Int. J. Risk Assessment and Management, Vol. 7, No.

5, 2007 589

Mine reclamation bonding and environmental

insurance

Richard Poulin*
Département de Génie des Mines, de la Métallurgie et
des Matériaux, Université Laval,
Québec (QC), G1K 7P4, Canada
E-mail: Richard.Poulin@vrex.ulaval.ca
*Corresponding author

Michel Jacques
École d’Actuariat, Université Laval,
Québec (QC), G1K 7P4, Canada
E-mail: michel.jacques@act.ulaval.ca

Abstract: Mineral extraction is normally followed by rehabilitation of the

mined area. A growing number of jurisdictions are using environmental
bonding to provide financial assurance that rehabilitation will be carried
out as agreed at the permitting stage. The current practice in environmental
bonding for mining is critically reviewed. In theory, it is an efficient economic
enforcement mechanism but has shown shortcomings in its application.
Elements of a solution are identified through the emergence of environmental
insurance. The use of insurance as a complement to bonding could prove
beneficial by creating a useful framework and by reducing the risk for the
public and the environment. We propose a simple model showing how risk
could be quantified.

Keywords: rehabilitation bonding; environmental bonding; mining; assurance;

financial bonding; environmental insurance; mineral policy; Monte-Carlo
simulation.

Reference to this paper should be made as follows: Poulin, R. and Jacques, M.

(2007) ‘Mine reclamation bonding and environmental insurance’, Int. J. Risk
Assessment and Management, Vol. 7, No. 5, pp.589–606.

Biographical notes: Richard Poulin is a Professor of Mineral Economics

at Université Laval in Québec. He holds a PhD from McGill University.
He has also been Professor of Mineral Economics at the University of British
Columbia. He previously worked in the Mineral Engineering industry for
12 years in Canada and overseas. His main research topics are mineral resource
valuation by real options and risk associated with environmental bonding.

Michel Jacques is a Professor of Actuarial Science at the School of

Actuarial Science of Laval University in Québec. His teaching interests lie
in Actuarial Mathematics (calculation of life insurance premiums and reserves),
in Financial Economics (evaluation of derivative products) and in Probabilistic
Distributions of Property and Casualty Insurance Claims. His research interests
focus on stochastic modelling and option evaluation in an insurance context.

Copyright © 2007 Inderscience Enterprises Ltd.

590 R. Poulin and M. Jacques

He recently got interested in Actuarial Evaluation of Environmental Risks.

He received a PhD in Mathematical Physics from Louvain University in
Belgium and is an Associate Member of the Society of Actuaries and of the
Canadian Institute of Actuaries.

1 Introduction

Mining is the extraction of non-renewable resources from the ground and as such, it
involves at least some irreversible changes in the natural environment. The extent to
which such impact is of an adverse nature depends on how this concept is defined.
The environmental impacts can be measured either in absolute terms and compared to a
pre-existing status quo or in terms that render them comparable to the benefits which
they also involve. A possible compromise is given in the Canadian Whitehorse Mining
Initiative:
“on closure, returning mine sites and affected areas to viable and, wherever
practicable, selfsustaining ecosystems that are compatible with a healthy
environment and with human activity.” (NRCan, 2003)
The advantages of restoration can prove difficult to measure because of uncertain
property rights, high transaction costs and missing markets for some of the benefits that
the environment confers upon us. Also, ecosystems are extremely complex, characterised
by non-linearity and non-reversibility beyond often unknown thresholds (Odum, 1997).
Minerals are common pool resources under a government property regime.
Full tenure is granted after obtaining a mining permit or lease. State property regimes
remove most managerial discretion from the user and generally convey no long term
expectations in terms of tenure security (Bromley, 1991). Users have no economic
incentives to internalise externalities; so limits to ensure the presence of environmental
objectives are introduced by regulators. The basic objectives of those limits are to
minimise public health risk and to allow the land to support other uses when mining is
completed (Deisley, 1991).
It is well accepted that polluters should pay for their actions. Bankruptcy, corporate
dissolution and outright abandonment are means by which polluters avoid
responsibility for environmental costs. Assurance practices, bonds in this case, act as an
important complement to liability rules, restoration obligations and other compliance
requirements, and are not a substitute. These practices foster cost internalisation by
mandating the existence of a reserve of capital dedicated to the satisfaction of liabilities
(Boyd and Ingberman, 2001). Cost internalisation by responsible parties yields the most
equitable means of compensation; it promotes deterrence, risk reduction and innovation
to reduce environmental harm (Boyd, 2002).
However, bonds have shortcomings in their application. Timid enforcement and lax
monitoring will not extract the full potential of bonds. We will review the current practice
in environmental bonding for mining and propose an alternate approach.
 Mine reclamation bonding and environmental insurance 591

