The Impact of Major Losses in Marine Hull Market: Part 1

With persistent growth in size, value, and complexity of the vessels, the potential severity of losses is continuously growing for the global marine insurance industry.

Overview

The marine hull insurance market is attracting attention and raising considerable concerns due to its noticeable volatility throughout the industry. This volatility can be attributed to various causes which can and do significantly impact the performance of overall marine hull insurance market. Specific vessel types are particularly vulnerable to total losses. Noteworthy incidents in the past, such as the sinking of RMS "Titanic"[1] in 1912 and the "Costa Concordia"[2] in 2012, and the most recent collision of "Dali"[3], followed by the collapse of the Francis Scott Key Bridge in the US port of Baltimore. act as stark reminders of the potential risks inherent in this sector. Moreover, with persistent growth in size, value, and complexity of the vessels, the potential severity of losses is continuously growing for the global marine insurance industry.

Highlight of discussion points

The main challenges and trends in marine hull insurance: In this article, we will be discussing how major losses, especially related to specific vessel types and causes, are affecting the volatility and performance of the marine hull insurance market. It will also highlight the factors that influence the marine hull insurance cycle, such as hull value, premium rate, capacity, and inflation.

• The data and insights from International Union of Marine Insurance (IUMI) and the Nordic Association of Marine Insurance (Cefor): Through review of data from IUMI and Cefor, we will illustrate the frequency and severity of major losses in the global and regional markets. It will also show how major losses account for a significant share of the total loss amount and premium income, and how they vary by vessel type and cause.

• The key points from IUMI marine insurance reports: We will summarize some of the specific topics and challenges that IUMI marine insurance reports have addressed in recent years, such as the increase in fire losses on Roll-on/Roll-off (Ro-Ro) and container vessels, the impact of climate change and decarbonization on marine risks, and the claims inflation due to rising vessel values and complexity. We have adopted the major losses threshold of USD10 million as used by IUMI in recent years.

• The relationship between maximum Insurance capacities, attritional loss ratio, and major loss severity: This article will also comment on how underwriters need to balance their exposure to maximum loss scenarios, their attritional loss ratio performance, and their potential for major loss severity. It suggests strategies to manage the volatility and profitability of the marine hull insurance book, such as portfolio diversification, data analytics, risk management, and cycle management.

• The distribution of probability of major losses in China market: We will analyse the frequency and severity distribution of major losses in the China market, using a lower threshold of RMB 10 million. It shows that the China market has losses of moderate severity and consistent frequency, but also contained extreme losses, mostly related to bulk cargo carriers and builder's risks. It also compares the China market with other regions and markets in terms of vessel types, average values, and total losses.

• The other matters that affect marine hull insurance: We will also discuss other matters that marine insurers need to consider, such as the terms and conditions of hull insurance coverage, the impact of inflation on repair costs and total losses, and the exposure to special vessel types and builder's risks. We will also suggest to underwriters to keep the attritional loss ratio below 40% and to control the exposure to high volatile business.

Views through the years from IUMI and Cefor about major losses:

IUMI's database on reported losses

IUMI's reported global loss database sheds light on the considerable influence major losses have on the overall marine hull insurance market. From Underwriting Years (UY) 2013 to 2021, although only 2% of reported losses exceeded USD 10 million, these claims accounted for 29% of the total loss amount. These statistics convey the disproportionate adverse impact of major losses on the marine hull insurance industry as compared to attritional, or smaller, more frequent losses.

These statistics convey the disproportionate adverse impact of major losses on the marine hull insurance industry as compared to attritional, or smaller, more frequent losses.

?Source: IUMI. Information reorganized with permission from IUMI.

The fact that almost a third of losses were major losses demonstrated the magnitude of their adverse impact. Insured parties are paying a significant portion of their premiums not necessarily for attritional losses they might experience during the insured period, but to compensate for the potential risk of substantial losses that could occur at any time during such period. This reality suggests a market where infrequent but severe claims drive a significant share of premium calculations, affecting all participants regardless of individual loss experience.

Historical Major Losses

According to IUMI, the vulnerability of marine hull insurance market against major losses has been evident.

The Costa Concordia disaster in 2012 was a notable incident in that year, with the Costa Concordia event alone accounting for approximately USD522 million in losses. One single loss impacted more than 10% of the European marine hull insurance market. A tsunami occurrence in Japan and a hurricane occurrence in the USA which mostly impacted yachts insurance, also caused notable losses for that year.

Source: IUMI

[i]UY2006, With major losses accounting for 18% of the premium income according to the presentation by IUMI in 2007.

In 2019, a single builder's risk loss happened and contributed 20% loss ratio for European market for UY2014.

Whilst the cost of the hull insurance claim might have been manageable, the incident had far-reaching consequences for global trade and supply chain operations.

The case of the Ever Given[4], which blocked the Suez Canal in 2021 is especially noteworthy. Whilst the cost of the hull insurance claim might have been manageable, the incident had far-reaching consequences for global trade and supply chain operations. It underscored the interconnectivity of hull-related insurances with broader economic and logistic frameworks. Such incidents can lead to massive contingent business interruption losses that, whilst not directly falling under marine hull insurance, resulted in considerable adverse financial impact far beyond the marine industry.

