“The impact of piracy . on marine insurance”

Κωνσταντίνος Καττίδης

February 2013

Marine Insurance EXN 332

“Analyse the impact of piracy on marine insurance.”

“ The growing demand for a single policy conceptcovering all possible consequences of a pirate attackcannot be met by the insurance industry. This is due tothe great diversity of interests of the parties concerned.”Tillmann Kratz, Expert on FacultativeRisks and Corporate Underwriting

Contents

1. Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . 1

2. Global Piracy Hotspots . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

3. The Economic Cost of Piracy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

4. Piracy and Marine Insurance . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

5. Marine Insurance Policies and Piracy Coverage . . . . . . . . . . . . . . . . . . . . . . .3

5.1 Hull Insurance . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . .4

5.2 War Risk Insurance . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 4

5.3 P&I insurance . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . .5

5.4 Cargo Insurance . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .5

5.5 Kidnap and ransom insurance. . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . 6

5.6 Loss of hire/earnings Insurance. . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . 6

6. Cost of Excess Insurance . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6

7. The implications of employing guards to insurance premiums. . . . . . . . . . . . . . . 7

8. Conclusion . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

1. Introduction

Approximately 80% of world trade currently travels by sea, representing around 93,000 merchant vessels, 1.25 million seafarers, and almost six billion tons of cargo. In recent years, the world shipping sector is facing one of the world’s oldest crimes against this trade, piracy. The International Maritime Bureau defined piracy as “An act of boarding and attempting to board any ship with the apparent intent to commit theft or any other crime and with the apparent intent or capability to use force in the furtherance of the act”. It may be reasonable to assume that piracy has existed for as long as maritime commerce has existed between states. Although piratical attacks have changed their nature through the years, as pirates aspiration is not to steal any more. Synchronous pirates would rather hijack a vessel with cargo and crew on board and demand the ransom for the ship release. Golden years of piracy were at the end of 20th century. Nowadays, piracy remains one of the biggest risks of merchant vessels and it’s steadily increasing trend, poses a significant threat to world shipping. The global shipping industry is most concerned about vessels that carry oil, chemicals, coal, iron ore, wheat and other commodities. These vessels tend to be more vulnerable to pirate attacks than container vessels because they ride lower in the water and they are traveling with lower speed.

2. Global Piracy Hotspots

Map 1.1 shows all the piracy and armed robbery incidents reported to the IMB Piracy Reporting Centre during 2013. The Gulf of Aden which lies between Yemen and Somalia and connects the Indian Ocean to the Red Sea and the Suez Canal is the area with the most piracy incidents reported. Somalia has the longest coastline in Africa with 33,000 km. This area is very important because more than 20,000 ships pass it through, to go to and return from Suez Canal every year. Other areas of the

world including Indonesia, Nigeria, Bangladesh, Philippines, Malacca Straits, Tanzania, Peru, Brazil and India are viewed also at high risk for ocean piracy.

3. The economic cost of piracy

The main factors contributing to the overall cost of piracy as the graph 1.2 illustrates are ransoms, insurance premiums, security equipment and guards, re-routing, increased speeds, military operations and counter-piracy organisations. The insurance market has evolved to reflect continued developments in piracy. The total cost of insurance was approximately $635 million in 2011. From the statistics of the International Maritime Bureau, in 2008, the amount paid to pirates in ransoms was estimated at US$150 million and 111 ships were attacked. By 2009, the number of ships attacked had increased to 217, with 47 vessels and 867 crew members taken hostage. In August 2009 the Suez Canal reported a 20% drop in revenues, partly as a result of piracy. Ransoms of about US$75 to US$85 million were paid in 2010 to secure the release of 21 ships and in 2011 Somali pirates attacked 237 ships and successfully hijacked 28. In 2012 the number of ships attacked was 269. Geopolicity, the international management consultancy group, has estimated that the total annual monetary cost of piracy to the international community is between US$4.9 and US$8.3 billion. Somali piracy cost the international community up to US$ 6.9 billion that is a billion dollars more than Somalia’s GDP.