2 Financial assurance by environmental bonding

If agencies diligently pursue legal actions against delinquent operators, this would
tilt the firm’s decision towards site reclamation (Gerard, 2000), but it may not be enough.
Despite legal standards for ambient pollutions, a firm has an incentive to shirk on
pollution control given that its profits derive from market prices that do not reflect social
preferences for environmental quality. Environmental shirking is when a firm provides a
socially inefficient level of pollution control. The regulator’s question is how to induce
the firm to provide an efficient level of pollution control when behaviour is imperfectly
monitored (Shogren et al., 1993).
Bonding is an enforcement mechanism that relies on financial incentives and
reputation effects to deliver site reclamation at a lower cost, based on added flexibility.
The goal is for the firm to internalise perceived social costs into its private resource
allocation decisions. The value of the bond would be a function of the regulator’s
estimate to rehabilitate the land, given the current state of knowledge.
Upon completion, the firm requests the release of the bond, and the regulator has the
discretion to withhold the bond if the site is not satisfactorily reclaimed. In response,
the firm can challenge the decision in court. The court will make its decision based on a
comparison of the permit terms and the condition of the site. Since the bond’s value can
be adjusted over time, it can reflect increased knowledge about the potential damages
from a firm’s activity; it can diminish if the passage of times proves some of the feared
damages to be unfounded (Perrings, 1989).
Host governments have a general policy of requiring a bond amount which is prudent
in the light of all reasonably foreseeable risks, but should not insist on protection against
unlikely events with falls more in the realm of insurance. Setting the bond amount at the
worst case scenario would be an extremely risk averse strategy. One can not expect an
industry to be viable if it is subject to what appears to be overly conservative bond cost
estimates (Kirschner and Grandy, 2003). The bond needs to be high enough to guarantee
the performance of the required obligation or internalisation of future liabilities, but a
bond higher than that level is wasteful because it ties up capital (Boyd, 2002).
Bonding often is done through a financial surety issued by a bonding company, an
insurance company, a bank, or another financial institution which agrees to hold itself
liable for the acts of failures of a third party. The application of financial assurance as an
instrument of environmental control in mining projects seems to be an inevitable
tendency, but still lacks studies to identify its incidence and effects on the mining sector.
All Canadian provinces that have mining activity utilise bonding as a requirement for
mining permitting.

2.1 Advantages
Environmental bonding would protect in cases where the mining enterprise goes
bankrupt and can not afford to pay for reclamation, or simply goes out of business,
often resulting in the government having to bear the financial burden of reclamation.
In case of undercapitalisation or early dissolution, bonding is a direct means to
internalise externalities, rather than extended liability which is then not effective
(Boyd and Ingberman, 2001).
592 R. Poulin and M. Jacques

Environmental bonding encourages the distribution of responsibilities among all

stakeholders, decentralising the decision making process to protect lease areas and it
relies on performance objectives rather than on a preestablished course of action
(Ferreira and Suslick, 2001).
With bonding, the risk is minimised by the presence of financial guarantees.
In theory, a bond would expand the regulatory authority’s monitoring and enforcement
capabilities by including the resources of the surety provider (Cornwell, 1997). However,
we do not agree with this argument since the bond provider is primarily preoccupied by
the solvency of the firm, and not by the environment. Indeed, it pays for insolvent clients
only (Boyd, 2002).
The mining operator must demonstrate that rehabilitation has been performed
satisfactorily in order to recover the bond amount, meaning that the burden of proof
rests with the company. From a societal point of view, there are advantages in shifting
the burden of proof from the regulator to the firm. Now the firm must prove that
environmental standards have been met. This situation will reduce litigation. Instead of
taking the firm to court to prove that the firm is liable for damages, now the firm must
prove that the remaining damages are below the regulator’s threshold. Otherwise, a
portion or the entire bond would be forfeited. This not only discourages the firm from
shirking, but also encourages it to keep and provide records and to conduct research that
would establish the firm’s innocence (Shogren et al., 1993).
Bonds may appeal in the political arena, since deposit systems for recyclable
resources have been implemented throughout the world. They give visibility to the
regulating agency that holds large sums in escrow accounts. Mining firms accept that
governments need to demonstrate to the community that they have received sufficient
financial protection from the holders of mineral rights to ensure effective rehabilitation
(Miller, 1998).
By posting the bond, an explicit registration of the value of potential environmental
costs is given, opening the issue to public debate and scrutiny. Citizens care about the
environment beyond its implication for their personal welfare (Paavola, 2002).
The role of community pressure and other forms of informal sanctions are explored in
Hettige et al. (1996), Arora and Cason (1996) and World Bank (2000). These papers
generally find support for informal community pressure and social norms as playing an
important role in emissions and/or compliance. Compliance is costly, but surprisingly,
many studies find that firms usually comply even though the monitoring is far from
meticulous and punishments are seldom enforced (Heyes, 1998). An explanation of this
fact is that managers care about their corporate image, a hypothesis supported by survey
evidence found in Cahill and Kane (1994). If it is in the best interest of shareholders to
comply with environmental laws, we would expect compliance to be more prevalent in
firms where top management objectives are more closely aligned with shareholders
(Cohen, 1999).
Bonding aims at making the achievement of rehabilitation plans financially
viable and, as such, does not issue directives concerning upstream technology, but can be
an incentive to develop new technologies. Since bonding ties up a significant portion of
the firm’s assets, development of clean technologies could reduce this economic
disincentive (Jacques and Poulin, 2004). The firm would find it in its interest to invest
resources into direct research in order to get the value of the bond as low as possible
(Shogren et al., 1993) as long as the regulator takes these into account when determining
bond requirements (Ferreira et al., 2004).
 Mine reclamation bonding and environmental insurance 593

