Marine Insurance: More Pain Than Gain

Marine Insurance: More pain than gain?

February 2012

Believed to be the earliest form of insurance, marine insurance has been tightly linked with trading activities for centuries. The expansion of English maritime trade made London the centre of an insurance market that, by the 18th century, was the largest in the world. By the 19th century, membership of Lloyd's was regulated and in 1871, the Lloyd's Act was passed, establishing the corporation of Lloyd’s to act as a marketplace for members, or “Names”. The collective body of general insurance law was codified in 1906 into the Marine Insurance Act. Since then, marine and non-marine insurance law have diverged, although both are fundamentally based on the same original principles.

The Marine Insurance Act 1906 is very important. Though English in origin, it does not only govern English Law, but dominates marine insurance worldwide. The Act applies not only to commercial marine insurance, but also to protection and indemnity insurance (P&I clubs). The act, though, is reaching the end of its life and a new Bill is expected in 2013.

In Canada, marine insurance is governed by the Marine Insurance Act, which is also modeled on the English Act.

Types of Marine Insurance

There are three main types of marine insurance – Protection & Indemnity (P&I), hull & machinery, and cargo.

1. Protection & Indemnity (P&I). The word “protection” simply means that the insurance also covers assistance when a ship is involved in an accident and the ship owner and his Master needs help. P&I insurance is an indemnity type of insurance, and the ship owner (or member of the club) must demonstrate his loss before the club will indemnify him under the terms of the insurance policy. The club never assumes the owner’s liability; technically the owner (or member) is always responsible for payments. In practice, the club takes over the business of handling claims and ensuring that payments are made correctly.

2. Hull and machinery insurance protects the ship owner’s investment in the ship. It is a property insurance which covers the ship itself, the machinery and equipment. The owner will be protected for losses caused by loss of or damage to the ship and its equipment.

3. Cargo Insurance policies are taken up to protect against loss of or damage to goods while they are being transported over sea, air and land (includes parcel post and carryings by courier service). Although the term "marine cargo insurance" is sometimes used, it actually includes cover for the land transit commencing from the moment the goods leave the storage until they arrive at the final warehouse.

Factors affecting the shipping industry

Given its close links to trade, it is not surprising that the marine and transportation industry is feeling the pressure of a volatile global economy. The resulting reduction in shipment volumes, combined with excess capacity and competition, has created a situation where premium rates have been languishing at artificially low levels.  According to the International Union of Marine Insurance (IUMI), while there was some improvement in shipping activity in the early part of 2011, including increased industrial activity, more stability in the charter market, and an upturn in project cargo activity that had been put on hold between 2009–2010, most shipping operators are still feeling the pressure of aggressive competition, the threat of an over-supply of tonnage in the upcoming years, and unpredictable energy prices.

Over-Supply of Tonnage: The average age of the world fleet, at 21 years, has also been relatively stable since 2006. In 2000, the average age of the world fleet was 19 years. New vessels, ordered prior to the financial crisis, are beginning to enter the market, notes the IUMI, and this is going to put significant pressure on freight rates and the viability of older tonnage. However, owners with newer tonnage generally benefit from lower operating costs.

Perils: Piracy has impacted vessel routing through the Gulf of Aden and continues to be a significant risk for owners and crew who must endure more protracted ransom negotiations, increasing interest in kidnap and ransom insurance for crew. On land, economic volatility has increased theft and strike damage risks.

Environmental: There is also general concern about the impact of vessel accidents on the environment. For example, the “Rena” cargo ship which crashed off the coast of New Zealand in January 2012, grounded on reefs in sensitive environmental areas. The IUMI says such accidents could produce new, harsher pollution legislation to which owners will need to be able to respond with improved processes and controls. In addition, ballast water regulations continue to tighten, which can be both onerous and costly. The International Maritime Organization has plans to fit the entire world fleet with ballast water treatment kit by the end of the decade, and this has been calculated to cost ship owners between US$1m to $5m per vessel.

Still a Buyer’s Market

The IUMI calculates that worldwide, the premium income for marine insurance was US$22.9 billlion (2010) and US$25 billion last year. It is expected to reach US$30 billion this year.  (China, which was included for the first time in 2010, accounted for US$1.96 billion in premium that year). Slightly more than half of the premium (50.7%) last year went towards insuring transport/cargo. Global cargo premium market for 2010 saw Japan as the most prominent, accounting for 14.6% of the US$12.8 billion premium market, followed by China and Germany, at 9% each.

Quite shockingly, hull and machinery insurance has technically been at a loss for 15 consecutive years, which has led the IUMI to wryly note that “something is stable after all”. At its September 2011 conference, IUMI warned that the future of the global hull market depends on insurers properly understanding “the dependencies between macroeconomic parameters and repair cost.” What insurers require are good models to estimate expected claim cost (which is equivalent to risk premium), trade / fleet development and underwriting discipline / capacity. As always, the impact of major claims has to be factored in, IUMI said.

