Piracy insurance poised to increase

Piracy insurance poised to increase Increase in attacks, security requirements, translate to higher premiums for ship operators.

By Eric Kulisch

      Insurance to cover ship owners from acts of piracy has been one of the few bright spots for an insurance industry buffeted by the recession and natural disasters.
      Insurance companies have seen lower income from annuities, sizable losses in investment portfolios, shrinking reserves, large property damage claims from hurricanes in 2008, and a pullback in policy renewals by businesses and consumers.
      As Somali pirates increased activity last year in and around the Gulf of Aden, insurance companies increased their premiums for commercial vessels transiting the region. But the shipping industry could soon face even higher premiums or requirements to adopt expensive security measures for their vessels as a condition of obtaining insurance, according to Michael Frodl, a Washington-based attorney advising specialty insurance companies about emerging risks such as piracy.
      Ocean carriers are covered by hull insurance for acts of piracy that damage their boat. They can also take out special kidnap-and-ransom indemnity policies that reimburse costs for paying a ransom, negotiations, ransom delivery, medical expenses, and loss of income. The cost of such piracy policies, which can be bought for individual transits or on an annual basis, was 10 times greater in April than in October 2008, according to global insurance broker Aon Risk Services. But costs have dipped about 30 percent since then because the monsoon season made it difficult for pirates to conduct operations.
      Between November 2008 and May, total insurance costs for ships transiting the Gulf of Aden and surrounding waters was $400 million, according to BGN Risk.

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      Premiums for very large crude carriers have reached 0.1 or 0.2 percent of the value of the ship, which could equal a one-time fee of $100,000 to $200,000 for a $100 million ship that is returning empty through the Suez Canal and Red Sea, according to Frodl. Fully loaded tankers usually have to travel around the Cape of Good Hope because they require too much draft to go through the Suez Canal.

'We're expecting a significant rise in piracy attacks when the southwestern monsoon season ends. As such, insurance prices are likely to be on the cusp of turning upwards.'

Clive Stoddart kidnap-and-ramson team head, Aon Rish Services

      The average insurance cost is about $20,000 per transit, factoring in that premiums vary by vessel and some bottom feeders don't even pay insurance, he said. The figure is up 20-fold from 18 months ago.
      Frodl questioned BNG's estimate for total piracy coverage in the Gulf of Aden, saying that multiplying the transit insurance cost by the estimated 20,000 annual transits through the waterway does not accurately reflect the market. He guessed the market is probably one-third to half the BGN figure because many ships from developing nations don't even have insurance, frequent voyagers through the Gulf could have low premiums, and Western ships that do pay regular property insurance often rely on the principal of general average to spread any damages from a piracy attack to the cargo customer after the fact rather than take out extra policies.
      As calm weather becomes the norm, Aon said it expects a significant increase in pirate attacks and insurance premiums. It is urging ship owners to lock in quotes before the market changes again.
      'We're expecting a significant rise in piracy attacks when the southwestern monsoon season ends. As such, insurance prices are likely to be on the cusp of turning upwards,' said Clive Stoddart, head of Aon's kidnap-and-ransom team, in a Sept. 4 statement. Underwriters are still offering reduced premiums for fast or empty vessels that can more easily escape an attack, he said.
      Although piracy insurance coverage rose quickly last year, it didn't go up as much as it could have given the heightened risk off the Somali Coast, Frodl said.
      Underwriters are ginning up premiums as if the rate of successful hijackings was much higher, he said. About one in every 500 ships moving through the Gulf of Aden is ever captured by pirates, but prices reflect a capture rate of one per 100. Nonetheless, the premiums still did not adequately cover insurers' long-term exposure to the risk.
      One of the main reasons insurance was underpriced relative to potential losses is that providers didn't want to jack up rates so high that they drove customers to competitors. The prevailing wisdom at the time was that companies could make up any losses through their investment portfolio. Insurers also didn't fully grasp the magnitude of the problem and assumed that the increase in international naval forces in the region would tamp down criminal activity at sea.
      Now insurance companies are placing less faith in returns generated on Wall Street, and underwriters are more carefully calculating whether they are capturing enough money up front to pay claims due to the increased frequency and severity of pirate attacks, Frodl said.
      So far this year there have been 138 pirate attacks, of which 33 were successful, according to the U.S. State Department. That compares to 122 pirate attacks and 42 captures in 2008 and 19 attacks with 12 hijacks in 2007.
      As the piracy market matures, insurers have to collect more premiums to offset an expected increase in claims or start imposing a risk-reduction strategy among customers they underwrite. That means getting ship owners to adopt maritime security best practices, Frodl said.
      Insurance companies should structure policies insisting on the use of best practices, such as posting watches at all times in the danger zone, to deal with the problem of inadequate premiums and eliminate the moral hazard associated with cargo customers who balk at paying more for security, he said.
      Faced with a low-margin business, many vessel operators had determined that the odds of a successful hijack are low (about one-third of 1 percent) and that paying ransom is a cheaper cost of doing business than investing up front in prevention.
   Ship owners will increasingly be squeezed by insurers who demand higher premiums or security investments and customers expecting rock-bottom shipping rates in an oversaturated freight transportation market in which carriers are struggling to survive, the insurance attorney observed.
      The International Association of Independent Tanker Owners (INTERTANKO) in February issued model contract language to be included in the bill of lading that allows the ship master to take all necessary preventive measures against an attack and says customers that charter the ship are responsible for paying the extra costs, including additional insurance premiums, crew costs, security personnel and equipment.
      But most ship operators are not adopting the new INTERTANKO language to bill their security costs because business is so bad. The fear is that customers will view it as an open-ended commitment and turn to their competitors, Frodl said.

