Companies that choose this option must also provide an extra document from the parent company that promises to cover the necessary expenses. All the required documents have mandatory language that Ecology can provide. Companies using the corporate guarantee for their third-party liability coverage also need an extra document from the Attorney General in their home state.
A payment bond is the same thing as a “surety bond for payment.” If you wanted to use this option, you would go to a bonding company. Your company and the bonding company would sign a contract and you would pay the bonding company a premium (just like when you buy insurance). The bonding company would sign a document that basically promises that you will do the closure (or post-closure or corrective action cleanup) like you are supposed to. If you don’t, the bonding company promises to pay the amount of your cost estimate. The money would go into a standby trust fund and then it would work just like a normal trust fund. Payment bonds are not as common as they used to be, but there are still some companies that offer them. Your insurance agent may be able to help you find a bonding company if you are interested in using a payment bond for financial assurance. If you choose a bond, you’ll need to prepare a trust agreement just like you were using a trust fund (only you don’t give the Trustee any money at the beginning).
A performance bond is the same thing as a “surety bond for performance” and is very similar to a payment bond. The difference between a performance bond and a payment bond is what the bonding company promises to do. If you use a performance bond, the bonding company still promises that you’ll do the closure (or post-closure or corrective action cleanup). If you don’t do what you’re supposed to, the bonding company gets a choice: they can either pay the amount of the bond into your trust fund (just like the payment bond) or they can choose to hire a contractor and do the work themselves. Using a performance bond is just like using a payment bond except the mandatory wording is a little different. All of the other requirements are the same. Performance bonds are very unusual and might be very difficult to find.
Note that options that pay money out directly (letters of credit and bonds) also require a standby trust agreement. The trust uses the same agreement as a regular trust, but it won’t actually get created unless there is a default on obligations and Ecology steps in. The standby trust agreement needs to be in place because Ecology needs to tell the bank or bonding company where to send the money in case of default. The state can’t take the money—it doesn’t belong to the government. Having a trust agreement standing by and waiting to go takes care of that problem. That’s why insurance policies don’t need a trust agreement—the insurance company doesn’t pay out the full amount of the policy. Instead, they keep control of the money and just pay the bills as they are submitted.
For More Help
The Department of Ecology is currently working on developing more Web-based forms to help you prepare financial assurance documents. Until they are available, email us, and we can send a Microsoft Word document to fill in. We can assist with all forms.
Whether for a business owner who needs financial assurance, an insurance agent who represents companies that provide financial assurance, or just an interested private citizen, we are happy to explain financial assurance. To know more about financial assurance email Kimberly Goetz , Ecology’s Financial Assurance Officer, or call her at (360) 407-6754 .
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