California is the latest state to find itselfin the cross hairs of a national debate about hydraulic fracturing,which is commonly referred to as “fracking.”

Viewed by the most optimistic of our populace as “America's roadto energy independence,” the practice is muddying legislative andenvironmental waters. As concerns about water contamination,earthquakes, and property damage (both structural and related tomarket value) continue to trickle in, property and casualty(p&c) insurers find themselves smack in the middle ofconflicting scientific and political stances.

The enormity of exposure and resultant litigation, even if mostlytheoretical at this point, has p&c insurers worriedabout fissures to the already shaky public perceptions of theindustry, which is entrusted with far more than making good on thepromise and terms of a given insurance policy.

Digging Deep

From an insurance standpoint, reputational risk is arguably agreater concern than the equipment or technologies employed infracking. The process has been used for much longer than some mediareports let on—since 1947 in the United States—althoughenvironmental-liability coverage was not readily offered until thelate 1970s.

Historically, addressing pollution exposures of property owners,businesses, and contractors has been a relatively straightforwardendeavor for insurers. Carriers have long established solid methodsfor structuring coverage and making appropriate underwritingdecisions to minimize pollution exposure. It should be noted thatgeneral liability, professional liability, property and autopolicies typically exclude pollution. Thus, underwriters forenvironmental or specialty coverage weigh significant pollutionrisks in order to create suitable terms to fill in gaps that mayexist with standard lines.

Well-versed in handling these difficult risks, underwritersmight consider the following items:

• Is environmental liability subject to a sublimit under thepolicy?
• Are terms provided on an occurrence basis or claims-madeonly?
• Are fines, penalties and punitive damages covered (whereinsurable by law)?
• Are emergency-response costs included? If so, are theysublimited?
• Is coverage for natural-resource damage included?
• Is coverage provided for non-owned disposal sites?
• Are defense costs inside or outside the limits ofliability?
• Does the applicant have driller blow-out policy or wellblow-out coverage?

Despite the fact that carriers have reached a certain level ofcomfort in grasping an array of plausible pollution risks, frackingappears to be another matter, one that may involve addedcomplexities, such as contaminated property, bodily injury,clean-up costs, natural-resource damage, or transportation-relatedpollution. Moreover, even if liability is not established,policyholders will be looking for defense against third-partyclaims.

Now let's take a step back to consider the larger picture. Ifthe fracking process has not fundamentally changed, and ifthe related exposures are similar to that of otherenergy-extraction techniques, then what is going on?

“Do Not Drink This Water”

It's true the practice holds enormous potential for U.S.economic growth and diminished reliance on foreign energy sources.However, current pockets of litigation foretell an uphill battlefor insurers, who are obviously selective in the risks theyassume.

“The difficulty is not that drillers are doing something new anddangerous, but that the activity has a higher profile with moreenergized environmental lobbying,” Willis said of fracking in its2012 energy market report.

There is certainly no shortage of drama in the ongoing frackingdebate, which can make separating fact from fiction all the moreproblematic. One case in point is a recent confession by ColoradoGov. John Hickenlooper to the Senate Committee on Energy andNatural Resources. A staunch proponent of fracking, Gov.Hickenlooper told the committee that he once drank a glass offracking fluid produced by Halliburton, adding it wasn't “tasty”but that he “is still alive.”

Finding humor in the governor's odd disclosure, Minnesota Sen.Al Franken then asked if the experience was part of “some bizarreoccult practice.”

Iconic images captured in the Academy Award-nominateddocumentary GasLand have also fueled controversy. Onehandwritten sign in the 2010 documentary displays the verbiage, “DoNot Drink This Water,” while a Colorado man holds a flame to hiskitchen faucet and turns on the water, igniting a fire. Coloradoofficials later said they determined the gas wells were not toblame. Instead, the homeowner's own water well had reportedly beendrilled into a naturally occurring pocket of methane.