2.2 Shortcomings
Franceschi and Kahn (2000) put forward the idea that performance bonding tends to
focus on ensuring a minimum level of environment quality rather than an optimal
environmental policy and that there is no reward for exceeding the minimum level.
Bonding encourages compliance with reclamation agreements and the approach is as
good as the agreement reached prior to mining. In fact there is no a priori reason to
believe that the benefits of reclamation always exceed the cost. In other words, bonding
promotes regulatory compliance, but it in no way suggests that the standard promulgated
by the regulations is necessarily efficient (Gerard, 2000).
Local governments do not always have the resources to make the necessary
inspections. In the case of mining on public land in the USA for example, the Forest
Service cited budget constraints, lack of qualified personnel, remoteness of sites, and
higher priority work as reasons for a lax inspection record (Gerard, 2000).
Amounts considered, and the terms of the obligations in the agreements with
regulators, vary between jurisdictions mainly because of differences in expertise.
Cost overrun for rehabilitation and catastrophic accidents will not be detected in due time
if local inspectors are not qualified. Even if the regulator has technical expertise and is
not complacent, there are examples where problems have been identified in advance and
rehabilitation has not been properly conducted (such as for the Mt. Nansen mine in the
Canadian Yukon (Copland, 2001)). Deily and Gray (1991) note that if a firm finds
compliance too costly and will otherwise shut down, it is a likely candidate to pressure
the regulating agency and to generate political opposition. In particular, that firm’s
employees and other local citizens who will be hurt from a plant closing are likely to be
vocal opponents of any such stringent regulatory enforcement activity. Moreover the
government will fail to enforce as stringently when the cost of compliance is very high
(Cohen, 1999).
Determining the value of the bond can be a difficult task. The estimate of closure
cost must be as accurate as possible since it will form the technical basis for the value of
closure funds required (de Lima et al., 2003). The total cost includes the capital cost of
the closure work and, when applicable, the cost of all monitoring and care and
maintenance. These costs can be estimated with reasonable accuracy provided there is
sufficient site specific information and data (Anderson et al., 1999). But since quality
engineering information is required by banks to finance a mining venture, the same is
expected concerning the environmental aspects. In general, there have been two
ways to set bond amounts. The first is a per acre calculation. In the second, the bond is
set at the expected reclamation costs, which usually include administrative expenses
and a profit margin for a third party contractor. The per acre calculation can only
be a crude approximation. Examples of inadequate amounts are given by Kuipers and
Carlson (2000) for numerous American states. Expected costs, confirmed by arm length
specialists, will give much better estimates but will not include unplanned events.
Insufficient bond amount or unrealistic schedule of deposits could result in unsecured
rehabilitation cost. If funds are deposited following a time constraint rather than a cost of
rehabilitation constraint, solvency problems occurring early in the mine life are not
covered. If and when this situation can be foreseen, it is too late to obtain financial
guarantees from a struggling firm.
The regulator will not discriminate between firms, this being already done by the
surety. Firms that have the capacity and demonstrated ability to manage their own affairs
594 R. Poulin and M. Jacques

