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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 financial assurance mechanism to use. These mechanisms are options for covering the costs associated with closure, cleanup, accidents, or other contingencies. All mechanisms are equal under the law.

Trust fund

A financial assurance trust fund works like a trust fund for a child — money is deposited into an account and a Trustee invests and manages the money. If there are expenses, the Trustee can pay them if they’re allowed. If your trust fund loses money in the market or your expenses go up unexpectedly, money will need to be added to the trust fund to keep it up to date. The Trustee is typically paid to manage the trust fund. The primary downside is that all money needs to be paid into the trust fund upfront. The exact language that is in the law must be used in a trust agreement. The trust agreement itself is called an “instrument” and is the document that actually sets up the trust fund.

Letter of credit

Using a letter of credit is a popular option for financial assurance. The form (available from us) is simple. It promises that the bank will pay the amount of the letter of credit if and when it is determined by us that it is due. Banks generally charge an annual fee of between 2 percent and 5 percent 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

Insurance is a popular option for third-party liability financial assurance. It is rare for closure, post-closure, or corrective action financial assurance. For third-party liability, the facility pays a premium and the insurance company agrees to pay a claim if one occurs during the policy period.

Insurance for closure, post-closure, or corrective action is difficult to find. Most insurance companies don’t write these policies anymore. Some may sell a "fully-funded" policy. 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. 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 contract.

We must approve the terms of the policy. This type of financial assurance does not need a standby trust agreement.

Financial test

The financial test is a form of self-insurance. It is limited to the biggest and most financially stable companies. 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.

Corporate guarantee

The corporate guarantee is similar to the financial test. The 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. Companies using the corporate guarantee for their third-party liability coverage also need an extra document from the Attorney General in their home state.

Payment bond

A payment bond is the same thing as a “surety bond for payment.” Your company and the bonding company sign a contract and you pay the bonding company a premium. The bonding company signs a document that 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 goes into a standby trust fund and then it works 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. If you choose a bond, you’ll need to prepare a trust agreement just like you were using a trust fund, except you don’t have to pay upfront as if you were using a Trustee.

Performance bond

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, 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.