Machinery, what is the underwriter’s problem?

We are haemorrhaging money! Machinery is the biggest cost in terms of overall claims amount that insurers pay. Machinery incidents amount to over 40% of the overall claims paid by underwriters. To give some background, insurers cover the cost of replacing machinery which has broken as a result of negligence by the crew providing such loss or damage has not resulted from want of due diligence by the
insured, owners or managers. This is very wide coverage and effectively acts as warranty insurance for the machinery. Obviously it is open to abuse and insurers trust the owners to be open and honest when presenting a claim for machinery damage.

I have been in the insurance industry for over 30 years and have benefited from the Braemar’s, previously the Salvage Association, monthly reports. The top four causes of casualty are always machinery, grounding, fire and collision in that order. This is also backed up by the International Union of Marine Insurers (IUMI), where the data is kindly provided by Lloyd’s List Intelligence.

If you break down the losses by cost, main engine damage accounts for over 60% of the claims cost, followed by auxiliary engines (20%) and turbo chargers (10%). The table below shows some examples of engine damage claims. This is not small change!

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I enjoy playing with figures and statistics! So let me work through an interesting statistic with you. The annual marine hull premium for all insurance markets is USD7.6bn. (Source IUMI). The average loss ratio over is approximately 85%. Loss ratio is the percentage of the premium that insurers pay out in claims. Therefore on average insurers pay out USD6.5bn in claims. Machinery claims as explained above account for 40% of the overall claims. I think that figure is generous and consider the figure to be nearer 50%. Let’s go with 40%, therefore insurers are paying out USD2.6bn a year for machinery damage claims.

Pause. The average engine costs around USD1.5m. Divide USD2.6bn by USD1.5m that amounts to 1,733 new engines. In 2015 there were around 1,600 new deliveries in terms of new buildings. Therefore the insurance industry is paying out more for machinery claims than it costs to fund all the new engines being installed in the new buildings in one year! Aren’t we nice chaps!

The issues with engine casualties need to be identified. I consider strongly that the insurance industry has funded a lot of the research and development costs related to engines. Take low sulphur fuels (LSF) issues for example. The number of claims the insurers have paid out because of LSF have been increasing. I was assured by a major engine manufacturer a few years ago that this was not an issue and the engines can happily run on HFO or LSF without any risk. Who is kidding who? You only need to analyse the graph below to see the manufacturers’ assurances are worthless!

The London Joint Hull Committee and Braemar produced an excellent paper on LSF and cat fines in 2013 and I seriously recommend that anyone with an interest should study it. The paper culminated with the introduction of a new to tackle the cat fine issue, but sadly I have rarely seen it used.

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To give an example…

A 54,000 DWT bulk carrier built in 2005. Engine damage. The alleged cause of the damage was the supply of poor fuel oil bunkers with excessive levels of cat fines. The cost of repairs was in the region of USD 1,500,000.

Human factors are still the major cause of loss. You can design machinery to mitigate the loss and put regulations in place, but this still may not be good enough. Shipping companies must adopt safety cultures to ensure the crew are not breaking the rules and are adhering to best practices. This is becoming more and more difficult with the pressures on crews these days. If you take a large container ship there may only be three or four technical staff on board. There is more emphasis on outside engineers for repair and maintenance. However the technical staff still needs to be able to fix the engine and understand the issues in deep sea when the outside personal are unavailable.

I support the crew. I object to the finger always being pointed at crew when things go wrong. More often than not it is not their fault because they have not been trained properly, or they are under great pressure and sometimes fatigued. In some cases it is a convenience to blame the crew when actually it is covering up a serious breakdown in management responsibility. For example when a ship transfers to LSF it is often when a ship is about to enter port. This is the busiest time on board as the crew prepares the ship for all the inspections to comply with the regulations and prepares for loading/discharge of cargo. Switching to LSF is not straight forward and is not a matter of turning one switch off and the other on. If something is going to go wrong this is the time. Why are the crews fatigued? Have they not been trained properly? Is the crew inexperienced and been promoted too quickly in order to comply with regulations? Was the LSF laboratory tested for cat fines, and so on. These are management responsibilities. Why should underwriters pay for this?

