BUSINESS CONFIDENTIAL
New Environmental Accounting Standards
and
a
d Environmental
o
e ta Counterparty
Cou te pa ty Analysis
a ys s
October 2012
Contact:
John Rosengard
(415) 982-3100
www.erci.com
Select notes included from the ERCI ASC 410-30 Webinar given on
October 1, 2 & 3, 2012
© 2012 Environmental Risk Communications, Inc.
New Environmental Accounting Standards


What’s new?
¾
“Rules” are no longer in effect (FASB 5, AICPA SOP 96-1, SEC SAB 92)
¾
“Standards” were issued in 2009, and are now in effect
¾
Recognition benchmarks, counterparty risk analysis are new
¾
Optional disclosure of trigger points (future reserve increases)
¾
FASB continuing
g alignment
g
with international standards ((IASB);
) SEC, PCAOB, AICPA,
and ASTM are all aligned
Key takeaways
¾
Transition to expected value
¾
Transition to present value, to match display of other contingent liabilities
¾
¾
Have good timing and more reliable estimates
Tabular reconciliation for display/disclosure (match AROs, pension)
© 2012 Environmental Risk Communications, Inc.
2
New Environmental Accounting Standards
GAAP < 2009
GAAP > 2009
Environmental Remediation
Liabilities
FASB 5
EITF 93-5
SEC SAB 92
AICPA SOP 96-1
ASTM E2137
ASTM E2173
ASC 410-30
Asset Retirement Obligations
FASB 143
FIN 47
ASC 410-20
410 20
© 2012 Environmental Risk Communications, Inc.
3
Example of New Standards: Recognition Benchmarks

From ASC 410-30-25-15, there are specific points when a “subsequent
measurement,” updating costs for a site-specific liability is expected:
¾
Identification and verification of an entity as a potentially responsible party
¾
Receipt of unilateral administrative order
¾
Participation, as a potentially responsible party, in the remedial investigation /
feasibility study
¾
C
Completion
l ti
off ffeasibility
ibilit study
t d
¾
Issuance of record of decision
¾
Remedial design through operation and maintenance, including post-remediation
monitoring
Almost identical to GASB
© 2012 Environmental Risk Communications, Inc.
4
Example of New Standards: Recognition Benchmarks
Primary
Characteristic
Secondary Characteristic
ESTIMATE
CLASS
LEVEL OF PROJECT
DEFINITION
Expressed as % of
complete definition
END USAGE
Typical purpose
of estimate
METHODOLOGY
Typical estimating
method
EXPECTED
ACCURACY
RANGE
Typical variation in
low and high ranges
(a)
PREPARATION
EFFORT
Typical degree of
effort relative to
least costs index of
1 (b)
Class 5
0% to 2%
Concept Screening
Capacity Factored,
a a et c Models,
ode s,
Parametric
Judgment, or
Analogy
L:-20% to -50%
H:+30%
30% to +100%
00%
1
Class 4
1% to 15%
Study or Feasibility
Primarily Stochastic
L:-15% to -30%
H:+20% to +50%
2 to 4
Class 3
10% to 40%
Budget
Budget,
Authorization, or
Control
Mixed, but Primarily
Mixed
Stochastic
L:-10%
L:
10% to -20%
20%
H:+10% to +30%
3 to 10
Class 2
30% to 70%
Control or Bid /
Tender
Primarily
Deterministic
L:-5% to -15%
H:+5% to +20%
4 to 20
Cl
Class
1
50% tto 100%
Check
Ch
k Estimate
E ti
t or
Bid / Tender
D t
Deterministic
i i ti
L:-3%
L
3% to
t -10%
10%
H:+3% to +15%
5 to
t 100
Notes: (a) The state of process technology and availability of applicable reference cost data affect the range markedly. The -/+
value represents typical percentage variation of actual costs from the cost estimate after application of the contingency
(typically at a 50% level of confidence) for given scope.
scope (b) If the range index value of “1” represents 0
0.005%
005% of project
costs, then an index represents 0.5%. Estimate preparation efforts is highly dependent upon the size of the project and the
quality of estimating data and tools.
Source: AACEI Definition of Cost Estimate Classes
© 2012 Environmental Risk Communications, Inc.
Definition we use at ERCI
5
Example of New Standards: Recognition Benchmarks
USEPA Guide to Developing and
Documenting Cost Estimates
During the Feasibility Study
(July 2000)
ASC 410-30 BENCHMARK A
BENCHMARK B
BENCHMARK C
D
E
BENCHMARK F
ASC 410-30
410 30 Benchmarks
Benchma ks
A. Identification and verification of
an entity as a potentially
responsible party
B. Receipt of unilateral
administrative order
C Participation,
C.
Participation as a potentially
responsible party, in the remedial
investigation / feasibility study
D. Completion of feasibility study
E. Issuance of record of decision
F. Remedial design through
operation and maintenance,
maintenance
including post-remediation
monitoring
Overlap
Previous Overlap
CLASS 5
CLASS 4
CLASS 3
CLASS 2
CLASS 1
© 2012 Environmental Risk Communications, Inc.
AACEI Estimate Classes
5. Concept Screening
4 Study of Feasibility
4.
3. Budget, Authorization or Control
2. Control or Bid/Tender
1. Check Estimate or Bid/Tender
6
Example of New Standards: Counterparty Risk

