Module 2 P&I Insurance: History, Operation & Practice 2023/24 PDF

Module 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE A qualification for the P&I industry produced by the International Group of P&I Clubs 2023/24 EDITION ...

Module 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE A qualification for the P&I industry produced by the International Group of P&I Clubs 2023/24 EDITION  A qualification for the P&I industry produced by the International Group of P&I Clubs Module 2 P&I Insurance: History, Operation and Practice  Published by the International Group of P&I Clubs, 3rd Floor, 78/79 Leadenhall Street, London, EC3A 3DH All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means (electronic, mechanical, photocopying, recording or otherwise) without the written permission of the publisher. Copyright © International Group of P&I Clubs 2020 Author: International Group of P&I Clubs The Author asserts moral copyright in the work. Edition 2023/24 revision 3. Production, design and layout: Carmarmedia.co.uk, the Institute of Chartered Shipbrokers and Coracle Online Ltd Front cover and chapter cover photography: Danny Cornelious DISCLAIMER While care is taken to ensure the accuracy of the information, no warranty of accuracy is given and users of that information are expected to satisfy themselves that the information is relevant and suitable for the purposes to which it is applied. In no circumstances whatsoever shall the contributors or the International Group of P&I Clubs be liable to any person whatsoever for any loss or damage whensoever or howsoever arising out of or in connection with the supply (including negligent supply) or use of this information.  Contents CONTENTS Introduction VII Examination IX Chapter 1: The background, history and development of P&I insurance 1 1.1 The origins of marine insurance 2 1.2 The founding of the Protection Clubs 9 1.3 Further statutory developments 11 1.4 The development of the Indemnity Clubs 12 1.5 The origins and use of Club correspondents 16 1.6 The status and functions of the Club correspondent 17 Chapter 2: Mutuality and the cover provided by the Clubs 23 2.1 The concept of mutuality 24 2.2 The distinction between Group Clubs and Non-Group Insurers 28 2.3 The structure of P&I Club rules 29 2.4 General conditions applicable to P&I Club cover 33 2.5 Standard cover available under P&I Club rules 42 2.6 Standard exclusions from P&I cover 47 2.7 The concept of the ‘omnibus’ rule 51 2.8 Role of the Clubs in providing bail and other security 59 P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE V Contents Chapter 3: Other types of marine insurance and their relationship with P&I cover 65 3.1 Hull and machinery policies 66 3.2 Freight, demurrage and defence (FD&D) insurance 76 3.3 Multi-modal transport risks 77 3.4 Construction/building risks 81 3.5 Loss of hire 84 Chapter 4: The International Group of P&I Clubs 86 4.1 Membership, structure and role of the International Group 87 4.2 Limiting Club cover 104 4.3 Liabilities to passengers and seamen 107 4.4 Overspill claims 108 Chapter 5: Financial operation 111 5.1 The concept of solvency 112 5.2 Financial statements: overview 113 5.3 Capital adequacy 115 5.4 Security ratings 118 5.5 Impact of reinsurance on financial statements 119 5.6 The investment of reserves 119 APPENDICES 123 Appendix 1: The standard form of Club Letter of Guarantee 124 Appendix 2: Structure of the programme for the 2019/20 Policy Year 125 Appendix 3: Examples of fixed premium P&I insurers 126 VI INTERNATIONAL GROUP OF P&I CLUBS  Introduction P&I Qualification programme Module 2 - P&I Insurance: History, operation and practice Introduction The content of this module forms part of the P&I Qualification (P&IQ) programme but may also serve as reference material. This module provides candidates with a general understanding of the evolution of the P&I Clubs into their current form, their operation and practice, their co-operation within the International Group, and their place within the marine insurance market. Assumed knowledge None assumed. What you’ll learn in this module To succeed in the examination of this module you should take note of the learning objectives for each chapter and the knowledge rating key below. Guide to knowledge ratings General background awareness necessary 1 Requires a knowledge of the major concepts and issues 2 Requires a thorough understanding of concepts as well as significant detail, the ability to evaluate them and to apply them to various situations. 3 Learning objective Your objective should be to learn the content of the chapters to the level required by the knowledge ratings. Chapter 1 The background, history and development Knowledge rating of P&I insurance The origins of marine insurance 1 Founding of protection Clubs 2 Development of indemnity Clubs 2 P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE VII Introduction Chapter 1 continued Knowledge rating Origins and use of Club correspondents 2 Chapter 2 Mutuality and the cover provided by the Clubs Knowledge rating The concept of mutuality 3 P&I Club rules and cover 3 Standard exclusions from P&I cover 3 Concept of the ‘omnibus’ rule 3 Normal extensions of cover 3 Role of the Clubs in providing bail and other security 3 Chapter 3 Other types of marine insurance and their Knowledge rating relationship with P&I cover Hull and machinery policies 2 Freight, demurrage and defence (FD&D) insurance 2 Multi-modal transport risks 2 Construction/building risks 2 Loss of hire 2 Chapter 4 The International Group of P&I Clubs Knowledge rating Membership, structure and role of the International Group 3 Nature of the International Group agreements 3 The structure of the reinsurance programme 3 Co-reinsurance 2 Limiting Club cover 3 VIII INTERNATIONAL GROUP OF P&I CLUBS  Introduction Chapter 5 Financial operation Knowledge rating The concept of solvency 2 Capital adequacy 2 Adequate reserving, including the use of incurred but not reported (IBNR) claim projections 2 Security ratings and the measures used by rating companies 2 Impact of reinsurance on financial statements 2 The investment of reserves 2 Examination Exams are held twice a year in May and October. The syllabus is examined on the learning text in this module. Unless specifically stated in the learning text, students will not be examined on the appendices. Refer to www.pandiq.com for the latest learning materials, syllabus and examination dates and all other information on P&IQ. