Marine insurance and convoy

The prominent way to protect against piracy is to cover the potential financial losses with insurance. Marine insurance is one of the earliest forms of insurance invented. Historically, this connected with another key deterrent method: convoy. Both played a vital role in the Somali piracy epidemic.

Marine insurance first developed in the late 17th century, when London’s Lloyd’s Coffee House quickly became the hub of information on British maritime trade for merchants, insurers, the Government and Lords of Admiralty. At Lloyd’s, members obtained government information on any misconduct of merchant ship captains, while the Lords received information on ships taken by privateers. To reduce the incidence of claims, Lloyd’s insurers offered reduced premiums if merchants used convoy protection.

Edward_Lloyds.jpg

Lloyd's Coffee House

Convoy developed in the early years of Spanish Caribbean settlement in the late 16th century. Spain’s military resources focused on Europe but it still needed to protect its lucrative treasure fleets from European sea-raiders. Convoy worked on the idea of protection in numbers. At the time, merchants armed their ships, so multiple ships travelling together offered the greatest armed protection.  The Spanish convoy system helped Spain curb sea-raider threats until 1628 and, between 1655 and 1725, no pirate successfully took a Spanish treasure ship while in convoy.

While sovereigns considered convoy an integral piracy deterrent, it did not engender much enthusiasm from ship-owners and merchants. Merchants desired protection for their trade, not control of it. Travelling with a convoy cost them money because merchants needed to wait in port for a convoy to materialise. In the meantime, they needed to cover the cost of provisions and wages, perishable cargoes, and any port fees. This meant that when the convoy finally set sail, some of the faster sailing ships were inclined to break away in the hope of reaching their markets ahead of the others. This cause great consternation from insurers.

To counter this problem, in 1793, Lloyd’s insurers compelled the British Government to pass an Act requiring all vessels engaged in foreign trade to sail in convoy unless specifically authorised by the Admiralty. The Act imposed severe penalties on captains who disobeyed the orders of the escort commander. For merchants and ship-owners, the new law meant now they were delayed not only by awaiting a convoy but by a naval ship’s engagement in trade for its own benefit. For insurers, the Act represented the marine insurance industry’s historic influence over the government.

The situation sustained a fractious relationship between ship-owners, insurers and the government compounded by the occasional flaring of piracy through the early 19th century. Since piracy threatened state economic interests, for the government, the insurer’s need to reduce risk continually outweighed the merchant’s need for profit.

What role did insurers play in the Somali piracy epidemic?

When Somali piracy emerged around 2007, there was little enthusiasm in the shipping industry for organised, protective convoys for the multitude of different flagged ships traversing the Gulf of Aden. Convoy rested entirely in the domain of a state navy’s responsibility to its own ships, not any other state. So while Russia, China, Korea, India, and Japan offered naval convoy to their own merchants, this was rarely employed by other ships. However, convoy would emerge in a different way in the fight against Somali piracy. Meanwhile, insurers retained their centuries-old influence over shipping.

One of two significant measures insurers undertook in response to Somali piracy was changing the way ships could insure against piracy. In 2005, piracy moved from hull insurance (protection against physical damage) to war risk. Unlike the annual nature of hull insurance premiums, war risk insurance allowed insurers to charge premiums per journey on ships travelling through regions deemed a ‘war risk’. In 2008, as a result of the escalation of Somali piracy, leading marine insurers deemed the Gulf of Aden a war risk.

The detrimental financial effect on ship-owners was immediate. War risk premiums skyrocketed. Insurers also introduced kidnap and ransom insurance for the first time and encouraged its purchase to cover the costs incurred in the statistically unlikely event of a hijack. While this was happening, the shipping industry faced significant financial pressures from the Global Economic Crisis. To make matters even worse, despite the increased presence of naval patrols, piracy was escalating. Frustration in the shipping industry grew.

By 2010, members of the shipping industry began deciding to take physical deterrence of Somali pirates into their own hands. The insurers responded with the second significant measure to counter Somali piracy: endorsing the use of armed guards on ships.