Robert D Hogue. International Insurance Monitor. Volume 52, Issue 4. Fourth Quarter 1999.
As one of the earliest forms of insurance, marine insurance is often shrouded in an aura of intrigue. It’s a tough business to follow because most of it is international and few domestic companies consider it one of their major lines of business.
Only about 0.06% of net written premium of U.S. property and casualty insurance companies is ocean marine premium. The largest domestic writer of ocean marine insurance is Continental by a wide margin. It is followed by AIG, and St. Paul. There are about twenty five smaller significant players and twenty five minor players.
Over the past 10 years, inland marine insurance had a growth rate of 60 percent. It is now a $6.3 billion industry and holds a 2.5 percent property and casualty insurance industry market share, according to A.M. Best. Inland marine is a very fractured business with a lot of sub groupings, each with its own unique set of operating fundamentals. Domestic inland marine is dominated by Allstate and American Bankers. Continental is also a major player, as are Aetna, ALFA, AIG, Fireman’s Fund, Hartford, Travelers and Zurich. And, there are about forty much smaller players.
All of this is unfortunate because marine insurance is by far the most fascinating business in the insurance industry.
The History of Marine Insurance
Marine insurance is as old as marine trade and has existed in various forms dating back to 3000 BC. Early merchants trading on China’s rivers practiced a form of loss control by deliberately spreading a given cargo among several vessels, thereby reducing the potential loss.
In Mesopotamia around 2,300 BC, the Sumerians, Assyrians, Arcadians and Babylonians, the inhabitants of Mesopotamia in ancient times, were peoples that had assimilated cultures from different origins, forming extremely complex societies. Historical tablets allow us to have an idea of how Babylonian merchants organized themselves to cross the immense deserts surrounding Mesopotamia, and how they were able to travel ever greater distance. Caravans traveled together in order to guarantee the replacement of camels lost on the journey—another early form of insurance.
It is in the ancient civilization of Babylon that we find the earliest record of insurance in the form of “bottomry.” The Code of Hammurabi (c. 2100 BC) sets bottomry, or the advance of money on the security of a vessel to protect against the loss of the cargo by marine perils, at 20%. Traders, whose cargoes were advanced by merchants were thus protected from debt in the event that the cargo was lost. This practice continued throughout the Mediterranean region and was further emphasized in an edict by the Roman Emperor Justinian, who restricted the interest money advanced to bottomry to 12%.
In Greece and Phoenicia, around 1100 BC, there emerged intense commercial activity in the Mediterranean Sea that led the Greeks and Phoenicians to unheard of maritime expansion. The markets in the ports of Byblos, Athens, Tyre and Carthage were full of iron, tin and lead from the mines of the West; wheat, olive oil honey and resin from the East; sheep, lamb and goats from Arabia. The genius of the Phoenicians leads them to invent the first alphabet, while Greece becomes the center for arts and science. Peoples of great enterprise, the Greeks and Phoenicians were permanently exposed to activities of risk in their maritime undertakings. Around 500 BC, an idea arises to group together various people and businesses to form a pool of their reserves. In the case of misfortune—piracy, fire, shipwreck—no single individual or business would have to shoulder the burden alone.
Another marine insurance term found in ancient time is General Average. The Greek Indian and Phoenician traders are known to have used the concept, and a written reference to it is made in Rhodian Law (c. 700 BQ). “Let that which has been jettisoned on behalf of all be restored by the contribution of all,” the law states. “A collection of the contributions for jettison shall be made when the ship is saved.” Justinian also codified the concept of General Average, taking it a step further to include the following: ‘When a ship is sunk or wrecked, whatever of his property each owner may have saved, he shall keep it for himself.” This concept was widely used throughout the early civilizations.”
The practice of General Average was the first case of mutual insurance, a form of insurance, which would only undergo changes 1,500 years later in Western Europe. Danish navigators began forming guilds whose role was to indemnify its members against losses at sea. The same era also finds the first use of premiums in marine insurance. The merchant cities of Lombardy, Venice and Florence were the centers of Mediterranean trade and it is here that written records began to emerge. By 1255, the Merchant State of Venice had embodied the principals of mutual insurance against the loss of pillage through contribution. In 1347, the first insurance contract was made in Genoa, Italy; and the first policy in Pies, in 1385. After the Middle Ages, maritime trade had intensified. The oldest marine policy known to have been issued was on a vessel named Santa Clara, and the oldest policy document in existence was dated April 24, 1384 covering four bales of textiles on a journey from Pies to Savona.