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE IX Chapter 1 X INTERNATIONAL GROUP OF P&I CLUBS  Module 2 CHAPTER 1 THE BACKGROUND, HISTORY AND DEVELOPMENT OF P&I INSURANCE Chapter 1 What you’ll learn in this chapter The background, history and development of P&I insurance Knowledge rating The origins of marine insurance 1 Founding of the protection Clubs 2 Development of indemnity Clubs 2 Origins and use of Club correspondents 2 In this module we will use the following working definition of a P&I Club: An association of owners and operators of ships that have grouped together to insure each other on a mutual non-profit-making basis against their liabilities to third parties and certain costs and expenses arising out of the operation of their ships. The P&I Club of today stems from two historic sources: marine insurance and mutual insurance. 1.1 The origins of marine insurance Earliest origins The actual concept of marine insurance as a protection against loss by marine perils has been traced back to the third century BC. However, the origins of marine insurance as it is still practised today can be traced to the activities of merchants in the cities of Lombardy in Italy in the 13th century – the oldest existing policy of marine insurance dates from 1347. By the 14th century, the Lombards had carried the concept of marine insurance – the transfer of maritime risk to an independent third party in return for the payment of a premium – to other European countries such as England, France, Belgium and Holland. Marine insurance in English law Although the Lombards were expelled from England in 1483, the practice of marine insurance based in London continued to flourish and, in 1601, the first English statute relating to marine insurance was passed – the Act touching Policies of Assurances used among Merchants. The preamble to that Act not only expresses the basic principles of marine insurance as still practised today, but shows that they were already firmly established by the beginning of the 17th century: 2 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance And whereas it has been time out of minde an usage amongst merchants, both of these realms and of foreign nations when they make any great adventure (specially into remote parts) to give some consideration of money to other persons (which commonly are in no small number) to have from the assurance made of the goods, merchandise, ships and things adventured or some part thereof, at such rates and in such sort as the parties assurers and parties assured can agree, which course of dealing is commonly termed a policy of assurance, by means of which policy of assurance it cometh to pass that upon the loss or perishing of any ship there followeth not the undoing of any man, but the loss lighteth rather easily upon many than heavily upon few, and rather upon them that adventure not than those that do adventure, whereby all merchants especially the younger sort are allured to venture more willingly and more freely. Lloyd’s coffee house There were no marine insurance companies in England in the 17th century but, towards the end of that century, in 1688, Edward Lloyd established a coffee house in Tower Street in London, near the Thames, where shipowners, masters and merchants with an interest in foreign trade met to socialise, to keep abreast of affairs and to do business with one another. Lloyd’s coffee house gradually developed into an informal insurance market, which was the forerunner of the Lloyd’s insurance market of today. The individuals who accepted insurance risks in the coffee house were called ‘underwriters’, simply because they used to write their names and signatures at the bottom of the policy document ‘under’ the terms and conditions set out in it. Lloyd’s Coffee House by George Woodward, 1798 P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 3 Chapter 1 The origins of mutual insurance The origins of mutual insurance (as opposed to marine insurance), in the form of collective self-help against fortuitous loss, can be traced back at least as far as the Greek and Roman civilisations, where associations existed to protect individuals against burial expenses, illness and other perils. In later times, particularly in England in the Middle Ages, the craft trade guilds protected their Members through sharing of losses against theft of cattle, damage by fire, sickness and death. By the 18th century, the work of the guilds was continued by the formation of ‘friendly societies’ providing support and assistance in mitigating the general misfortunes of life to their Members. The Bubble Act While the roots of the P&I Clubs of today lie in the development and practice of marine and mutual insurance, the Clubs’ direct predecessors were the Hull Clubs, which developed in England during the 18th century and flourished for about 100 years. In 1720, in response to the developing stock market scandal of the ‘South Sea Bubble’, the English Parliament passed an Act, now known as the Bubble Act, which forbade the formation of joint-stock companies without a royal charter. In addition, it granted charters to two insurance companies, the Royal Exchange Assurance Corporation and the London Assurance Corporation, to write marine insurance. They remained the only companies entitled to do so until the Act was repealed in 1824, and thus had a monopoly among insurance companies until then. However, the right of individuals to underwrite marine insurance was not affected, so business continued as usual in the Lloyd’s coffee house. The South Sea Bubble, a Scene in ‘Change Alley in 1720 by Edward Matthew Ward 4 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance