It’s Almost July of this year. What’s so special in July, you may ask.
Naaa.. It’s not my birthday and it’s not my son’s birthday.
This is the time I have to shell out a huge chunk of money for my car insurance. Year after Year, each year.
Now if I am so much worried about my Car’s insurance premium, Imagine about the ship owners.
Imagine how much money they need to pay for the insurance of their ships. But that is the cost they cannot avoid.
These costs are for the insurance of ship’s hull and machinery. The good part in this insurance is that costs are known to the shipowner and they can plan for that.
But when a ship is navigating at sea, carrying cargo and is involved in all these activities, it is subjecting itself to a number of claims against the ship owners.
For example, a port can claim that ship damaged its fenders or a buoy while berthing. Or the port can claim that ship polluted their waters.
So it is not about only insurance of damage to the hull and its machinery but also about all the claims that ship owner can get against him.
There can be a number of other kinds of claims. Some logical and some illogical. But ship owners have to make sure that they are insured for all of these.
In this post, we will discuss where P&I clubs fit in the marine insurance and how do these work.
Let us jump in.
Where do P&I clubs fit in marine insurance?
Broadly there are three types of marine insurance.
- Insurance for the ship (Hull and Machinery)
- Insurance for the cargo (Taken by the shipper)
- Insurance for the third party claims
Insurance for the ship’s hull and machinery is provided by H&M underwriters. This is the oldest kind of marine insurance and most basic one too.
This is the insurance for the damage to the ship’s hull and machinery.
H&M insurance policies have few important clauses that shipowners have to abide by.
For example, H&M policy has International Navigation Limits. The international navigation limits define the geographical limits within which the ships can trade without any additional premium.
Another example, H&M policy restricts the ship to proceed to war zones without informing the H&M underwriters. Again, this is because of additional risk that these areas pose.
The shipper has shipped the cargo and the cargo gets damaged during the voyage. Can shipper claim all the costs from the shipowner or carrier?
If you understand the “Hague-Visby rules” you will know that these rules provide many defenses to the shipowner.
So if these defenses apply to a case, the shipper would have nobody to claim these damages from.
This is the reason that shipper insures the cargo at each leg of the voyage.
P&I insurance is used for the third party claims towards the ship owners. Shipowners provide a service of carrying the cargo of the shipper.
While providing this service, a shipowner may be subjected to a number of claims from third parties.
These claims could be damage to the jetty, pollution from the ship or even the fines to the ship from authorities.
Shipowners need to insure for all these third party claims. P&I clubs provide insurance to the shipowners for all these claims.
Why P&I Clubs?
Before the 19th century, the term “marine insurance” only meant the insurance for the ship’s hull and machinery.
This was the time when most of the ships were sailing vessels.
The chances of collision between two sailing vessel’s were less. But as more and more steamships came to the sea, the chances of collision between ships increased.
Underwriters became concerned about this increased risk. Rightly so because in collisions between two vessels, H&M insurers not only have to cover the damages of the insured ship but also pay for the damages of the other ship if the blame is on the insured vessel.
To take care of part of this risk, they introduced a clause in their policies.
This clause was called “3/4th Collision Clause” or “Running down clause“. As per this clause, the underwriters will only pay 3/4th of the total liability or claims against the ship owners in a collision incident.
This clause is there in the Hull & Machinery policies even today.
Let us see this with an example. Let us say there has been a collision between two ships. The “hull & machinery insurance” of both the ships will study the investigation of the collision to set up the percentage of blame.
Let us say the blame was set as below
Ship A: 70% responsible for the collision
Ship B: 30% responsible for the collision
The repair costs for both the ships are as follows
Ship A: USD 100,000
Ship B: USD 250,000
Total cost of repairs: USD 350,000
The liability of both the ships will be
Ship A: USD 245,000 (70% of the total costs)
Ship B: USD 105,000 (30% of the total costs)
So ship A need to pay USD 145,000 to ship B apart from USD 100,000 damages to its own ship which will be covered by H&M insurance.
As per 3/4th collision clause, the H&M insurance company will pay only 3/4th of this amount.
So payable by H&M insurance: USD 108,750
Payable by shipowner: USD 36,250
The ship owners wanted to insure this amount too without exorbitantly increasing their insurance premium.
Shipowners could get this 1/4th liability insured but for that, they needed to pay an additional premium. Shipowners wanted to avoid that.
This led to the formation of P&I clubs which works on the principle of mutual sharing or pooling of the risk.
With time the P&I clubs insured many other risks the owners were subjected to in their business of running the ships.
How do the P&I clubs work?
P&I clubs work on a non-profit basis. It is the club of shipowners who are acting both as assured and insurers.
P&I clubs work on the principle of mutual sharing and pooling of the risk.
What does this mean? Let us understand this with a simple and most basic example.
10 shipowners form a club for sharing each other’s risk. All these 10 shipowners have one ship each which is of the same type, size and value.
At the end of the year, one ship had third party claim of USD 1000 to pay. This claim of USD 1000 will be shared by all the 10 shipowners equally.
