Marine Insurance I

Course Overview and Core References

• Course Designation: Marine Insurance I
• Instructor: Christabel Ewedji, FICS
• Course Outline & Structure:
  • 1. General Introduction to Marine Insurance:
  • 1.1 Risk and maritime transport activities
  • 1.2 Risk management options
  • 1.3 Historical Development of Marine Insurance
  • 1.4 Scope of Marine Insurance
  • 2. Marine Insurance Markets and Practitioners:
  • 2.1 Marine insurance markets
  • 2.2 Insurance associations
  • 3. Marine Insurance Principles:
  • 3.1 Insurable interest
  • 3.2 Utmost good faith
  • 3.3 Indemnity (Proximate cause, Subrogation)
  • 4. Effecting Marine Insurance:
  • 4.1 Role of Brokers
  • 4.2 Market Procedures
  • 4.3 Marine Policies
  • 5. Marine Losses (Ship and Cargo):
  • 5.1 Total Loss
  • 5.2 Partial Loss
  • 6. Marine Liability Insurance:
  • 6.1 History of protection and indemnity (P&I) clubs
  • 6.2 Cover provided
  • 6.3 Underwriting principles
• Primary Textbooks:
  • Introduction to risk management and insurance by Mark Dorfman
  • Marine insurance principles and basic practise by R. H. Brown
  • Marine insurance volume II by R. H. Brown
  • Marine insurance principles and basic practise by Mishra
• Key Reference Documents:
  • Marine Insurance Act ($1906$)
  • ICS notes
  • Other sources

Fundamental Scope and Definitions in Marine Insurance

• Foundational Axiom: In $1789$, Benjamin Franklin stated: "In this world, nothing is certain except death and taxes."
• Scope of Coverage in Marine Insurance:
  • Hull & Machinery (H&M): Covers damage to ship due to any mishap like crash, collision, or piracy attacks.
  • Cargo: Provides coverage to cargo against any damage, loss, or misplacement.
  • Freight: Covers the loss of freight earnings.
  • Life & Protection: Covers the life of crew members and others on ship.
• Definition of Risk in Maritime Transport:
  • Risk in the maritime domain is defined as the uncertainty concerning a possible port sector.
  • Risk is the potential of loss (an undesirable outcome) resulting from a given action, activity, and/or inaction.
• Insurable Loss:
  • An insurable loss includes the undesired and unplanned reduction of the economic value of an item.
  • It is classified as either Direct or Indirect.
• Perils versus Hazards:
  • Peril: Defined as the cause of loss.
  • Perils of the Sea: Stranding, sinking, collision, and extraordinary heavy weather.
  • Perils on the Sea: Fire, piracy / barratry, thieves, jettison.
  • Hazards: Conditions that increase the frequency or the severity of losses.
  • Includes moral hazards and morale hazards.
• Pure Risk versus Speculative Risk:
  • Pure Risk (Static Risk): Insurable risks that only involve the possibility of loss or no loss.
  • Speculative Risk (Dynamic Risk): Not insurable risks involving the potential for gain; some are mitigated by the use of derivatives or securities.
  • Risk-Profit Equation: The higher the risk, the higher the profit.

Maritime Industry Risk Profile and Empirical Data

• Transportation Risk Index ($2021$) Insights:
  • Maritime transport providers perceive threats related to cyber security as well as data privacy as the most challenging.
  • Businesses must be aware of price risks and the potential downfalls of shipping incidents, among other challenges.
• Global Maritime Incident Statistics ($2020$):
  • Total shipping incidents: $2,703$ incidents.
  • Total losses: $40$ total losses.
  • Cargo ship losses: $37\%$ of total vessel losses were cargo ships.
• Key Disruption Factors in Global Shipping:
  • Trade disputes.
  • Extreme weather conditions.
  • The COVID-19 pandemic.
  • Rising demand in containerized goods, leading to major delays and disruptions in the shipping industry.
• Route Blockage Risk:
  • Despite occurring rarely, the blockage of important shipping routes constitutes another significant risk factor that must be taken into consideration.