Disadvantages of the limited market The disadvantages of limiting the marine insurance market in the way provided by the Bubble Act were to become increasingly apparent as the 18th century progressed. In the first place, the two companies were conservative in the risks that they would underwrite, and expensive in the risks they did underwrite. Indeed, it is said that, by the end of the century, the companies underwrote only 4% of the total marine risks insured, the balance being underwritten by individual underwriters. Further disadvantages were as follows: difficulty in getting claims paid, because underwriters were litigious or insufficiently funded for the risks they had undertaken (or both); access to the market was limited in that, at times of great risk to the merchant fleet, underwriters would simply stay away and not attend their place of business; access to the market in London was difficult for the shipowners based in the ports around the country; in consequence, they often used brokers. However, brokers tended to be expensive and some of them were unreliable. The formation of the Hull Clubs The proven inadequacies of the limited market introduced by the Bubble Act led directly to the formation of the so-called ‘Hull Clubs’. These were associations of shipowners based at the ports who grouped together to insure their hull risks on a mutual basis. This was particularly the case in the north-east of England, and especially in the coal transport trade. Given the provisions of the Bubble Act, there was some doubt regarding the legality of these associations. Their operations were, however, not much impeded, and by the end of the 18th century the judiciary was regarding them with favour. According to Hazelwood and Semark (P&I Clubs: Law and Practice): “These early Hull Clubs were very local friendly affairs usually managed by only a secretary and a manager and a small committee. The Clubs afforded an immediate, local and intimate means of taking insurance on ships. Personal acquaintance between members was an advantage in itself and not only were these Clubs insurance concerns but they were places where ‘men of the sea pooled their difficulties and where help (both financial and otherwise) was given in sorting things out.’ The Club system of calls also met with the approval of shipowners as it amounted to a form of insurance on credit or insurance by instalments or at least deferred payments. Also the small Clubs were so simple in their administration, they were very economical and, being mutual in character, profits were not part of the calculations in underwriting.” This is a reference to the practice of making calls on Members only when money was P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 5 Chapter 1 needed to pay claims. Many of these features still remain part of the Club business philosophy. The decline of the Hull Clubs The concept of the mutual Hull Club worked best in the context of a close-knit local shipping community. As the 18th century progressed, three factors began to weaken its effectiveness: the commonality of risk became diluted as, in a drive for expansion, new owners from further afield were admitted as Members and risks shared were less alike; as there was as yet no system of individual rating, and claims were simply shared between owners, the Members with the better-performing ships increasingly found themselves paying the claims of their less competent competitors; as the Clubs were not incorporated associations, payment of claims was dependent upon each individual Member paying his pro-rata contribution. As a result, payment was sometimes slow and unreliable. Because of these and other factors, the Hull Clubs entered a period of decline early in the 19th century. This decline was hastened by the repeal of the insurance provisions of the Bubble Act in 1824. As a result, more insurance companies entered the marine insurance field, together with the Lloyd’s underwriters, and the market became more competitive, especially for the better risks. The Clubs increasingly found themselves left to insure ships of ageing and deteriorating quality, with Members unable to sustain the burden of the claims they gave rise to, and a number of Clubs closed as a result. Indeed, it is possible, at least in England, that insurance provided through mutual Clubs would have disappeared entirely had not certain other changes occurred in the first half of the 19th century – in particular, a significant increase in the liabilities to which shipowners became exposed. This in turn gave rise to the need for new and extended insurance protection. The rise of the Protection Clubs One significant driving force was collision risk. In the 18th century this risk seems to have been perceived as relatively unimportant but, by the start of the 19th century, concern was growing, and collision cases began to appear in the law reports of the time. Certain principles were confirmed by the House of Lords in the case of Hay v Le Neve in 1824: where a collision was caused by the fault of a ship, it was liable for the damage suffered by the other ship; where the collision was caused by the fault of both ships, liability was divided equally 6 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance – at least in the Admiralty Court. Extending the limitation of liability However, by the Responsibilities of Shipowners Act 1813, the regime of limited liability that had been first introduced in the Responsibilities of Shipowners Act of 1734, dealing with loss of or damage to cargo arising from a tort of the crew was extended to cover collision damage, that is, the liability of the owner for loss of or damage to the other ship in collision, and loss of or damage to cargo on board both of the ships. Liability was limited to the value of the ship and freight immediately prior to the accident. As a result, the owner could still be liable up to the full value of their ship (and freight) even if their vessel was lost as a result of the collision. Thus, the owner’s maximum exposure