Allianz Global Corporate & Specialty

Implications arising from the Global Financial Climate Marine Insurance considerations: A technical report.

Photography: Container ships by John W Banagan

Photography: Photo by Image Source

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Foreword by Ron Johnson

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Insolvency or financial default of a carrier

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Financial default of a buyer

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Exporters selling under Cost Freight or similar conditions

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Financial default of supplier

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Financial default of supplier‘s marine insurer

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Currency fluctuations and sovereign debt issues

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Conclusion

Foreword The current global financial climate combined with the recent sovereign debt issues are triggering currency fluctuations, making it difficult to price products and services, increasing the risk of buyer and or supplier defaults, which create challenges for businesses involved in international trade. The May 2012, PIMCO Report1, notes that the global shipping industry, which international trade is entirely dependent upon, is in its worst trading cycle since the 1980s.

Ron Johnson

The shipping industry, often seen as a barometer of global economic strength, has been hurt by a combination of high fuel costs and a slump in trade. This has suppressed shipping rates accelerating a fall in vessel values and resulting in a retreat of lending from European banks that have traditionally accounted for the bulk of finance for international shipping.

Regional Manager Marine AGCS - Pacific +61.3.6332.3184 ron.johnson@allianz. com.au

These challenges have prompted the Shipping Industry into a downward spiral as it moves into some of the worst conditions the industry has seen in as many as 25 years. 2011 saw some of the world’s leading shipping conglomerates including Korea Lines and tanker operators, such as General Maritime, collapse in bankruptcy protection.

Companies involved in international trade need to be aware of how their marine insurance protection would operate in the event of: • • • •

Insolvency of carrier, charterer or shipping company owning or operating a vessel with their critical cargo onboard? Financial default of a buyer of their cargoes? Financial default of their supplier and/or its marine insurance cover? Financial default on sovereign debt of a particular country or debtor nation or group of countries?

This Paper is intended to provide some general information regarding the potential impact of such events on marine cargo insurance policies held by a business. The Paper also offers recommendations on key issues that brokers should discuss with their clients. Ron Johnson Regional Manager Marine Allianz Global Corporate & Specialty - Pacific

More recently the world’s oldest shipping company, Stephenson Clarke Shipping, started in 1730, went into liquidation in July 2012. While it was only a small company and is unlikely to have any major implications for the wider market, it certainly shows how challenging the current economic climate is for shipping. The Financial Times 2 and the Telegraph 3 also concluded, in recent reports, that the future could see more shipping companies becoming insolvent. All these factors potentially have serious implications on the operation and effectiveness of marine cargo insurance protection held by businesses, involved in international trade, on the cargoes they ship.

1. www.autralia.pimco.com/Insights/Global Shipping: Any Port in a storm? 2. Wave of insolvencies looms for shipping industry: Robert Wright: Financial Times December 11, 2011. 3. German at centre of shipping crisis: Ambrose Evans-Pritcher: The Telegraph August 2012. Photography: Oil rig by Canita Delimont

Insolvency or financial default of carrier Insolvency of a carrier, shipping company or charterer will usually lead to the arrest of the vessel at a particular port, terminating the voyage at that point.

Owners of cargo on board an arrested vessel are generally obliged to remove their cargo and arrange any further onforwarding at their own cost. So where can cargo owners turn to recover these discharge and on forwarding costs that can prove to be very significant? The standard cargo insurance clauses in common use of Institute Cargo Clauses (A), (B), and (C) all contain a specific insolvency of carrier exclusion 4.6. The wording of the 1982 Clauses excludes “loss damage or expense arising from insolvency or financial default of the owners managers charterers or operators of the vessel“ that would prevent possible recovery of the costs from cargo insurers.

Recommendation Brokers and/or clients might be wise to ensure cargo policies are: • • •

Using the 1.1.09 Cargo Clauses; The wording of any standard amendment clauses in use have been drafted to suit the 1.1.09 clauses; and The amendment doesn’t have the effect of narrowing the coverage provided in the 1.1.09 clauses.

The new Cargo Clauses (A), (B) and (C) adopted in 2009 modified this exclusion to bring it more inline with the Commodity Trades Clauses where the exclusion only applies “where, at the time of loading the subject matter insured on board the vessel, the Assured are aware, or in the ordinary course of business should be aware, that such insolvency or financial default could prevent the normal prosecution of the voyage”. In practice the danger is that continuing to use the more restrictive 1.1.82 clauses might leave clients exposed to uninsured expenses in the event that the carrier defaults. Care needs to be taken when making modifications to the 1.1.82 clauses to bring them more into line with the Commodity Trades Clauses as these amendments may not necessarily be the most effective in providing protection. Often, the wording of the modification may have the effect of deleting Clause 4.6 in its entirety and replacing it with a wording that may be narrower in coverage than that provided under Clause 4.6 of the new 1.1.09 Cargo Clauses.