4. Piracy and Marine Insurance

In reaction to the steep increase in sea piracy cases especially in the main high-risk piracy zones, the maritime insurance industry has responded by increasing dramatically its shipping rates and premiums. All shipping companies must place extra insurance costs in order to hedge economically from piracy. But it is not only the financial implications that have captured the world’s attention. The personal

safety of crews and passengers is of prime concern. Shippers generally purchase ocean marine insurance in order to protect against a financial loss or injury to their crew, cargo and the ship itself. Lloyd’s of London introduced and shaped the marine insurance business. Over those years, the principles of marine insurance remained constant, however the insurance markets have introduced new products and procedures have changed in order to follow the needs of owners of vessels transiting through the high-risk areas. The sharp increase in piratical incidents and the costs associated with them started a discussion as to the piracy coverage under modern marine insurance policies. Until 2005, piracy was insured under ordinary hull coverage, after that time London underwriters started transferring it to the war risks policies. Historically, piracy in England has oscillated between being covered as marine risk and war risk. Due to the increase in piracy attacks, the London Market has reacted by placing piracy under the hull war insurance cover including loss, damage or robbery caused by pirates. Because of the large number of diverse interests affected by a pirate attack on a ship (owners, crews, charterers, cargo shippers), there can be no single, full comprehensive insurance product covering losses or damage incurred by the various parties in consequence of such an attack. In order to meet the needs of those parties, the marine insurance market responded quickly to the increasing risk of piratical incidents, providing in addition to the standard covers such as hull, cargo, war risks policies and P&I coverage, the specialized marine policies, such as K&R insurance or loss of hire/expenses policies. .

5. Marine Insurance Policies and Piracy CoverageDamage to the vessel and its equipment resulting from piratical attack might be recovered under either hull or war risks policies. Furthermore, ransom payment might be recoverable also under hull or war risks policies and in addition, under K&R policy, if such is obtained. Also loss of hire/earnings due to piracy policy provides coverage to the loss of hire/earnings caused by suspension of the ship’s operation while the vessel is detained. There are six basic types of ocean marine insurance:

5.1 Hull InsuranceIt is often split into a Hull & Machinery (H&M) policy and an Increased Values (IV) policy which insures the remainder of the ship for total loss only. The insured perils clause of hull and machinery policies includes physical loss of or damage to the Insured Vessel (as defined in the Marine Conditions), and third party liabilities, costs and expenses caused by many reasons including piracy. Piracy claims may contribute to both H&M and IV policies. Total losses arise from theft of the vessel or from scuttling due to pirate attack and partial losses can come from damage incurred to the ship even if the pirates were unsuccessful. Furthermore, it has been argued that payment of ransom might be illegal, therefore, could not be recovered under the marine insurance policies. It estimated that piracy has doubled the cost of hull insurance.

5.2 War Risk Insurance Today the great majority of ships are insured against piracy under their war risks insurance. War risks insurance is designed to provide coverage to the loss or damage of the vessel due to acts of war. The shipowner purchasing the additional coverage to the hull policy that excludes violent theft, piracy and barratry will have to obtain the Institute War and Strikes Clauses amended by the Extension Clause in order to be insured against the peril of piracy. There are practical advantages to including piracy as a war risk. Deductibles are typically not applied to claims to war

risks insurance policies, but are applied to claims on marine risks policies. It also protects the ship owner’s marine risks claims record in the event of a claim. Insurers can charge an additional premium if a ship trades in pirate infested seas. The war risks additional premium areas enables cover to be paid by those that bring the risk exposure (charterer or customer). War risks insurers will often reduce rates for voyages through the listed areas if they are satisfied with the piracy prevention measures in place and / or if K&R cover is purchased with an appropriate limit.

