Freight Insurance: Protection against Third-party Risks

Freight Insurance: Protection against Third-party Risks

Nima Roshanaei

Board of Directors of the Shipping Association of Iran


Cargo insurance is the best way for businesses to reduce financial exposure and mitigate supply chain risks. Supply chain disruption can happen at any time, and the level of preparedness determines whether businesses will be able to cope with its financial repercussions. Sending thousands, if not millions of dollars’ worth of merchandise off on a cargo ship or a cargo aircraft comes with some level of risk. While technological advances have improved navigation, air and maritime safety, freighting cargo remain risky business. This risk is largely covered with insurance; so much that insurance has become the main element in the operation of sophisticated economies throughout the world today.

Transport risk is unavoidable, particularly as supply chain has become more complex as goods remain in transit for longer. Even with robust supply chain risk management and special security procedures, risk will always exist in critical areas of the supply chain, and transport cargo insurance keeps the bottom line safe and the supply chain protected. Freight insurance encompasses more than the goods in transit, and can apply to both domestic and overseas mode of transport including land, sea, air and rail. In transporting goods, multiple parties are involved. This means there can be confusion as to where liability lies and a presumption that another party is responsible for safe transportation and will pay compensation if things go wrong. The key issue will be the detail in the sales contract between the buyer and seller of goods and this will often be based on Incoterms. Incoterms determine if it is up to the purchaser or the seller to take out shipping insurance.

Entities with an interest in the seaborne trade must procure insurance covering different parts of the risk during maritime voyage. There are several distinct types of insurance relevant to commercial maritime voyages, including coverage for hull and machinery (H&M), cargo claims and protection and indemnity (P&I). There are a host of risks that can result in huge losses. Perils of the sea include sinking, stranding and collision, while goods could be damaged as a result of bad weather, or jettisoned or washed overboard. Ships are at risk of fire, explosion and also subject to criminality and vandalism. Businesses need freight insurance to reduce the risk of importing and exporting. Following aspects are covered under the common types and benefits of freight insurance:

All Risk Coverage. This coverage provides extensive protection against damage or loss due to external factors. Damages due to inappropriate packing, Infestation, Cargo abandonment, Customs rejection, Employee’s dishonesty are included under all risk coverage.

Free From Particular Average Coverage. FPA coverage clause excludes coverage partial losses to the cargo or to the hull. The shipper does not pay for minor losses and is only held liable in case of significant losses to the cargo. This coverage belongs to special category and covers particular perils only. There is difference in coverage depending upon the storage location of the cargo. In this policy, following perils are included: Collision, Heavy weather, Sinking, Derailment, Non-delivery, Fire and Earthquake.

Warehouse to Warehouse Coverage. This coverage is applicable when shipment is unloaded from the ship and it gets transported to the customer’s warehouse. Insurance companies are very particular about compensating only the insurance holder’s cargo, not other owners’ cargos.

There are different types of cargo insurance policies, categorized into following classifications:

Open Cover Cargo Policies: When insurance holder opts for coverage against various consignments, then open cover cargo policies get activated. These policies are segmented in two categories namely renewable policy and permanent policy. Renewable policy is required for a particular value requiring renewal after policy expiration. Most of the single trip or voyages fall under this category. Permanent policy can be drawn up for a decided time period permitting countless shipments in that period.

Specific Cargo Policies: When a company approaches an insurance company or broker for insuring a particular consignment, then it can fall under the specific cargo policies. These policies are also termed as voyage policies because only shipments are covered under them.

Contingency Insurance Policy: There are certain cases where customer, not the seller is responsible for insuring the goods against loss or damage. There are perils associated with it if goods get damaged during transit and customer refuses to accept them. In few cases, some customers do not insure the goods and tend to avoid the liability. Under such circumstances, affected sellers can seek rectification with the help of the legal system. This can be costly for them and they may lose the case. Therefore, sellers are advised to go for contingency insurance which have a very less premium rate.

Freight insurance is therefore a measure that people take in advance, to assuage risks which can incur at any moment in time. Insurance protects people and businesses against certain potential losses and financial hardship at a reasonable and acceptable price. Extreme supply chain challenges cannot be completely avoided. Modern freight insurance is more than a tool of risk management. Given the potential hazards of global commerce, identifying, prioritizing and mitigating risks are extremely important. A layered approach to supply chain risk management is the best way of protecting cargo. The insurance sector collects and generates information on risks, and also analysis, distributes and aggregates this information. Policy holders can better assess the risks that they are taking, and also make better estimates of the risk-adjusted return on possible projects. They may also be able to direct their efforts at risk mitigation where the cost-benefit ratio is most favorable. A by-product of the deep understanding of risks is to attain expertise in how to reduce the probability of damages occurring and the extent of those damages and enforce the implementation of risk mitigation measures, in order to reduce moral hazard and adverse selection.

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