Piracy – Who DOESN’T Bear the Cost

Piracy has always been a major concern in the shipping world.  However, the surge in piracy, particularly off the coast of Somalia over the past few years, has called for specific changes in shipping practices.

In the first nine months of 2009, there were 306 incidents of piracy reported to the IMB Piracy Reporting Centre (PRC).  Of this number, 114 times pirates boarded the vessel, 34 times pirates hijacked the vessel and 88 times vessels were fired upon.  While the Gulf of Aden and the East Coast of Somalia remain the regions of highest threat, pirate activity has expanded into the southern parts of the Red Sea, the Bab el Mandab Straits and the East Coast of Oman.  This has led to the development of an entire industry of pirate negotiators and security firms who undertake to settle on ransom amounts and organize the drop shipment of the cash.

Shipowners sending their vessels through these dangerous waters have been slow to respond to these dangers, but have finally starting coming around to the inevitable: the beefing up of security for the ships.  This includes paying extra amounts to join a protected convey in high-risk waters, hiring armed helicopters to fly over the ship, and in some instances, hiring armed guards to be on board the vessel itself.  The great fear, of course, is that if a ship has its own onboard armed guard, this could provoke more violent action from the pirates.  At present, the pirates have been fairly non-violent, in most circumstances holding the crew hostage but not harming its members.  With the presence of armed guards, this tendency could change.

A conflict with pirates undoubtedly costs the shipowner money, be it damage to the vessel, operating costs (such as daily hire of the crew) for the lost time at sea and potential claims from cargo interests.  Moreover, insurance companies don’t always pay.  With the rise in piracy incidents, many shipowners have been discovering the limits of their maritime insurance.

There are two categories of damage for which an insurance company might actually pay out.  Hull & Machinery insurance and insurance on the carried cargo would cover physical loss or damage.  Arising liabilities would be covered under Protection and Indemnity (P&I) Insurance.  Practically speaking, P&I will provide sums for crew’s loss of life, personal injury or illness, substitution of crew members and/or repatriation and for loss of personal items of the crew.  Ransom payments, however, are considered to be beyond the scope of P&I.  But is that fair?

Way back in 1590, it was decided in Hicks v. Pallington that ransom payments were subject to general average contribution.  This means that the risk of having to pay ransom was spread out amongst all parties involved in the voyage.  To the surprise of many naive shippers, this includes those who have shipped the cargo, even after they have paid all of the freight and other costs billed to them.  Since P&I insurers also have an interest in seeing the vessel on its way before any harm befalls the crew or any potential pollution results from the piracy incident, there seems little justification to exclude P&I insurers from general average contributions.  Paying the ransom decreases the chances that the P&I insurers will have to pay out under their policy.

But what about Hull or War Risks insurers?  The normal standard of cover for Hull insurance is the Institute Time Clauses – Hulls (ITCH).  These clauses purport to cover piracy, but exclude expenses arising from “any terrorist or any person acting from a political motive” (the Strikes exclusion).  It almost seems like a game of semantics.  While the ITCH clearly anticipates piracy, if we were to consider pirates to be terrorists, the risk would be deflected away from the Hull insurers and onto the War Risks insurers.  Many times, this isn’t a big deal because the insurers are the same.  Practically speaking, the vast majority of ransom claims through Hull insurance are denied.

War Risks insurance, however, tends to operate differently from Hull insurance.  First, there is typically no deductible.  But there is also usually a provision requiring the insured to warrant that they will not sail within a certain distance of the Somalian coast.  Thus, having failed to claim in Hull insurance, the shipowner is unlikely to find recourse through War Risks insurance, either.

As an odd point, insured parties might not be able to enforce payment for pirate ransom in the English Courts.  The majority of these insurance policies are construed under the laws of England.  Under the English Proceeds of Crime Act, it is illegal to pay ransom to an organization if the paying parties have a reasonable belief that the organization being paid is a terrorist one.  Once again, we see the problem of conceiving of these pirates, who are indeed involved in highly organized activities funded by a large number of investors, as terrorists.  There just aren’t clear guidelines for identifying terrorists in the maritime setting.

Since it is very likely that a piracy claim could fall between the gaps of P&I , Hull and War Risks insurance, many firms now take out Marine Kidnap and Ransom (K&R) insurance which would cover ransom payments, the cost of negotiators, and other expenses which might arise due to a piracy incident.  The matter of pirate terrorists has yet to be tested by the courts.

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