as a result of a collision would be the value of their own ship, if lost, plus the liability to third party claimants limited to the value of the owner’s own ship plus freight. The possibilities of insuring this exposure were, however, limited by the Merchant Shipping Act of 1745. This Act prohibited shipowners from insuring against their liabilities for sums in excess of the value of their vessels – presumably on the grounds that they had no insurable interest beyond that point (the concept of an insurable interest in an exposure to liability had not yet been developed). There is evidence that the Hull Clubs were, by the beginning of the 19th century, including cover in respect of liability ‘against running down or doing damage to any ships or cargoes… but not exceeding the sum insured on the ship doing the damage both for the damage done and received’. The commercial market was, on the other hand, said to be reluctant to cover collision liability, ‘because of their severe attitude toward negligence of shipowners and crew’. The Collision Clause of 1824 The case of De Vaux v Salvador in 1836 established that the liability for damage done in collision was not a ‘peril of the sea’ and therefore not recoverable under the standard form of SG Policy in use at the time. That confirmed the need of insuring that liability under a special clause, such as the Collision Clause of 1824. This clause provided cover against any sum not exceeding the insured value of the ship and freight that the assured became liable to pay ‘in case the said ship shall, by accident or negligence of the Master or crew, run down or damage any other Ship or Vessel’. The clause did not include cover for liability for loss of life or personal injury arising from the collision. Nevertheless, presumably to be on the safe side, in 1861 Lloyd’s underwriters introduced a specific exclusion to this effect. All cover under the clause was, however, limited to ‘Three Fourth Parts of the Sum so paid’. Note further that the collision liability cover was not yet conceived as a separate P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 7 Chapter 1 and additional insurance to the hull policy. That meant that underwriters only paid a maximum of the insured value of the ship once, even if the ship were lost in a collision for which it had responsibility towards the other ship and its cargo. From this analysis, it is clear that it was not the shipowner’s exposure to the one- fourth collision liability under the terms of the standard hull policy that was the major driving force behind the creation of the P&I Clubs. Rather, it was, together with two other factors which we examine in the next two sections, the need for collision cover above and beyond the insured value of the ship that prompted the formation of the Clubs. The Fatal Accidents Act 1846 The first of the remaining factors was the passage in 1846 of the first Fatal Accidents Act, popularly known as ‘Lord Campbell’s Act’, after the name of its sponsor. The main purpose of the Act was to grant to the personal representatives of a deceased person the right to sue for damages any person whose wrongful act, neglect or default had caused the death in question. Previously, the position at common law had been that the action for damages died with the person killed, leaving the dependants of the deceased without a remedy in law. In the maritime context, the Act of 1846 represented a considerable increase in risk for the owners of passenger ships which, at this time, were engaged in carrying tens of thousands of emigrants across the Atlantic to North America. The principle of vicarious liability, by which the employer was held responsible by the law for the negligence of the ship’s employees in the course of their employment, had already been established in the 1839 case of Duncan v Finlater. After 1846, therefore, the shipowner was potentially exposed to claims from the dependants of every passenger lost at sea through the negligence of the ship’s master in the navigation or handling of the vessel. The Harbours, Docks and Piers Clauses Act 1847 The second of the remaining factors was the Harbours, Docks and Piers Clauses Act 1847. By section 56 of this Act, the harbour master was empowered to remove any wreck obstructing the port facilities and to claim the costs of doing so from the owner of the wreck, regardless of the cause of the accident. Further, by section 74 of the Act, the shipowner was liable to compensate the harbour/port authorities for damage done to the port facilities by their vessel, regardless of whether the damage was caused by the shipowner or the shipowner employees’ negligence. Faced with a serious increase in their liability exposure, shipowners began to press the government to include liability for passenger death and injury within the limitation regime for cargo that had already been established by the Responsibilities of Shipowners Acts 1734 to 1813. 8 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance The Merchant Shipping Act 1854 In 1854, the efforts of shipowners to reduce their liabilities were in part successful, in that the Merchant Shipping Act of that year granted the shipowner the right to limit their liability for loss of life and personal injury to passengers to the value of the vessel and freight, provided that, in respect of the passenger risk, that value should be deemed to be not less than £15.00 per registered ton. That was a high figure: it is thought to be about twice the average value of a British vessel at the time – and in consequence, about twice the amount of any insurance limited to the value of the ship itself. 