I believe crews have to be trained up to ‘airline pilot’ standard these days. It is all very well engine manufacturers designing more technical engines and systems, but if a crew member has not be trained then it is a recipe for disaster and the insurers end up paying. I have been involved in a number of incidents where the crew do not understand the warning systems and turn them off, sometime resulting in catastrophe simply because the crew has not been trained. This is not fair on the crew and I consider in the event of a casualty everyone should share the burden of responsibility including the onshore management.

There are commercial pressures with the owners trying to remain solvent in a very poor freight market. Therefore pressures will be put on maintenance, spare parts, procurement and training budgets. Spare parts are a key issue. In the past engines could be fixed relatively easily with OEM or a third party manufacturer parts. Now the engines are so sophisticated that the getting the right spare part with the correct tolerances is fundamental and also expensive.

I also consider that insurers are partly to blame for the situation that we are currently in. That is because when there is claim the insurers focus on the proximate cause which I consider to be a too higher a level. We should be asking our surveyors, i.e. you, to investigate more of the root cause of the claim, the multiple prime causes that contributed to the proximate cause. There may be a generic link between the root causes. Then the surveyors deliver recommendations to how systems and so on can be changed in order for the incident not to reoccur. Additionally the surveyors and/or insurers may be able to identify trends and take appropriate action.

It is the insurer’s responsibility to ask the surveyors for this information rather than just delivering the proximate cause which is satisfactory from a claims viewpoint. Insurers are leaving a lot on the table in terms of loss prevention. The aviation and offshore industry has moved forward on this basis sadly the shipping and marine insurance industries have been left behind.

These concepts were suggested at the IUMI 2015 in Berlin by John Walker, Braemar Chief Surveyor America, and I whole heartedly support him. I thank him for his very valuable contribution to the conference. I also consider the insurance marine insurance industry should take note and do something.

I wish to touch on Big Data. I appreciate it is trendy phrase at the moment. I do believe that marine hull insurance will start using data in their pricing models. Motor insurance has already gone down that route and the management with 99% confidence level is able to predict the profitability, or loss of a motor portfolio. If you take the derivative of motor insurance being warranty insurance, when you purchase a second hand car you can buy warranty insurance which covers the spare parts when they go wrong. It is interesting and obvious that the parts covered get less and the car gets older. This is because the insurers know with a high level of confidence which parts will go wrong and when, hence excluding them for cover when the car reaches a certain age. Consider the number of engines of cars. It is phenomenal!

Take this to marine insurance. Marine engines are basically supplied by 11 manufacturers, of which 3 are dominant. There are only a limited amount of models. I am sure given time and money an insurer will do the analysis to work out which parts of the engine will go wrong within a set time period. This will then become a factor of the underwriting pricing model. I consider up to now, and in the near future, that underwriters have been blissfully unaware of the risks they are taking on in terms of machinery damage cover. Once one insurer starts doing this and gets it right the other insurers will follow. It is not as if the insurers are making a lot of money! I consider the marine engine manufacturers have had it easy up now with the insurers, but within the next 10 years the manufacturers will have nowhere to hide.

To be an underwriter you have to understand the clauses and the technical issues. However I firmly believe that a lot underwriting skill lies in the common sense of the underwriter. If something does not look right it probably is not and do not be afraid to follow your instincts, or to ask questions. Many a time in my career I have asked the obvious question and no one knew the answer. Therefore for the final part of this article I will pose some obvious questions about machinery and ships which have not been answered to my satisfaction.

Ship builder guarantee. A lot of casualties appear to happen when a vessel is new. This is only natural until the issues are ironed out. However it appears to be insurers who are at the wrong of casualty paying out. Where are the shipbuilder guarantees? What is the period of the guarantee and what is the small print? Underwriters really should be asking these questions and guarantees differ from build country to build country and yards within the country. I suspect there is an awful of lot of recoveries out there which potentially the insurer could claim against the yard.