After 1492, new trade routes were continually being discovered. Risks and losses to business, however, increase proportionately. Terrible creatures inhabited the seas and sailors’ imaginations.
Around 1629, the Low Countries became great maritime powers. The port of Antwerp in Flanders controlled 40% of all world trade. Holland set up the East India Company, the first really modem company to insure maritime transport, caravels, goods and warehouses against storms, pirates, and fires, the plagues afflicting the great ocean trade routes. Assuming responsibility for enormous losses, paid for by the large premiums received from the companies in more fortunate times, this type of institution spread all over the European continent.
These basic concepts of marine insurance were brought by the Lombards to northern Europe and England in the 13th Century By the 17th Century, London, with the emergence of the Lloyd’s of London Association, had developed into a leading center for marine insurance.
The well-known Lloyd’s of London traces its roots to a coffee shop founded by Samuel Lloyd in 1688 and was favored as a meeting place for the transaction of insurance business amongst underwriters and merchants. Edward floyd’s premises were situated near the Tower of London in the latter part of the seventeenth century. Because of its proximity to the River Thames, floyd’s coffee house attracted the patronage of men who were connected with the sea, among whom were merchants prepared to accept insurance on ships and their cargoes. The men accepting this business became known as underwriters, because they wrote their names under the wording on the insurance contracts.
By 1734, the official list of vessels and values known as the “Lloyd’s List” was first published. More than 250 years later, it continues to serve as the leading shipping list in the marine insurance industry. In 1769, underwriters took their informal arrangement and founded the organization we know today as Lloyd’s of London. Ten years later, the first standard policy wording was developed for use at Lloyd’s. Today, Lloyd’s of London is still acknowledged as the largest meeting place for underwriters and shippers to transact marine insurance business.
The London insurance market has grown into a major UK industry, which employs over 250,000 people. The employment areas within insurance are many and varied, and are undergoing the most rapid change in the history of the industry. The majority of insurance personnel will continue to work within one of three main areas of the insurance market—Lloyd’s of London, insurance companies and insurance brokers. The London Market is an overlap of the three sectors and it deals with specialist risks in the rest of the world; over the last five years it has generated half of Britain’s vital invisible earnings.
In 1906, the British Parliament enacted the Marine Insurance Act. This legislation continues to influence marine insurance policy wordings and conditions. Admiralty law or maritime law is the distinct body of law (both substantive and procedural) governing navigation and shipping. It is to the marine insurance industry what the NAIC is to the U.S. property and casualty insurance industry. And, lawyers influence marine insurance to a much greater degree than do actuaries influence other lines of property and casualty businesses.
Admiralty law or maritime law is the distinct body of law (both substantive and procedural) governing navigation and shipping. Topics associated with this field in legal reference works may include: shipping; navigation; waters; commerce; seamen; towage; wharves, piers, and docks; insurance; maritime liens; canals; and recreation. Piracy (ship hijacking) is also an aspect of admiralty.
In the U.S., the courts and Congress sought to create a uniform body of admiralty law both nationally and internationally in order to facilitate commerce. The federal courts derived their exclusive jurisdiction over this field from the Judiciary Act of 1789 and from Article 111, 9 2 of the U.S. Constitution. Congress regulates admiralty partially through the Commerce Clause. American admiralty law formerly applied only to American tidal waters. It now extends to any waters navigable within the United States for interstate or foreign commerce. in such waters, admiralty jurisdiction includes maritime matters not involving interstate commerce, including recreational boating.
Under admiralty, the law of the ship’s flag deter-mines the source of law. For example, a ship flying the American flag in the Persian Gulf would be subject to American admiralty law; and a ship flying a Norwegian flag in American waters will be subject to Norwegian admiralty law. This also applies to criminal law governing the ship’s crew (this has caused great protest when U.S. citizens sought regress for sexual harassment while being employed on the Love Boat).