Dieter Berg, head of Marine Underwriting from Munich Re states bluntly that many insurers do not get their sums right and underestimate the potential of a major loss. “It is simply mind-boggling when you see how the values of vessels have been developing. Yet, surprisingly, in my view this niche segment does not even appear on the radar of the Board in many companies,” he said in a web discussion. The world fleet is now younger, as many ship owners took advantage of the last crisis to scrap old vessels. There may be fewer losses but those that do occur are more costly. “This is due to the higher values and spiralling repair costs, including steel and labour,” Berg said. A ship's hull insurers have to ask themselves seriously whether potential major losses are adequately priced. The alarm bells from Italy [see Costa Concordia case study] will be followed by critical analyses by managers. Berg predicts that smaller players will recognise that hull insurance for ships is just not a profitable venture for them.

John Sullivan, Cooper Gay Marine Reinsurance Director adds that the marine industry will always face major challenges. Despite improving technology, it will never fully be able to defend itself against natural catastrophes. This peril is particularly relevant to the offshore sector. Both the Japanese tsunami and Thai floods at the end of 2011 have had a significant detrimental effect on the marine portfolio last year, and highlight the diverse nature of risks to assess.

The Canadian Situation

According to the Canadian Board of Marine Underwriters, for the 2010 marine insurance statistics (the latest available), gross written premium was C$191 million, and gross incurred losses were approximately C$85 million.

As in the global market, excess insurance market capacity on virtually all marine lines continues to make this a buyer's market, writes Marsh practice leader Matthew Yeshin in the broker’s Insurance Market Report 2012. The downside is that the soft market for marine insurance is starting to impact insurers' profitability as competition continues to drive down rates, despite signs of loss challenges.

Yet, insurers continue to see it as an area for growth and are committing resources to fuel this growth, particularly in Cargo and Inland Marine, Yeshin says. As a result of this commitment to growth, there is active competition among existing and new insurers, which is keeping downward pressure on pricing.

Hull: The hull market is experiencing flat to slight rate reductions on individual fleets depending on their records, notes Yeshin. The impact of the Japanese earthquake and tsunami had negligible effects on the market. This trend appears set to continue for the current year, as increased capital and capacity enters the market and regional insurers expand beyond their current borders. (In the fourth quarter of 2011, the premium rate decreases ranged from 0% -5%, compared to decreases of 0% to 10% in the fourth quarter of 2010.)

Liability: The market is stable with slight rate reductions as insurers, looking to reduce their exposure to energy-related risks, have supplied additional marine liability capacity, although rate reductions are limited to accounts with exceptional loss history. In general, claims are becoming less frequent; however, the loss quantum is increasing, particularly in pollution, wreck removal and salvage incidents says Yeshin. The liability market is a diversified portfolio of risks each requiring different forms of coverage ranging from the traditional charterers liability, ship repairers, cargo owners, protection and indemnity, ports and terminal liabilities to the specialist operations of dredging, marine construction and installation, salvage, diving and offshore drilling operations. With such a broad range of operations, it is difficult to provide a general comment on all liability risks; however, insurers are taking a less favourable view towards energy-related operations and those dealing with offshore construction, drilling and production environment, Marsh notes.  In Canada, P&I was flat, with a proposed 5% general increase in the last quarter, compared to a 5% decrease in the 4Q of 2010.

Cargo: The cargo market continues to have lots of capacity chasing what seems to be a declining premium pool, which is positive for cargo insurance buyers, but as losses start to rise, underwriters will need to reconsider their pricing. In addition, traditional ocean cargo underwriters have started expanding into inland marine risks, writing aggressively, but on a class of business that has higher claims frequency, which is draining resources and eroding profitability. Premiums in the fourth quarter of last year saw decreases ranging from 0% to 10% (international), while the domestic/inland book saw premium increases range from 0% to 5%.

Looking ahead for Canada

Marsh anticipates continued downward pressure on pricing due to competition among insurers, although the focus will be on gaining accounts with good risk profiles. Less profitable accounts, particularly on the hull and liability side may see some rate increases, as well as some tightening on coverage and deductibles.

Vessel valuation, maintenance, capital upgrades, ship management, and cargo loss control will be key considerations for insurers evaluating client risk. “We anticipate that many of the large, global market players will be actively involved in providing these value-added services in conjunction with placement,” practice leader Yeshin writes.

The Scourge of Piracy

Pirate attacks against vessels in East and West Africa accounted for the majority of world attacks in 2011, signalling a rising trend, the International Chamber of Commerce (ICC) International Maritime Bureau’s (IMB) global piracy report revealed on January 19. Of the 439 attacks reported to the IMB in 2011, 275 attacks took place off Somalia on the east coast and in the Gulf of Guinea on the west coast of Africa.

The report showed a slight drop in the total number of recorded incidents of piracy and armed robbery worldwide, comparing the 439 recorded incidents of piracy and armed robbery in 2011 to 445 in 2010. The falling numbers come after four consecutive years of increased piracy and armed robbery worldwide.

The 802 crew members taken hostage in 2011 also marked a decrease from the four-year high of 1,181 in 2010. Overall in 2011, there were 45 vessels hijacked, 176 vessels boarded, 113 vessels fired upon and 105 reported attempted attacks. A total of eight crew members were killed throughout the year, the same number as 2010.

