Surety Exposure in Coal — A 2021 Perspective
By George W. Thompson, SIAS Senior Advisor, Surety & Financial • 8/16/2021
As a boy growing up in Pittsburgh, I became intimately aware of the coal-mining industry. Many homes in the general area where I was raised were built on top of old, abandoned deep mines. My parents’ home had a coal chute, coal-storage cellar, and a coal-fired furnace. Subsidence of homes, other buildings, and roads was always a concern. In my travels throughout western Pennsylvania, there were many abandoned strip mine operations and boarded-up deep mine portals where the coal had been depleted, and big holes, rusting equipment, and water hazards were all that remained.
In 1977, the Federal Surface Mining Control and Reclamation Act (SMCRA) was enacted to bring a universal body of law and reclamation standard to all States where any type of coal (bituminous, anthracite, orlignite) was being mined. Some States, like Pennsylvania, had already toughened their State reclamation requirements. Under SMCRA, affected States were offered the opportunity to accept and enforce the Federal standard under a concept known as primacy. Several States did not establish primacy and the Federal Office of Surface Mining, Reclamation and Enforcement, under the U.S. Department of the Interior, assumed the enforcement responsibility.
The enactment of SMCRA afforded the domestic surety industry with the premium generation opportunity to issue reclamation bonds to guarantee that mining companies would reclaim disturbed lands and restore them back to their original contours and usages. In simple terms, that meant grading, seeding, tree planting, and site monitoring or ongoing maintenance for a predetermined period. As these benchmarks were achieved, mining companies could apply for reductions in the posted surety penal sums and ultimately obtain a total release of the bonds.
As time went by, the basic reclamation requirements were extended by statute to include water runoff management and pollution remediation obligations. Those additional exposures extended the life of the surety bond and on some permits eliminated the potential for either reductions or releases if the State determined perpetual water treatment was necessary. The surety bond now became not only a reclamation guarantee, but also a security mechanism for funding future water management in the event of the operator’s insolvency.
Each of the various coal-mining States had their own calculus, if you will, to set the bond penal sums based on type of mining, size of permit, expected permit life, etc. Initially, the surety industry was reluctant to issue reclamation guarantees. To fill this void, new, less capitalized surety companies entered the marketplace. Many of those surety companies are no longer in business. In recent years, surety risk appetite returned to the coal industry with several new, better capitalized surety companies entering the market, each competing for a share of an individual mining operator’s surety program.
So, what’s happened? Coal has fallen on difficult times and no longer has an enviable position in the power generation sector. Coal-fired powerplants are being dismantled. States are looking at significant reclamation and water-management issues. Bond amounts posted are inadequate to cover the full cost of reclamation let alone funding water-related issues. State funds, or pools, are in jeopardy and future funding via coal-tonnage production royalties will be severely affected.
On June 7, 2021, the Joint Committee on Government and Finance, West Virginia Office of the Legislative Auditor, released an 80-page report on the status of reclamation in its State. Quite frankly, nothing in that report is a revelation! Absolutely nothing has changed in West Virginia, only the names of the players.
In summary, disturbances are bigger, water issues have increased, coal companies have filed for bankruptcy and reorganized, the future for coal is bleak, and the largest surety provider in the State is one coal bankruptcy away from insolvency. Last, but not least, posted security by the coal companies (surety bonds, cash, letters of credit,and certificates of deposit) will not come close to covering the actual cost of reclamation and post-mining water monitoring. Furthermore, the State Special Reclamation Funds will be quickly exhausted with little or no hope of replenishment. This is because the coal operators cannot make tonnage payments if no coal is being mined. The only hope is the Federal Abandoned Mine Land Reclamation Fund (AML Funds) that is available to all States sharing similar issues and concerns. The United Mineworkers Union also has a stake in the AML Funds to pay for medical benefits for retirees and their dependents. Once again, this fund is generated from coal tonnage royalties from all active coal-mining operations in the United States.
Coal-mining companies have never been the darling child of the surety industry and the reinsurance companies that provide support for the primary issuers of the bonds. A reclamation bond is a long-term, indefinite obligation (non-cancelable, even for non-payment of premium), and subject to regulatory oversight. Owing to noncompliant operators, the coal industry has earned a black eye with many constituencies. The surety industry’s risk appetite for underwriting coal has fluctuated over time, and smaller or less capitalized coal operators have struggled to find surety to support their bond requirements under mutually satisfactory underwriting terms and conditions.
Meanwhile, several surety companies got creative to fill the void. With pressure from lobbyists, trade associations, and other organizations, these new providers were welcomed with open arms by the regulators and Insurance Commissioners. For the most part, these new entrants lacked underwriting sophistication, sufficient balance sheet capital and surplus to support their commitments, a U.S. Treasury limit,[1] and an AM Best rating.[2] A U.S. Treasury limit and an AM Best rating are minimum entry requirements in most States to issue surety bonds of any type or size.
Where are we in 2021? A significant shortfall in security to fund the full cost for reclamation and, more importantly, for treatment of post-mining water discharges. One or more surety companies have aggregate surety liabilities that cannot be covered by their own balance sheets. So, who is left holding the bag? Where does the accountability rest?
It cannot be placed solely on the back of the coal-mining industry! The industry, once vital to the U.S. economy, is struggling to survive. The market demand for thermal coal has been declining while the cost of extraction has been increasing; cheaper fuel alternatives, such as natural gas, are becoming more readily available; and environmental concerns, particularly of legacy mining, are at a critical point, particularly concerning who will pay for the required cleanup and mitigation.
The exception is mining for metallurgical coal, which is necessary for steel manufacturing, and thus it is vital for the United States that this segment of the coal industry survives. But this is a small segment compared to thermal coal. The 42.7 million short tons of anthracite coal mined in the United States in 1949 accounted for 8.9% of total U.S. coal production of 481 million short tons; in 2019, U.S. production of anthracite coal was 2.6 million short tons, which was only 0.4% of total U.S. coal production of 706 million short tons.[3]
So, if a large sector of the coal industry defaults on paying for the cleanup of decades of mining, some of the sureties underwriting these costs falter, and the State bond pools are insufficient, then the brunt of the costs will end up in the public’s lap because the alternative, not to clean up, will result in serious threats to the environment, water quality, and public health.
[ 1 ] The U.S. Treasury limit (T-limit) is established every year on July 1 by the U.S. Department of the Treasury. The T-limit is based on a capital and surplus analysis of the financial condition of a surety; the resulting value is the maximum penal sum that the surety is authorized to issue on an individual surety bond. Any bond issued in excess of the T-limit must have the additional support via acceptable collateral or facultative reinsurance.
[ 2 ] AM Best, founded in 1899, is the world’s first credit rating agency. “A Best’s Credit Rating (BCR) represents an independent opinion of an insurer’s financial strength and its ability to meet its ongoing insurance policy and contract obligations.” Best’s Credit Rating Methodology (BCRM)
[ 3 ] Table ES1. Coal Production, 1949-2019