WORKSHOP ON HULL INSURANCE

1. WORKSHOP ON HULL INSURANCE BY ASIF NAQVI 18TH JULY 2012, KARACHI ORGANISED BY THE PAKISTAN INSURANCE INSTITUTE

2. HULL WORKSHOP This workshop is designed to give a basic idea of the international hull market and to introduce the various policy forms and the risks they cover. Various text books and websites have been used in the preparation of this presentation.

3. HULL WORKSHOP Topic 1. MIA 1906 Until the year 1907 the law of marine insurance was derived mainly from the decisions of the courts and the treatises of text writers, but its leading principles are now contained in the Marine Insurance Act 1906, the full title of which is “An Act to codify the Law relating to Marine Insurance” . Some of the sections that need to be highlighted are: Sec 22: Contract of marine insurance must be embodied in the policy. Sec 23: Policy must specify the name of the assured

4. HULL WORKSHOP Sec 24: Policy must be signed by or on behalf of the insurer Sec 26: Subject-matter must be designated in the policy It must however be noted that in view of the modern commercial practice, the English and Scottish Law Commissions have recommended the repeal of sections 22, 23 and 24. The Act has a deep relevance, not only to marine insurance but to insurance in general.

5. HULL WORKSHOP SG Form and the General Clause For centuries, the SG policy form, which stands for Salutis Gratia or possibly Ship and Goods had been in use and it was finally discontinued in the early eighties. It has been replaced by the MAR 91. “ The new Marine Policy and Institute Clauses are intended as modernization of the antiquated language of the SG Policy: a continuation rather than a radical departure from the mainstream of the Marine Insurance Act 1906 and the decided cases on the old terminology.

6. HULL WORKSHOP Changes there are, in substance as well as in language. The former should be readily identifiable, the latter should be interpreted in the context of the old jurisprudence. If this is appreciated and applied there need not be an upsurge of litigation as a result of the new Marine Policy and the Institute Clauses.”

7. HULL WORKSHOP An important part of the SG Form was the General Clause which reads as: “and of all other perils, losses, and misfortunes, that have or shall come to the hurt, detriment or damage of the said goods and merchandises and ship, etc. or any part thereof.” The insertion of the General Clause ensured that perils other than those which are not incidental to a marine adventure are also covered.

8. HULL WORKSHOP Topic 2 : Losses Occurring and Claims Made: As a general principle, losses must occur and claims must be made during the policy period. However there are exceptions to this rule and we will have a look into the relevant situations later on.

9. HULL WORKSHOP Topic 3 : Rating of marine hulls: Underwriting considerations include amongst other things, the flag, ownership and management of the vessel. Full Condition rates will differ from Total Loss rates. For a twelve month period on full conditions (e.g. ITC 83) the calculation will be based on three factors:

10. HULL WORKSHOP 1.The market rate for total loss 2.The size of the ship (usually the FDWT) 3.The amount per ton the underwriter requires to cover claims other than total loss (known as ex-TLO claims)

11. HULL WORKSHOP Example: Lloyd’s MAR Form subject to ITC 83/ Period of cover 12 months/ Insured value $8000000/ General cargo vessel of 20000FDWT/TLO rate 0.5%/Ex TLO premium $5 per ton TLO = $8000000X0.5% = Premium $ 40000 Ex TLO = 20000X$5 per ton = $100000 Total =$140000 (Check - Insured value $8000000 X 1.75% = $140000) N.B: With regard to premiums it must generally be noted that depressed freight rates will have a downward pressure on hull premiums as ship owners would be trying hard to meet their daily operating costs.

12. HULL WORKSHOP Topic 4: Offshore structures and navigating hulls The navigating hulls would include: General cargo ships Container vessels Tankers Bulk carriers Offshore supply vessels Tug boats Passenger ferries Pleasure yachts

13. HULL WORKSHOP Ship Valuation: Following method (known as the Five Factor Model) is taken into account when estimating the value of a vessel. Type of vessel (e.g. tanker, bulk carrier etc.) Features ( shipyard, gear, hull construction) Vintage (how old is the vessel) Deadweight (Vessel’s carrying capacity) Freight earning capacity.