Somali pirates accounted for 54% of the attacks. But while the overall number of Somali incidents increased from 219 in 2010 to 237 in 2011, the number of successful hijackings decreased from 49 to 28.

Oceans Beyond Piracy noted in its February 2012 report that approximately 80% of anti-piracy costs are borne by the shipping industry, while governments account for 20% of the expenditures associated with countering piracy attacks.

The report estimates the 2011 economic cost of piracy was between US$6.6 and US$6.9 billion. The breakdown of the costs includes US$2.7 billion in fuel costs associated with increased speeds of vessels transiting through high risk areas, US$1.3 billion for military operations, and US$1.1 billion for security equipment and armed guards. Additionally, US$635 million is attributed to insurance, US$486 million to US$680 million is spent on re-routing vessels along the western coast of India, and US$195 million is the estimated cost for increased labour costs and danger pay for seafarers.

The vast majority (99%) of the billions spent are attached to recurring costs associated with the protection of vessels – costs which must be repeated each year, Oceans Beyond Piracy reported. This figure is in sharp contrast to the $38 million spent for prosecution, imprisonment, and building regional and Somali capacity to fight piracy. Average ransoms also increased 25% from approximately US$4 million in 2010 to US$5 million in 2011. Although the total cost for ransoms was US$160 million for 2011, money collected by pirates represents a mere 2% of the total economic cost. While ransoms provide the incentive for Somali pirates to attack vessels and hold hostages, they represent a disproportionally small cost compared to the nearly US$7 billion spent to thwart these attacks, Oceans Beyond Piracy said in a statement.

Insurers have taken issue with the report, questioning the Oceans Beyond Piracy calculations which say ship owners paid $635m in insurance to protect themselves from piracy last year.

According to the subscription news service Lloyd’s List, the industry has voiced frustration that the report has not taken account of insurance companies’ feedback. However, the insurance market has yet to agree on its own estimate for the total value of the marine war risks and Kidnap & Ransom (K&R) insurance markets. War risk premiums stood at roughly US$230m for 2011, says Oceans Beyond Piracy. But UK broker Seacurus director Nick Maddelena disagrees with the OBP report’s findings and estimates the 2011 K&R market at just $120m.

A Seacurus Bulletin published in January noted that ransom prices have reportedly fallen recently following an incursion by Kenyan troops into Somalia beginning in October 2011; pirates have sought quickly to conclude deals in advance of expected battles between the Kenyan troops and Somali militants.

However, it might be too early to celebrate. The recent release of the Italian Aframax “Savina Caylyn” and her crew after almost 11 months of captivity has seemingly marked a high water mark in the piracy war. According to observers the release is extremely significant as the rumoured ransom is very high, with sources quoting US$11.5 million.  This seems to confirm the pattern indicated with the US$12 million ransom demanded for the “MV Zirku” back in June 2011, Seacurus said.

While some brokers like Willis have labelled K&R and War Risks as among the fastest-growing segments of insurance, Lloyd’s Market Association marine committee chairman Andrew Voke has said that piracy claims have overtaken the income gained from premiums. Significant claims have led certain underwriters including Beazley, Hiscox and Chubb to distance themselves from the market.

Costa Concordia: A Full Blown Catastrophe

On 13 January 2012, the luxury cruise liner Costa Concordia ran aground off the Italian island of Giglio. The Costa was a multi-story liner carrying over 4,000 passengers. Latest reports put the number of fatalities at 25.

The ship is insured for 405 million euros (US$513 million) by a bevy of insurers including XL, RSA and Generali. Investigations into the exact cause of the accident continue. Costa Cruises has publicly criticised the vessel’s master, Francisco Schettino, who remains under house arrest on charges of abandoning ship and for manslaughter. As at February 22nd, Italian prosecutors have widened their probe of the Costa Concordia shipwreck to include seven employees of the vessel's operator, Carnival Corp's Costa Crociere SpA.

Munich Re released a statement soon after the Costa Concordia incident, stating only that based on current estimates, the reinsurer expects the claims burden from the stricken cruise ship to be in the mid double-digit million euro range. Besides costs for the vessel under hull insurance, further losses may arise due to liability claims from passengers, recovery of the wreck, and possibly from environmental liability claims. Insurer Validus Holdings Ltd, has said it may be liable for US$50 million to US$65 million. Validus's estimate of its own losses are based on its prediction that the total insured payout on the shipwreck will be US$845 million to US$950 million, meaning the Bermuda-based company expects to shoulder about 15% of the industry-wide loss.

According to Lloyd’s Market Association chairman Rupert Atkin, the Costa Concordia loss is the equivalent of a catastrophe event in the marine world. “The industry understanding is that the hull account is not priced adequately to pay a loss of this size and rates will have to be repriced across all types of vessels,” he says. Even though the relatively small number of very high value vessels in the world fleet has been well run and total losses have been very rare, the Costa Concordia loss has vividly and tragically demonstrated the scale of losses that can result from human error and poor judgment.

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