A third party approach to environmental regulation: Possible roles for insurance companies

This dissertation explores the use of third party inspections, coupled with Model Risk Management Programs (Model RMPs), in implementing the EPA's Rule on "Risk Management Programs for Chemical Accidental Release" required under s112(r) of the Clean Air Act. It focuses on the possible roles of insurance in this third party approach and shows that it could enable insurers to more cost-effectively provide coverage against the risks of chemical accidental releases. Inspections are information-generating devices that enable insurers to mitigate problems associated with information asymmetry: adverse selection and moral hazard. The effects of inspections on these problems are determined using a theoretical model that extends the one-period competitive equilibrium models of adverse selection (Rothschild and Stiglitz; Wilson; Miyazaki) to include the moral hazard problem. Other postulated benefits of the third party approach are also discussed. These include serving as a signal about the facility's safety, lower regulatory cost enforcement, internalization of the costs of regulation and accidents to firms, and more socially cost effective accident prevention. In addition, some major findings from a series of informal roundtables on the third party approach held at the Wharton School are presented. The participants at the roundtable sessions, organized into three subcommittees, discussed the possibility of implementing the third party approach for the ammonia refrigeration industry in dealing with the provisions of EPA's Rule. The general consensus was that a third party approach applied in this industrial segment would benefit all stakeholders. The findings of this dissertation suggests that EPA could utilize third party inspections in implementing its Rule for certain industrial segments under certain conditions. These conditions include (1) a large number of small facilities that need assistance in meeting regulatory requirements, (2) these facilities employ a narrow and mature technology where well-specified standards based on good industrial practices may be developed.