1.2 The founding of the Protection Clubs The Shipowners Mutual Protection Society The Merchant Shipping Act of 1854 came into effect on 1 May 1855: the very day that the first of the so-called ‘Protection Clubs’ opened for business. The first Protection Club was called ‘The Shipowners Mutual Protection Society’ (the predecessor of the present Britannia Steam Ship Insurance Association). Its managers were a London- based partnership, Tindall, Riley & Co, which had a number of Hull Clubs under its management. The partners had recognised the growing need of shipowners for liability insurance and the general reluctance of the commercial market to provide what was required. They saw a business opportunity and seized it. The Club’s early statutes The early statutes of the Club have survived and give a clear indication of the reasons for its foundation, as follows: The Shipowners Mutual Protection Society Capital — one million established for the purpose of protecting Ship Owners against the liability incurred under the 504 Sect, of the ‘Merchant Shipping Act, 1854’, and also the risk of running down other Vessels and Craft, not covered by the ordinary Marine Policies... The risks against which a shipowner could now limit his liability were principally the following: death of or injury to passengers carried by his ship; loss of or damage to cargo on board his ship; P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 9 Chapter 1 death of or injury to any person on board another ship, by reason of the improper navigation of his ship; loss of or damage to the other ship, or loss of or damage to its cargo, by reason of the improper navigation of his ship. The cover to be provided by the new Club was designed to meet the needs of shipowners described in the preamble to the statutes. Two further interesting points arise from these statutes: the cover offered by the Club was not unlimited. It was limited to the sum agreed to be secured; the obligation to pay rested, not with the Club itself as a separate legal entity, but with each of its Members individually. It was to be some time before the Clubs became legal entities in their own right and the obligations to reimburse the Members became an obligation of the Club, rather than that of each individual Member. Other early Protection Clubs Shortly after the Shipowners’ Mutual Protection Society was founded, the Shipowners’ Protection Association was established in Topsham in Devon, under the management of Mr John Holman. It began trading on 1 January 1856 and later became The Shipowners’ Mutual Protection and Indemnity Association, based today in Luxembourg. Some 20 years earlier, John Holman had founded a Hull Club, the West of England Insurance Association, and this Club was revived in 1870 as a protection and indemnity insurer for larger vessels, also under the management of the Holman family. This Association is the forerunner of today’s West of England Shipowners’ Mutual Insurance Association (Luxembourg). The North of England Protection Association was founded in 1860 and by the end of the 19th century, most of the other Clubs of today had been established. When does the policy year begin? One feature that the Protection Clubs inherited from their Hull Club predecessors was the date at which the policy year began: not on 1 January, but at noon on 20 February. The historical reason for this apparently strange tradition was that many of the vessels insured by the Clubs were laid up during the winter months when the Baltic Sea was frozen. It had become accepted that the first date on which ships could sail from the River Tyne and be sure of finding the Baltic ‘ice free’ was 20 February. Many of the hull policies were issued for a 12-month period from 20 February with a suitable warranty: for example, ‘laid-up from 1 November unless otherwise agreed’. Most P&I Clubs still maintain this tradition and provide 12-month ‘time’ policies running from 20 February 10 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance of one year to 20 February in the following year. However, this is not universal. 1.3 Further statutory developments The 30 years or so after the founding of the first Protection Clubs saw a number of major developments. Merchant Shipping Act (1854) The Merchant Shipping Act of 1854 itself placed obligations upon shipowners for the relief of sick or injured seafarers. Over time, most of these obligations came to be insured by the Protection Clubs. Section 458 of the 1854 Act introduced the concept of statutory salvage, and also provided that: salvage in respect of the preservation of the life or lives of any person or person belonging to any such ships or boats [the salved vessels]… shall be payable by the owners of the ship in priority to all other claims for salvage… This risk was quickly covered by the Protection Clubs. Merchant Shipping Act (1862) The Merchant Shipping Act of 1862 changed the basis of calculating limitation from the value of the vessel and freight to fixed amounts per register ton, depending on the interest damaged. These amounts were £8.00 per ton for property claims, including cargo, and £15.00 per ton for death and injury claims. The revision of the Collision Clause In 1883, the Collision Clause of 1824 was revised and replaced by the Original Lloyd’s Clause, partly due to the changes to the basis of limitation introduced by the 1862 Act. The main features of the Original Lloyd’s Clause, as compared with the Collision Clause of 1824, can be summarised as follows: that the limit of the assured’s insured liability was revised according to the provisions of the Merchant Shipping Amendment Act, 1862; that the liability for wash damage or for damage caused by impeding navigation was excluded; P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 11 Chapter 1 that the liability for loss of or damage to cargo on the insured vessel was also excluded. The overall effect was to narrow the cover down to (three quarters of) the liability for damage done to the other vessel by collision. As the commercial market cover reduced, so the cover given by the Clubs expanded, the risks excluded by the Original Lloyd’s Clause being in due course assumed by the Protection Clubs. In addition, this clause has been interpreted as establishing the cover for collision liability as a separate and additional insurance contract, even though there is no express provision in it to this effect. The significance of this development was that, under the one policy, the insured shipowner could claim up to the insured value of the ship for the damage it sustained in the collision and up to three quarters of the insured value for its liability for damage done to the other ship (and its cargo) in the collision. 