In this article, we will discuss Hull and Machinery insurance, or "H&M," along with the risk premium methodologies for hull and machinery insurance, coverage structures, and other related concepts.
However, before all this, we will address the periodic and cyclical insurance market capacity that develops independently of the choices and experiences of shipowners and operators, which is as effective and valuable as the items we have listed specifically for hull and machinery insurance. The capacity supply in insurance markets shows unique periodic movements and timing, much like freight markets and all other markets, oscillating between hard and soft ground. Soft markets generally imply lower prices and broader coverage, while hard markets are the opposite of these movements.
The reasons for hard markets typically include insurers focusing more on technical results rather than investment returns due to low investment yields—caused by low interest rates—and a decrease in their risk appetite, along with increases in damage frequency and social inflation-driven increases in damage amounts or catastrophic losses (for example, MV Dali, Costa Concordia). Claims from reinsurers in different industries can also lead to increased costs for hull and machinery insurance. Other factors contributing to hard markets include legal systems favoring insured parties, an increase in societal and environmental laws and penalties (for example, pollution incidents in Turkey), and strict tariffs imposed by financial credit rating agencies on insurers' business plans. These factors push insurers to be more cautious. Conversely, in a soft market, insurers may increase their risk appetite.
In the hull and machinery insurance markets, this increase can be measured primarily by the rising number of Managing General Agents (MGAs) that specialize in only a few products. To clarify the distinction between MGAs and insurers: insurers write risks for shipowners and operators under their own coverage—potentially with facultative or treaty reinsurance—while agents have the capability to write risks on behalf of a specific insurer or insurers. Agents are organizations that purchase insurance capacity wholesale from insurers. They can demonstrate more experienced, flexible, and developed capabilities specifically for hull and machinery insurance than insurers, as they specialize in only a few products. When insured parties work with agents, they should act based on the feedback received from their brokers. Nowadays, while the trend is toward softening markets, catastrophic losses are forcing the reinsurance market to behave cautiously.
Hull and machinery insurance capacity is one of the rare areas where individual risk assessment is conducted as part of this system.
During the technical premium calculations for ships' hull and machinery insurance, certain qualitative and quantitative factors play a role. Qualitative factors primarily aim to eliminate insurers' doubts regarding providing insurance coverage. You can view insurers as investors making insurance investments in ship operators and owners. It is essential for shipowners to ensure they have sufficient capacity in their ship operations. Qualitative factors include risk assessments where the operator's experience plays a significant role and encompass the following data:
"Lloyd’s Intelligence" and PSC data, directors' resumes, recent condition survey data and results, and if applicable, results from the OCIMF's "Ship Inspection Report Programme – SIRE" and "Chemical Distribution Institute – CDI"... Quantitative factors, on the other hand, are related to the technical specifications of the insured vessel. These specifications include the type, age, flag, place of construction, and type of machinery of the vessels. These mentioned quantitative factors can be developed.
The annual premiums provided for vessels fundamentally consist of two components: (US$ x DWT/GT/CuM) + ("TLO Cover" or "Total Loss Only" element). These two components constitute the annual H&M premiums for the insured parties. While DWT is used as a unit for tankers and bulk carriers, TEU is used for containers, cubic capacity for LNG and LPG, and towing power for tugs, while gross tonnage is used for others.
When these two elements are examined separately, it can be stated that the total loss risk frequency is lower compared to partial losses and is calculated based on the insured value of the vessel and the age element, independent of most qualitative and quantitative factors. TLO multipliers in the Lloyd’s of London market practically vary between 0.04% and 0.3% based on the age of the vessel. On the other hand, the amount per ton of DWT is calculated using various methods. The average pricing in the Lloyd’s insurance market can be suggested as US$ 1.00 per ton. When not considered according to the volumes of ships and fleets, this level can drop to around US$ 0.50 cents, and even today, we see that in market pricing, for fleets with cumulative values exceeding billions of dollars, this level has fallen below that. Hull and machinery insurance premiums are technically formed by blending the quantitative factors provided above with pricing tables created by insurers based on their own or accessible other market actuarial data, along with expandable elements such as operational area, coverage breadth, and personnel retention. However, technical premium calculation is not the only method among hull and machinery insurance premium calculation methods. The premium calculation based on the insured's past claims record is referred to as "Burning Costs," meaning claims calculation. This calculation, while a simple method, requires sufficient data to work efficiently and must pass through the filter of an experienced insurer. In summary, the average of claims from the past 5 or 10 years is found by adding the total loss element and the insurer's operational expense margin.
