Allianz Global Corporate & Specialty

General Average and Salvage ChargesMarine Insurance Considerations: A technical report.

Foreword by Ron Johnson

Introduction a history of General Average

What is General Average?

Salvage Charges

Delay in delivery of cargo

Conclusion

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General Average

The law of General Average is a legal principle of maritime law to which all parties, in a sea venture, proportionally share any losses resulting from a voluntary sacrifice of part of the ship cargo to save the whole in an emergency.

The tenet of General Average is that a party who has suffered some extraordinary expenditure or loss in order to save property belonging to others has the right of compensation for its loss from all parties to the voyage who have benefited from it (e.g. a merchant whose cargo is jettisoned to save a voyage).

Foreword

The laws of General Average have been deeply embedded into maritime law for hundreds of years. The earliest documented laws date back to the Digest of Justinian, Book XIV, in 530 ACE.

The recent grounding of a fully loaded cargo vessel on a reef off the coast of New Zealand highlights the dangers and consequences of even a minor maritime shipping event.

Owners of cargo onboard a grounded vessel face an anxious time waiting to see what develops before filing an insurance claim or potentially re-ordering lost cargo.

For those cargo owners who rely on insurance protection from supplier-arranged foreign marine carriers, it is unsettling not knowing if or when these insurers will respond to claims at the point of discharge.

Such cases are complex and potentially touch on several aspects of maritime law not regularly encountered by cargo owners such as General Average and Salvage Charges.

We have developed this report in response to frequently asked questions by brokers about how marine insurance policies respond to such events. It can be used by brokers to discuss certain exposures with their clients.

Some of the questions asked by cargo owners, when discussing the effectiveness of their marine cargo

insurance protection in the event of a grounded vessel, may include:

What do you do in case of potential loss? Could you face costs associated with the vessels

salvage? What if your cargo insurance was arranged by an

overseas supplier? What if the cargo is critical to get a project

completed and operational? Do you even have insurance cover for such an

exposure?

We are pleased to share this report as a useful reference tool and to provide technical information regarding standard marine insurance wordings.

Allianz Global Corporate & Specialty offers expert knowledge such as this paper to assist our global customers in understanding technical insurance matters and complex exposures. We hope you appreciate the quality product we offer to you and your customers.

Ron JohnsonRegional Manager MarineAllianz Global Corporate & Specialty - Pacific

Ron JohnsonRegional Manager Marine AGCS - Pacific+61.3.6332.3184ron.johnson@allianz.com.au

Introduction: A history of General Average and maritime law

Global cargo transit has been a regular feature of the history of maritime activities up to the present day.

Ships carrying cargo and the masters who operated them were protected by a maritime system dating back to the unwritten Lex Maritima.

This early type of coverage was developed on the island of Rhodes, an important maritime center, around the 9th Century BCE.

The code was later adopted by the Greeks and the Romans who added their own regulations, which eventually led to the Digest of Justinian Book, XIV, in 530 ACE.

The law of general average is also deeply rooted in Rhodian Law, which stated that in order to lighten a ship, merchandise has been thrown overboard; that which has been given for all should be replaced by the contribution of all.

Due to the international nature of shipping and the differences in the laws application, however, as a means to introduce international uniformity, General Average was formally codified into the York-Antwerp Rules, in 1890.

The rules have been updated numerous times, most recently in 2004. The rules state:

There is a general average act when, and only when, any extraordinary sacrifice or expenditure is intentionally and reasonably made or incurred for the common safety for the purpose of preserving from peril the property involved in a common maritime adventure.

While general average traces it origins back to ancient maritime law, it still remains a part of admiralty law today .*

* Lowdnes & Rudolfs Law of General Average and The York Antwerp Rules by J F Donaldson and CT Ellis; Stevens & Sons Limited, London.

What is General Average?

