Inflation & Marine costs: Is your hull coverage adequate?

Authored by AXA XL’s Jarek Klimczak and Jonathan Lacorazza

When inflation hits, it tends not to discriminate. For commercial marine operations, inflation can pose some pretty serious challenges.

With the combined value of commercial merchant fleets increasing 26% year-over-year, the cost of replacing hulls and marine equipment has increased dramatically. Supply chain disruptions, material shortages and higher labor costs are pushing up marine hull construction prices.

Have you adjusted your hull policy’s limit to account for inflation? If not, keep reading.

The perfect storm?

Marine insurance claims have increased as well. A war in Ukraine, climate-related weather events, cyber-attacks, and the pandemic have led to higher claim costs. Materials costs for repairs and machinery breakdown claims are expected to increase as inflation continues to bear down on the industry. The most expensive claims involve fire and explosion, yet other incidents such as grounding and sinking can create devastating consequences for operators.

Such was the case in March 2022 when the container vessel Ever Forward ran aground in the Chesapeake Bay. A little over a month later, the ship was floating again. The final cost to free the vessel is yet to be determined, but it includes $676,200 to restore damaged oyster bars where the ship grounded and more than $100 million in environmental damages. Still, that figure is not expected to reach the same costs as those incurred when the Ever Given, owned by the same company, grounded in the Suez Canal in 2021, blocking a critical shipping lane and costing its owners $900 million.

Adjusting the insurance program

These factors impact on your marine insurance program. The effect of inflation on repairs, claims, and losses means your current insurance program may not cover serious claims. Your loss history and the age of your fleet all need to be considered when putting your insurance program together.

Determining the proper valuation for your vessel is critical.

You and the Underwriter will establish an agreed value that will be listed on the policy. For standard vessels, the starting point is usually a market value based on condition, type, and age. Vessels that cannot be easily substituted, replaced, or made available may be insured at an agreed value above market value. The price of insurance for full replacement cost for such craft may not be palatable.

In some instances, agreed value below market value may be permissible if the vessel is laid up or other circumstances exist. While this form of valuation might be possible, Underwriters often will not support this low amount – the price of repairs does not lessen with the decrease in the agreed value1.

When the cost of repairing and salvaging the vessel exceeds the agreed value, a constructive total loss occurs. This is yet another reason why correct valuation is critical, which is compounded by inflation. Not only do you have a vested interest in adequate insurance, but so does the insurer. If the agreed value is significantly less than the market value, negligible damage may lead to a constructive total loss. Your insurance premium considers partial and total losses. If any partial loss will become total, the insurance company’s premium is compressed.

These compressed premiums coupled with the emergence of increased claim costs could create systemic pricing inadequacy for an insurer’s portfolio, which can have negative implications for shipowners — specifically, volatility in hull insurance pricing year over year, an insurer’s unwillingness to deploy capacity due to a negative trend on underwriting margin, and increased market shortage of hull capacity on the macro scale.

Our recommendations

We recommend the following:

Obtain a Condition & Value (C&V) survey for your vessels. Is your current coverage accounting for the increased costs associated with materials, repairs, and vessel values? To get a proper valuation of your vessel, work with your insurance carrier to determine whether you need a professional appraisal through a marine surveyor. The C&V survey is often known as an “insurance survey” and generally required every 3-5 years. Given the impact of inflation, you may not want to wait. The survey will evaluate the worth of the vessel based on its geographic location, condition, type, status, model, builder, year of construction and the extent of its equipment inventory. Also, research the costs associated with repairs and labor to get a complete picture.Consider appointing certified appraiser. The valuation report shall be indisputable and shall endure any scrutiny that comes your way. The answer for such approach is a USPAP-compliant appraisal, which can only be obtained by using an accredited appraiser. The acronym USPAP stands for the “Uniform Standards of Professional Appraisal Practice”. The USPAP standard manual is published every two years by the Appraisal Standards Board of the Appraisal Foundation, an industry group authorized by Congress to write appraisal standards.Understanding the approach. The appraiser must understand implications and limitations of three different approaches: sales comparison, cost, and income. The income approach isn’t often used in marine appraisals. There is no income being produced by pleasure boats, so such method will be irrelevant. The cost approach uses the principal of substitution; a prudent buyer will not pay more than the cost of acquiring a substitute asset of equivalent utility. The sales comparison (market) approach is generally the most commonly used approach for marine assets.Know the various standards for liquidation value:
Fair Market Value – If the boat/ship was bought on the open market for the best price possible, the seller would be receiving fair market value. Both the buyer and seller would have reasonable knowledge of relevant facts of the item, and neither would be under any compulsion to buy or sell.
Orderly Liquidation Value – The middle ground value – if the boat/ship cannot be sold over a reasonable period, approximately 3 to 6 months, this is the estimated gross amount you’d receive.
Forced Liquidation Value – Usually done at a public auction, this is the estimated gross amount you’d receive if you needed to sell equipment as soon as possible, approximately within 30 days.Ensure the policy limit includes all the items insured. Many policies cover not only the hull, but launches, lifeboats, rafts, furniture, bunkers, stores, supplies, tackle, fittings, equipment, apparatus, machinery, boilers, refrigerating machinery, insulation, motor generators and other electrical machinery.Improve risk mitigation. Prevention of accidents and claims begins with sound risk management. AXA XL’s Marine Risk Management team can improve your risk portfolio by reviewing data, modeling, and forecasting methods. They can help you understand where additional training or safety measures need to be implemented.Revamp your people processes. By establishing consistent hiring and training processes, your organization can put the right people in place and improve overall productivity as well as safety. Reducing losses makes your insurance program much more appealing to your carrier and may lead to broader coverage and/or lower rates.Review your policy terms. Our Marine Insurance team can walk you through your current coverage language and suggest policy terms that may offer your organization even better protection.Revisit self-insured retention. Are you holding enough in reserve to pay your portion of a future claim? Does risk retention still make sense to your organization given today’s inflationary landscape? AXA XL can help you determine whether any deductibles or risk retention on your part is adequate given the impact inflation is having on your insurance program.Consider the future impact of inflation. In an environment in which premiums are going up and coverage terms are becoming more restrictive, it is tempting to decrease coverage to stay within a budget. However, many organizations fail to calculate the cost of one sizable claim and its impact on revenue. As inflation continues, so too do the high costs associated with replacement or repairs on key vessels. Should your organization suffer a large claim, how well protected are you under your current insurance policy? Will you be able to recover quickly?

Planning for rough seas

Addressing the issues above now rather than later will help your organization avoid potentially devastating loss costs in the future. With inflation showing no signs of waning and with continued pressure brought to bear on the market from supply chain disruptions, labor shortages and materials cost increases, the marine insurance market will face an inflationary landscape now and in the foreseeable future. As inflation drives up the price of everything, including your fleet values, preparing for the storm can help your organization recover quickly should a claim occur.