Shipping is attracting money from all sorts of different places – with new investors and lenders entering the market looking for high returns and the promise of asset play. These new investors and lenders consider the projects presented carefully, using the best lawyers, ship valuers and surveyors to make deals as watertight as possible. They check borrowers as much as they can – obtain detailed reviews on the insurances arranged on the assets and insist on the best. However, they are then making a huge mistake – they let someone else arrange their contingent insurance protection and as a consequence devalue that protection by over 50 percent in the process. Why?
Until a claim is made on an insurance policy it is simply a piece of paper in a file, which gives some comfort on dark stormy nights
The best place to start is to examine what the insurance does that the investors should be buying. All marine assets will have three basic types of cover that the owner will buy – these are hull and machinery, war and protection and indemnity (P&I) cover. All of these will be checked by investors and their advisors for both their breadth and the security of the underwriters accepting the risk. This is standard and those covers are correctly the responsibility of the owner or operator of the vessel. The loan documentation will contain a general assignment and notice of that assignment will be signed at drawdown so that the world at large can be told of the investor/lender interest and the relevant policies endorsed accordingly.
This is fine so far, but as with all contracts of insurance there is the possibility of avoidance of claims by underwriters. It doesn’t happen often, thankfully, and the vast majority of insurance claims are processed without dispute as to liability or quantum. Even where there are disputes they are invariably resolved by compromise without financial detriment being suffered by investors or lenders. The problems come when underwriters don’t pay or the compromise available is not sufficient to satisfy investors and lenders. It is this position that contingent insurance protections are there to deal with – they step in to pay investors and lenders when the owner’s policies don’t and it is the very infrequency of such claims that means the correct attention is not being given, to either the wordings used or who is arranging the cover.
The problem
The contingent insurances available fall basically under two headings: Mortgagee’s Interest Insurance (MII), which is for lenders securing their position with ship mortgages; and Lessor’s Interest/Innocent Owner’s Insurance (LII/IOI), which is designed to protect finance investors who buy vessels and give them to third party operators by way of lease, bareboat or management. Requirement for these insurances is included in loan documentation, but securing cover is frequently simply a box just to be ticked and failure to tick the box correctly can be a very expensive hobby.
Until a claim is made on an insurance policy it is simply a piece of paper in a file, which gives some comfort on dark stormy nights. Only when money is needed does the adequacy of that piece of paper get tested and only during the claims process are cracks and deficiencies found. Those cracks may be overcome with legal argument, but at the same time may be fatal to a claim. Lessons are learned with every claim and the marine insurance world has a habit of throwing up unique problems. MII and LII/IOI insurances are not like the hull and machinery policies purchased by owners – underwriters of MII and LII/IOI covers don’t expect claims. Rejection of claims made by owners on their insurances is a rare occurrence and as a consequence claims on contingent protections are rare too.
Any contract, whether by way of insurance or not, will never be perfect and there will always be debate about the meaning of words and the obligations of each party. The more debates there are the more the contractual terms will be defined and arguments rehearsed about what the contract actually does. That is a hugely useful part of the process – if you like a form of evolution. A learning process with different points being raised each time a claim or dispute arises and changes made to reflect the needs of the parties in the future. The more disputes there are the more a contract gets examined and the quicker the learning process becomes, such that each side gets to know more and more about the product they are buying.
Difficulties to overcome
The difficulty for MII and LII/IOI assureds is that the evolutionary process is slow and largely unpublicised, occurring quietly out of the glare of the public eye and it is because of this snail like pace of development that wordings and coverage available vary, perhaps more than any other type of insurance cover.
By way of example owners buy their hull and machinery cover on various sets of international clauses with standard amendments, which are understood by both those arranging cover and those giving the cover. In contrast MII is arranged either on the standard Institute Mortgagees Interest clauses (there are two sets dated 30/5/1986 and 1/3/1997) or on a myriad of wordings designed by brokers in conjunction with their clients. The Institute MII clauses should be avoided by lenders and investors at all costs and if the piece of paper reached for in times of trouble is based on such clauses, then simply ticking the box has turned out to be no tick at all. Other sets of clauses may look similar but there will be subtle variations based on pieces of experience and assureds looking at wordings and saying “what if this happens – can we amend to take account of that?”
The difficulty is that no matter how long you sit in a room trying to think of every eventuality to close possible gaps, the marine world will produce a situation that no-one has thought of – or a lawyer acting for underwriters will read a clause in an entirely different way to that which is intended. Interpretation of wordings is both an answer and a problem, and even if wide wordings are used those tasked with collecting claims may have no idea of what weapons they have at their disposal; a little like having a gun but not knowing how to fire it.
Advice going forward
The first part of the advice then is to use the right wording to give the best chance of recovery. The second part of the advice is never to let an owner, operator or manager arrange the cover on behalf of a lender or investor. Defences used by the underwriters of owners’ or operators’ policies rely on an act or omission of that owner or operator – that act or omission may be entirely innocent but mistakes happen nevertheless and claims may be declined as a result. All MII and LII/IOI protections are based on the premise that they are protecting an innocent lender or investor who is unaware of the issues affecting the owners’ or operators’ insurances. The required innocence or lack of knowledge is blown away though, if the owner or operator acts as agent for the lender or investor who will be fixed with the knowledge of their agent. Immediately the lender may be deemed to be aware of an act of non-disclosure, breach of warranty or breach of condition and if that is the case the widest wording available won’t save the MII or LII/IOI claim, which is destroyed before it even starts. The box has been ticked, but ticked by the wrong person and the complete lack of attention to this highly important part of the process can be very costly.
When mistakes happen the usual response is ‘this must never happen again’ or ‘we’ll get this right next time’. The problem with contingent policies like MII and LII/IOI is that most lenders or investors may never see more than one claim and there may never be a next time to get it right. It is a quite unique experience in that this has to be done correctly first time and plugging one of the various policy holes for ‘next time’ will be little consolation as the experience purchased at such a high cost, with an MII or LII/IOI claim not collected, will never be used. Shipping is a great business for lenders and investors alike, but they shouldn’t let such a large part of the insurance process be left to chance.
MII and LII/IOI claims can be thought of like London buses – you may wait for ages for one to come along and when it does you must get on, as the next one may never arrive. Use the right wording – which has been stress tested for claims and your own broker who knows how to collect those claims – and you’ve got a chance of enjoying the ride. It’s like anything; if you want something done properly, do it yourself.