without the need for environmental bonding would prefer an accreditation programme
(Miller, 1998). This notion of self assurance would require the examination, on a regular
basis, of the firm’s solvency by a trained professional. Again, the probability that a
financial constraint is identified too late in the process is high, leaving no room for the
legislator to call a guarantee.
A factor limiting the use of bonds lies in the liquidity constraints facing the regulated
firms. According to a recent survey of mining companies (see KPMG, 2000), the need to
raise equity is still very much a priority. An environmental bond can tie up a significant
portion of a firm’s assets and could prove to be a heavy burden for smaller firms.
Even with a low probability of occurrence, if the potential cost of inefficient precaution is
high, the bond will be large. If a firm does not have the assets to post a bond, then credit
and insurance markets will not provide any assistance. Liquidity constraints imposed by
the bond can force a firm out of production or can restrict its entry into new markets.
Problems of exclusion are simply inherent in the bond tool and need to be recognised
when considering applicability of bonding for environmental policy (Cornwell, 1997).
If the firm cannot post the bond, the project might be dropped even though, from the
ex post social welfare viewpoint, the initiative may be beneficial (Shogren et al., 1993).
In contrast to the argument that bonds are minimally intrusive into the internal operations
of the regulated firm (Costanza and Perrings, 1990), the liquidity constraints will be
binding in many instances. Indirect costs may include a reduction of the company’s
borrowing capacity and an increase in the cost of credit (Miller, 1998). Also, the political
and legal importance of the appearance of equal treatment biases regulators towards
uniform requirements, despite the fact that some firms have demonstrated their ability in
responsible environmental management.
The application of financial assurance as an instrument of environmental control,
where monitoring is quasi inexistent will negatively affect companies that operate legally
(Rezende, 2000).
The current accounting practice widely followed is to build up a provision that
accumulates to the estimated cost of rehabilitation over the years. This does not
follow the standards of international accounting practices. This point is raised in
PricewaterhouseCoopers (1999):
“The practice of estimating the future cost of restoration and then building
up to that cost over the life of a mine by making periodic provisions
(the `incremental … recognition’) is adopted by many mining entities and grew
out of conservative provisioning practices … The incremental method, which is
the most widely accepted and practiced, is not in accordance with the concepts
of the International Framework … If it is acknowledged that a liability exists
for damage already done, then there is no justification for only recognising part
of the liability.” (PricewaterhouseCoopers, 1999, Chapter 10)
The bond amount in mining is often obtained through a surety bond. However, the surety
bonding market for mining appears to be shrinking (Kirschner and Grandy, 2003).
Numerous surety carriers went bankrupt in the USA and the surety business underwent a
heavy concentration: 40% of the business is held by five carriers. Moreover Skaer (2002)
notes that bonds in the mining sector represent only 1% of the surety business, meaning
that this line of business is not very important for surety carriers. Additionally, bonds in
the mining sector represent liabilities extending far into the future; an attribute that is
not very attractive for surety carriers. The availability of bonds could hence become
problematic, forcing the search for an alternative.
 Mine reclamation bonding and environmental insurance 595

3 Sharing the risk

Bonding practices can differ. In Canada, mineral resources are of provincial jurisdiction
and bonding is mandatory to get a mining permit (with the exception of the province of
Prince Edward Island that does not have mining). Table 1 gives a list of acts in which
mining rehabilitation and assurance are detailed. Specific details are in regulations which
are subsidiary to those acts. The general principle put forward is that the mining operator
must guarantee, with a sum of money, that the closing plan submitted for obtaining the
mining permit will be realised. The main differences between the provinces lie in the
timing of the deposits, and to a lesser extent, in the allowed form of financial guarantee.

Table 1 List of acts in the Canadian provinces

Province Act
Newfoundland Mining act
Nova Scotia Mineral resources act
Environment act
New Brunswick Mining act
Québec Loi sur les mines
Loi sur la qualité de l’environnement
Ontario Mining act
Manitoba Mines and minerals act
Mine closure regulation
Saskatchewan Environmental protection act
Mineral industry environmental protection regulations
Alberta Environmental protection and enhancement act
British Columbia Mines act
Bonding act

The full amount for closure is required upfront before ground breaking. Only the
provinces of Québec and Manitoba do not require the amount to be given before
development and have a predetermined schedule of deposit. Moreover the bond amount
in Québec is 70% of dump sites rehabilitation costs. The schedule is the built up
sequence over the last 15 years of the mine life to reach the required amount. The other
provinces do not offer this flexibility but have a provision for incremental bond payment
in specific cases. These are, more often than others, cases where the financial burden of
providing moneys upfront would prove difficult. The result is that higher risk cases will
give the least guarantee. This practice is justified in the name of competitiveness to lure
exploration and development money. Selfassurance is only used in Manitoba, Ontario
and British Columbia, based on some form of financial rating.
In many cases, the amount accumulated in trust funds is inferior to the rehabilitation
cost if it had to be done immediately. So provinces are sharing part of the risk with
mining companies. This proved to be acceptable, by ignorance or by choice, in a period
of transition, from no guarantee at all. However, with time and bad experiences, the
tolerance to unsecured risk (insufficient funds or cost overrun) has diminished.
596 R. Poulin and M. Jacques

Da Rosa (1999) presents principles for a financial guarantee to be acceptable. Closure

costs (both rehabilitation and postclosure) should be covered by reasonably liquid
financial guarantees. Financial assurance should be readily accessible from financially
healthy guarantors. The bond amount and its release should be open to public discussion.
The assurance should not be viewed as a substitute to legal liability.
When we confront these principles with the shortcomings described above and the
current Canadian practice, we are led to ask the following questions. Is it acceptable that
the bond amount be lower than the estimated rehabilitation costs? If not, is it acceptable
for some period of time? If so, how long can a mining operator be short? Who is bearing
the risk in the end? And maybe more important, how should risk be shared?

