Environmental Liability Management: Loss Contingencies
June 12, 2014 - Kestrel Management • dynaQ
Cost-effective management of environmental liabilities is a challenge for any organization, but it is particularly challenging for those companies with a large portfolio of liabilities at varying stages of maturity. The complexity of liability management is increased even more for those organizations adhering to generally accepted accounting practices (GAAP), which apply additional requirements to the process. Ultimately, the goal of liability management is to create a reliable system that enables the company to minimize risk and quickly drive projects to closure with as little expenditure of internal and external resources as possible.
The manner in which a liability is accounted (and managed) is based largely on the liability itself and the available information. Environmental liabilities are typically managed as either loss contingencies or asset retirement obligations (AROs). A company may also decide to address certain environmental liabilities as operating expenses or capital expenditures. Regardless, companies should employ a cross-functional team (i.e., finance, law, operations, and EHS departments) to establish and document a repeatable and defensible process—consistent with applicable GAAP standards—for how the liability will be managed. Further, companies should develop standard procedures that define how and when costs associated with the liabilities are estimated.
This article is the first of a two-part series that provides an overview of loss contingencies and AROs and outlines some of the best practices for effective management of environmental liabilities. The first installment focuses on loss contingencies; the second will address AROs.
Environmental Loss Contingencies
An environmental loss contingency represents the cost to remediate an environmental liability where:
- It is probable that the liability has occurred, and
- The cost can be reasonably estimated.
The GAAP for loss contingencies is established in Accounting Standards Codification (ASC) 450-20. In very general terms, environmental loss contingencies include environmental investigations and remediation that are not the result of normal operations and that are generally triggered by a regulatory agency action or order.
As stated, the goal of loss contingency management is to create a system to cost-effectively minimize risk and quickly drive projects to closure, while keeping in mind the ultimate outcome of enabling future final use options to return the property to productive and valuable use without rebound liability.
Lifecycle Costs of Remediation
While the most significant cost of a remediation project is typically the expense of the remediation itself, the overall lifecycle cost of a project can be impacted significantly by the following:
- How efficiently a project moves from stage to stage (milestones) and, ultimately, to closure. Many projects get stuck at some point along this path, often significantly increasing the overall project lifecycle cost. Maintaining project velocity through each milestone can keep costs in check.
- The project team’s understanding of critical aspects of the Conceptual Site Model (CSM) before remedies are selected and implemented. Often, projects jump to a remedy—particularly interim remedies—before there is a clear understanding of the CSM (i.e., constituents of concern (COCs), pathway, receptors), resulting in premature or only partial remediation.
- Failure to address all risks associated with a site. This can include physical risks associated with buildings, foundations, and other historical operating structures and equipment.
- The project team’s understanding of the designed project end point. A periodic assessment of the end point of a project is vital to aligning stakeholders and ensuring that all efforts are directed toward the desired outcome. As data and information are collected on a project, it is sometimes necessary to reset the project strategy toward an alternative end point.
- How efficiently and effectively the project team communicates critical project information for decision making. A portfolio-based approach establishes a standard way of communicating project activities, schedule, and budget. This allows for more efficient communication between critical internal stakeholders (e.g., legal, public relations, real estate, and senior management) and with external consultants/advisors.
Portfolio-Based Management Model
There are several key elements to developing an effective portfolio-based management model, including those described in the sections below.
Standard Project Milestones
Controlling a large number of ongoing site remediation projects requires establishing a series of standard project milestones (i.e., project progressions) and associated work subtasks. This standardization establishes a common language and sets the framework for developing common subtasks for project budgeting and scheduling.
A milestone structure for remediation projects would typically include the items listed below. This structure can be adapted to projects where certain impacts to groundwater or soils can move at different velocities through project milestones.
- Project startup: Early project activities that typically include records review, strategy development, regulatory agreement negotiations, etc.
