Insurers Weigh Risks of an Oil Train Catastrophe

In the event of a mass-casualty accident involving the derailment of a crude-carrying train in a densely populated urban area, who would be responsible for the compensation for deaths, injuries, damage to property and environmental clean up?

The short answer is the railroad operator. By law, the operator of any railroad in the United States or Canada cannot refuse to transport any cargo, no matter how hazardous, provided it conforms to applicable regulations.

Marine and air transportation carriers can limit their liability as a condition of carriage. But uniquely in the case of rail, the railroad operator cannot insist on an agreement sharing the risk with the shipper. The railroad operator is liable for all costs in the event of an accident up to an unlimited amount.

“Once the railway has received a car from a shipper, all of the risk and exposure associated with that car are then transferred to the railway even when the liability arising from the carriage of the dangerous goods is not caused by the negligence of the railway,” Canadian National wrote in a letter to the Canadian Transportation Agency (CTA) on January 21.

“Should an incident occur within or near a densely populated area … an incident … has the potential to be truly catastrophic and result in billions of dollars in personal injury and property damage claims,” the Association of American Railroads (AAR), which represents railroad operators, wrote in its own submission to the CTA.

“The damages potentially resulting from an exposure could risk the financial soundness and viability of the rail transportation network in North America,” the AAR warned.

The transportation agency is urgently reviewing the rules covering third-party liability and minimum insurance cover following the rail disaster at Lac-Megantic, Quebec, in July 2013, when 63 tank cars containing crude oil derailed, causing a fireball that killed at least 42 people and destroyed the town centre.

Montreal, Maine & Atlantic, the train operator at Lac-Megantic, filed for bankruptcy protection just one month later when it became clear that costs arising from the accident would overwhelm the company.

The costs of the clean-up alone have been put at $200 million. Compensation for deaths, injuries and damage to property will add hundreds of millions more. Montreal, Maine & Atlantic had liability insurance of only $25 million, typical for a small railroad.

On October 16, Canada’s federal government promised it would toughen safety standards and “require shippers and railways to carry additional insurance so they are held accountable,” as part of the governor-general’s speech from the throne outlining the legislative programme for the coming parliamentary session.

The Canadian Transportation Agency is reviewing all aspects of rail insurance, including whether railroad operators should be required to obtain minimum levels of cover, and whether special rules should apply to the carriage of hazardous cargoes such as crude oil and ethanol.

Changing the liability rules to enable railroads to pass some of the risks on to shippers is outside the review’s scope, as it would require changes to legislation in both Canada and the United States. But the throne speech implies it could be considered by senior policymakers at some point in future.

“Every time we pick up a carload of chlorine, we’re placing a bet on the company,” Norfolk Southern Chief Executive Charles Moorman told the Wall Street Journal in a superb article about the problems posed by limited railroad insurance (“Fiery Oil-Train Accidents Raise Railroad Insurance Worries” Jan 8).

Moorman’s example was not entirely fanciful. In the early hours of January 6, 2005, a train carrying 42 freight cars, including three tank cars filled with chlorine (which is highly toxic) and one of sodium hydroxide (a strong corrosive) derailed in the small town of Graniteville, South Carolina, when wrongly set points sent it into a siding, where it collided with a stationary train.

Graniteville’s population was just 1,200. The moving train was travelling at only 47 miles an hour. The industrial area around the siding was largely empty at that time of night. Only one of the chlorine tanks burst. The two others, plus the tank car carrying sodium hydroxide, safely contained their deadly contents.

The poisonous chemicals were being moved in specially reinforced tank cars that were much less likely to breach in the event of a train derailment than the much-criticised Class 111 tank cars now being used to move crude oil and ethanol.

Nonetheless, the chlorine tank that ruptured in Graniteville emitted a lethal gas cloud that killed nine people (including the train engineer). Some 554 others were taken to local hospitals complaining of respiratory problems (75 were admitted). In total, more than 5,000 people had to be evacuated from within a 1-mile radius for several days. Chlorine gas settled into the local river and killed hundreds of fish.

Norfolk Southern eventually paid $4 million in civil penalties under the Clean Water Act and other federal environmental laws, but that has been dwarfed by payouts for deaths, injuries and damage to nearby businesses.

It is easy to see how the accident could have been much worse if it had occurred in a densely populated area in daytime.

Just one of the three chlorine tanks that derailed at Graniteville released its contents. By contrast, 60 out of 63 Class 111 tank cars carrying crude that derailed at Lac-Megantic ruptured and released their contents in a terrifying inferno.

In a larger and more densely populated urban area, the loss of life and damage to property could be even more devastating.

Railroad operators and safety regulators have taken steps to mitigate the risks and prevent “catastrophic release or explosion in proximity to densely populated areas,” according to the U.S. National Transportation Safety Board.