4 A vision of remedies to bonding shortcomings

The bonding mechanism is usually based on an assumption of planned remediation and

the value of the bond is computed accordingly. In many cases, the bond amount is not
sufficient to cover planned remediation, because of cost overruns. If the mining company
has insufficient funds, the final cost will be paid by society. Financial imperatives
point to simultaneous consideration of planned remediation and accidents, including
catastrophes. From the technical side, accidents result from poor rehabilitation design,
construction deficiencies, loose monitoring or really unexpected material behaviour.
The technical potential for accidents is intimately linked to that of planned remediation
and it thus makes technical sense to consider planned remediation and accidents together.
Assurance for uncertain costs is best thought of as mandatory insurance. An important
characteristic of insurance is that, by forcing cost internalisation, it creates an
incentive to reduce uncertain environmental risks via improved technology or
management (Boyd, 2002). This is especially true when insurance is required from the
insured to perform its core business activity.
A third party covering cost overruns would provide a safeguard. Being liable
for the overruns, the third party would critically review rehabilitation plans and
link his involvement to a bonding amount less likely to be overrun. After a while, we
would expect a global decrease in cost overruns. It would also have interest in
monitoring environmental behaviour. Damage insurance is critical to internalise the
environmental costs for firms likely to suffer low probability but high impact
accidents (Goodstein, 2002). Hence a natural candidate for the third party is the
insurance industry. For a general description of environmental insurance, see Hollaender
and Kaminsky (2000).
However, private insurers view themselves as service providers and are usually
not interested in being a government enforcer. This is noted in Freeman and
Kunreuther (1997):
“When government rules stipulate that compliance with insurance equals
compliance with the law, the insurer may assume a level of responsibility that
is inconsistent with its risk bearing role … The insurer would become, in effect,
a watchdog over its customers rather than a service provider.” (Freeman and
Kunreuther, 1997, p.102)
On the other hand, suggesting giving insurance a role within an equilibrium economics
model, Merrifield (2002) states:
 Mine reclamation bonding and environmental insurance 597

“I argued that insurance companies would do a better job of monitoring risk

reduction efforts. Their money is directly at risk, and they enjoy greater
insulation against the political pressures that sometimes influence the behaviour
of regulators.” (Merrifield, 2002)
Because of the potentially high amounts to cover, insurers would need an access to
reinsurance in order to further share risk. However, the reinsurance market is shrinking
since September 11 and it is doubtful that reinsurers would be interested to invest in a
new market beyond their current knowledge. The airline industry is also having trouble
getting insurance cover since September 11. Many companies went bankrupt, some of
them putting the blame on their insurers for charging prohibitive premiums. Since then,
airline companies regroup and seek authorisation to create captive insurance companies
with the sole aim of covering exclusively the group members (Best’s Review, 2002).
Although it would be possible to involve the private insurance industry as a third
party for mining, we propose a different approach. Our proposal is to create an
international captive insurance company for the mining industry. Proof of insurance will
be necessary to obtain permits. For rehabilitation, the current bonding mechanism
will remain, but the bond amount will be held by the captive company who approves the
reclamation plan. The captive company will treat the amount as an annuity and provide
for payments, as rehabilitation work progresses (parallel to a pension scheme). Moreover,
it will provide insurance for cost overruns, charging the operator a premium. In order to
improve environmental control, the usual insurance techniques can be used: performance
classification for premium rebates, deductibles for a first layer of cost overruns and
possible coinsurance for a second layer. The overrun insurance can be packaged
with an accident or catastrophe cover. This extra cover is meaningful since failures of
tailing dams have produced huge costs in the past (see ICOLD, 2001). An unlimited
liability for this part is however out of question since it would be too costly. Hence a limit
of liability will have to be incorporated. Possible avenues for higher claims could be:
society’s responsibility through public funds, a catastrophe pool funded by taxes on the
mining industry or products, or an involvement of the financial markets through emission
of securitised instruments (for instance, bonds with coupons, defaulting in case the limit
is pierced).
The captive company would be under the financial responsibility of the mining
industry but, like captive insurance companies created by air carriers, it would be
managed by insurance companies or actuarial consultants. The concept will require
explanations: image of loss of control by the regulator, non-refundable premiums,
creation of a risk adverse climate, perception of pardon for careless firms, possible lack
of flexibility and control of the solvency of the insurance book of business. All these
difficulties can, in principle, be easily taken care of by a suitable communications plan
and the usual financial standards of practice (Poulin and Jacques, 2004).
An insurance captive company under the responsibility of the mining industry and
with compulsory membership would transfer some of the cost from the regulator to the
regulated. It should be compulsory because most firms do not spontaneously decide to
insure against environmental risks (Monti, 2001). Since firms with deep pockets are
likely to reclaim regardless of the relationship between the bond amount and the
realised reclamation costs, they would not voluntarily participate in the captive company.
The same would apply to financially struggling firms, for which it will be an added cost.
The captive company would have both technical and financial expertise. It would thus
compensate for eventual lack of expertise from the regulator. Being liable, it would not
598 R. Poulin and M. Jacques

