30 September 2014Re/insurance

Trouble at sea

The MV Sewol ferry sank off the coast of Jindo Island, South Korea on April 16, carrying 476 passengers, a large portion of whom were high school students. More than 200 bodies were found, 174 were rescued, and the remaining individuals are—to date—unaccounted for. Reports have suggested that the captain and his crew abandoned ship, delaying orders to evacuate passengers, and questions have also been raised as to whether the ferry was carrying substantially more cargo than was permitted.

Clive O’Connell, partner at Goldberg Segalla Global, spoke to Bermuda:Re about some of the consequences for re/insurers when such serious criminal negligence allegations are made regarding the circumstances of a loss. He explained that the Korean government will pick up the initial cost of compensation, but some of these allegations—if proved true—could destroy the Chonghaejin Marine Company’s insurance cover, “because it does appear possible that there were alterations made to the body of the vessel which led to its demise and those alterations were not communicated to insurers”.

In the extensive ongoing investigation, authorities hope to clarify whether this suspected overloading of the vessel or the alleged communication breakdown between the crew and disaster teams was more instrumental in the sinking of the ship. Risk management—or the lack of it—for passenger ships in particular extends well beyond the physical characteristics of the vessel and can lead to lessons learned in the hardest of ways.

Liability losses

Over the last two years there have been five major shipping disasters, one of which bears some similarities to the Sewol incident. Thirty-two people died when the Costa Concordia struck a reef off the coast of Isola del Giglio, Italy in January 2012. The captain also abandoned the vessel before all the passengers had been rescued, and is subject to an ongoing manslaughter trial as a result. Both incidents resulted in hull as well as significant liability losses, with crew behaviour—which exacerbated lives lost—proving remarkably similar in both incidents.

The loss figure for the Sewol has been calculated at around half a billion dollars, whereas the Costa Concordia loss has reached upwards of $2 billion. One factor that has increased cost levels for the latter loss has been a direction from the Italian government that the salvage must be conducted with the marine environment in mind. The question is how have reinsurers been affected by these complications?

In this sense, the two events need to be looked at quite distinctly. The Costa Concordia was directly insured into the traditional European insurance market, with considerable reinsurance coverage. As O’Connell explained, “The lion’s share of ultimate liability, as happens with massive losses, falls on to reinsurers because the insurers themselves are protected against catastrophe.” He went on to say that the situation in Korea appears to be somewhat different, although it may be too early to say precisely how different.

Regarding the suspected overloading of the Sewol’s cargo, reinsurers may immediately be in a far better position if insurers can avoid, or at least limit, their liability. This depends heavily on who provided the original policy and how large it was. O’Connell affirmed that it was purchased locally, and added that this local carrier’s external reinsurance arrangements would also be a deciding factor.

Lloyd’s and Bermuda have certainly been involved in the Costa Concordia calamity, yet O’Connell is unsure about the Sewol, “as there’s already a question as to whether or not the insurance will respond and to what extent”, so there may be limited participation from these markets in terms of any reinsurance payout.

Large liability claims are a widely anticipated outcome of such tragic events. What these losses demonstrate, as O’Connell explained, is that whichever geography and whatever class the vessel, “whether it be an overcrowded local ferry or a modern cruise ship taking people on holiday through the Med”, they are all susceptible to human error.

This is a dynamic that ought to push prices up, but wider market dynamics may preclude this from happening. Nevertheless, some reports have suggested that protection and indemnity reinsurance rates will rise for all vessel types in the coming year, with passenger vessels hit particularly hard, facing as much as a 20 percent rate hike in the coming renewals.

While all of these factors must be taken into account, one must remember that commercial lines developed from marine insurance because ships have always been at risk of sinking, and that the existence of risk is a necessary component of insurance. Losses have been a feature of the marine industry from its beginnings; what these losses show is the potential size that they can take.

The insured losses from just one ship are likely to be exponentially larger than the cost of its hull, because of the liabilities that come into play. The nature of shipping is changing: ships are getting bigger, cargo loads are becoming larger, and the implications of disasters are growing.

Yet O’Connell does not think this should surprise or deter anyone looking to enter the marine market today, and concludes: “They’re all factors that have to be accounted for when assessing their appetite for that risk.”