Piracy's Impact on Insurance

by Rene L. Siemens, Joshua J. Pollack and Jessica L. Freiheit

Piracy's Impact on Insurance

There has been a devastating surge of piracy in the wake of Somalia's civil war. As a result, the Gulf of Aden-or "pirate alley"-has turned into the world's most dangerous waterway. In 2008, there were 111 pirate attacks in the Gulf of Aden and off the east coast Somalia, including 42 vessel hijackings. By mid-May, there had already been more attacks in the area in 2009 than during all of 2008, including 29 successful hijackings. In November 2008, the Sirius Star, carrying two million barrels of crude oil from Saudi Arabia to the United States (worth approximately $100 million) became the largest oil tanker to be seized by pirates. It was held for two months until being released upon payment of a ransom. 

More than 10% of all seaborne oil passes through the Gulf of Aden to the Suez Canal. The alternate route, traveling around the southern tip of Africa, is significantly longer and more expensive. Routing a single tanker from Saudi Arabia to the United States around the Cape of Good Hope adds approximately 2,700 miles to each voyage and about $3.5 million in annual fuel costs. 

The dramatic rise of piracy in the Gulf of Aden is changing the insurance landscape. While piracy is not a new insured risk, the increase in pirate attacks along the Gulf has affected premiums and coverage. According to a recent report, insurance premiums for ships traveling through the Gulf have rose from between 0.05% and 0.175% of the value of their cargo, compared to between 0% and 0.05% in May 2008, an increase of 350%. Premiums for kidnap and ransom coverage have reportedly increased by as much as 1,000%. 

Large ships typically carry three separate types of insurance. Hull insurance covers physical risks to the insured vessel, machinery and provisions. Cargo insurance covers transported goods or merchandise. Protection and indemnity (P&I) insurance covers liability to crew, passengers and other third parties. Some shippers also carry business interruption ("loss of hire") insurance to cover lost earnings due to delays. 

Historically, coverage for piracy has been a mixed story. Clause 2.1.5 of the International Hull Clauses, for example, covers piracy as an included peril: "This insurance covers loss of or damage to the subject-matter insured caused by piracy." The American Institute Hull Clauses, which were established in 1977, list pirates as a covered peril. In 2005, however, marine underwriters in London began a transition from covering piracy under hull policies to covering it under separate war risk policies. 

Some cargo policies expressly cover damage to cargo as a result of piracy. The most common London form of marine cargo insurance, Institute Cargo Clauses (A), covers "all risks of loss of or damage to the subject matter insured except as provided in Clauses 4, 5, 6 and 7." Clause 6.2 excludes coverage for "capture, seizure, arrest, restraint or detainment," but expressly excepts piracy from this exclusion. Other London and American cargo clauses, however, expressly exclude piracy. Some P&I policies also expressly cover piracy. Others exclude it, and some are silent. 

If all this was not confusing enough, Somali piracy has added some new wrinkles. Given that the pirate attacks are a consequence of civil war and often carried out by heavily armed paramilitary groups, policyholders are beginning to fear that, even where policies promise to cover piracy, insurers may invoke the various "war," "civil war" and "riot" clauses in their policies to deny coverage. It is not clear that this approach will be successful, but the uncertainty has led many brokers and insurers to urge policyholders to purchase war risk policies just in case. 

Unlike hull policies, premiums for war risk policies are typically paid per transit and underwriters often charge extra for trips through high-risk areas. (The Gulf of Aden has been on the high-risk list of the London Market Association's Joint War Committee since May 2008.) While other policies tend to allow ships to move freely around the world, war risk policies require policyholders to contact their insurer if they intend to trade in dangerous areas. In these ways, war risk policies can help insurers contain their exposure to piracy risk while pricing it more accurately. 

A Pirate's Motivation 

Another wrinkle is that Somali pirates have been motivated by kidnap and ransom payments, not the value of the vessels or cargo. It has long been understood that ransom may be covered by "general averages," a voluntary agreement by the owner, charterers, insurers and other interests to pay a proportionate share of a ship's expenses. Under Rule A of the 2004 York-Antwerp Rules (which codify the principles of general averages), "there is a general average act when, and only when, any extraordinary sacrifice or expenditure is intentionally and reasonably made or incurred for the common safety for the purpose of preserving from peril the property involved in a common maritime adventure." 

Marine insurance policies, moreover, typically cover "general average" costs and may therefore reimburse the insured for ransom if piracy losses are not expressly excluded. Where ransom is paid to protect the vessel, cargo or crew, the cost might also be covered under a marine policy's "sue and labor" clause, which provides coverage for the costs that an insured incurs to diminish or avert a loss. 

Insurers may respond to ransom coverage claims by disputing whether the ransom cost was reasonable, subject to a war or terrorism exclusion or even uninsurable as a matter of public policy. Policyholders wanting to nip such disputes in the bud have the option of purchasing kidnap and ransom coverage, under which the insurer will even provide a response team to take charge of ransom negotiations. 

Despite the widespread availability of coverage for physical damage, loss of cargo and ransom-related costs, many policyholders face a potential gap in insurance coverage for the financial impact of business interruption or loss of earnings due to delays. Clause 4.5 of Institute Cargo Clauses (A), for example, provides that "in no case shall this insurance cover loss damage or expense proximately caused by delay, even though the delay be caused by a risk insured against." General averages similarly do not cover losses resulting from delays. Rule C of the 2004 York-Antwerp Rules provides in pertinent part that "any loss or damage sustained or expense incurred by reason of delay, whether on the voyage or subsequently, and any indirect loss whatsoever, shall not be allowed as general average." The International Hull Clauses (01/11/03) appear to be silent as to whether delay-related damages are covered, and as already noted, many policyholders do not purchase insurance to specifically cover business interruption or "loss of hire." 