14. HULL WORKSHOP Having established how to model these five factors, the next step is to use actual sales to calibrate the model. Specifically, the parameters which determine the shapes of the mathematical functions for age, deadweight and freight earnings are adjusted to match the sales data as closely as possible. Finding these best fit relationships requires a set of mathematical and computational techniques known collectively as regression analysis.

15. HULL WORKSHOP Some of the vessel values as at 29th June 2012 are as follows: 1.TANKERS (Built 2007): VLCC / LR1 / Aframax / MR – $226.16 / DWT 2. BULKERS( Built 2007): Capesize / Panamax / Handymax - $252.12 / DWT 3.CONTAINERSHIPS (Built): $6401.78 / TEU

16. HULL WORKSHOP Freight Market: In the liquid sector, the freights are depressed for VLCCs primarily due to oversupply of tonnage and a steady flow of new buildings entering the market. The products market is presently favoring charterers as owners are unable exert sufficient pressure and have to do ballast voyages. In the dry market, only the smaller bulk carriers are working at good rates.

17. HULL WORKSHOP Offshore structures include: Semi-submersibles Jack-up drilling rigs Drill ship Deep water platforms Tension leg platforms The Exploration and Production Sector due to its very challenging nature has many risks common to a marine adventure but Control of Well, Loss of Well and Blowout are some of the major risks which are encountered in the E and P sector. Widely used covers in this area include EED 8/86 and Welcar 2001.

18. HULL WORKSHOP Energy sector is highly capital intensive and the demand for capital keeps growing. According to a recent survey by US investment bank Dalhman Rose and Co the spending on E and P is pointing to an 11% rise for 2012 taking the total to $595 billion ! Scandinavian countries and the US are the leading players in this area. We shall not be going into any of the offshore specifics as it is a highly specialized area in its own right.

19. HULL WORKSHOP Topic 5: An overview of the hull market from IUMI – premiums and losses for different types of vessels Product providers The market for marine insurance is worldwide but according to the International Union of Marine Insurers the main providers for hull are 17% London Market (split 13% Lloyd's and 4% Company market) 14% Nordic Market 10% Chinese market 9% Japanese market

20. HULL WORKSHOP

21. HULL WORKSHOP Total Losses The number of total losses recorded for 2011 stands, at present, at 55, which is down from the 63 total losses reported by IUMI 12 months ago for 2010. Since last year’s report, the 2010 year has deteriorated. The number of reported total losses has increased for 2010 from 63 to 87 and for 2009 from 67 to 86.

22. HULL WORKSHOP HULL FACT SHEET FROM IUMI

23. HULL WORKSHOP Topic 6: Division of risks between commercial insurers and P and I Clubs There are many forms available in the commercial market but still the most used ones are the ITC 1/10/83. For the sake of better understanding we shall use the risks covered by this policy form only. The insurance will cover damage to the vessel due to any one or combination of the following risks:

24. HULL WORKSHOP Perils of the seas, rivers or lakes (previously covered under the General Clause) Fire, explosion Violent theft by persons from outside the vessel Jettison Piracy (alternates between the Marine and War markets) Contact with land conveyance, dock or harbor equipment or installation Earthquake, volcanic eruption or lightning Accidents in loading or discharging of cargo or shifting of cargo or fuel

25. HULL WORKSHOP Cover is also available for risks which cannot be strictly attributed to the perils of the seas. These are included under what is sometimes incorrectly termed as the Inchmaree Clause: Latent defect Negligence of ship staff Negligence of repairers Barratry Contact with aircraft or objects falling therefrom Cover is also provided for general average, salvage, pollution hazard and collision liability.