be tempted by complacency, and part of the monitoring process would be diverted from
the regulator to the captive company. As argued by Kunreuther and Freeman (2001), by
monitoring the insured’s activities as part of ongoing underwriting procedures, insurance
companies provide economic incentives for their clients to comply with the standards.
Also there is economic incentive for the insurer to assure compliance with standards
since its loss experience is directly related to this activity. However, the captive company
could be placed in the uncomfortable position of an environmental policeman being
entrusted with the power to decide which firm can continue their activities and which
should, instead, withdraw from the market (Monti, 2001).
Mining companies are mostly large multinationals with operations in various
countries; in particular, in countries different from the one where they are registered.
The captive company would have to be present at, and bring its expertise to, the
supranational level. In the medium term this would bring some form of uniformity
between jurisdictions. Although local standards of rehabilitation and funding might be
slightly different, a minimal set of rules (protecting both the environment and the public)
would prevail across borders.
Being involved right from the start, the captive company would have backed the
rehabilitation plan. Anderson et al. (1999) also propose that a third party takes care of
the rehabilitation funding, including cost overruns, through a Liability Transfer
Agreement (LTA). They suggest that the third party might also carry the actual
rehabilitation work, but we believe that the mining industry is the best candidate to
perform this. Moreover, the LTA would end up in a transfer of the mine property to the
third party, whereas our proposal lies in a captive insurance company managing
the financing of rehabilitation.
With a responsible industry, rehabilitation problems do not come from negligence
but from unforeseen events. These events can potentially happen to any member
of the industry and it is reasonable to share the risks across the industry as a whole.
Hence, without anticipating the premium fixing rules that are going to be used, the worst
case scenario would not be the principal rationale for pricing. The current bonding
mechanism implicitly contains some provision for cost overruns at a site specific level. In
our proposal, the bond part amount will not contain any such provision since it will be
taken care of by the insurance part. We believe that the combination of bond amount and
premium in our proposal, relying on sites and operators diversification, should create a
financial burden lower than the current (individual level) bonding mechanism.
We described earlier in this paper that the current bonding approach raises accounting
and liquidity concerns. The second part of our proposal (insurance premium) should be
viewed as an operating expense, with no incidence on borrowing power. Moreover,
contrary to deposits, expenses benefit from a more favourable fiscal treatment.
With a captive company involved, future rehabilitation financing will fall completely
outside of government budget. As with regular insurance activities, a regulatory agency
will have to develop solvency regulation and monitor financial compliance. This type of
state involvement is well known in many countries for usual insurance activities and it is
quite efficient. Governments can rely on their own expertise in this respect to develop the
appropriate body.
With bonding, the individual company has to give proof that rehabilitation has been
carried out to the satisfaction of the regulating agency in order to receive the exit ticket
and get back the bond amount. Since the financing of rehabilitation is in the hands of the
captive company instead of in those of the individual, the captive company will itself fix
 Mine reclamation bonding and environmental insurance 599

the requirements and supervise the work. The captive might have to give proof that
governmental expectations are met but individual members will be totally exempted from
this step. A more subtle burden of proof will however show up for individual members in
their relation to the captive company. Intensive discussions might take place when
the individual premium is revealed to the member operator. Proof of historic good
conduct would have to be given to the captive company in order to improve individual
classification and hence lower premiums. This discussion will however take place over a
global perspective instead of over a specific site with definite technical requirements.
The public is rightfully anxious to get a guarantee that rehabilitation will take place
according to governmental standards. The approach used in bonding is to give an exit
ticket to the firm, freeing it from any further responsibility, only when all rehabilitation
work has been performed. With pollution however, one never knows for sure that all
future problems have been taken care of. Notwithstanding possible complacency on the
part of the regulator, the very idea of leaving a site without any future responsible party is
troublesome. With a captive company, there is no need for an exit ticket. In principle, the
captive company will be responsible for mining sites forever. Of course, this is subject to
the captive company solvency. This follows Franceschi and Kahn (2000) proposing a
required permanent insurance policy as a closure condition.
Also, the extent of the insurance cover will have to be carefully designed. It is
expected that the cover will evolve in time, once claims experience gets realised. There
will probably appear a need for some kind of reinsurance. Even though the reinsurance
market might not be interested right now, once the captive company has been operating
smoothly for some time, the situation might change.

5 A simple model

We consider a set of mining sites presenting the same risk characteristics and the same
costs distribution. Real costs are different from site to site, but come from the same
probability distribution. It is assumed that the sites are operated by different companies,
so that bankruptcy of a company affects only the site which it operates. In this simple
model, we assume that the amount of money requested from the operator to obtain
the mining permit is deposited at the beginning of the period under consideration.
All amounts are thus available once permits are issued and we do not consider the
risk that the amount is not fully deposited, because the operator goes bankrupt before
completing all payments. We also disregarded investment of the deposited money
(no discounting takes place).
We consider three different schemes in order to finance rehabilitation
• Scheme 1: Traditional bonding. The operator deposits the bond amount at permitting
time in the custody of the regulator. If rehabilitation costs are lower than expected,
the operator recovers the difference from the regulator. If costs are higher than
expected, we assume that all operators who are not bankrupt at rehabilitation time
have deep pockets and are willing to pay the extra costs. This assumption may be
justified by reputation arguments. The regulator has to provide for the difference of
cost only if the operator is bankrupt and costs are higher than expected. We assume
that the regulator does not keep extra money if the operator is bankrupt and the costs
are lower than expected.
600 R. Poulin and M. Jacques