So each shipowner would contribute USD 100 to pay this claim. This means that with just USD 100, each shipowner was able to cover the risk of the third party claims.
Now that we know the basic principle of working of P&I clubs, let us understand few basic terms used in P&I clubs.
In more realistic situation P&I club cannot afford to ask the contribution of each owner only when there are some claims to settle.
In our example, the claim of USD 1000 would need to be paid immediately to avoid the delays to the ship. This means that P&I club needs to have money in its account to pay for the third party claims.
P&I clubs maintain a fund and ask the shipowners to contribute to this fund
- when a new shipowner joins the club or
- when the fund money goes down because of the claims settles.
- Annually or as per the rules of the P&I Club
All these requests to the shipowners for the payment are called “Calls”.
So these may be
- Advance calls (Paid when a shipowner joins the club or at the beginning of year)
- Supplementary calls (Paid when the funds have gone down because of claims paid )
- Release calls (to settle the account of a ship that is sold or scraped or shipowner leaves the P&I club)
Deductibles in a claim is a common practice in all kind of insurances.
The deductible is the pre-set amount deducted from the insured loss.
Let us say that a P&I club has set the deductibles for claims arising from damage to the jetty as USD 5000.
Now if the claim towards the shipowners for one of such incident is USD 30000. Then the P&I club would pay USD 25000 after USD 5000 as deductible from this claim.
Deductible serves two purposes
- It discourages the shipowners from claiming the small amounts.
- It ensures that shipowners have increased interest in minimizing the casualties and claims
Now let us see this from the perspective of a ship owner who just bought a ship and needs to enter a P&I club.
A new shipowner entering into the club
It is important for the shipowner to insure all risk involved with the operation of a ship. Apart from “Hull & Machinery” insurance, entry of the ship into a P&I club is important.
So the ship owner would first approach the P&I club for including him and his ship into the club.
The P&I Club will assess all the factors before deciding if it is OK to include this ship owner and this ship into the club. Some of the factors the club would be looking for are
- Suitability of the cargo spaces for the intended cargo
- Proficiency of the crew
- previous track record of the ship owner and/or Ship managers
- Standards of classification society
Once the club decides that the ship can be covered, the details of the cover provided by the club would be shared with the ship owner.
The details would include the call rate and deductibles for each type of risk. Call rate is expressed as amount per gross tonnage.
If agreed the ship owner will pay the “advance call” and P&I club will issue the “certificate of entry” to the ship owner.
Finances of a P&I club
Let us see how the finances of a P&I club are handled?
As discussed, the P&I Club maintains a fixed amount of fund which is used for the settlement of claims.
The P&I Club maintains this fund through the payments of the advance calls and supplementary calls from the members.
Some part of this money is also invested to earn some profit which again goes into the fund. This all becomes the income part of the P&I club.
So in short, the income part of the P&I club include
- The Annual contribution from the members.
- Contribution of new members or new ships entering the club
- Interest/Profit earned on the investments of the fund
It is too obvious to say that P&I clubs will have many expenditures. The major chunk of which goes in the settlement of claims against its members.
Apart from that, another expenditure of the P&I clubs is the management cost of running the club. Management cost would include the salaries of the employees and rent of the offices etc.
P&I clubs also reinsure some of its risks. The cost of such reinsurance also comes under expenditures.
So the expenditure part includes,
- payments made as claims settlements,
- Management costs
- Reinsurance costs
Balance of Income and Expenditures
Once the incomes and expenditures are known, the balances are just the game of addition and subtraction.
At the end of the year, the amount short of the agreed amount to maintain in the fund is contributed by each ship owner.
The contribution paid by a ship owner is equal to the “call rate” multiplied by the total gross tonnage of his ships insured by the P&I club.
The call rate would be different for different owners and for different ships.
The call rate for a ship owner depends upon factors like
- past history of claims of the ship owners
- the age of the ship
- crew proficiency and knowledge
- trading patterns of the ship
I know we don’t hear this terms quite often. But there is this group of P&I clubs that plays an important role in the third party claim insurance.
This is the group of 13 P&I clubs. All these P&I clubs are bound by the agreement called “International Group Agreement“.
The purpose of this group is to
- set the rules of engagement and cooperation between the clubs
- provide a unique and invaluable forum for sharing information on matters of concern to clubs and their members
- Provide a pooling agreement between clubs for claims exceeding USD 10 million
So any claim that exceeds USD 10 million, the excess amount will be shared by the member clubs of this group.
As this is a huge group, it allows the group to economically share the large claims.
It is not uncommon for the seafarers to deal with P&I club correspondents. When there is a claim or an incident, we are asked to call for the attendance of P&I club representative.
If we know how the P&I club functions and more importantly that they are on our side, dealing with these situations becomes easy.
This makes the knowledge about the functioning of P&I clubs so much important.
About Capt Rajeev Jassal
Capt. Rajeev Jassal has sailed for over 19 years mainly on crude oil, product and chemical tankers. He holds MBA in shipping & Logistics degree from London. He has done extensive research on quantitatively measuring Safety culture onboard and safety climate ashore which he believes is the most important element for safer shipping.
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