LONDON (Reuters) – In the event of a mass-casualty accidentinvolving the derailment of a crude-carrying train in a denselypopulated urban area, who would be responsible for the compensationfor deaths, injuries, damage to property and environmental cleanup?

The short answer is the railroad operator. By law, the operatorof any railroad in the UnitedStates or Canada cannot refuse to transport anycargo, no matter how hazardous, provided it conforms to applicableregulations.

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

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

“Should an incident occur within or near a densely populatedarea … an incident … has the potential to be truly catastrophic andresult in billions of dollars in personal injury and propertydamage claims,” the Association of American Railroads (AAR), whichrepresents railroad operators, wrote in its own submission to theCTA.

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

Insurance review

The transportation agency is urgently reviewing the rulescovering third-party liability and minimum insurance coverfollowing the rail disaster at Lac-Megantic, Quebec, inJuly 2013, when 63 tank cars containing crude oil derailed, causinga fireball that killed at least 42 people and destroyed the towncentre.

Montreal, Maine & Atlantic, the train operatorat Lac-Megantic, filed for bankruptcy protection just onemonth later when it became clear that costs arising from theaccident 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 addhundreds of millions more. Montreal, Maine & Atlantic hadliability insurance of only $25 million, typical for a smallrailroad.

On October 16, Canada's federal government promised itwould toughen safety standards and “require shippers and railwaysto carry additional insurance so they are held accountable,” aspart of the governor-general's speech from the throne outlining thelegislative programme for the coming parliamentary session.

The Canadian Transportation Agency is reviewing allaspects of rail insurance, including whether railroad operatorsshould be required to obtain minimum levels of cover, and whetherspecial rules should apply to the carriage of hazardous cargoessuch as crude oil and ethanol.

Changing the liability rules to enable railroads to pass some ofthe risks on to shippers is outside the review's scope, as it wouldrequire changes to legislation in both Canada andtheUnited States. But the throne speech implies it could beconsidered by senior policymakers at some point in future.

Betting the company

“Every time we pick up a carload of chlorine, we're placing abet on the company,” Norfolk Southern Chief ExecutiveCharles Moorman told the Wall Street Journal in a superbarticle about the problems posed by limited railroad insurance(“Fiery Oil-Train Accidents Raise Railroad Insurance Worries” Jan8).

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

Graniteville's population was just 1,200. The moving train wastravelling at only 47 miles an hour. The industrial area around thesiding was largely empty at that time of night. Only one of thechlorine tanks burst. The two others, plus the tank car carryingsodium hydroxide, safely contained their deadly contents.

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

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

Norfolk Southern eventually paid $4 million in civilpenalties under the Clean Water Act and other federal environmentallaws, but that has been dwarfed by payouts for deaths, injuries anddamage to nearby businesses.

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

Just one of the three chlorine tanks that derailedat Graniteville released its contents. By contrast, 60out of 63 Class 111 tank cars carrying crude that derailedat Lac-Meganticruptured and released their contents in aterrifying inferno.

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

Ruinous liabilities

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

Trains carrying poisons, explosives and radioactive materialsare designated as “key trains” – subject to a strict speed limit of50 miles per hour, given priority over all other trains on thenetwork, and routed away from densely populated areas whereverpossible.

Following the disaster at Lac-Megantic, the key traindesignation will be extended to any train carrying 20 or morefreight cars of hazardous material, including flammable liquidssuch as crude or ethanol.

So far, with the exception of Lac-Megantic, all thederailments involving flammable liquids have taken place away frommajor towns. Routing trains away from urban areas and imposingspeed restrictions can mitigate some of the risk, but they cannoteliminate it entirely.

“A railroad moving hazardous shipments facesexposure to potentially ruinous liability,” the Association ofAmerican Railroads told the Canadian Transportation Agency'sreview.

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

Inadequate cover

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

Part of the problem is there is just not enough insurance tocover a really serious incident. There are only 30 or 40 companieswilling to offer railway liability insurance, typically in discreteamounts of $5, $10, $20 or $50 million, which are then bundledtogether in liability stacks to provide the desired amount of coverfor a railroad, according to the CTA.

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

“Given the number of players in the rail insurance industry andtheir risk tolerance, there are practical limits to what railwaycompanies can obtain in the market for third-party liabilityinsurance,” the CTA acknowledged in a discussion document publishedin November 2013.

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

Liability reforms

The Canadian Transportation Agency's review, and theresulting submissions from both rail operators and shippers, haveoutlined several options for liability reform.

One option is to require railroads to obtaina minimum amount of cover, perhaps depending on the mix of cargothey carry.

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

The CTA's equivalent in the United States, the SurfaceTransportation Board, does not even review the adequacy ofinsurance, which is regarded as a commercial matter for therailroad operator.

In theory, the CTA could specify a minimum insurance level forthe railroads' operations inCanada. But given the limited amount ofcover available, it might not make much difference.

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

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

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

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

More importantly, it might also make shippers more careful andreduce the total amount of risk involved in carrying hazmat loadssuch as crude oil.

At the moment, shippers can force railroads to accept a hazmatcargo provided it is offered in the correct type of container, andpass on all liability, even if they could have used an even safercontainer.

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

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

Naturally, the shippers do not agree. “It is imperative thatliability continues to rest with the carrier,” the Renewable FuelsAssociation told the CTA on behalf of ethanol shippers. “This willhelp maintain accountability in the shipping industry and keepsafety standards high.”

Hazmat shippers already pay significantly higher rail transportrates, according to the ethanol industry, to compensate railroadsfor the risks involved. But no rate premium can truly compensaterailroads for the losses associated with a catastrophicincident.

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