The law of General Average is a legal principle of maritime law to which all parties, in a sea venture, proportionally share any losses resulting from a voluntary sacrifice of part of the ship cargo to save the whole in an emergency.

The tenet of General Average is that a party who has suffered some extraordinary expenditure or loss in order to save property belonging to others has the right of compensation for its loss from all parties to the voyage who have benefited from it (e.g. a merchant whose cargo is jettisoned to save a voyage).

The claim is adjusted by an average adjuster who calculates the value of each saved interest. Each interested party is then obliged to contribute towards the general average loss or expenditure proportionately.

An important point is that the voyage must be saved for General Average to apply.

The four essential prerequisites for a General Average declaration are:

1. Incurrence of an extraordinary sacrifice or expenditure

2. Occurrence of an intentional or voluntary, but not necessarily inevitable, act

3. Presence of a real and substantial, but not necessarily imminent, peril

4. Resolution must be for the common safety and not merely for part of the property involved.*

Calculation of General Average

Calculation of General Average contributions is quite a complex task. Given the somewhat hybrid development of the rules, correct interpretation continues to be a specialized task for correct interpretation continues to be a challenging task left to experts who specialize in General Average adjusting.

General Average security usually takes the form of a General Average Bond signed by cargo owners, together with either a cash deposit for the amount determined by General Average adjusters or a General Average Guarantee provided by the cargo insurers.

Guarantees are usually only accepted from reputable insurers with a strong financial backing. Where the insurer does not meet the minimum financial strength criteria, additional security may be required before release of cargo.

Therefore, cargo owners and their brokers, in the current global financial climate, are advised to deal with a respected marine insurer with a healthy solvency margin and a strong international credit rating.

What types of marine casualties can give rise to General Average? The following are some examples of events and expenditures that are likely to be involved in a General Average loss:

Event Expenditure

Grounding / stranding

Damage to vessel and machinery through refloat efforts

Loss or damage to cargo through jettison or forced discharge

Cost of discharging, storing and reloading of discharged cargo

Port of refuge expenses

Fire

Damage to ship or cargo due to efforts to extinguish a fire on board

Jettison of cargo Port of refuge expenses

Cargo shifting in heavy weather

Jettison of cargo Port of refuge expenses

Heavy weather collision or machinery breakdown

Port of refuge expenses

* Notes on General Average by J S Crump, Rishards, Hogg International.

Enforcement of rights in General AverageUnder international shipping law, the shipowner has a duty to obtain General Average security not only for their own benefit but also for the benefit of other cargo owners who have suffered a loss recoverable under General Average.

The shipowner enforces this duty through a lien held over the cargo while in custody for cargo owners General Average contributions.

This lien enables the shipowner to demand lodgement of acceptable security for estimated General Average contribution before release of the cargo.

Amount

Contributory Value

Ship Sound Value per certificate US$ 13,000,000

Cargo CIF Value of all cargo on board US$ 12,000,000

Summary of GA Disbursements

Ransom payment US$ 2,500,000

Delivery and success fee US$ 250,000

Negotiation fees US$ 300,000

Lawyers fees US$ 100,000

Bank charges US$ 10,000

Adjustors fees US$ 40,000

Total US$ 3,200,000

Appointment of General Average

Ship US$ 13,000,000 pays 52% US$ 1,664,000

Cargo Owner 1 US$ 5,000,000 pays 20% US$ 640,000

Cargo Owner 2 US$ 4,000,000 pays 16% US$ 512,000

Cargo Owner 3 US$ 2,000,000 pays 8% US$ 256,000

Cargo Owner 4 US$ 1,000,000 pays 4% US$ 128,000

Example of General Average Claim adjustment for a piracy event.

Salvage Charges

Salvage Charges to refloat a grounded vessel usually are expensive, often running into the millions of dollars.

Consequently, under Admiralty Law, each party is liable to contribute independently of the other parties, with the Salvor being entitled to proceed against each party of the property saved for which he has a separate lien.