Shipping delays due to piracy, kidnapping or re-routing are an increasingly serious risk for ships navigating the Gulf of Aden, however. Ship owners and charterers face loss of revenue and increased charter costs. Late delivery of cargo may be detrimental to cargo owners who face a decline in the value of their cargo or cancellation of contracts due to the delay. Oil is common cargo for ships traveling this highly pirated waterway, and its value can be time-sensitive given the fluctuating prices in the commodities markets. 

Recognizing the potential coverage gap for damages caused by piracy-related delays, several brokers in the London market have announced new insurance products that are tailor-made to cover these losses. In December 2008, for example, Aon announced a new policy designed to cover the "financial impact of business interruption or loss of earnings" suffered by charterers, who are paying for hiring the vessel even while the vessel is detained; ship owners, who, in the event of contract frustration, may lose out on charter revenues; and cargo owners, particularly of seasonal goods, who face cancelled contracts if the goods are held up. According to Aon, the coverage is triggered from day one of a pirate attack with no deductible and is a contained in a standalone policy to complement existing hull, war, cargo and P&I policies. 

Who Pays? 

An interesting question that has been raised recently is whether the insurer or the insured must bear the loss when pirates seize a ship's cargo, the cargo is later released, but due to the piracy-related delay, the cargo cannot be sold or dramatically loses its value. Is this a total loss, such that the insurer must pay and then try to recoup what it can through salvage after the cargo is released? Or is it not an insured loss at all? 

This is the question at issue in a February 2009 lawsuit filed in the United Kingdom by Masefield A.G., a Swiss commodities trading company, against Lloyd's underwriter Amlin Corporate Member Ltd. Masefield claims that it incurred $13.3 million in losses (plus damages and interest) from the seizure of 9,000 metric tons of palm methyl ester (PME), a form of biodiesel that was aboard the Bunga Melati Dua tanker, which was taken hostage by Somali pirates on August 19, 2008 while travelling from Malaysia to Rotterdam. 

Approximately six weeks after the ship was captured, its owners paid a ransom and the ship was released, eventually arriving in Rotterdam almost two months late on October 26, 2008. Masefield claims that: (a) the instant the pirates seized the ship, the PME became a "total loss" under its cargo policy with Amlin; and (b) when the cargo arrived in Rotterdam it could not be sold because, with the approach of winter, the market for PME falls dramatically. Amlin denied any liability under its policy on the grounds that Masefield did not abandon, and was not "irretrievably deprived" of, physical possession of its cargo. 

As this dispute shows, there are numerous risks in sailing the high seas. Companies should take into account the importance of the timely delivery of cargo aboard ships navigating the dangerous Gulf of Aden, the increased risk of vessels being detained by pirates until a ransom is paid and the gap in many marine insurance programs for delay damages due to acts of piracy. Cargo owners, charterers and ship owners are advised to consider seeking specific coverage for delay damages in advance of any perilous voyages in the Gulf of Aden or other pirated waters. 


Rene L. Siemens, a partner in Proskauer Rose LLP's Los Angeles office, is a member of the firm's litigation and dispute resolution department and its insurance recovery and counseling practice group. Joshua J. Pollack is a senior associate in the litigation and dispute resolution department of Proskauer Rose LLP's Los Angeles office. Jessica L. Freiheit is an associate in the litigation and dispute resolution department of Proskauer Rose LLP's Los Angeles office, and a member of its international practice and intellectual property practice groups. 

 

The Year of the Pirate 
by Emily Holbrook

Since mid-2008, there has been an unprecedented amount of pirate activity off the coast of eastern Africa. According to the International Maritime Bureau, piracy attacks around the world more than doubled to 240 from 114 during the first six months of 2009 compared to the same period in 2008. The following are some of the most notorious incidents. 

Bunga Melati Dua 
August 18, 2008
This Malaysian oil tanker was taken hostage by a crew of Somali pirates while en route to Rotterdam. The pirates demanded a ransom of $4.7 million for the release of Bunga Melati 5 and its sister ship Bunga Melati Dua. In late September, the ship and its crew were released in exchange for a $2.9 million ransom.
 

Faina 
September 25, 2008 
In a hijacking that made headlines worldwide, the MV Faina was holding 33 military tanks, along with various weapons, when it was accosted by pirates in the Gulf of Aden. The Ukrainian ship and its crew of 17 was released four months later, on February 5, after a $3.2 million ransom was paid. 

Yasa Neslihan 
October 29, 2008 
The Yasa Neslihan was en route from Canada to China with 77,000 tons of iron ore when it was captured by Somali pirates. The crew of 20 was released January 6, with an undisclosed ransom amount paid out. 

Karagol
November 12, 2008 
This Turkish tanker was carrying 4,500 tons of chemicals and 14 crew members when it was hijacked off the coast of Yemen. The India-bound ship and its crew was released January 13 with ship owners paying an undisclosed ransom amount. 

Sirius Star 
November 15, 2008 
In the mother of all hijackings, Somali pirates took this Saudi Arabian "supertanker," which  was carrying close to $100 million of crude oil when it was commandeered 420 miles off the coast of Somalia. The pirates demanded $25 million in ransom for release of the ship and its 25 crew members. A $3 million ransom was negotiated and the ship was freed January 9. 

Hansa Stavanger 
April 4, 2009 
This 20,000-ton German vessel was seized about 400 miles east of Mombasa, in an area where pirates had not previously been active. Ship owners paid a $2.7 million ransom for release of the vessel and crew, which occurred August 3. 

 

Emily Holbrook is associate editor of Risk Management.

 

 
Reprinted from Risk Management Magazine.
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