1.4 The development of the Indemnity Clubs During the 19th century, cargo claims do not appear to have represented a significant type of risk for shipowners. At that time, shipowners’ liabilities towards the owners of cargo were governed by the common law and not yet by statute. Under the common law there were very few defences available to the shipowners, as carriers and, in theory, they were strictly liable to the cargo owner if the cargo became lost or damaged while in their custody. However, because the common law at that time permitted almost total freedom of contract, the shipowners were able to include terms in their contracts of carriage to the effect that the carrier was not liable for any loss or damage to the cargo, however caused. They were therefore able to exonerate themselves, perfectly legally, from all responsibility and liability for the cargo. The Bills of Lading Act, passed in 1855, sought to protect the interests of cargo interests against such terms introduced by carriers into the contract of affreightment. The Westerhope case The event that changed that situation was the sinking of the Westerhope in 1870. This vessel had on board a quantity of cargo destined for Port Elizabeth in South Africa. It carried the cargo past Port Elizabeth, intending to discharge it there on the return journey to Cape Town. However, before it reached Port Elizabeth on the return journey, the ship sank off the South African coast with the loss of the entire cargo. The claim The owner of the cargo pursued a claim against the owner of the Westerhope for the loss of its cargo even though there were wide exemption clauses contained in the bills of lading, which purported to exonerate the shipowner from all liability for loss of or damage to cargo. The cargo claimant’s argument was that there had been a ‘deviation’ from the contracted voyage because the Westerhope should have called into Port Elizabeth the first time it passed that port. If that had happened, then the cargo would 12 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance have been discharged safely. It was argued that the deviation was a fundamental breach of the contract of carriage and, as such, the carrier could not rely on the exceptions exonerating it from liability. It is to be noted that under common law the sea carrier has an implied obligation not to deviate from the contractual voyage. The court agreed and held the shipowner liable to compensate the cargo owner in full for the lost cargo. The attempt to recover the compensation The owner of the Westerhope was entered with the North of England Protecting Club. It duly attempted to recover the compensation paid to the cargo interests by making a claim for indemnity from the Club. The directors of the Club declined the claim, on the grounds that it was not a risk covered under the Club rules – although a small ex gratia payment was eventually made. The repercussions Following that case, an article appeared in most of the shipping newspapers of the day, written by a Mr J Stanley Mitcalfe, who was an underwriter with the Northern Maritime Insurance Company Ltd in Newcastle upon Tyne. His article drew attention to the wide range of potential liabilities shipowners might have towards cargo owners and underwriters and for which they had no insurance cover. A number of shipowners, particularly in Newcastle, took the article very seriously indeed and approached Mitcalfe to ask him to form a mutual indemnity association to cover these potential cargo liabilities. Mitcalfe agreed and, as a result, the Steamship Owners’ Mutual Protection and Indemnity Association was formed in Newcastle in 1874. The full significance of potential cargo liabilities quickly became apparent to many other shipowners, and the membership and work of the Indemnity Association grew rapidly. In 1886 it merged with the North of England Protection Association to create the North of England Protecting and Indemnity Association. A number of other Protection Clubs, noting the developments in the North of England, added cargo liability risks to the cover they offered, either by adding the cargo risks to their existing covers or by forming a separate association or class within the association to cater for them. For example: The West of England Association incorporated the indemnity risk from 20 February 1886. The United Kingdom Mutual Steamship Assurance Association, formed originally as a Hull Club in 1869, introduced protection cover in 1871 and indemnity cover in 1886 but as a separate class, a distinction that lasted until the two classes were amalgamated with effect from 20 February 1959. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 13 Chapter 1 Why ‘indemnity’? The use of the word ‘indemnity’ in the names of the Clubs is significant. It makes clear that the liability of the Club is only to reimburse or indemnify its Member against the liability to the third-party cargo interest that he has incurred. The Club is, accordingly, under no obligation to the aggrieved third party direct. Today, this feature extends to practically all risks covered by the Clubs and has important consequences in the event of a Member’s insolvency. In particular, it exempted the Clubs from the provisions of the Third Parties (Rights against Insurers) Act 1930, which gave a third party the right to sue the insurer of the party liable direct, if that party went into liquidation. The 1930 Act has now been replaced by the Third Parties (Rights Against Insurers) Act 2010 which, save for claims for personal injury and death, maintains the Clubs’ position as it was under the 1930 Act. Further increases in shipowners’ liabilities In many ways, the history and development of the P&I Clubs over the years since the 1850s is a reflection of the steady increase in the liabilities of their