Until 1982, piracy was a war risk under English hull clauses. Under the 1982 ITC Hull policy wording, it was adopted as a regular hull risk. In 2005, optional clauses were introduced by the Joint Hull Committee which excluded piracy from the hull policy, together with a corresponding write-back clause for the risk under the war policies. Today, London market clauses (Institute Time Clauses Hulls) provides an option to cover piracy under hull or war policies.

Since May 2008, when Gulf of Aden was classified as a war risk area by Lloyds Market the cost of war risk premiums have increased from $500 per ship, per voyage, to up to $150,000 per ship, per voyage, in 2010.

5.3 P&I insurance More than 90% of ocean-going ships are insured by the mutual P&I Clubs that are members of the International Group of P&I Clubs. P&I insurance covers third party liabilities such as damage of cargo, injury/death of passengers or crewmembers. Piracy is not covered by the P&I Clubs as named peril but potential liabilities that might arise from piracy include injury, illness or death of crew which P&I insurance covers. Furthermore, the liabilities can extend to pollution or wreck removal, if the pirates destroy the vessel. The most claims that were made to the P&I Clubs so far, in respect to piracy, were regarding the crew injury or death, cargo loss or damage to it. However, Somali pirates do not intend to cause any damage, either to the ship/cargo or to the crew, as long as ransom is paid to them. Therefore, most likely the vessel is to be returned to the shipowner untouched and with safe and healthy crew on board. The P&I clubs have made it clear that they do not cover ransom payments but it has been recently argued that P&I Clubs should contribute to ransom through GA. It seems logical to include the P&I Clubs into the contributing parties, since they have very strong interest in releasing the crew and preventing any major pollution damages.

5.4 Cargo InsuranceCargo carried by a ship is not insured by the ship owner but by the owner of the cargo which may well be a large number of different parties for a large ocean-going cargo ship. The costs directly related to piracy traditionally have been considered a marine peril, covered by a cargo insurance policy for the goods being shipped and a hull and machinery policy for the vessel itself. The cargo is often more valuable than the vessel itself, yet in the event of a hijacking, cargo owners may not be alerted to the situation and are unlikely to be involved in the subsequent negotiations and ransom payment. The marine cargo insurance covers the physical loss or damage to the cargo for the cargo owner. The excess premium on cargo transiting piracy regions is estimated to have increased by between $25 and $100 per container in the past few years. Historically ransom payments been paid by the owner of the vessel. However during 2008 as the size and frequency of ransom claims increased General Average has generally been accepted by Hull and Cargo insurers as the fairest way of dealing with ransom claims.

5.5 Kidnap and ransom insurance

Marine K&R insurance indemnifies the shipowner for the losses that arise as a result of a demand for a ransom payment that follows illegal threats or actions taken by pirates against the insured shipowner, their vessel or crew. The insurance also covers personal accident losses caused by a kidnap. These include death, dismemberment, and permanent total disablement of a kidnapped person. Cover can be obtained from these underwriters covering either individual high risk voyages or annually on a global basis. The average ransom demand is about $4 million dollars, an amount that has more than doubled in the last three years. In some countries, the payment of a ransom is prohibited by law. British courts, on the other hand, have confirmed the legality of ransom payments. If the payment of ransom is considered illegal in the applicable jurisdiction, owners may even have difficulty in recovering the expenditure from P&I or from hull and cargo insurers under General Average. On the other hand, there seem to have been no problems so far to recover insured amounts from K&R insurers. One estimate suggests that, globally, ransom payments could be worth US$500 million annually, Munich Reinsurance Company estimates that K&R premiums increased tenfold between 2008 and 2009. It was said to be as much as US$ 30,000 for US$ 3,000,000 of cover for one single journey through the Gulf of Aden. Premiums on kidnap and ransom insurance policies have raised in excess of 1000% from 2008 to 2011.