General Average. The reluctance of customers to share the cost of security is underlined by two cases being litigated in London in which Russian and Chinese cargo owners are refusing to pay their shares to indemnify the ship owner for having paid a ransom to pirates to gain the release of a vessel.
      Shipping companies have typically relied on the maritime principle of general average in which all parties in a sea venture share pay, in proportion to the value of their cargo, any expenses from damage to a ship or its cargo or for direct action taken to prevent harm to them. General average is essentially a gentlemen's cost-sharing arrangement that has allowed ship owners to self-insure after an incident to avoid taking out extra protection and indemnity insurance.
      The Russian and Chinese parties argue they did not authorize the payment of a ransom and should not have to make a contribution to bail out the ship owners.
      If the Russian and Chinese cargo interests succeed in not paying their fair share under general average then ship owners who opt not to take out extra kidnap-and-ransom protection will be encouraged to demand up front escrow amounts from customers equal to what the cargo owner would have to pay to indemnify the ship owner in the event of a hijack and ransom, Frodl said.
      The protection and indemnity industry is very worried about similar lawsuits in the future. Officials are considering holding a conference later this year to tighten the rules, which were never designed to deal with the ransom indemnification in the range of $2 million or more, he said.
      Insurance policies should come in behind the INTERTANKO clauses by giving a break on premiums to companies that take precautions, and reject claims for companies that neglect to take protective steps, Frodl said.
      Requiring best security practices 'may not only help insurers not go bust and so be there for all the shippers who've paid in and expect to get their claims honored, it may also make respecting best practices cost effective for shippers' by evening the playing field, he said.

Best Defense. Perhaps the best line of defense a ship can take is to maintain maximum speed through the danger zone, according to maritime industry officials and security experts. But operating at top speed, especially for large deadweight ton tankers, is very expensive in terms of fuel consumption. The problem with waiting until pirates are spotted making a move is that the enormous ships can take at least a half-hour to reach top speed, twice the length of time pirates know they need to get on board a ship before naval forces arrive on scene to repel an attack.
      Another critical defensive technique is to maintain a constant lookout for pirates. Maritime authorities and security experts repeatedly remind vessel operators to maintain vigilance. The reminders are necessary, Frodl said, because crews on the new generation of massive containerships and tankers rely so much on automation that they have become less alert to their surroundings. Computers have also allowed ocean carriers to reduce the size of the crews.
      'These ships are so automated that the officers on the bridge spend most of their time looking at the consoles and don't look out the windows much,' Frodl said. They are also lulled into complacency because the rules of the road give the largest ships the right of way, so officers assume that other ships will yield to them.
      'They might as well be in a simulator. That's how pirates sneak up on these guys. They're not paying attention,' he said.
Underwriters will likely charge as much as they can without overcharging to cover the cost of claims, while at the same time giving relief to clients that take steps to reduce the chance of a hijack and a potential claim, Frodl predicted.
      Some ocean carriers have gone beyond training their crews in passive defense tactics and hired unarmed, or in some cases armed, guards to ride their vessels through pirate-infested waters. Insurance companies are the silent partners facilitating many of these transactions, according to Patrick Cullen, a researcher on private military contractors.
      Some private security firms have teamed up with insurance brokers to offer a combined security and insurance package. Bringing the insurance company into the discussion ensures the client that any private security brought on a vessel will not void its insurance policy, and guarantees to the insurance company that proper security procedures are in place, which can lead to premium reductions.
      'Insurance brokers are creating insurance products that they market themselves as providing a cheaper rate if you work with a security provider that they recommend,' Cullen said.
      Hart Security, for example, last October partnered with broker Swinglehurst Ltd. to offer a combined protection package for Gulf of Aden voyages.
      Ship owners can now obtain war risk insurance through Lloyds of London that includes piracy coverage when Hart personnel protect their vessels.
      Maritime & Underwater Security Consultants (MUSC) has also joined forces with Special Contingency Risk Ltd. to provide an integrated risk mitigation service. The company says its Vessel Shield product eliminates the uncertainty in regular maritime policies about whether piracy is covered in the event of an actual hijack. MUSC provides vulnerability assessments and security plans for vessels, risk intelligence, contact with local authorities, anti-piracy drills, crisis response and advise, negotiation services, ransom payment logistics, and vessel and crew recovery ' but not guards.
      From the insurance company's perspective, the protection packages are not just to lower premiums, but also to make a profit by lowering the risk associated with new clients.
      It's unclear whether lower premiums offset the security component in the package and what types of revenue sharing occur between the insurance broker and the security firm.