International Underwriting Association
The IUA is the new London market trade association formed on Dec. 31, 1998 as a result of a merger between the Institute of London Underwriters and the London International Insurance and Reinsurance Market Association. The ILU represented the London company market for marine, aviation and transport business. The ILU, which was founded in 1884, represents marine insurance companies in London, while LIRMA was created in 1991 and represents international reinsurance and nonmarine insurance companies. LIRMA is the offspring of an earlier merger, that of the Policy Signing and Accounting Centre and the Reinsurance Offices Association.
Now the London market will be represented by Lloyd’s, on the one hand, and the company market through the ILU-LIRMA merger. The merged body has around 110 members and over 80 associates from nearly 40 different countries, and is the largest trade association for international insurers and reinsurers in the world, the ILU and LIRMA. The combined premium income of members through London is an estimated $10 billion.
Inland Marine Underwriters Association
Founded in 1930, Inland Marine Underwriters Association (IMUA) is the national association for the inland marine insurance industry. IMUA serves as the voice of the inland marine industry, with more than 400 member companies representing over 90 percent of all inland marine insurers. The association provides its members with comprehensive training and educational programs, including research papers and bulletins, industry analysis, and seminars on current inland marine issues.
The Bottom Line Ocean Marine
Higher claims in 1998 and continuing competition are making it difficult for marine underwriters to make a realistic return on capital according to Nigel Jenkins, who chairs the International Underwriting Association’s Marine Committee.
An IUA report, “IUA Marine Report & Statistics 1998,” suggested that overcapacity is contributing to severe competition and deteriorating rates in all the marine market sectors-hull, cargo, energy, excess of loss and liability. While the aviation sector was not discussed in the report, it is facing similar depressed conditions and higher claims. The IUA report noted that conditions have become so bad there is a widely held view that the marine hull market worldwide is operating at a loss and is in the midst of “the most concentrated downward cycle ever witnessed by the hull underwriting community.”
In 1998, total income processed on behalf of ILU members was $1.67 billion at current exchange rates, while claims payments totaled $2.53 billion, according to ILU underwriting figures, which marks the London marine sector’s ninth successive year of negative cash flow.
The ILU results are broken down into classes as follows:
For the hull, energy and liability class, the ILU in 1998 took in premiums totaling $316.0 million and had claims of $55.7 million, resulting in a loss ratio of 17.6% after 12 months. This compares with 1997 premiums of $410.9 million, claims of $54.1 million and a loss ratio of 13.2% after 12 months.
For the 1998 cargo account, the ILU had premiums of $76.5 million and had claims of $31.7 million, with a loss ratio of 41.5% after 12 months. This compares with 1997 cargo premiums of $100.5 million, claims of $46.2 million and a loss ratio of 46% after 12
There appears to be continued rough waters in store for international marine insurers, according to a report recently issued by Munich Re. Following a selection of very good results achieved by many insurers in the last three years, Munich Re now expects “dramatic rate reductions,” possibly lasting to the end of the decade.
A substantial rise in capacity, coupled with an almost unchanged level of demand for marine insurance and a considerable increase in loss potential, threatens to Plunge the entire market deep into the red, the report said.
The report noted that premium volume of the global marine insurance market totals almost $20 billion, with the share of the London market (including Lloyd’s) in this figure at 35 percent. The largest single national marine insurance market (with, however, only a minor share of the insurance coverage placed internationally) is Japan, with a premium income of some $2.6 billionmaking it almost twice as big as the U.S. or German markets.
Transportation by sea, said the report, continues to be the main international flow of trade, which creates the demand for marine insurance. According to the report, “spectacular shipping accidents of recent years have strengthened reservations about the still increasing practice of shipping companies sailing under flags of convenience” (e.g., Liberia, Panama, etc.). The level of training of crews and officers, the technical equipment, the standard of management and also the state of repair of ships operating under such flags is often very poor or even catastrophic. In its report, Munich Re reported that “over half of the approximately 80,000 ships in the world merchant fleet are more than 15 years old, and the vast majority of these old ships operate under flags of countries with absolutely no maritime tradition or appropriate legislation.” Munich Re warned against what it sees as a “worldwide decline in specialist expertise and in new recruits to this area of marine insurance.” Marine insurance, the report said, “is so very important in economic terms, both on a national and international basis.”