Engine Guarantees. Similar to the above. You buy a new car and often get at least a two year guarantee against parts. How come this does not work with marine engines? Insurers seem to pay first and struggle to get anything back from the engine manufacturer. Yet again I suspect insurers could have claimed back an awful lot from the manufacturers, but all too often the crew conveniently get blamed absolving the manufacturers of any responsibility.

Spare part commission to the yards. The yard receives commission form the manufacturers for the distribution of spare part that often which forms part of a claim against the insurers. Is this not a conflict? It also pushes up the claim amount. Should insurers have access to the manufacturers directly to access the spare parts rather than pay an increased cost because of the commission?

Engine notices from manufacturers are kept ‘confidential’. A few years ago I spoke to a classification society about engine claims. They said the manufacturers are very helpful and in the event of fault the manufacturers produce a notice distributed to the classification societies, owners and ship yards. I enquired as to whether the insurers should have access to such notices. The answer was very clear No! The manufacturers do not want to worry the insurers about such things as to what can or will go wrong! The classification society did say if they passed these notices on then the manufacturers will stop supplying them. Surely there is a safety issue here and the more people know, the better the safety of the ship and more importantly the crew?

Engine manufacturers’ accountability. In shipping, as with most aspects of any industry, there is a third party, who audits or grades the quality of the operation or unit. In shipping you have the classification society for ship structure, the flag for crew and regulation compliance, SIRE surveys for tankers, Rightship for all vessel types, but with special focus on bulkers and even the IIMS acting in a positive role to improve the quality of marine surveying.

However within the marine engine arena this is sadly lacking. There does not appear to be a third party to turn to in order to get some comfort as to the quality, or why a certain engine part malfunctioned. So for example if a part malfunctions the engine manufacturer says it needs to be replaced. I would like to be able to appeal and confront a third party regulator as to why it broke down, will it happen again and does the manufacturer bear some responsibility and therefore contribute towards the cost of replacement. The manufacturers seem to be masters of their own destiny whereas most of us have to justify ourselves to a third party when it goes right or wrong!

Ship records. Put simply. When you buy a secondhand car most people would insist on having the log book. In shipping this does not appear to be the case. IUMI published a position paper in September last year which I whole heartedly support. The first paragraph reads:-

There is an increasing tendency for the outgoing technical managers to remove all records from the ship when a vessel changes ownership, leaving the incoming crew and management with very little information on the condition of the ship and the machinery.

During the first few weeks of ownership there is an increased risk without the possession of ship records from machinery breakdown which could impair navigation, lead to fire and explosion and ultimately lead to personal injury. During the build up to purchase the new owner teams are usually only allowed to observe and at best, when the transfer happens, the new owner is given the running hours. Loss of the maintenance reports also means there is no documentation of the conduct of a repair and whether manufacturers or non-standard replacement parts were used.

Let me translate this into real life. Two years ago I insured a ship owner who had his fleet third party managed by one of the major management companies. The owner decided to change the management company to a more local one where he had a financial interest, understandably. However within the first three months of the transfer three vessels had engine claims arising from the cylinder liners. When I quizzed the owners about the records of the main engine cylinder liner calibrations from the previous manager the answer was there were none and they had not been passed over to the new manager. If the new manager had the cylinder calibrations the loss could have been avoided. The outcome was an overall insurance claim of around USD1.5m.

There is no standard obligation to hand over records but I support the IUMI stance that the present situation is not satisfactory and transfer of records should form part of the ISM code. The IUMI stance is summarised as below and the more support we can get from the surveying industry the better.

IUMI remains sure that a significant improvement in the risk profile would be achieved by requiring the maintenance records, operating reports, and spares inventory to be part of the permanent service history of the ship and covered by the regulatory regime, possibly through additional clauses in the sale and purchase agreement. However, early resolution cannot be expected through either IACS or implementation in the ISM code.

In conclusion, machinery is one of the biggest cost burdens to the shipping and insurance industry. Whilst appreciating each industry has to make an adequate return to their shareholders, it appears that the machinery manufacturers have the unfair advantage and I consider it is time to have more equality between all parties to the marine adventure.

Feature written by Simon Stonehouse, Head of Marine at Asia Capital Reinsurance Group (Asia Capital Re)

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