ASC 410-30-30-1(b):
¾

Does not specify
p
y / applies
pp
to environmental
obligations in general
Assess the likelihood that other potential responsible parties will pay their
full allocable share of the joint and several remediation liability.
410-30-30-7:
¾
An entity should assess the likelihood that each potentially responsible
party
p
y will pay
p y its allocable share of the joint
j
and several remediation
liability. That assessment should be based primarily on the financial
condition of the participating potentially responsible party. This assessment
requires the entity to gain an understanding of the financial condition of the
other p
participating
p
gp
potentially
y responsible
p
p
parties and to update
p
and
monitor this information as the remediation progresses. The entity shall
include in its liability its share of amounts related to the site that will not be
paid by other potentially responsible parties or the government.
• New expectations for everyone
• Must include probability of default
© 2012 Environmental Risk Communications, Inc.
7
Who are Your Environmental Counterparties?

PRPs or PLPs on a multiparty site cleanup

State or Federal agencies funding “orphan share” allocations

Insurers funding remedial work

Contractors on fixed-price contracts

Sureties providing financial assurance bonds

Banks issuing financial assurance letters of credit

Insurers providing your contractors with cost cap insurance, workmen’s comp,
commercial/general and automotive liability coverage

Landfills accepting new waste from your current projects

Landfills which accepted wastes from your projects in the past
© 2012 Environmental Risk Communications, Inc.
• Where future environmental cash flow goes
• They are your counterparties
Technically
Counterparty
8
Why do Your Environmental Counterparties Matter?

They are probably your leading source of new environmental projects

They are your principal reason for increased allocations at multiparty sites

Your stakeholders would benefit from thoughtful preemptive action
¾
Buying back a formerly-owned site before an enforcement action
¾
Joining a PRP group before a formerly-utilized landfill enters CERCLA
¾
Cashing out a PRP before they enter Chapter 7 (liquidation) or 11 (reorganization)

FASB wants you to understand and quantify this risk

Tracking is mandatory

This is no presumption of immateriality; this is a determination of senior
management based on data, not assertion
This is why it matters
© 2012 Environmental Risk Communications, Inc.
9
What Do We Know About Counterparties Already?

Identity

Terms of Purchase & Sales Agreement

Current credit capacity

If publicly traded, their financials and possibly their reserve policy
What Don’t We Know About Counterparties?

If they have transferred a liability onward

If they have a reasonable reserve for the counterparty liability

If they have bought any insurance coverage, including self-insurance
© 2012 Environmental Risk Communications, Inc.
10
Counterparty Risk on Environmental Liabilities

In ERCI’s experience…
¾
Commercial databases display live metrics of current financial health
¾
Corporate credit scores are real time
¾
10-K and other annual reports are not real time
¾
Average probability of default, across entire economy: 1.4%/year
¾
Commercial default = environmental default
¾
Credit range of economy is similar to credit range of a multiparty cleanup site’s PRP
group (not stronger or weaker than average)
1/3 Allocation disappeared after
Typical
yp
company
p y treats environmental
liabilities like any other
30 years

T k
Takeaways
¾
Counterparty risk is a significant
trigger to recent and future costs
¾
The “musical
musical chairs effect”
effect
averages out to 34.5% of lost
allocation in 30 years
¾
34.5% assumes credit rating and
allocation are perfectly
distributed
© 2012 Environmental Risk Communications, Inc.
N
Normal
lD
Default:
f lt 1.4%/year
1 4%/
11
Counterparty Risk on Environmental Liabilities
Issue
Effect
Baseline rate of default is 1.4%/year per PRP
The default rate is actually a range from
0.09%/year (highly-rated companies) to
10%+/year
Sequence of defaults is random
Larger companies tend to default in recession;
smaller companies tend to default in recoveries