In any case, this is not the only report—or visual depiction forthat matter—of flammable drinking water, for lack of abetter term. Popular Mechanics reports that as much as 50layers of natural gas can occur between the surface and deep shaleformations, and methane from these shallow deposits hasintruded on groundwater near fracking sites. In May 2011,Pennsylvania officials issued the largest fine ever to a gasdrilling company. The state fined Chesapeake Energy $1 million forcontaminating the water supplies of 16 families in Bradford County,Penn. Because Chesapeake had not properly cemented its boreholes,gas spread along the outside of the well, between the rock andsteel casings, into aquifers. Engineers have since commented thatthe problem can be corrected by using stronger cement andprocessing casings to create a stronger bond, thus ensuring animpermeable seal.

More Transparent Processes

Also fueling public speculation is the fact that many drillingcompanies have only reluctantly divulged (after some very publicprodding) vital information about fracking fluid's composition. InJune 2010, Texas became the first state to pass a law requiringfull public disclosure of the chemical compounds used in drillingcompanies' wells. Just as insurance agents and claims adjustershave found—and practiced—over the years, greater transparency tothe process creates positive vibes with policyholders and thegeneral public.

In the case of the drilling chemicals, the regulationseventually revealed some interesting (benign) ingredients, such asinstant coffee and walnut shells. However, certain fluids containedknown and suspected carcinogens, including methanol and benzene.The larger issue for drilling companies and their respectiveinsurers is actually what to do with the fluid after it rises backto the surface. In Texas' Barnett Shale, for example, wastewater isreinjected into impermeable rock more than a mile below the ground.

Looming Legal Disputes

To date, the brunt of fracking-related lawsuits have beenconfined to contamination to surrounding properties, as well asground and surface water, as John F. Mullen and Kim Hollaender,attorneys with Nelson Levine de Luca, asserted in “Digging Deep:Fracking Litigation Trends,” which appeared in Claims'February 2012 issue.

“Suspected causes of contamination include faulty well-casings, improper drilling,and/or improper disposal of fracking fluids,” Mullen and Hollaendersaid. “These plaintiffs tend to live predominantly in rural areaswith private water wells said to be contaminated with frackingchemicals. Meanwhile, other plaintiffs allege high quantities ofnon-fluid substances in their wells as a result of the frackingactivity that caused hazardous substances, such as methane, to migrate into the wells.

“[More] recently, plaintiffs and their attorneys have pursued avariety of additional allegations of injury resulting fromfracking,” they continued. “Some plaintiffs charge that frackingresults in air pollution and excess noise, both with regard to thedrilling process itself and the compression stations employed.”

“Not In My Back Yard”

We know that fracking is being used to a greater extent thanperhaps ever before, and in more areas, some of which are heavilypopulated. This means that extraction operations are danglingprecariously close—or at least closer—to our backyards,carrying greater potential for disruption, damage, and safetyhazards that warrant careful consideration, if not immediatecredence.

Insurers may very well see an uptick in claims by homeownersaffected by fracking operations. Most homeowners' insurancepolicies extend coverage for direct physical loss or damage thepolicyholder's home and structures, but there are notableexceptions. The residents of Youngstown, Ohio, a Midwesternepicenter for fracking controversy, are intimately familiar withcertain “exceptions.” Numerous homeowners there have reportedsettling, cracking, shrinking, or other types of property damageallegedly stemming from nearby fracking site activity. Furthermore,some Youngstown residents allege graver consequences offracking—tremors and earthquakes. A case involving D&L Energyhas seemingly supported such claims. For instance, D&L Energyoperated a Class II injection well that was linked to a4.0-magnitude earthquake in Youngstown in 2011. According to apreliminary report released in March 2012, about 11 otherearthquakes in the Youngstown area emanated from within a half mileof that same 9,000-foot-deep injection well.

Subsequent reports that “all of the earthquakes originated fromwithin five miles of local drilling sites” in the area have beenproven false.

On the subject of earthquakes, are homeowners in any hurry topurchase additional coverage? Some experts contend that homeownersseeking coverage for incidents supposedly tied to fracking shouldopt for earthquake insurance. This raises some interestingquestions on both sides of the fence. Are already cash-strappedAmerican homeowners and businesses really interested in shellingout more in the way of insurance premiums? Even in California,which is notorious for its devastating rumbles and quakes,earthquake insurance premiums remain a hard sale.