While Salvage Charges technically fall into a separate category than General Average, for simplicity they are usually treated as General Average expenditures. Accordingly, the important aspects discussed under General Average will equally apply to Salvage Charges.

How do marine cargo policies respond to General Average losses and Salvage Charges?

Exports on a Cost, Insurance and Freight (CIF)/Carriage and Insurance Paid to (CIP) basis

Clients with marine cargo insurance policies covering exports sold on a CIF/CIP or similar basis can expect to be covered for General Average contributions under their cargo policies. Institute Cargo Clauses (A), (B) and (C) each provide protection for General Average and Salvage charges.

The term Salvage refers to the practice of rendering aid to a vessel in distress. Maritime law has long decreed that third parties who freely participate in a successful salvage of life or property at sea without doing so under the terms of a contract are entitled to remuneration.

Essentially, Salvage Charges apply in the event of a successful salvage due to a voluntary act independent of any contract. Conversely, under the Lloyds Open Form, a standard legal document for a proposed marine salvage operation, under the heading No cure - No pay, if an attempted salvage has been unsuccessful, no award/compensation will be received for the effort or time spent if the salvage is unsuccessful.

However, this principle has been somewhat weakened in recent years and awards are now being permitted in cases where, although the ship may not have been salvaged, pollution or damage to the environment has been avoided or mitigated.

Enforcement of Rights for Salvage ChargesAn important difference between Salvage Charges and General Average is that with Salvage Charges the remuneration may not always be for the common good.

However, an important aspect of all of the Institute Cargo Clauses is that they specifically exclude delay.

Losses incurred merely due to delay in delivery are not commonly allowable expenditures for General Average purposes under York-Antwerp Rules.

Recommendation: Project owners should consider buying additional insurance protection against any delay in start-up of a project attributable to delay in delivery of procurements critical to the projects completion.

Exports on Cost & Freight (CFR), Free (or Freight) On Board (FOB) or similar terms

Clients exporting on a CFR, FOB or similar basis may have no claim for General Average and Salvage Charges.

This is the case since the title to the goods would have transferred to the buyer, regardless of whether or not they hold marine insurance covering exports due to lack of insurable interest.

In practice, this should be of little or no consequence to the seller unless the buyer defaults in settlement.

The risk of buyer default could significantly increase in cases where the buyer holds no marine cargo insurance and is unwilling to or cannot provide suitable General Average security for release of its cargo.

In such cases of default, the exporter would be unable to obtain release of the goods without providing proof of the required General Average or Salvage security to the shipowner.

In this scenario, the exporter would face an added difficulty. Security might be required since the cargo would likely be in a foreign country, although technically the exporter would have no insurable interest in the goods at the time of the event.

Thus, a claim filed under any form of marine cargo policy the exporter held for security would be unlikely to succeed unless the policy wording was very carefully constructed to respond to such events.

The Maersk Tacoma incident off the Victoria coastline in Australian waters in 2001 raised an interesting twist to the notion of buyer default when the vessel returned to the port of origin for the cargo to be transhipped.

The cargo would not be transhipped without a General Average security, which left some exporters in difficult negotiations with buyers.

Imports purchased on CIF, CIP or similar terms.

Clients purchasing goods on CIF, CIP or similar terms where marine cargo insurance is arranged by the seller are in the hands of the suppliers insurer.

While this should normally be a simple matter, delays in providing the necessary paperwork and suitable guarantees can often occur at the point of discharge where the insurer is not represented in the country.

Recommendation: In such cases, purchasers should contact the nominated local claims settling agent to avoid an unnecessary delay in release of the cargo.

Imports purchased on CFR, FOB or similar terms

Clients holding a marine cargo insurance covering imports can expect the policy to respond to any costs related to General Average and Salvage Charges for cargoes purchased CFR/FOB or similar.

Delay, however, remains as an exposure where clients should consider cover, especially when it comes to critical items for projects.