Munich Re said that it anticipates a considerable increase in the future loss potential of shipping. We do not rule out the possibility of insured losses from a single event-for claims under all lines of insurance combined-amounting to several billion dollars. For instance, the report said, “one such scenario would be the sinking of one of the enormous modem cruise lines, causing the death of as many as 2,600 passengers and subsequent suits for compensation in the U.S. courts.” The biggest losses so far have been between $1 billion and $2 billion-the offshore platform “Piper Alpha” explosion and the oil spill of the tanker Exxon Valdez, respectively.
According to A.M. Best, inland marine insurance premiums grew 8.9 percent in 1994. The property and casualty industry’s growth rate was 3.4 percent. Also, the loss ratio inched up from 59.1 percent to 59.3 percent.
For inland marine, the concern centers on crime. Property crimes remain a serious and growing problem, and improvement in the nominal crime rate for these offenses has lagged behind the more serious violent offenses. While property crimes bit all insurers hard, inland marine is particularly susceptible due to the unique nature of the product. The susceptibility to theft of cargo in transit or property located at a construction site is much higher than property at a fixed location, and the challenge of property protection is much greater.
As a result, the losses from theft to the inland marine industry have been staggering. For example, during accident year 1997 the total dollar value of stolen cargo in the state of California was $62.2 million. On a nationwide basis, the value of cargo stolen has been estimated as high as $10 billion. This problem is being addressed, but it is far from being solved.
With the seemingly never-ending growth in our society’s demand for information, the space industry is acquiring more and more importance in global communications. The rapid technical development of the related satellite systems is continually presenting space insurers with new challenges and with new growth opportunities. Unfortunately competition in space insurance business, which is highly exposed, very technically demanding and volatile, has become so harsh that it is barely possible to obtain risk-commensurate premiums.
The largest player in space insurance is Munich Re. The are a limited number of other major players, and an increasing number of minor players. 10 specialized underwriters handle roughly 75% of the capacity, and they lead in determining the rates and conditions for space insurance . Munich Re has established itself as the global market leader in the geostationary satellites, as well as in the expanding segment of LEO (low earth orbit) and MEO (medium earth orbit) space risks, thanks to its respected expert participation in the insurance of satellite constellations like IRIDIUM and ORBCOMM.
Insurance protection for the space and space-related industry has been available in the commercial market since the mid 1960’s when Early Bird became the world’s first commercial communications satellite. The emergence of the commercial space sector was, in early years, particularly slow to develop and it was only with the advent of the NASA Space Transportation System (STS), spurred on by a group of enthusiastic space entrepreneurs in the late 1970’s that the industry really took up the challenge.
Although insurance for space ventures has always been available, the market has undergone some very fundamental changes especially following the problems in the mid 1980’s encountered by the STS payloads, and subsequent underwriting losses, which threatened to destroy the very fabric of the insurance market. This situation was further compounded by both the STS Challenger loss and the expendable launch vehicle (ELV) failures leading to a temporary suspension of all further commercial launches.
Despite these problems, and losses totaling approximately $1 billion, the space insurance market continued, albeit with a much reduced capacity. The re-introduction in the late 1980’s of the ELVs, which included vehicles from the United States, Europe, Japan and China, provided a much broader base from which recreated opportunities were presented to the insurance industry. This resulted in a rekindled interest within the insurance market and a corresponding increase in insurance capacity.
Space insurance claims are enormously expensive. A recent case involved a claim surpassing $200 million for one satellite. In the case of dual launches (launching 2 satellites at once), the total amount for one launch can exceed $400 million. Furthermore, the number of launches of currently insured commercial satellites is about 20-30 satellites per year, so the number of contracts is limited. In the event of a total loss of a satellite, this would be a very heavy burden for one insurance company to bear. Thus risk is accepted and spread throughout the worldwide space insurance market.
Since space insurance coverage began in 1965, the capacity of the space insurance market has been steadily increasing. However, at one point in the mid 1980s there was a series of launch failures (the space shuttle Challenger explosion occurred right in the middle of these,) and the market experienced a very risky situation. But after that the number of commercial satellite launchings increased and accordingly so did the market capacity. Currently the maximum capacity is estimated at $600 million.