Comprehensive Taxonomy of Shipping Risks

• Price Risk:
  • Freight rate risk.
  • Operating cost risk.
  • Interest rate risk.
  • Asset price risk.
• Credit Risk:
  • Risk between ship owner and charterer.
  • Risk between investor and shipyard.
  • Risk in forwards transactions between two investors.
  • Risk between bunker supplier and ship owner.
• Pure Risk:
  • Accidents.
  • Liability from oil or chemical spillage.
• Technical Risks:
  • Risks that attach to the ship herself and its equipment on board.
• Financial Risks:
  • Imposed by method of financing projects, particularly vessel acquisitions.
  • Dependent on the ratio of equity capital to borrowed funds (capital gearing).
  • A high capital gearing ratio attaches severe risk to future cash flows, in that the cost of capital must be met whether or not profits are being made.
  • In periods of depression where profits are low, excessive pressure on cash flow creates severe liquidity problems for companies.
• Commercial Risks:
  • Relates to trading activities of the ship and occurs in connection with economic developments which affect ship operations.
  • Usually manifests in the form of market conditions (quotas) or operating conditions.
  • Major commercial risks in shipping are freight rate volatility, competition, and port delays.
• Political Risks:
  • Relates to rules of the game which comprise either international or national standards for operating the ship, compliance with which more often than not has cost implications.
  • May also be viewed in the context of countries engaged in world trade.
  • Outbreak of war or presence of warlike conditions puts vessels at risk, even when flying neutral flags.
• Liability Risks:
  • Relates to claims from third parties which may arise out of:
  1. Contractual Relationships: Claims from cargo owners or crew members. In these losses, a limit of liability may apply depending on the terms or rules governing the carriage contract.
  2. Non-Contractual Relations (Tortious Acts): Liabilities such as collision (for which the owner of the offending ship becomes liable), contact with fixed or floating objects, damage to shore installations, and port facilities.

Corporate Risk Management Framework and Execution

• Rationale for Enterprise Risk Management:
  • Avoidance of bankruptcy costs.
  • Management of capital structure and the cost of capital.
  • Generating economic benefits for public listed companies.
  • Tax advantages.
• Definition of Risk Management:
  • The logical development and carrying out of a plan to deal with potential losses with the purpose of managing an organization's exposure to loss and protecting its assets by offsetting risk events or mitigating their effects.
• The Three-Step Risk Management Process:
  • Risk management activities occur before, during, and after losses.
  • Step 1: Identify and Measure Potential Loss Exposures (Risk Identification and Evaluation):
  • To logically measure loss exposures, losses must be considered across four distinct dimensions:
    1. Direct property loss
    2. Consequential losses
    3. Liability losses
    4. Losses caused by death, disability, or unplanned retirement of key people
  • Step 2: Loss Control and Risk Financing (Risk Analysis, Management/Loss Control):
  • Choose and implement the most efficient methods of controlling and financing loss exposures.
  • Loss Control Activities (Designed to mitigate the cost of loss):
    • Risk avoidance
    • Loss prevention
    • Loss reduction
  • Risk Financing Alternatives (Determines when and by whom loss costs are borne):
    • Risk assumption (Self-insurance, Financed risk retention, Non-insurance)
    • Risk transfer (Insurance, Captive insurance, Non-insurance hedging via FFAs, OPTIONS, SWAP, and Hold-harmless agreements)
  • Step 3: Monitor Outcomes (Risk Monitoring):
  • Regular review of plans in line with assets to ensure the plans meet current needs.

Risk Management Decision Matrix

• Categorization of Risk Management Options by Loss Severity and Frequency:
  • High Severity and Low Frequency: Risk Transfer (Insurance and Non-insurance mechanisms).
  • High Severity and High Frequency: Risk Avoidance.
  • Low Severity and Low Frequency: Risk Assumption.
  • Low Severity and High Frequency: Loss Prevention.