The British Marine Insurance Act 1907 specifically excludes any loss caused by delay. Delay has traditionally been viewed as a financial business risk beyond the scope of general insurance and thus, delay is a standard exclusion in all Institute Cargo Clauses.

As many large scale infrastructure projects import critical items in a modular form from other regions to the project, project owners are faced by numerous challenges involving the logistics.

In analyzing the cost-benefits of modular construction versus conventional stick build construction, the increased maritime risk is often overlooked.

Project owners and developers are wise to factor in this exposure when undertaking the cost-benefit analysis.

Delay in delivery of cargo, especially those critical for completion of a project

Delay has long been viewed as a financial business risk and beyond the scope of the general insurance market.

The very nature of many infrastructure and project cargo risks means that the consequences of loss or damage to cargo can have a significant impact by delaying commencement of operations, most particularly in cases where the cargo may be critical to the completion of a project.

Impacts can include potential loss of revenue as the result of incurring additional expenditure by extending the start date of the project. Such losses and costs can be and are regularly insured under a Marine Delay in Start-Up Insurance (DSU).

A crucial feature of a Marine DSU policy is that, like most business interruption policies, insurers rarely offer any form of business interruption/DSU cover unless they have control over the material damage loss that might give rise to a claim.

Even though there are sound underwriting reasons for this decision, it creates difficulties for buyers of critical items purchased on CIF, CIP or similar terms.

Such buyers will find it nearly impossible to purchase any form of Marine DSU Cover. Even if they try to arrange a separate marine cargo policy, unless the wording is carefully drafted claims are likely to fail for lack of insurable interest.

To further research Marine DSU insurance, please refer to a previous white paper published by Allianz Global Corporate & Specialty entitled Marine Delay in Start-Up (DSU): A mysterious insurance coverage simplified. It can be downloaded at www.agcs.allianz.com and is recommended reading.

Recommendation: In the very early planning stage, owners and project managers should consider making provision for a principal controlled Project Cargo Policy for procurements.

Shipping was one of the earliest activities that required international cooperation in terms of laws and regulations. Over time, maritime law has developed alongside globalization.

This report outlines the current issues that an insured can face when considering the appropriate cover. For brokers, it contains a comprehensive presentation of

measures an insured should consider and understand in order to obtain appropriate coverage, including:

For protection, in the event that general average or salvage costs are applied,

For cover in case their insurance supplier is in another country; or

For control of goods, especially project owners, rather than relying on the suppliers marine insurance protection - as the recent grounding in New Zealand highlighted.

This paper also highlights the risks of relying on a suppliers marine insurer when sourcing critical components for a project.

It makes a strong argument for a principal-controlled Project Cargo and Delay in Start-Up Insurance for new significant projects in our era of globalization and the procurement of modules offshore.

Allianz Global Corporate & Specialty manages risk from a broad perspective and will work with brokers to fit the cover to the needs of the client. This report sets out to raise awareness of the risks and inform brokers of some of the solutions available.

For all inquiries, please contact your local Allianz Global Corporate & Specialty underwriter.

Conclusion

Awareness and communication are key for the broker to properly consult with clients about General Average and Salvage Costs.

Copyright 2013 Allianz Global Corporate & Specialty AG. All rights reserved. The material contained in this publication is designed to provide general information only and was believed to be correct at the time of publication. Allianz Global Corporate & Specialty AG assumes no obligation to update any information contained herein. The descriptions of coverage are abbreviated and are subject to the terms, conditions and exclusions of the actual policy. For full coverage details, please refer to the actual policy forms.In relation to Australian clients and risks, Allianz Global Corporate and Specialty - Pacific issues Allianz Australia Insurance Limited ABN 15 000 122 850 insurance

Allianz Global Corporate & Specialty AG,Fritz-Schaeffer-Strasse 9, 81737Munich, GermanyNovember 2013

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