The number of contracts for space insurance (particularly launch insurance) is low and the claim amount per loss is very large, so future insurance premiums are greatly affected by losses or damages in previous launches. Launch insurance rate levels really depend on such factors as the reliability of the launch vehicle and the satellite, the level of complexity of the satellite, the scope of coverage, and the amount of insurance, but recently they are at about 15 to 22 percent of amount of insurance. In other words, if the amount of insurance were $100 million then the insurance premium would need to be between $15 million and $22 million. However, the estimated aggregate amount of insurance premiums collected over the last 30 years is roughly $4.2 billion and the amount of claims paid out is roughly $3.4 billion
For some applications the capacity limits of the geostationary communications satellites, which occupy a “fixed” position 36,000 km above the equator, are now being reached. Besides this, the rights of use for the coveted satellite positions in geostationary orbit are distributed between states in accordance with UN rules and cannot be increased to an unlimited extent. For some time now, therefore, satellites have been traversing space in new orbits: LEOs and MEOs staggered in different orbital planes at heights of between 700 and 20,000 km, these satellites are interlinked as wireless networks—so-called “constellations.”
On I st November 1998, for example, the satellite-based mobile communications system IRIDIUM began commercial operations. This system makes it possible for the first time to communicate between any two points on the earth direct by satellite using standardsize mobile phones. With its leading participation in the IRIDIUM risk, Munich Re broke new ground in covering LEO constellations. The innovative coverage concept provides appropriate protection for the insured’s commercial interests and takes into account the special spacerelated risks involved in low and medium earth orbits.
Thus further opportunities for growth in the space industry are certainly apparent.
Between 40 and 300 individual satellites have to be transported into orbit to create a LEO constellation. In the operational and maintenance phase, further launches are needed when replacement and back-up satellites are required.
The constellations planned up to the year 2003 alone, including ICO, Teledesic and Skybridge, will require the launching of over 500 satellites.
Worldwide there are over 50 different types of launch vehicle available with payload capacities of 1 to 18 tons to transport one or more LEO or MEO satellites.
On a sad note: The hook in all of this lies in the fact that the satellite companies don’t make much money Iridium has recently filled for bankruptcy protection, and the others are short of capital.
“There’s not another insurance business in the world where you can watch as you earn 50 percent of your premiums in 18 minutes,” says Alden Richards, founder of the niche insurance brokerage Space Machine Advisors (SMA). He neglects to mention that there’s also no other insurance business where 100 percent of your potential earnings and plenty of your equity can be incinerated in the split-second, explosive flash of a faulty rocket.
Richards, a space nut and Trekker with a joint degree from Yale in contemporary Chinese legal institutions and medieval English literature, knows about false starts. In 1991, Johnson & Higgins fired him because he was spending too much money pursuing new space insurance accounts. Cut adrift, Richards only gravitated further toward the emerging high-risk, highreward realm of space insurance. He launched SMA later that year, and his timing couldn’t have been much better. Owing to the data-delivery race between Teledesic, Iridium, and Globalstar, the number of insured satellite launches doubled between 1996 and 1997. This January Richards closed a $4 billion deal for PanAmSat.
In the process, his nimble, four-person SMA staff trumped the world’s largest insurance brokerages: Marsh & McLennan, Aon, and Sedgwick. The deal included full coverage for 24 satellites, including two never-before-flown spacecraft (HS 702, HS 601) on two never-before-fired rockets (Delta III, Zenit), the Zenit launching from a floating launch platform (Sea Launch) never before seen outside science fiction—all at a premium of just 15.5 percent of the satellite’s hardware value.
The space insurance business is a high risk/high reward gamble. Recently, the number of liftoff failures has tripled as insured payloads doubled. And, by some estimates satellites will soon collide every 18 months.
Still, the high payoff potential—as much as $50 million per launch—has kept underwriters willing and SMA busy. “It’s such a chaotic industry —it’s in such chaotic motion—that it’s not the time for anything traditional,” Richards says. “It’s time to abandon your precepts.”