Major loss average loss ratio

Although it may not be possible or meaningful to estimate the severity of losses in every single underwriting year, we can still get a view of the severity of the impact from major losses on the industry over a period. Through some simple calculations, a few conclusions can be drawn from the data compiled by CEFOR and IUMI. For example, the simple average major loss ratio to value of marine hull book (major loss ratio) is around 13% per year for the period of underwriting years (UY) 2013-2022 without consideration the developing factors. This is a dynamic figure with major losses development and record extension. If UY2012, which saw significant losses, was included, the average major loss ratio must be higher than what was calculated above. In general, a 10-20% major loss ratio is considered an experience loading to marine hull insurance costing, acceptable to both direct and reinsurance hull costing, in most portfolios around the world. It tells the average view of the degree innocent vessels have to bear the potential major losses happened anywhere anytime. We have verified this major loss ratio in a few other major marine hull markets, as a whole market average major loss ratio, we hope it could be a reference point in considering the major loss loading, and it always needs to be adjusted according to each portfolio with risk factors like vessel types etc.

Source: IUMI. ?Information reorganized with permission from IUMI.

Attritional Loss ratio

If we deduct the major losses from the losses overall, the attritional loss ratio is typically expected to be more stable and predictable since it excludes those large, less frequent events. However, as you will observe below, there can still be volatility in attritional loss ratios, as evidenced by the relatively higher ratios in underwriting years (UY) 2014-2018 within the 2013-2022 period.

Source: IUMI. Information reorganized with permission from IUMI

This suggests that there are additional variables at play affecting the marine hull insurance book's performance. Factors such as the value of the hulls being insured, changes in direct market insurance capacity, fluctuations in premium rates, and economic factors like inflation, can indeed contribute to performance volatility. These marine environment variables are playing a marine insurance cycle role affecting the attritional loss ratio performance. Marine insurance volatility is a combination of marine major losses and marine insurance cycle. Indeed, the key to understanding the volatility in a marine hull insurance book lies in the delicate balance between exposure, premiums, and the incidence of major losses. Below is a simplified view of how major losses interacting and influence the overall performance:

• Major Loss Frequency: The occurrence of major losses brings about significant volatility into the book. These losses can vary year to year, both in frequency and severity. In years without such losses or with less severe losses, the book's performance can appear much better. However, it is exactly that unpredictability which makes it difficult to make reliable predictions over a short observation period on the expected performance of any hull insurance portfolio.

• Long-Term Perspective on Major Losses: It's important to average out the impact of major losses over a longer period. This approach helps to mitigate the perceived volatility, providing a more stable and realistic view of the book's performance. Ensuring that the premium accurately reflects the exposure (including the potential for major losses) and maintaining profitability without compromising competitiveness is a delicate exercise. It involves statistical modeling, trend analysis, and market insight. A long-term strategy accommodates the inevitable occurrence of major losses, allowing the book to perform smoothly over a more extended period by absorbing shocks and distributing their impact over a longer period.

Some clues from IUMI Marine insurance reports indicating the state of the marine hull insurance cycle and concerns for major losses:

The insurance statistics presented by IUMI reveal some specific challenges and trends in marine hull insurance over a few years.

The soft cycles and driving factors

The soft cycle consistently affects the performance of the marine hull insurance book every few years. These cycles are driven by globally softening insurance terms, which include reductions in hull value, premium rates, and the slowing increase in the volume and number of vessels, combined with overcapacity, intense competition.? They are also sometimes influenced by subsidiary movements or shifts in reinsurance market capacity.

Based on the IUMI statistics, it is observed two soft cycles happened in the historical periods UY1998-2002, and UY2014-2018.

Source: IUMI

When we look more closely at the developing factors in the soft cycle in recent years without the major losses, we can discern how they are correlated and led to the soft cycles.

Source: IUMI. Information reorganized with permission from IUMI.

Some clues relative to the insurance cycle are identified from above. During the soft cycle of 2014-2018, the exposure increased with vessel numbers, average tonnages and total tonnage. While the premiums in the period have been slacking and were unable to keep up with the pace of exposure increasing. the gap between exposure and premium from 2013 to 2019 expanded due to the inadequacy of premium.?

The loss ratio in 2013-2019 was higher than other periods after removing the major losses. It has been driven by several risk factors: The first factor is the consistently reducing insurance premium rate since 2013. The second one is the decreasing average hull insured value which in turn led to the reduction of total insured value during 2013-2019.

The widening gap between the average Gross Tonnage (GT)[1] and the insured value during the period mainly explained why the exposure increased, while the insured value was decreasing. The situation had lasted until 2020 when the gap narrowed, and premiums increased. Premium inadequacy had systematically driven the market loss ratio growing in the period; Another underlying risk factor is the average vessel age increasing which has impacted the hull exposure deterioration.

The combination of all these factors has led to the soft cycle during 2014-2019. The soft cycle terminated when the premium adequacy started improving with average and total insured value picking up since 2020 and narrowed the gap between exposure and premium. ??