26. HULL WORKSHOP Exclusions: War exclusion Strikes exclusion Malicious acts exclusion Nuclear Exclusion

27. HULL WORKSHOP We now come to the cover provided by the ship owners’ P and I Clubs and it usually caters for the risks which the commercial market is not ready to offer. The International Group of Protection and Indemnity Clubs has 13 Members and it has a common reinsurance program called Hydra. Apart from the main clubs who offer cover on a basis of variable premiums called “calls” there are many fixed premium facilities as well.

28. HULL WORKSHOP The Cubs work on the basis of the “pay to be paid” Rule, which means that it is a condition precedent that the ship owner member pays before he is reimbursed by the Club. The Directors of the IG can however exercise discretion in this regard. One of the main roles of the International Group is coordinating the operation and regulation of the clubs’ claim-sharing agreement (the Pooling Agreement). All qualifying claims in excess of USD 8 Million are shared between the clubs in accordance with the terms of the Pooling Agreement by which the clubs reinsure each other for claims in excess of USD 8 Million. Much of the Group’s work involves defining and refining the scope of cover for Pool claims and the rules and guidelines under which the claims are shared.

29. HULL WORKSHOP The cover provided by the Clubs includes but is not limited to the following: Cargo ( claims for short delivery, loss of or damage to cargo) Crew claims (repatriation, medical or death expenses) Collision liability (to the extent not covered by the commercial market) Damage to fixed and floating objects or shore installations Third party liability for injury or death Pollution of the sea Fines and wreck removal costs

30. HULL WORKSHOP Kidnapping and Ransom (specialist cover) This cover is also provided by commercial insurers. Piracy is one of the most contentious issues in the shipping world. According to international brokers, ship owners are seeing insurance premium for K & R increase by ten times as piracy escalates.

31. HULL WORKSHOP Topic 7: Forms used in the hull market Some of the “Full Conditions” policy forms which are commonly used in the hull market are as follows: Institute Time Clauses Hulls 1/10/83 (still widely used) Institute Time Clauses Hulls 1/11/95 Institute Time Clauses Hulls 1/11/03 American Hull Clauses June 2, 1977 Norwegian Marine Insurance Plan

32. HULL WORKSHOP Topic 8: Comparison of Norwegian Insurance Plan/ American Hull Clauses / Institute Clauses Comparison of ITC 83 and ITC 95 would show that the due diligence proviso in the former is limited to Assured owners or Managers whilst the latter extends it to Superintendents as well. The International Hull Clauses retain a similar proviso for due diligence as in ITC 83. Cover provided by all the foregoing forms is on the “named perils” basis. The International Hull Clauses treat latent defect somewhat differently and the insurer bears half of the cost of the part that has itself broken.

33. HULL WORKSHOP The American Clauses provide 4/4ths Collision Liability and have more risks in the Inchmaree Clause than in the Perils Clause and hence their coverage is narrower. The Norwegian Marine Insurance Plan differs fundamentally from all the aforementioned clauses in the sense that it is an “all risks” cover with certain exceptions such as ordinary wear and tear and/or poor maintenance of the subject-matter by the insured.

34. HULL WORKSHOP Topic 9: Loss of Hire Insurance and relevant Forms As we all know that in the context of marine insurance delay is not covered even if it is caused by an insured peril and the only instance where an assured might recover part of his delay costs (demurrage) is in collision liability. However in shipping, delay is quite a recurring issue and a ship owner who has his ship off-hired has to protect himself against financial losses which he has to bear in consequence of his ship becoming inactive. Loss of Hire Insurance is designed for this specific purpose as there is no other form of insurance either in the P and I world or the commercial market which caters for such a loss.