shipowner Members. The Employers’ Liability Act of 1880 introduced the concept of compensation for injuries sustained at work although only to a limited extent. A growing concern for human suffering at work produced further legislation dealing with compensation to seamen for injuries suffered at work and the safety of seamen on board ship. The Clubs were able to adapt their cover to indemnify Members for their increasing exposure to such claims. Carriage of Goods by Sea Act 1924 In 1924 cargo claims were again in the picture, through the Carriage of Goods by Sea Act. This gave effect to the Hague Rules 1924, which had been drawn up by a conference of shipowners, underwriters and merchants, accepted by many governments in the International Convention for the Unification of Certain Rules of Law relating to Bills of Lading, and signed at Brussels on 25 August 1924. The Hague Rules were formulated with the objective of bringing about uniformity into the contractual terms contained in bills of lading while providing a minimum of contractual obligations on the part of the carrier and a maximum of contractual defences, all the while protecting the cargo interests from wide exclusion clauses. What counts as a ‘ship’? In 1926, the judgment in Merchant Marine Insurance Co Ltd v North of England P&I Association established that a floating crane on a pontoon was not a ‘ship or vessel’, so that damage done to it by a ship was payable by the Club, and not by hull underwriters under the Running Down Clause. This has thrown many such claims onto the P&I cover. 14 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance What about towage? In 1936, it was decided in Furness, Withy & Co v Duder that liability for damage done in collision arising by reason of a towage contract (the insured ship being in collision with an attendant tug, and the contract making the tow responsible for all collisions), and not by reason of negligence on the part of the insured vessel, was not a liability ‘by way of damages’. It was therefore not covered by the Running Down Clause, and such claims were also established as being for the P&I Club. P&I Clubs: risks insured In terms of risks insured, the development of the P&I Clubs since the end of the Second World War has been concentrated in the following fields: liability to passengers and crew; liability for cargo; liability for oil pollution; wreck removal; and limitation of liability for risks in general. Conclusion The development of P&I insurance over the last 150 years has been driven by the ever-increasing liabilities being placed on shipowners by individual nations or the international community. In most cases, the Clubs have had the responsibility of representing the views of the shipping industry to national and international legislators in an effort to ensure that the final outcome is measured, fair and, above all, insurable. Most of this work is done through the International Group. This enables the shipping industry to speak with one voice – and with great authority – on most issues. International organisations active in the maritime regulatory field appreciate the effective contribution the shipping industry can make to their work. To this end, the International Group has consultative status at the International Maritime Organization (IMO), the International Oil Pollution Compensation (IOPC) Funds, and the Comité Maritime International (CMI), as well as observer status in a number of key international forums, such as the United Nations Conference on Trade and Development (UNCTAD), the United Nations Commission on International Trade Law (UNCITRAL) and the International Labour Organization (ILO). Its views may not always prevail but they are usually respected. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 15 Chapter 1 1.5 The origins and use of Club correspondents Over recent years a number of P&I Clubs have established overseas offices, including branches licensed to do insurance business in the country where they are located. However, a Club’s operations have traditionally been centralised in its head office in its country of origin, despite the fact that most claims arise elsewhere. In order to deal with these effectively, Clubs recognised early in their existence that they needed competent representatives in the various ports of the world, able to give their Members prompt and effective service. To enable it to be represented in all the major ports of the world, as well as in many lesser ports, and to provide a global service to its Members, each P&I Club has, over time, built up an international network of ‘correspondents’. Probably the first such correspondent was appointed in Antwerp in 1871, in the person of Jacques Langlois, described as an ‘international law agent’. Four years later, in 1875, Langlois was appointed by a second Club as its correspondent in Antwerp. This is an early example of the practice, still prevalent today, of a correspondent working for a number of Clubs, rather than exclusively for one. Such correspondents may be local maritime lawyers, specialist P&I Club representatives, ship agents with suitably qualified personnel, or in some cases, surveyors. Although the same organisation may well act both as P&I Club correspondent and as a ship agent in the same port, the functions of each role differ considerably, to the extent that they may be handled by separate departments within the same firm. A ship agent is a local expert acting as a representative of the owner of the ship A ship agent is engaged by the shipowner or the charterer to render to the ship all the services it may require during its call at the port in question. These include ensuring 16 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance that pilots, stevedores, berths and tugs are ready for the ship’s arrival. Then, once the ship has arrived, the agent arranges for the supply of everything needed, from bunkers to vegetables, as well as liaising with customs, port health officials and other local authorities on the ship’s behalf. Action Step: For a fuller explanation