Using Monte Carlo simulation, ERCI calculated the range of outcomes (p10 to
p90) over 30 years
2/3 Allocation disappeared after
30 years
Normal Default: 1.4%/year
1 4%/year
© 2012 Environmental Risk Communications, Inc.
Randomized for Credit Rating
12
Counterparty Risk on Environmental Liabilities
Issue
Effect
Allocation isn’t correlated to rate of default
Allocations vary from 0.01% to 100%, which is
the consequence from the (roughly) 1.4%/year
probability of default
All PRPs defaults are independent events
Small probability that all other PRPs default in
year 1
R d
Randomized
i d ffor Credit
C dit R
Rating
ti
© 2012 Environmental Risk Communications, Inc.
R d
Randomized
i d ffor Credit
C dit & All
Allocation
ti
13
Counterparty Risk on Environmental Liabilities


Randomized for Credit & Allocation
Takeaways
¾
Cost of default is significant
¾
Counterparty risk is concentrated in smaller PRP
groups (2-5 parties)
¾
Large group benchmark: “one-third of the PRP group
gone in 30 years”
¾
Small group benchmark: “we
we might lose a big PRP
next year”
Hypothetical Example
¾
Five PRPs,, all have 20% share
¾
$10 million in future costs over ten years, our share is $2 million now
¾
Random mix of credit ratings, assume we are the best of all five
¾
Counterparty
p y risk from the other four parties:
p
$155,100
$
,
¾
Our reserve should be $2,155,100, or 8% higher than $2 million
PRP
Credit Percentile (100 =
Best)
Probability of failure in
1st Year
Probability of failure by
10th Year
Current value of liability
A (us)
100%
0.03%
0.30%
$2,000,000
B
80%
0.09%
0.90%
$2,000,000
$9,900
C
60%
0.24%
2.38%
$2,000,000
$26,400
D
40%
0.24%
2.38%
$2,000,000
$26,400
E
20%
0.84%
8.14%
$2,000,000
$92,400
Sum:
$155,100
© 2012 Environmental Risk Communications, Inc.
At-risk, reduced for
interim payments
14
Any Change to “Probable and Reasonably Estimable”?

“Probable” now includes unasserted claims

“Reasonably estimable” (ASC 410-30-25-7) acknowledges inevitability of
uncertainties and identifies these four key factors:

¾
Extent and types of hazardous substances at a site
¾
Range of technologies that can be used for remediation
¾
Evolving standards of what constitutes acceptable remediation
¾
Number and financial condition of other potentially responsible parties and the extent
of their responsibility for the remediation (that is, the extent and types of hazardous
substances they contributed to the site)
FASB is essentially saying “we
we have heard all of this before; create a reliable
estimate anyway”
• Stepped process
• Cannot transition to Class 1 from no
previous
i
classification
l
ifi
i
© 2012 Environmental Risk Communications, Inc.
15
Best Practices: Tabular Reconciliation Summary
Environmental Liabilities by Year
Opening Reserve Balance (Liability)
2012
2011
2010
1000
900
800
+R
Reserve IIncreases
100
100
100
+/- Updated Estimates
100
100
100
+ Accretion
100
100
100
(200)
(200)
(200)
1100
1000
900
1250
1400
1500
Jan 1
- Spending
S
d
= End of Year Reserve
Dec 31
Loss Contingencies (see next page)
Future contingent reserve included
Opening Recoveries Balance (Contra Liability)
+ Recoveries Recognized
- Recoveries Received
Offsets value of
liability
= End of Year Recoveries
200
900 Net
200
200
100
100
100
(100)
(100)
(100)
200
200
200
100
200
300
Performed by some companies
Recoveries Contingencies
© 2012 Environmental Risk Communications, Inc.
16
Recognition Triggers of Loss Contingencies
Encouraged, but not required
Has to:

Site
• Calculate
Useful tool for environmental remediation liability forecasting
• Display to
Management
¾
ASC 410-30-50-9 “Disclosures that are encouraged but not required” • Decide
¾
Display for management of “reasonably possible” future reserve changes
¾
Site-specific
¾
Clear recognition trigger (event/decision)
¾
Range
g of costs, range
g of timing
g
¾
Can populate a multiyear probabilistic reserve increase schedule
Recognition Trigger
Value: What reserve
increases in what sequence?
Low Value
Expected
Value
High Value
Timing
28
40
60
3/31/2014
Site 1
CAMU size and installation year
Site 2
Remedy selection: SVE for 10 years
7
10
15
2014-2015
Site 3
Remedy selection: P&T for 30 years
49
70
105
1/1/2015
Site 3
Source removal: 300,000 CY soil (lead)
35
50
75
1/1/2015
Site 4
Scope of investigation
3.5
5
7.5
1/1/2014
Site 5
NRDA claim/damages
7
10
15
2015-2018
Site 5
30% design of soil removal 20,000 MT (lead)
21
30
45
7/1/2016
Site 5
Remedy selection for 195,000 MT (solvents)
28
40
60
7/1/2016
Site 6
Spill excavation, pipeline areas A-1 to C-10
14
20
30
2013-2014
…
Others…
…
975
…
…
Sum of Loss Contingencies
© 2012 Environmental Risk Communications, Inc.
1250
17
Best Practices: Recommended Disclosure Items
Environmental Liabilities by Year
2012
Loss Contingencies
2011
2010
1250
1400
1500
Determination within 12 months
200
350
450
D t
Determination
i ti
within
ithi 12
12-24
24 months
th
100
200
350
Determination within 24-36 months
100
100
200
Determination within 36-48 months
50
100
100
Determination within
h 48-60
8 60 months
h
50
0
50
0
100
00
750
600
300
Determination after 60 months

Typical supporting statements to management (not necessarily for disclosure)
¾
“There are near-term decisions related to site 1”
¾
“Decisions more than five years out relate to sites 15 and 19, and are contingent our
experiences
i
iin fi
finishing
i hi
the
h work
k on site
i 1”
© 2012 Environmental Risk Communications, Inc.
18
Best Practices: Recommended Disclosure Items
Environmental Liabilities by Year
2012
2011
2010
Counterparty Risk
Top 20% (least risk counterparties)
0
0
0
S
Second
d 20%
0
0
0
5
5
5
30
35
40
300
3 0
350
400
00
Middle 20%
Identify where risk is located
Fourth 20%
Bottom 20% (most
(
risk
k counterparties))
Display the trend

Typical
yp
supporting
pp
g statements to management
g
((not necessarily
y for disclosure))
¾
“All risk in the bottom 20% relates to insurers or tenants which have been noticed of
our contingent claims. If they file for bankruptcy, we will be noticed and need to
produce an estimate within 90 days of that filing or risk a permanent loss of future
contributions.
contributions.”
¾
“Only two companies make up 80% of the numbers shown above, and their status is
updated every 90 days.”
¾
“We’re not transferring large environmental liabilities to weaker parties.”
Highest risk to promote lower trend
© 2012 Environmental Risk Communications, Inc.
19
What Does Counterparty Risk Analysis Look Like?
Cost forecast x
allocation
Credit data researched
by ERCI
DNB
(1-5)
Contributions
under
d perfect
f t
conditions
Cumulative
l i
probability
b bili off
default
Risk Quantification
Probably of
some loss
l
of any kind
Best
Recoveries We Expect 2013-15
Recoveries We Expect 2016+
© 2012 Environmental Risk Communications, Inc.
What We Expect to Lose
• What is
financial risk?
• Contributions
to make
• Order for bank
20
What Does Counterparty Risk Analysis Look Like?
($000)
H
Hypothetical
th ti l

Key Takeaways
¾
Project
j
delays
y invite counterparty
p y risk
¾
Preventive action can be cost effective
© 2012 Environmental Risk Communications, Inc.
21
New Environmental Accounting Standards


Key takeaways
¾
Estimates should be more detailed
¾
Estimates should take more time
¾
Written variance analysis will help walk forward a reserve balance
¾
Table of recognition triggers will draw a bright line between “reserved” and “not yet
reserved,” and explain the direction of the portfolio
¾
Delays invite counterparty risk, preventive action can help
AACEI Class 3 or 2 estimates
Watchlist
“Display to Management” is not the same as “Disclosure to Shareholders”
¾
Estimate first, then display to management
¾
Let management decide what to disclose
• Estimate
• Display to Management
• Decide
© 2012 Environmental Risk Communications, Inc.
22
Conclusion

Questions?

Visit www.fasb.org to view ASC 410-30. Signup and
browsing is free.
© 2012 Environmental Risk Communications, Inc.
23