- Preliminary site investigation: Initial data gathering to assess the nature and extent of the impacts; may end with a Remedial Investigation Report (RIR)
- Site characterization and risk assessment: Complete characterization of the site to develop a CSM based on COCs, pathways, and receptors, and to identify physical aspects of the site that must be addressed as part of the project
- Feasibility study: Assessment of alternative remedial options
- Final design: Post-regulatory approved remedy design
- Implementation and OM&M: Remedy implementation and ongoing operation, maintenance, and monitoring
- End point: The targeted point for each project when all work necessary to eliminate the risk has been conducted or the point when no further work will result in additional risk mitigation
Standardized Work Breakdown Structure
For each of the milestones, a common set of subtasks is established to facilitate the development of detailed project workplans and for schedule and cost tracking. These subtasks ensure that workplans consider all the activities required to complete the work and allow for standardization across projects.
Having standardized project milestones and subtasks creates an additional benefit in that they can be used to create a more consistent and documented method for estimating contingent liability under ASC 450-20. By developing lifecycle cost estimating rules for each milestone, a company can ensure that its projects are using a common estimating logic (i.e., known and estimable) for determining the cost of investigation, design, and remedy implementation. A similar process could also be developed to ensure common estimating standards are applied to AROs ASC 410. (AROs will be discussed in more detail in our upcoming newsletter).
Project Control and Change Management
One common flaw in remediation projects is the tendency to enter into interim remedies or to identify a remedy that is not supported by data. This often results in incomplete remedies being implemented or remedies being installed that are not tied to a clear end point.
Developing standard project workplans allows for efficient project control and change management. As work progresses through milestones, data and information emerge to help identify a data-driven set of alternative remedies or a presumptive remedy. The disciplined progression of a project through milestones prevents projects from jumping to a preferred remedy without supporting data.
In addition, periodic review meetings—a key project control—create touch points to:
- Review all aspects of the project’s scope, schedule, and budget
- Test the validity of the end point
- Emphasize the continued forward momentum of the project
Centralized Project Database
Implementing a centralized database, such as Kestrel’s liability and asset management software (built on our dynaQ™ platform), to house all project workplans and other key documents provides another valuable project control. The central project database becomes the real-time repository for project information. Kestrel’s software includes the following:
- An internal database for tracking project scope, schedule, and budget for projects in a web-based workplan format
- Exportable workplans for use outside the database
- Password-protected access of the system to allow consultants to see only their projects and company staff to see all projects
- Front-end dashboard to allow senior management to monitor key project activities/status at a glance
- Ability to store key documents for each project
- Customizable project information page that houses project information (e.g., key contacts, project details, COCs, involved media)
- Customized project reports and summaries
- Ad hoc query capability
Periodic Project Reviews
Despite all good intentions, projects (particularly complicated ones) can drift off track or hit dead ends. When these situations occur, Integrated Site Reviews (ISR) can keep projects progressing to the appropriate end point.
A formal ISR can include an external facilitator for larger, more complex projects or be adapted by the project team for smaller projects. An ISR typically follows these steps to validate the project’s direction or to reset a new direction:
- An ISR team is formed consisting of a cross-functional group of stakeholders that could include the consultant, legal, internal environmental manager, real estate, operational staff, and other outside experts. Pulling together all stakeholders ensures that there is alignment and agreement on the selected end point.
- The ISR team meets (typically for no longer than a day) and goes through a structured review of technical, regulatory, legal, and third-party project drivers.
- Depending on the stage of the project, a blue sky set of alternative end points is identified.
- The alternative end points are developed, discussed, and evaluated.
- In the end, the current end point is either validated or a new end point is developed.
- All necessary changes to the project workplan are made.
Companies can respond to the challenge of managing contaminated properties by either internally staffing up to provide day-to-day oversight of the projects or by outsourcing the projects to a consultant, who can efficiently execute the project and serve as the public face. Whichever route a company decides to take, following the key elements described above will allow for effective portfolio-based management that will reach the desired end points.
Stay tuned for the second article in this series on environmental liability management, which will address AROs.
Submitted by: A.W. Armstrong