Photography: Container ships by John W Banagan

Financial default of a buyer Exporters selling under Cost, Insurance and Freight, Carriage and Insurance Paid or similar conditions.

Photography: Container ship by Hande Guleryuz Yuce

For exporters selling on Cost, Insurance and Freight (CIF), Carriage and Insurance Paid (CIP) or similar conditions, in the event of buyer default the position under standard Cargo Clauses is: •

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Cover ceases from the time that notice is received that the buyer has defaulted (i.e. the cargo will not be collected) but if the goods are still on the water then cover may continue for up to a further 60 days after arrival at port (Clause 9.1). Cover will cease though once the goods are discharged from the vessel. If the seller is still the Insured and the cargo has been discharged, it would no longer be in the ordinary course of transit and cover would cease as it would effectively be deemed to be in store (Clauses 8.1.2). The further 60 days after discharge mentioned in Clause 8.1.4 would also not apply as the earlier termination would be by virtue of Clause 8.1.2. While Clause 9 provides extended 60 days storage in certain circumstances, it would be ineffective in this case as the extended coverage only applies where the contract of carriage is terminated rather than default of the buyer. Where a certificate of marine insurance is used and has been endorsed over to the buyer (who then

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becomes the Insured) then the buyer’s actions would still terminate the cover as the Insured would be deemed to have left the cargo in a place of storage under Clause 8.1.2. Where, the cargo owner’s intention is to sell the cargo to a new buyer, it would constitute a new voyage from the overseas port that may fall outside the geographical limits of the current cargo policy. Importantly, the Insured would also be required to take reasonable measures to avert or minimise losses under Clause 16.1 and act with reasonable dispatch under Clause 18.

Recommendation In the event of a buyer default, sellers might be wise to: • Act promptly to ensure proper protection of the goods; • Urgently contact their broker and/or cargo insurer to ensure cover continues during any period of storage (that may include whilst on the wharf) or make other arrangements to insure the goods; and • Ensure the marine cargo insurance will respond to any new planned onward voyage.

Financial Default of a buyer Exporters selling under Cost and Freight, Free On Board or similar conditions risk notionally transfers to the buyer once landed onboard the vessel at the departure port. In the event of a buyer defaulting under Cost and Freight (CFR), Free on Board (FOB) or similar conditions, ordinarily the interest in the goods (risk) would revert to the seller at the point when the buyer defaults. Sellers holding marine cargo policies covering exports may have protection under their policy for the risk from this point on. But what happens if the cargo has already been the subject of a loss? The vessel may have also suffered an incident that has led to General Average being declared. Buyer default often occurs in cases where the buyer holds no marine cargo insurance protection of their own and the General Average security is substantial. Failure to pay may render the buyer liable to the seller for breach of contract but it may prove to be a costly and difficult task to pursue a buyer in a foreign country. In the event of General Average being declared, the seller would also need to lodge suitable security for the

estimated General Average contribution to obtain release of the cargo. This risk can be covered through a specific Sellers Contingency Interest Clause.

Recommendation In the event of buyer default under CFR, FOB or similar conditions, sellers might be wise: •

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Check cargo policy wordings to ensure a suitable Sellers Contingency Interest Clause is included. This will provide protection where a buyer may default. Contact their broker and /or insurer to ensure the policy will respond to export risks and cover the goods already on the water at that time.

Photography: Dockworker giving instructions and writing by Opla www.lantzendirffer.ni

Financial default of a supplier Supplier default should not pose a significant risk to buyers for goods purchased on CIF, CIP or similar conditions under a formal Letter Of Credit. The buyer can, with some degree of comfort rely on suitable documentation to establish existence of goods and proof of insurance being lodged before release of payment for the goods. There may be some danger where the Letter of Credit (LOC) merely states marine cargo insurance is required on Institute Cargo Clauses All Risks or Cargo Clauses (A) and not the specific 1.1.09 Clauses.

This risk could be avoided through ensuring a formal marine insurance certificate is issued with a local claims settling agent at port of discharge that would become a negotiable document in the hands of the buyer. No coverage is available under marine cargo insurance for prepayment if a distressed supplier defaults and short ships or simply doesn’t ship the goods at all.

The pre 1.1.09 clauses contain several more restrictive clauses from an Insured’s perspective that could materially affect the ability of the buyer to claim on the supplier’s marine insurer.

Recommendation

An example would be the Insufficiency of Packaging Clause 4.3, which is a blanket exclusion in the 1982 Clauses.

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In the event of a supplier being frugal when packaging goods, resulting in damage during transit, the buyer would have no claim under the supplier’s cargo insurance policy under the 1982 Clauses unless the Clauses have been amended.

For all purchases under CIF, CIP or similar conditions buyers might be wise to ensure:

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The terms of sale specify that coverage will be under Institute Cargo Clauses (A) 1.1.09 or similar conditions; An actual marine insurance certificate is supplied on these conditions; and There is a nominated local claims settling agent at port of discharge.

