# The devil and the deep blue sea

With the value of transported goods increasing in cost and decreasing in size - meaning cargo ships carry containers with much higher price tags on them - and the experience of ship crews falling, there is little wonder that high-cost marine claims rose sharply last year. Sam Barrett takes a closer look at a competitive market that is bedevilled by risk

Earlier this year, the International Union of Marine Insurance warned that underwriters and protection and indemnity clubs were facing a tide of high-cost claims, with few signs of improvement on the horizon.

According to its figures, 20 major claims were reported in the first six months of 2007 - amounting to a claims bill for hull and machinery underwriters of approximately $780m (£391m), with the full year's total expected to exceed$1.5bn. This represents a substantial increase on the previous year, when the total loss was around $350m. The size of claims has been the key driver behind this increase. Louise Nevill, hull and war underwriter at Talbot Underwriting, reports that quantum has risen steeply. "In the first quarter of 2007, a handful of vessels accounted for losses totalling more than$600m. Vessel values being at an all-time high, increased steel prices and a shortage of yard space have combined to create this situation," she explains.

While the extent of these losses might be responsible for a sinking feeling among underwriters, the market is proving a very buoyant one for the ship owners. "They've never had it so good," says Colin Sprott, chief underwriting officer for marine and offshore energy at XL Insurance. The fact that 95% of the world's goods are transported by sea at some point, coupled with recent economic conditions, has enabled owners to reap significant rewards.

"The global economic boom has created huge demand for shipping and, although it's tailing off now, there's been a massive increase in the amount of cargo shipped around the world," explains Alan Wilkins, head of marine cargo at Zurich UK General Insurance, which recently extended its coverage to smaller companies after focusing on the large multi-national end of the market.

These conditions have shifted freight rates up while also prompting ship owners to get as much use as possible out of their vessels. And with it taking many months to build a ship, rather than scrap an older vessel, owners are choosing to refurbish them so they can take advantage of the demand. But, with older ships at sea, this can push up the risk of a ship breaking up or beaching in heavy weather.

Another factor coming into play is the move towards larger ships, again prompted by heightened demand. By way of illustration, Maersk Line launched the largest ever container ship in 2006, the Emma Maersk. This vessel can hold 11,000 20-foot equivalent units (teu), compared to an average size of between 4000 and 5000 teus.

And while ships are getting larger, the goods they carry are getting smaller. "Electronic goods, such as I-pods and mobile phones, are reducing in size, which means the value of the goods within a container is rising," explains Barry McConway, director for marine insurance at Royal and Sun Alliance. "This is also happening with high cost goods, such as medical equipment."

Size matters

Consequently, this combination of volume, size and value creates potential headaches for underwriters. "It's not always easy to know your potential exposure," explains Mr Wilkins. As an example, if a ship like the Emma Maersk sails from China, it could hold goods from hundreds of different clients, potentially creating millions of dollars of exposure. "This means there could be a large aggregation," he adds.

Size is not only on a downward trajectory when it comes to the goods being shipped - crew sizes are also falling. According to John Tirel, vice-president for global marine and transportation, global markets, at Crawford and Company, although vessels are getting larger, the average crew size has fallen from 32 around 15 years ago to just 16. "This creates problems in terms of maintenance, tiredness and the ability to provide sufficient manpower in the event of emergencies," he says.

As well as potential problems created by smaller crews, Mr Tirel claims that standards of ship management have also slipped, affecting areas such as navigation, ship handling and the loading and unloading of cargo. "Lack of proper crew training, poor communication on board and the generally low standards of many international crews all increase the likelihood of accidents happening," he adds.

Tim Stephenson, marine partner with Hill Dickinson, agrees. He points to a lack of suitably qualified or experienced seafarers, with many overly reliant on technology. "Even the best built and maintained vessel can get into difficulty if its crew has had insufficient training or lacks experience," he explains.

But while crews - and their experience - shrink, ports are getting bigger to accommodate all the additional traffic. Mr McConway says these can prove danger points for cargo. "The way cargo is stored in these ports means you can get huge aggregation on docksides," he explains. "If something happens you can be badly hit."

Costs are also rising if something does go wrong. For example, larger vessels require more specialist skills in order to salvage cargo. "Last year when the Napoli was grounded it was possible to offload most of the containers," says Mr McConway. "But she's a relatively small vessel. With the larger ships it can be very difficult to offload and refloat them."

Repairs are also more expensive. The rising cost of materials is one factor but, on top of this, there can be problems finding a yard to carry out the work. Furthermore, because of the sheer size of some of the ships, repairs can only be carried out in the larger yards.

Environmental spillage claims are another expensive issue currently vexing insurers. "These are high profile, reflecting the broader concerns with environmental issues," says Mr Tirel. "This means such claims tend to be very expensive because of clean-up costs."

In addition, claims linked to toxic cargo or fuel and oil pollution often involve older ships, so their increased use at the moment - due to the high demand for shipping - is an obvious concern for insurers.