• Scheme 2: Full insurance. The operator pays an insurance premium to the insurer at
permitting time. All rehabilitation costs are paid by the insurer and the operator
never recovers any money from the insurer.
• Scheme 3: Combination of bonding and insurance. The operator deposits the
bond amount and pays an insurance premium for cost overruns at permitting time.
The amounts are left within a captive insurance company. If rehabilitation costs are
lower than expected from the bond, the operator recovers from the captive company
the difference between the bond amount and the real costs. If the costs are higher
than expected from the bond, the captive company pays for the difference, whether
the operator is bankrupt or not. In all cases, the operator does not recover the
premium part from the captive.
Table 2 gives values for the possible costs together with the associated probabilities.

Table 2 Rehabilitation costs model

Possible costs ($ millions) 8 10 15

Associated probability 5% 85% 10%

We assume that the bankruptcy rate is 5% for the period between permitting
and rehabilitation time. The bond amount is fixed at the most probable cost plus a
contingency margin (taken here as 10%), thus at $11 millions.

5.1 Results for 50 sites

We ran one million Monte Carlo simulations, each with a draw from the cost distribution
above and from the bankruptcy distribution for each of the sites in our set, fixed
here at 50. The simulations give a probability distribution for the cost to the regulator
in the bonding scheme, the cost to the insurer in the insurance scheme and the cost to
the captive company in the combination scheme. We detail below some characteristics of
these distributions.
First is the expected cost. This information is not very informative since the cost is
often nil and the weight of the zero costs is important. More information is revealed by
the conditional expected cost, given that it is positive and by the probability that there
is a positive cost. We also give the amount such that there is one chance in a hundred
(or a thousand) to pay at least that amount. These values for the three schemes are
given in Table 3 for a bond amount, an insurance premium and a combination of bond
and premium, all of $11 millions. We say that the price for operators is $11 millions.
Note that a negative expected cost means an expected profit.

Table 3 Risk characteristics for 50 sites, all prices at $11 millions

($ millions, except probability) Bonding Insurance Combination

Expected cost 1 –30 –25
Conditional expected cost 4.5 5.1 7.6
Probability of positive cost 22.2% 0.7% 0.9%
1 chance/100 to pay at least 8 –2 0
1 chance/1,000 to pay at least 12 10 15
 Mine reclamation bonding and environmental insurance 601

The interpretation of these values is as follows. Consider the bonding scheme.

The expected cost to the regulator is $1 million, globally, for the 50 sites. With the
bonding scheme, there is no possible profit for the regulator since the operator recovers
the excess amount if rehabilitation costs are lower than the bond amount. The cost to the
regulator can never be negative, so the expected cost is not very informative. On the other
hand, when the regulator is paying something, it pays $4.5 millions on average to cover
cost overruns in bankruptcy cases. Note that this amount is larger in the insurance and
combination schemes because, in those schemes, even deep pocket operators do not pay
the cost overruns.
This is however an average value. There are two more important questions.
What is the probability that the regulator has to pay something? The answer is 22.2% for
the 50 sites together (even if the probability for a single site is very low at 0.5–5%
(bankruptcy) times 10% (cost overruns)). Is there a non-negligible chance that the
regulator has to pay a large amount? The answer is there is one chance in a hundred
that the regulator could have to pay $8 millions and one chance in a thousand to pay
$12 millions. Now it depends on one’s own appreciation of risk to decide if this is an
acceptable risk or not.
The other schemes have a similar interpretation. A priori, the numbers are without
interest for the regulator or for the operators, since the regulator does not incur any cost
in those schemes and the operators do not incur extra costs once the insurance premium is
paid. However, those numbers are important for the insurer and the captive company.
If those numbers indicate a situation that is too risky, the insurer will not be interested
in providing the cover and the captive company might not be solvent. Most probably
the numbers in Table 3 indicate a situation too risky for an insurer to be interested to
take the risk. It is true that the probabilities of positive costs are quite low, but there is a
non-negligible chance that a high amount has to be paid.
Increasing the insurance premium will improve the situation. The question is
however, by how much the premium has to be increased over the bond amount in
order to arrive at a situation deemed acceptable to the insurer or the captive company.
Such a proposal is contained in Table 4.

Table 4 Reasonable risk characteristics for 50 sites; different prices

50 sites ($ millions, except Bonding Insurance Combination

probability) amount = 11 premium = 11.44 bond + premium = 11.5
Expected cost 1 –52 –50
Conditional expected cost 4.5 3.7 5.9
Probability of positive cost 22.2% 0.004% 0.002%
1 chance/100 to pay at least 8 –24 –25
1 chance/1,000 to pay at least 12 –13 –15

In this case, the captive company, for instance, is making profit more often than
999 times out of a thousand. This situation might be qualified as acceptable for a price to
the operator ($11.5 millions) that would correspond to a 15% contingency margin in the
usual bonding scheme.
602 R. Poulin and M. Jacques

Of course, with the combination scheme, the operator loses the premium part forever.
In exchange for this loss though, it gets rid of the possibility of having to pay for the
cost overruns, covered by the captive company. Even more important, the costs to the
regulator disappear. The situation may be summarised as in Table 5 if the prices
of the three schemes are all $11 millions.