Trains carrying poisons, explosives and radioactive materials are designated as “key trains” – subject to a strict speed limit of 50 miles per hour, given priority over all other trains on the network, and routed away from densely populated areas wherever possible.

Following the disaster at Lac-Megantic, the key train designation will be extended to any train carrying 20 or more freight cars of hazardous material, including flammable liquids such as crude or ethanol.

So far, with the exception of Lac-Megantic, all the derailments involving flammable liquids have taken place away from major towns. Routing trains away from urban areas and imposing speed restrictions can mitigate some of the risk, but they cannot eliminate it entirely.

“A railroad moving hazardous shipments faces exposure to potentially ruinous liability,” the Association of American Railroads told the Canadian Transportation Agency’s review.

“A carrier can be exposed to, and found responsible for, enormous damage claims even where it has done nothing wrong,” AAR observed. “While incidents involving highly hazardous materials on railroads are exceedingly rare, railroads could be subjected to multi-billion dollar claims solely because of the unusual characteristics of the commodities themselves.”

“Insurance does not provide a viable means to fully mitigate this risk,” according to the AAR. “Insurance should be recognized for what it is; an inadequate secondary layer of protection,” Canadian Pacific railroad emphasized to the CTA.

Part of the problem is there is just not enough insurance to cover a really serious incident. There are only 30 or 40 companies willing to offer railway liability insurance, typically in discrete amounts of $5, $10, $20 or $50 million, which are then bundled together in liability stacks to provide the desired amount of cover for a railroad, according to the CTA.

The maximum coverage available to a major railroad is between $1 billion and $1.5 billion. In its 2012 annual filing with the Securities and Exchange Commission (SEC), Norfolk Southern disclosed that it self-insures for losses up to $50 million from a single incident, has insurance coverage up to $1 billion, but self-insures again for amounts over that limit.

“Given the number of players in the rail insurance industry and their risk tolerance, there are practical limits to what railway companies can obtain in the market for third-party liability insurance,” the CTA acknowledged in a discussion document published in November 2013.

Following a major disaster, or a terrorist attack on a hazmat train, coverage might not be available at any price, or only on unacceptable terms, as all the railroad operators disclose in the “risk factors” section of their annual SEC filings.

The Canadian Transportation Agency’s review, and the resulting submissions from both rail operators and shippers, have outlined several options for liability reform.

One option is to require railroads to obtain a minimum amount of cover, perhaps depending on the mix of cargo they carry.

At present, the CTA requires railroads to have “adequate” insurance but doesn’t specify an exact amount because operations vary so much in terms of commodities carried, whether the railroad operates in rural or urban areas, etc.

The CTA’s equivalent in the United States, the Surface Transportation Board, does not even review the adequacy of insurance, which is regarded as a commercial matter for the railroad operator.

In theory, the CTA could specify a minimum insurance level for the railroads’ operations in Canada. But given the limited amount of cover available, it might not make much difference.

The railroads themselves want Canadian and U.S. governments to legislate a cap on their maximum liabilities for any one accident. Similar caps operate in other sectors like marine transport and nuclear power generation.

In the nuclear sector, the U.S. Price-Anderson Act limits the liability of any one company from the release of radioactive material. Losses about that level are covered by a fund to which all companies in the industry contribute.

As an alternative, the railroads want a change in the law to allow them to insist shippers share some of the liability as a condition of carriage before accepting a hazmat cargo.

Passing some of the risk on to shippers, and requiring them to self-insure or obtain adequate cover, would lower the risk of a catastrophic loss for the railroads.

More importantly, it might also make shippers more careful and reduce the total amount of risk involved in carrying hazmat loads such as crude oil.

At the moment, shippers can force railroads to accept a hazmat cargo provided it is offered in the correct type of container, and pass on all liability, even if they could have used an even safer container.

That explains why the shippers and tank car companies want to carry on using old Class 111 tank cars even though the dangers with them are well known, since there is no additional risk to them.

If shippers and tank car companies were made jointly liable and required to have their own insurance, there would be a much stronger incentive to phase out unsuitable Class 111 tank cars from crude and ethanol service much faster.

Naturally, the shippers do not agree. “It is imperative that liability continues to rest with the carrier,” the Renewable Fuels Association told the CTA on behalf of ethanol shippers. “This will help maintain accountability in the shipping industry and keep safety standards high.”

Hazmat shippers already pay significantly higher rail transport rates, according to the ethanol industry, to compensate railroads for the risks involved. But no rate premium can truly compensate railroads for the losses associated with a catastrophic incident.

From an insurance perspective, it is critical to route oil trains away from urban centres and retire Class 111 tank cars from oil and ethanol service as quickly as possible, to limit the risk of a catastrophe that could push one of the major railroads into bankruptcy.