When Pirates Attack

MILLS: The implications of the increase in pirate attacks and ransoms paid are having a great impact on the way insurers do business in the Gulf of Aden, which links to the Suez Canal and is the main freighter gate between Asia and Europe. More than 20,000 ships traverse this area annually and there have been 74 attacks and 15 hijackings so far this year.

Insurers are responding in two major ways. The first is by increasing premium rates. Shipping insurance rate increases — with premiums rising by at least tenfold, by some accounts — are primarily due to the increase in risk as the number of piracy incidents has spiked considerably since 2008. It does not appear that ransom demands, however shocking, are being considered in the rate-setting process — yet. In 2008, $100 million was reportedly paid out in ransom for captured crews.

London brokers are putting the figure at $400 million in extra insurance costs for the shipping industry, with premium levels estimated at $20,000 per vessel per transit in the Gulf of Aden, according to Lloyd's List. To put that in context with ship value, consider that the estimated purchase price of the Sirius Star was $160 million and the ship was carrying two million barrels of oil worth $100 million when it was captured in November 2008.

While recent incidents serve as an incentive to drive up rates, the trend really kicked in May 2008 when the Lloyd's Market Association flagged the Gulf of Aden as an "area of concern." While insurers are circumspect about the movement of rates, there is concern by shippers about the future availability and affordability if military action enters into the mix.

Up until recently, incidents of piracy have been all about money with little or no violence involved in ransom transactions. Since ships and cargo have gone unharmed, insurers have been willing to continue to provide coverage. However, there is growing concern among ship operators and insurers that this will change and violence among pirates will ensue in the aftermath of three pirates being shot dead during the April 2009 rescue of Maersk Alabama's captain and the subsequent call by President Obama to confront pirates and make them accountable.

The second way insurers are responding is by changing/creating new business models. Traditionally, there have been three types of insurance that kick in following a pirate attack: Marine hull insurance covers claims arising out of theft or damage incurred during an attack; marine cargo covers damage due to robbery or damage of the insured goods; and protection and indemnity is a liability coverage that protects against unjustified third-party claims and indemnifies legitimate claims.

Where insurance and piracy have been concerned, settling claims under traditional coverages has been murky business, with the debate centered on who covers the release of hostages. While cargo and vessel coverage has been covering ransoms, the argument is that underwriters who cover crews should help pay, as well.

To avoid this gray area, ship owners are increasingly turning to kidnapping and ransom coverage for their crews — a coverage that has traditionally been offered only in respect of individual executives. Also becoming popular are piracy insurance policies that indemnify ship owners from losses related to paying a ransom. Several insurers have begun to offer this coverage since the Sirius Star incident. Some policies include risk-management advice, including training crews and mitigation services that protect a ship from being hijacked in the first place. Other insurers have launched plans aimed at piracy losses, such as coverages that bundle risks such as ransom and cargo delays.

Is there concern that financial losses due to war risks and piracy will be too large for private ocean marine markets to bear?

For insurers, risk brings opportunity. The rising number of piracy incidents has increased demand for coverage and has fostered growth and new service offerings. However, if the level of violence associated with attacks were to increase, the market might react negatively by raising rates and decreasing capacity.

What kinds of risk management initiatives can be taken to lessen the severity of both premiums and claims?

There are four approaches. The first is to lobby for cooperation between governments. Due to the virtual total lack of government in Somalia, a solution to the piracy problem will not be solved until major global governments come together to form a solution. Since the nature of international shipping usually involves a number of jurisdictions attached to each ship (ship owner, cargo owners, domicile of insurer, residency of crew, etc.), the right of intervention is unclear. However, recent incidents have increased the presence of international navies in high-risk areas, which has served as some deterrent. But more must be done.

Second, an integrated risk management approach should be adopted. The old ways of ship sailing smarts are moving from the generational word-of-mouth advice to cutting-edge risk management techniques that consider new, complex, technical environments. By having a risk management framework in place that views vessels as units of a company, shipping owners can better get a handle on identifying risk exposure and use that knowledge to select measures that should be implemented to minimize risk.

Third, technical solutions must be adopted. These might include installing radar systems that can detect pirates at close range; converting a vessel's railing to make boarding more difficult; installing a satellite-based alarm system that automatically informs local authorities if a vessel has changed position unexpectedly; investment in onboard, non-lethal weapons such as the Long Range Acoustic Device, which is capable of sending long-distance and unbelievably loud signals that cause pain to the hearer, making communication impossible and detracting pirates.

Lastly, ships can sail around the Cape of Good Hope. While this option is thought to provide some level of protection against pirate attacks, it is not foolproof. The Sirius Star was 420 miles from the shore of Somalia when it was attacked. This option is also expensive. In addition to taking a ship two-to-three weeks longer to reach its destination, estimated added fuel costs for a tanker traveling from Saudi Arabia to the U.S. are put at around $3.5 million. In addition, the loss of time would cut down on the number of annual round trips possible.