35. HULL WORKSHOP The commonly used forms include: SP40B or the Lazard Form which is American. AB Stewart Wording is the English Form can be used with or without War Exclusion. Also Chapter 16 of the Norwegian Insurance Plan caters for Loss of Hire. All sets of conditions exclude Total Loss. It must be appreciated that Loss of Hire is not a standalone policy and has to be used in conjunction with one of the forms earlier mentioned and only losses from perils named in the relevant policy will trigger the cover. The Loss of Hire cover protects the owner from daily loss of earnings for a certain number of days, thus the owner must stipulate both the daily amount which reflects the actual daily income of the vessel and the number of indemnity days required in order to cover an “average worst case” scenario at a repair yard.

36. HULL WORKSHOP The sum insured is calculated by multiplying the number of indemnity days with the vessel’s stipulated daily income (charter hire). The parties must agree on the following terms: Deductible period The number of days compensated per accident The total number of days compensated for all accidents during the policy period No matter how simple it may appear, it must be noted that Loss of Hire is a specialist’s area of work.

37. HULL WORKSHOP Topic 10: Losses / expenses specific to marine adventure, their interpretation and treatment with relevant case law: Piracy (Clause 6.1.5 ITC Hulls 1/10/83) For the purpose of defining this peril we shall look at the Athens maritime Enterprises Corp. V Hellenic Mutual War Risks Assn (Bermuda) Ltd (1983). A ship named Andreas Lemos was anchored at Chittagong anchorage when a group of unauthorized people came onboard and appropriated the property before making good their escape. They did not use any force or threat of force until they were seen by ship staff while escaping with the stolen goods. At this point they threatened to use force but finally escaped without using any force at all. The claim failed.

38. HULL WORKSHOP In view of the aforementioned case and other decided cases, it has been established that: In order to qualify for a claim for piracy, use or threat of use of force is essential before the act is committed. Piracy is purely meant for private ends and if it is being committed with a political motive, it would not qualify as such. It is not essential that it must be committed on the high seas. It is a maritime peril and can be committed in adjacent waters, rivers etc. Piracy cannot be committed by stealth because that would be Simple Theft. Piracy may be committed by members of ship’s staff or those from outside.

39. HULL WORKSHOP Barratry (Clause 6.2.5 ITC Hulls 1/10/83) The most comprehensive definition of barratry comes from Earle V Rowcroft (1806) where it was established that “ trick or knavery in the sense of imposition practiced upon the owners by the master, with a view to promote his own interest at their expense was not essential to constitute barratry in English Law; but any act of known criminality or gross malversation , though not intended for owners’ prejudice, indeed if intended for their benefit, would yet, if in fact it operated to their prejudice, by causing the loss or seizure of the ship , be barratry in the master.” So if a master engages in blockade running, smuggling or even in an act which he thought would be beneficial for the owners but is illegal would qualify as barratry. It must however be appreciated that reported cases of barratry are few.

40. HULL WORKSHOP Violent theft (Clause 6.1.3 ITC Hulls 1/10/83) Violent theft, unlike piracy has no geographical limitations. It can only be committed by persons from outside the vessel. The violence in the case of violent theft is directed against the property. Violent theft can be committed for private gain or for public or political purposes.

41. HULL WORKSHOP Sue and Labour (Clause 13 ITC Hulls 1/10/83) Section 78 of the MIA 1906 deals with sue and labour which was formerly known as the bailee clause. This is a supplementary engagement and the assured is entitled to recover the expenses in addition to the primary loss of the subject-matter. Prevention of loss is the very object in view. It contemplates the benefit of the insurers only, and the insurers on that account undertake for the expenditure.

42. HULL WORKSHOP There are two aspects of this principle that the expenses must have been incurred to avert or diminish a loss which, if it occurred, would fall on the underwriters. The first, is that the peril must be one that is covered by the policy. The second is that the property must be in danger of loss of a type which is covered, so where the property is in danger of a partial loss or of a loss below the specified percentage, under a policy against total loss or containing the average warranty, it has been held that the insured cannot recover.