However, there are some plus points. As around a third of cargo is now shipped in containers, this helps to ensure goods are protected from wet damage as well as making them harder to steal. And although older ships are being worked harder due to demand, the quality of vessels currently being built is much higher, making losses less likely. For example, the double hull design on tankers can significantly reduce the risk of a major loss if the outer hull is damaged. "These newer ships also use much better technology, which can help with issues such as surveillance," adds Mr McConway. Similarly, the sheer quantity of shipbuilding being carried out is helping to reduce the average age of vessels.

But challenges are not solely emanating from the shipping industry and the global conditions currently driving it; pressures are also building from within the insurance market itself.

Tough investment markets mean insurers' returns are lower, putting the financial squeeze on them. And Solvency II, which is set to come into force in 2010, will require insurers to set aside adequate capital to cover the specific liabilities they face. But, without the ability to accurately forecast accumulated risk, this could lead to overcapitalisation - again putting pressure on reserves.

Competitive market

In spite of all these pressures, the market continues to be strongly competitive. "Premium increases are very difficult to achieve in the current market," says Ms Nevill. "Competition for marine business remains fierce, buoyed by new start-ups hungry for non-catastrophe exposed business and new ventures in the Far East."

To ensure margins are maintained, therefore, risk management is essential. "We do take an active approach to risk management," says Mr McConway. "We have a specialist subsidiary company that focuses on hull risk while another division looks at cargo, making suggestions on how goods are packaged to protect them from weather, theft and so on."

While this approach can help to ensure clients are well-managed, it does not necessarily remove all risk, as Mr Sprott explains: "We only go with well-managed fleets but this doesn't prevent losses as a result of collisions with badly managed ones. We've been affected because of this," he concedes, "but intend to stick to our risk management strategy."

In addition, with plenty of capacity in the market, even badly managed fleets can easily arrange cover. This means there is little opportunity for insurers to increase premiums to compensate for the rise in claims.

Unsurprisingly, this is not well received by the insurers. "There does need to be a movement in rates to promote long-term stability," says Mr Wilkins. He believes this will be driven by other areas of the commercial account. "If we see an upturn in these areas, marine will follow," he adds.

But while many commentators feel the competitive nature of the market means underwriters have to sit tight and wait for this to change, Mr Sprott believes one serious claim could provide the ammunition needed to right the market. "As the size of vessels increases, I believe we're getting to a point where the loss would be large enough to move the market," he says. "A collision between two of the huge container vessels or one of these and a cruise ship would result in a huge loss, especially as a single container can be worth as much as $1m. In a benign market, this sort of loss would stick out." PIRACY AT SEA With more goods being transported by sea, an upturn in piracy has also been noted. Figures from the International Maritime Bureau's Piracy Reporting Centre reveal there were 263 attacks in 2007 - up from 239 in 2006. "Piracy is on the increase, not only in terms of the numbers but, more worryingly, in terms of the level of violence used," says David Partner, associate director at broker Miller Insurance. Already this year, the Piracy Reporting Centre has logged a number of incidents where attacks involved firearms, resulting in the injury or near death of crew members. But Mr Partner says it is not only the increase in shipping traffic that lies behind the rise in piracy. He believes the frequency of attacks is also being driven by political instability, a reduction in naval presence and better use of technology - with the latter enabling pirates to access shipping information more easily. The size of claims as a result is also rising. Louise Nevill, hull and war underwriter at Talbot Underwriting, says that, although piracy claims tend to be fairly small in comparison to the large hull and liability incidents, this is changing. "There's a trend in Somalia for vessels to be held to ransom for$1m or more," she explains.

Piracy hotspots are shifting too. While ships used to be in danger of attack in South-east Asia, especially in the Malacca Straits, the focus has moved towards Somalia and Nigeria.

Addressing the problem of piracy requires a multi-pronged approach. Prevention remains a valuable option. "Avoiding routes that travel through dangerous areas as well as training crews in techniques to deal with pirates can help," says John Tirel, vice-president of global marine and transportation at Crawford and Company.

Insurance is available to help stem the financial loss, although Ms Nevill says that it is not always clear whether an incident is one of terrorism or of piracy, making it potentially problematic for policies to respond. "These can be closely linked and with coverage often under two different sets of clauses, with two different underwriters, costly disputes can arise," she warns.

Cargo insurers also tend to be fairly immune from piracy claims, with losses rarely relating to what is stored in the hold. Instead, losses are more likely to relate to the crew's possessions, the contents of the safe and, in extreme circumstances, a ransom demand.

Stand-alone policies are becoming more common, however, with Miller Insurance launching a kidnap and ransom policy earlier this year. This can cover kidnap, extortion and hijack as well as providing access to response teams that include independent negotiators in addition to support for those involved in an incident. "We need to know information, such as where a ship is going and for how long, where the crew is employed from and whether the vessel is seaworthy," explains Mr Partner.