The soft cycles are always intertwined with global events closely related to international trade, reinsurance capital, and the balance of capacity growth. From an underwriter's perspective, we cannot proactively change the cycle.

However, some successful cases in the market show that underwriters can adhere to their philosophy and defend their terms successfully based on their pricing models and portfolio, while others may struggle or undergo restructuring due to underpricing, higher-than-expected claims frequency or severity, or a combination of these and other factors.

While the market getting out of the soft cycle after UY2020 was driven by the improvement of the above factors like the overall hull value and average hull value improvement, the underlying correlation behind the value improvement could have been owners putting more resources into maintaining the vessels in good conditions, and crew training to avoid accidents arising from poor maintenance or crew negligence.

Source: IUMI. Information reorganized with permission from IUMI.

Some specific topics related with marine insurance risks are discussed in recent years of the IUMI presentations.

In 2017, the increase in number of fire losses on Ro-Ro and container vessels was flagged as a global concern. These incidents present significant challenges, both in terms of safety and financial impact and more importantly, the preservation of human lives. Ro-Ro vessels, which transport wheeled cargo such as cars and trucks, are particularly prone to fires due to the vehicles they carry, many of which contain flammable liquids and materials. ?

According to the IUMI statistics, out of 29 major accidents involving these types of vessels, 18 were caused by fire. 6 out of 7 such accidents which exceeded USD100 Million in loss of hull and cargo were caused by fire.? Similarly, the high density of packed goods on container ships, combined with misdeclarations, increased the risk of fires that can spread rapidly, compounded by the difficulty of accessing and extinguishing fires in deep-seated containers.

The spotlight on climate change, driven by the International Maritime Organization (IMO), reflects an industry becoming increasingly aware of environmental risks. Accommodating decarbonization in the marine industry can contribute to increased vessel values and complexity of vessels and adversely impact the severity and frequency of machinery-related losses.

In 2022, whilst IUMI discussed much about the Russian/Ukraine conflict and climate change, claims inflation was emphasized. Similarly, complexity in vessel build and specifications along with increasing values of units were highlighted to forewarn heightened volatility of the business. According to Cefor, there is a rising trend of USD300 million vessels in the European insurance market.

What Else Matters?

By analyzing frequency and severity distributions of losses, we gain insights into marine hull major losses, typically reflecting an average major loss ratio of 10-20% generally. It's crucial to consider the composition of coverages of hull insurance, which encompass collision liability and general average (GA). This amplifies the potential impact to any hull insurance portfolio in the most severe scenarios, especially when extreme insured values are involved.

When contemplating event losses arising from natural catastrophes or a war situation, it becomes evident that such occurrences could result in disastrous accumulation scenarios. Even if a marine hull insurance book could maintain an average loss ratio of 50-60% over a decade without a major loss, just one of such significant events could add another 10-20%.

To prepare for major losses, we suggest underwriters need to evaluate two key aspects.

Firstly, they must assess their capacity to handle a single maximum loss. The maximum capacity utilization could range from 3-4 times of overall annual premium book to potentially 10 times, depending on the volatility of the exposures such as ocean-going project vessels like dredgers, wind farm installation vessels, ocean-going Ro-Ro carriers, and mega containers in our portfolio.

Secondly, it is crucial to review the attritional loss ratio in their books. If the attritional loss ratio stands at 60%, the underwriters may have buffer to absorb the impact of a potential major loss or two. On the other hand, if the average attritional loss ratio is around 80%, they should carefully evaluate their ability to withstand the financial impact of major losses.

At the same time, underwriters need to be aware of the market dynamics and exercise good cycle management to mitigate such additional volatility to their marine hull insurance business. Portfolio diversification, data analytics, risk management and loss prevention, and claims management need to be focused upon. It is crucial to stay informed, be proactive, and remain flexible, enabling quick responses to both challenges and opportunities.

In conclusion, understanding the interplay between maximum loss capacity, attritional loss ratios, and the potential severity of major losses is imperative for crafting a resilient risk management strategy. This approach ensures that one's marine hull insurance portfolio remains robust and adaptable to unforeseen challenges, maintaining financial stability and sustainability in the face of a dynamic and unpredictable market and risk landscape.

This is Part 1 of a 2 part article.

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[1] Titanic: “The Titanic is Sunk, with great loss of life”, The Guardian, 16 April 1912 https://www.theguardian.com/news/1912/apr/16/leadersandreply.mainsection

[2] Costa Concordia: “Costa Concordia disaster”, Britannica, 31 July 2024, https://www.britannica.com/event/Costa-Concordia-disaster

[3] Dali: “Trapped cargo ship Dali will refloat to Baltimore Monday at high tide”, CNN, 19 May 2024, https://edition.cnn.com/2024/05/18/us/dali-ship-baltimore-bridge-refloats/index.html

[4] Ever Given: “Final report into Ever Given tanker’s Suez Canal blockage”, Insurance Business Magazine Asia, 11 July 2023, https://www.insurancebusinessmag.com/asia/news/marine/final-report-into-ever-given-tankers-suez-canal-blockage-452207.aspxom)

[5] Gross Tonnage is a nonlinear measure of a ship's overall internal volume.