Table 5 Summary of costs; all prices at $11 millions

Bonding Combination

Cost to regulator May be high 0

Probability for operator to recover $3 millions: 5% $2 millions: 5%

Probability for operator to pay $4 millions: 10% 0

extra

It is important to note that only risk considerations are taken into account in the results
above. For an insurance company or an insurance captive company, other costs have to
be considered: administrative costs (human resources, marketing …), taxation costs and
margins for profit, among others. However, for a captive insurance company with the aim
of protecting members and not to maximise investors’ profit, margins for profit should
not be a concern and administrative costs are known to be lower than for profit driven
organisations.
From the point of view of mining operators, the prices above do not take into account
the different taxation rules that might arise in a shift from the bonding scheme to an
insurance scheme benefiting from a more favourable tax treatment.

5.2 Results for different numbers of sites

The number of sites has a significant influence on the results. A smaller number of sites
make risk diversification less effective. Indeed, the reason why it is possible to offer an
insurance cover with a reasonable premium is the following: when a site incurs
rehabilitation costs lower than expected, the captive company keeps the premium
amount and builds up a financial reserve that can be used to pay for the sites that incur
cost overruns. In a bonding scheme with a situation less costly than expected, the extra
money goes back to the operator, thus leaving no way for the regulator to build up a
reserve. It is a well known result in the insurance world that selling more independent
contracts means that the premium necessary to achieve solvency can be lower, a result
known as diversification.
Remember however, that we have here to consider mining sites with the same risk
characteristics. The number of such sites cannot realistically be very high. The previous
results are based on 50 sites. Results given in Tables 6 and 7 are for sets of 10 and
20 sites, respectively. The simulation runs exactly as before, except for the number
of sites.
 Mine reclamation bonding and environmental insurance 603

Table 6 Risk characteristics for 10 sites

10 sites ($ millions, except Bonding Insurance Combination

probability) amount = 11 premium = 13 bond + premium = 13
Expected cost 0.2 –26 –25
Conditional expected cost 4.1 5.3 5.4
Probability of positive cost 4.88% 0.0012% 0.0012%
1 chance/100 to pay at least 4 –12 –10
1 chance/1,000 to pay at least 8 –5 –5

Table 7 Risk characteristics for 20 sites

20 sites ($ millions, except Bonding Insurance Combination

probability) amount = 11 premium = 12.17 bond + premium = 12
Expected cost 0.4 –35 –30
Conditional expected cost 4.2 2.5 5.7
Probability of positive cost 9.54% 0.005% 0.007%
1 chance/100 to pay at least 4 –17 –10
1 chance/1,000 to pay at least 8 –8 –5

We see that we can again arrive at a situation for the captive company where risk is
reasonable, but the price for the mining operators is now $13 millions (or a 30% margin)
if the set contains 10 sites and $12 millions (or a 20% margin) if the set contains 20 sites.

6 Conclusions

We believe that this proposal follows from the basic principles of an adequate policy.
Indeed, the proposal minimises disincentives for investment, since social requirements
of safety can be satisfactorily met without imposing too much financial stress on
mining operators. It offers a high probability of achieving the goal of environmental
protection, since good performers will be rewarded and there is an insurance covering
poor behaviour. The mining industry gets the opportunity to realise internalisation
of environmental liability with low transaction cost and has incentives to optimise
environmental protection. The proposal is flexible with respect to changes in technology,
since the process has result-based objectives. Finally, the mechanism is practical,
enforceable and applicable, managed by an insurance entity, with results overseen by the
regulator.
Once disturbance has occurred, the only environmental concern is that rehabilitation
takes place. The environment should not be impaired because of financial restrictions.
Any scheme that ensures appropriate rehabilitation independently of its costs is an
environmental plus. Since the captive company does not consider sites individually, the
very notion of cost overruns disappears. When rehabilitation is needed, the captive
company provides the money to do it, even if the costs are higher than what would have
been expected for that particular site. Principles for a sound financial guarantee are
respected concerning liquidity and healthy guarantors.
604 R. Poulin and M. Jacques

The public opinion is concerned when the state shares the environmental risk with
private mining companies. Mandatory insurance in conjunction with bonding would
reduce the state exposure. The costs to mining operators are higher but entail a trade-off
that is not prohibitive.

Acknowledgements

The authors would like to acknowledge the participation of Mélanie Côté in the survey
of provincial regulations and David Walker in the survey of dam failures costs.
Also, we thank Jean Dionne of the Québec provincial government for his support.

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