The buyer would simply be left to pursue its supplier through the normal court process. For goods purchased by pre-payment or on commercial invoice under CIF, CIP or similar conditions, it falls upon the buyer to manage and assess the suitability of all documentation associated with the transaction including cargo insurance that can leave them with some risks, particularly in the event of supplier default. Such transactions do not always specify the terms of marine insurance and often an actual marine insurance certificate is not sought. In the event of supplier default, the buyer may have no idea of who to pursue a claim against and may even run the risk that there is no actual insurance protection in force. Supplier default could also result in termination of any insurance policies the supplier held for goods on the water.

Photography: Container ships by Dan Prat

Default of a supplier‘s marine insurer While country regulatory regimes of the financial sector have tended to be robust and strong in preventing default of an insurer, there have been failures. Regulatory regimes may be insufficient when dealing with the rapid deterioration in the fortunes of a particular company. Sovereign debt issues of an insurer’s country of domicile could actually be the trigger for the financial default of an insurer. Stricter capital adequacy requirements forecast in the Basel Accords may also impact on the solvency of some insurers with some global rating agencies already flagging their intention to review research criteria they use for rating insurance companies. Buyers must therefore be conscious of these risks and take adequate steps to ensure that the security of a supplier’s marine insurer at least matches the criteria it would use in selecting its own marine cargo insurer.

Recommendation In the current global financial environment, buyers might be wise to: • •

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Where possible, purchase on CFR, FOB or similar conditions and arrange their own cargo policy that they would be in control of. When purchasing on CIP or similar conditions, ensure an acceptable marine insurance certificate is supplied with a local nominated claims settling agent at port of discharge. Conduct formal due diligence on the security and rating of supplier’s marine insurer.

Photography: Container ship at Port by Monty Rakusen

Currency Fluctuations and Sovereign Debt Issues A nation’s sovereign debt issues can often elicit rapid devaluation of its currency making imported products more expensive when traded in a stronger currency. In such cases, buyer default becomes a stark reality as they struggle to sell products in their markets at the inflated prices. Collection of payments may also be delayed or tied up if a country slows down or temporarily halts cash outflows.

Recommendation

These issues may impact on the adequacy of policy limits and could also trigger a break in the Transit Clause if there is an intentional hold in delivery of cargoes in store pending settlement of payment.

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While marine cargo insurance policies cannot respond to currency fluctuation exposures, cargo owners might be wise to:

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Trade on LOC where any doubts exist about the ability to collect payments of in a country where doubt exists on ability to repay foreign debt; Review Marine Cargo limits regularly to ensure they remain adequate; and If cargoes are intentionally stored pending collection of payment from buyers, contact their broker and/or marine insurer to ensure cover remains in force.

Photography: Cargo container ship by Dan Prat

Conclusion Awareness and communication are key for brokers to properly consult with clients about issues around defaulting buyers / suppliers.

Photography: 36clicks creative. www.corepics.com

Marine insurance has underpinned international commerce for centuries by enabling buyers and sellers to transfer many of the risks and perils associated with transport of their cargoes by air, land and sea to the marine insurance market.

It covers some of the risks associated with relying on a supplier’s marine insurer and makes a strong case for buyers to arrange their own marine insurance protection with a respected marine insurer holding a healthy solvency margin and internationally strong credit rating.

This paper highlights some risks of buyer and/or seller default on marine insurance policies held on cargoes.

Allianz Global Corporate & Specialty manages risk from a broad perspective and will work with brokers to fit the cover to the needs of the client. This report sets out to raise awareness of the risks and inform brokers of some of the solutions available.

In current global financial conditions, both buyers and sellers need to be alert to the impact of factors beyond their control on any marine insurance policies they hold in their own right or have a beneficial interest in.

For all inquiries, please contact your local Allianz Global Corporate & Specialty underwriter.

Disclaimer: © 2012 Allianz Global Corporate & Specialty AG. All rights reserved. The material contained in this publication is designed to provide general information only and was believed to be correct at the time of publication. Allianz Global Corporate & Specialty assumes no obligation to update any information contained herein. The descriptions of coverage are abbreviated and are subject to the terms, conditions and exclusions of the actual policy. For full coverage details, please refer to the actual policy forms. Allianz Global Corporate & Specialty consists of various legal companies operating under the Allianz Global Corporate & Specialty brand, namely Allianz Global Corporate & Specialty AG, Allianz Global Corporate & Specialty (France), Allianz Global Corporate & Specialty North America (legal name Allianz Global Risks US Insurance Company) and AGCS Marine Insurance Company. In relation to Australian clients and risks, Allianz Global Corporate and Specialty - Pacific issues Allianz Australia Insurance Limited ABN 15 000 122 850 insurance Allianz Global Corporate & Specialty Fritz-Schaeffer-Strasse 9 81737 Munich, Germany.