Often, we see these two methods blended. Particularly in soft markets where risk appetite increases, a method is applied where the element of chance and insight plays a greater role than technical and "burning costs" premium calculations in relatively clean claims records of fleets. Brokers and agents strive to maximize benefits for their insured parties in favorable markets. However, it should be known that markets offering dramatic discounts can also impose dramatic increases in hardening markets. For this reason, insurers who prefer stable pricing in "subscription" or placement policies should also be considered. Brokers can lower the weighted average of prices they obtain from different markets by arranging placement coverage and can benefit from insurers and agents with different reputations. In particular, in businesses involving banks, the credit ratings of firms and the demands of banks should be taken into account.
According to the Marine Insurance Act, a policy should be issued at an agreed value or the value should not be determined at the beginning of the term. The second type of policies is referred to as "policy of indemnity," meaning an open policy. This means that the value to be insured has not yet been determined; for example, insuring the risks of the market index-based loss of hire payment for the next month or the cargo value to be transported not yet being determined... According to the Turkish Commercial Code, in policies issued, the insurance value is the full value of the insured interest, and this value is the market value of the interest in question at the date the risk commenced. The nuance here is that during a potential claim within the policy year, insurers may question the market value of the interest in question at the risk commencement date—pre-loss—and may wish to invoke the provisions of "Underinsurance" and "Overinsurance" defined in Articles 1462 and 1463 of the TCC. The agreed value here serves as an additional leverage for insured parties and aims to prevent potential inquiries. If there is a significant difference between the insurance value determined at the beginning of the term and the market value, the note of agreed value will not grant shipowners and operators a comprehensive defense right.
Hull and machinery insurance clauses can be examined under many headings; however, in our region, primarily the Institute Time Clauses (ITC) and The Nordic Marine Insurance Plan (The Plan) are used. The Institute Time Clauses were revised in 2003 as "International Hull Conditions" with the 1983 and 1995 versions, and the listed risks are exhaustive. In the event of a potential loss, the burden of proving that the loss is covered under the insurance lies with the insured. The Institute Time Clauses can be defined as broad (clause 280) / narrow (clause 280 FPA UCB) / total loss (clause 284 or 289 excluding general average). In contrast, "The Plan" has a clause set that covers all risks except for the listed exclusions. Unlike the Institute, it is a living clause set and is regularly revised according to the needs of the sector and regulatory frameworks. Like the Institute Time Clauses, it does not require widespread arrangement on the slip or attachments and the burden of proving that the loss falls among the excluded exceptions in a potential loss lies with the insurer. On the other hand, in the practice of hull and machinery insurance in Northern European countries, 4/4 collision and liability coverage is included in hull and machinery insurances, allowing insured parties to keep P&I claims records under control, but in our region, due to the high validity of the letters of guarantee provided by P&I firms and the clubs' claims handling practices, 4/4 collision and liability is incorporated into P&I coverage.
While managing hull and machinery insurance costs with stable premiums is a strategy to be minimally affected by contracting and expanding insurance markets, choosing the most suitable insurer in low markets and finding oneself in a disadvantageous position again when the market rises is a different strategy. In my view, there is not much difference between the two. What is important here, especially in terms of claims payments, is the continuity of shipowners with the insurers in question. No company prefers to part ways with an insured party after making a total loss payment after a few years of premium procurement. On the other hand, several new clauses introduced by insurers recently concerning whether the operational areas of vessels are embargo zones, cargo transfer from ship to ship, and the uninterrupted operation of AIS devices are emerging as new elements affecting the existence of H&M coverage. Legal conditions that may vary according to where the insurance coverage is provided are becoming factors that can deeply affect the content of the coverage (for example, "Russia-related sanctions clause"). Just as many additions can be made to the market conditions and pricing dynamics I have tried to explain above, insurers' own complex algorithms can also be added. Hull and machinery insurances require considerable technical knowledge, market information, and monitoring. I will leave discussing the claims processes while explaining this complex structure for another article. For these reasons, shipowners and operators should obtain "Hull and Machinery" insurances through an intermediary who knows the market, maritime affairs, pricing, can document correctly, and especially has a dedicated expert claims team that is up-to-date with current developments. I wish for a year with minimal losses and maximum profits...
Sources: 1. FPAUCB–“Free from Particular Average” Unless Caused By fire, lightning, Explosion, Grounding, Stranding, Damage received in collision with Ship, vessel or “object.” Note: This narrowed coverage aims to exclude "machinery breakdowns" from coverage. Payment for damages to machinery or hull is conditional upon the cause of the damage being from risks such as fire, lightning, explosion, grounding, stranding, and collision with another ship or object. Additionally, total loss, salvage/assistance, and towing costs to the nearest safe port, even if due to machinery breakdown, and the portion of general average attributable to the ship are covered.
* Published in DTO Magazine
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