43. HULL WORKSHOP Constructive total loss / Notice of Abandonment (Clause 19 ITC Hulls 1/10/83) The doctrine of constructive total loss is peculiar to marine insurance. It originated from the cases of capture in the previous centuries. In simplest terms where the cost of recovering the subject-matter exceeds its insured value, there is a strong case for a constructive total loss. The nature of a constructive total loss can best be understood by comparing it with actual total. The latter is a total loss in law and in fact; the former is a total loss in law but not in fact, and must be converted, by a properly notified abandonment, into a total loss in fact, to entitle the assured to claim a total loss against the insurers.

44. HULL WORKSHOP Under common law, whether the policy be valued or unvalued, the true or market value, of the ship is taken as the repaired value for the purpose of determining whether there was a CTL Irving V Manning 1847). This principle has been continued in the MIA 1906 itself which in S27(4), confirms that the insured value is ‘not conclusive for determining whether there has been a constructive total loss’. But having said that, the opening phrase of S27(4) – “Unless the policy otherwise provides” – allows the parties to the contract to specify their own figure or value, which is to be taken as the repaired value of the vessel.

45. HULL WORKSHOP It is to be noted that a CTL claim is not subject to a policy deductible. With regard to application of deductible (Clause 12 ITC Hulls 1/10/83) following points need to be noted: Policy is subject to deductible in cases of Particular Average, General Average Sacrifice and Contributions, Sue and Labour Charges (except with a total loss), Salvage Charges and Contributions and to Collision Liability claims. Policy is not subject to a deductible in cases of Actual Total Loss, Constructive Total Loss, Sue and Labour Charges associated with a Total Loss and to Cost of Sighting Bottom following Stranding.

46. HULL WORKSHOP A further point worthy of mention is that successive partial losses cannot be accumulated into a constructive total loss. The reason being that the deductible is applied to each separate incident and hence the market value will change from the insured value after every incident.

47. HULL WORKSHOP Ademption of Loss – Cut off date In the context of constructive total loss and subsequent notice of abandonment the concept of ademption of loss would need some elaboration. Ademption of loss is where the subject-matter insured is restored to the assured before the action for a claim is commenced, thereby changing the basis of that claim. This could happen when a seizure takes place and the subsequent claim for a constructive total loss is precluded by the return of the subject-matter to the assured. However once the action has commenced the claim persists in full. Thus it is imperative that a cut-off date for the ademption be established, after which the claim for CTL persists regardless of a change of circumstances. On several occasions the courts have taken this date as the date of commencement of action.

48. HULL WORKSHOP Collision Liability (Clause 8 ITC Hulls 1/10/83) As we saw earlier that the commercial insurer would bear the collision liability in case the vessel comes into collision with another vessel. It must be noted that this is the oldest form of third-party liability and has its origins in De Vaux V Salvador (1836). The underwriter will bear 3/4ths of the damage done to the other ship depending upon the degree of blame of the respective vessels which suffer damage as a result of colliding with each other. The other 1/4th is usually borne by the ship’s P and I club, however there is a growing trend for the commercial insurer to offer complete liability.

49. HULL WORKSHOP Latent Defect (Clause 6.2.2 ITC Hulls 1/10/83) Latent defect could result from improper conjunction of materials or due to a fault in design. Under the 1983 hull and machinery policy the part which has the latent defect is not covered but the damage caused by the part having the latent defect is covered. This was established in Thames and Mersey Marine V Hamilton Fraser and Company (1884). As we said earlier that to recover under a marine policy, the losses must occur and claims be made during the policy period but latent defect would be covered by the policy which is current although the defect could have been present during the currency of earlier policies. We must be aware that the concept of latent defect has undergone fundamental changes since the decision in The Nukila.

50. HULL WORKSHOP Repairers’ Negligence (Clause 62.4 ITC Hulls 1/10/83) As with the latent defect, this could be a pre inception peril but would nevertheless be covered by the policy which is current. Let’s assume that while repairing ship’s machinery, the repairers acted negligently and the resulting loss did not become patent until the policy had expired and a new policy had attached. In such a case the loss would be borne by the underwriters who are on risk when the particular loss is discovered.