5.6 Loss of hire/earnings Insurance (LoH)None of the above policies provides coverage to the loss of hire/earnings caused by suspension of the ship’s operation while the vessel is detained. New LoH insurance products launched in 2008 also protects ship-owners, charterers and cargo owners against the losses of income or obligation to pay charter hire without a physical damage trigger if the vessel is held by pirates for several months. In average the vessel attacked by pirates is detained for 60 days. Thus, it is of crucial importance to shipowner/charterer to obtain loss of hire/earnings insurance.

6. Cost of Excess InsuranceThe Gulf of Aden was classified as a ‘war risk area’ by Lloyds Market Association (LMA) Joint War Committee in May 2008, and is therefore subject to specific insurance premiums. It is estimated that total excess costs of insurance due to Somali piracy are between $460 million and $3.2 billion per annum. Every year approximately 27,000 ships are transiting the Gulf of Aden. An approximate of 90% of those ships is insured by the two largest premiums related to piracy: war risk and K&R. The insurance premium for Kidnap & Ransom is $540 million and the War Risk Premium is $4.05 billion per annum on average. In total, insurance costs for those two insurances is $4.59 billion per annum. This is a huge cost for shipowners who are struggling to protect their ships and their cargo from piracy. Fairmont Shipping (Canada) Ltd reports that is incurring $100 000 to $120 000 in additional insurance premiums for each trip due to this increased area of high-risk. This effectively doubles their insurance cost for every trip. These additional costs are inevitably passed on to consumers too, which is reflected in the cost of commodities and manufactured. Several big shipping companies charge the so-called "piracy-tax". However, last year the dramatic fall in pirate attacks off the Somali coast forced down the cost of piracy insurance for commercial ships.

In May 2008, insurance underwriters at the Lloyds of London have raised rates with extra premiums at $10,000 to $20,000 per trip through for ships making the voyage through the Gulf of Aden and the Suez Canal. Also, due to piracy in the Gulf of Aden,

the cost of insuring a container went from $900 in 2007 to $9,000 in the closing months of 2008.

7. The implications of employing guards to insurance premiums

If ship owners deploy an armed security team on board during at-risk voyages they will achieve reductions to both war risks additional premium and marine K&R premium. If there is an intention to carry armed guards, any warranty must be amended to reflect this. Ship owners inform war risks underwriters of their intention to employ a security company and consult fully with their P&I clubs before entering into contracts to employ guards, armed or not. Today there are a large number of organisations offering security services such as The Security Association for theMaritime Industry (SAMI) which has been formed as an independent regulatory trade association for maritime security companies. Also, The International Association of Maritime Security Professionals (IAMSP) has been separately established to provide certification for individuals working in maritime security. Historically, no ship with armed guards on board has been successfully taken by pirates. The shipowners are spending up to $40,000 (£24,000) per passage on security guards.Furthermore, faster ships are cheaper to insure, as they are more challenging for pirates to attack. Anything over 15 knots tends to be fast as far as the pirates are concerned.

8. ConclusionSummarizing, the industry rates for this insurance protection are increasing because the ransom demands are going up and there is a significant increase in pirate activity. Nevertheless, the marine insurance market responded quickly to the increasing risk of piratical incidents, providing the standard covers such as hull, cargo, war risks policies and P&I coverage and the specialized marine policies, such as K&R insurance or loss of hire/expenses policies. The shipowner or cargo owner might obtain a sufficient coverage that will allow him to recover the losses suffered as result of the piracy. However, such insurance might be very costly, in addition to the fact that to obtain such coverage many different policies must be acquired. But considering the alternative, the policies are very affordable. A standard policy offers $3 to $5 million dollars in coverage. Without insurance protection, the only other option for many of these ship owners is to take a longer route which would inevitably drive up their operating costs substantially. And there still is no guarantee that the pirates will not move to attack the new route. Additionally, more and more ship owners are turning to the use of armed guards to repel the pirates. And we are seeing that when ships have had armed guards on board, they are often successful at repelling the attacks. So shipowners/cargo owners in order to deduce cost of insurance they employ an armed security team.

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