of the role of the ship agent, see the BIMCO website. Whereas the Clubs are in general comfortable with the correspondent acting also as a ship agent, they are less so where the correspondent is also the Lloyd’s Agent in the port. The reason for this is that the primary role of the Lloyd’s Agency network is to provide a survey and adjusting service for the Lloyd’s marine insurance market and for cargo underwriters in particular. Many certificates of cargo insurance contain a clause reading: “In the event of loss or damage which may result in a claim under this insurance, immediate notice should be given to the Lloyd’s Agent at the port or place where the loss or damage is discovered, in order that they may examine the goods and issue a survey report.” If a cargo claim should arise on a ship entered with a Club for which that same organisation acts as correspondent, there is a potential conflict of interest, which is better avoided. 1.6 The status and functions of the Club correspondent Status A P&I correspondent is not an agent, employee or ‘branch office’ of a Club. As such, a correspondent is not authorised to accept notice of a claim, in circumstances where the Club rules provide that notice shall be given by the Member to the Club or its managers. Functions A P&I correspondent provides a variety of services, but their principal role is to protect the Member’s position. A P&I Club’s local correspondent can give the shipowner and the master of the entered ship great assistance in setting up the correct procedure to be followed after an incident. Effective and immediate help can often reduce the Member’s potential liability and help to save costs. Another important aspect of the correspondent’s work is to keep the Club’s claims handlers fully informed of problems that arise and to recommend how, from the local point of view, they can best be resolved. They also take instructions from the Club in order to see the problems resolved without delay and as efficiently as possible. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 17 Chapter 1 Services The types of service that a correspondent provides include: giving immediate advice to Members and masters; keeping the P&I Club fully informed; arranging surveys; assisting with the release of a ship under arrest for a P&I-type incident, including, on occasions, the provision of security; advising on the defence of claims and on legal aspects of claims; arranging local legal representation and advice; negotiating with local interests such as cargo claimants, underwriters, customs and immigration officials, harbour and other authorities, in defending/protecting the Member’s position; processing and repatriation of stowaways; assisting with repatriation of seafarers; arranging medical assistance. Assisting the Member not the Club Assistance from a correspondent is rendered on behalf of the Member and not on behalf of the P&I Club. This is the case whether the Member approaches the P&I Club’s correspondent directly or via the P&I Club, which then passes on the request for assistance to one of the Club’s correspondents. This configuration can give rise to confusion and difficulty, both with third parties and with Members. For example, if a correspondent intervenes in a case at the direct request of the Member or the master and it turns out that the risk is not covered by the Club, then the correspondent’s fees are for the account of the Member and not for the Club. Although the Clubs have different policies in this regard, a Club often reimburses the expenses anyway, although under no liability to do so, and will seek to recover them from the Member. It does this in the belief that it is in the general interest of all Members that correspondents should act immediately when requested to do so – there should be no delaying possibly vital action to deal with the claim and contain the likely damages until the insured status of the Member is confirmed. 18 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance The qualities of a correspondent A P&I correspondent must have expertise in the practical and legal aspects of claims that may be faced by Club Members. Indeed, the prime reason for their appointment is their local knowledge and ability to assist and co-ordinate the handling of a problem within their port/jurisdiction. P&I Club correspondents tend to fall into two distinct categories: commercial organisations and legal practitioners. The qualities that P&I Club correspondents are required to display depend to some extent into which category they fall. Taken overall, the qualities are numerous and include most, if not all, of the following: immediate availability to the Members to give practical and prompt advice; an effective network of local contacts and good relationships with the local authorities; the ability to resolve quickly and satisfactorily a wide variety of practical problems relating to the operation of various types of ship; a thorough knowledge of national law, regulations, and local byelaws, so as to be able to give or to obtain prompt and effective legal advice for the Member; the ability to liaise effectively with experts in other disciplines such as naval architects, fire experts, marine surveyors, cargo specialists and biochemists, in the analysis and interpretation of reports; a working knowledge of international law in respect of maritime affairs; the ability to give advice on the defence of claims, on the legal aspects of claims, and on prospects in litigation; the ability to liaise with lawyers (local and overseas) in the analysis and handling of individual cases; the ability to supervise the work of local or national lawyers who are acting on behalf of the Member and the Club; the ability to negotiate effectively with local claimants. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 19 Chapter 1 Example of a Club’s regional network of correspondents Requesting the assistance of a correspondent The Club’s correspondent should be called whenever it is clear that an incident has occurred that is likely to result in a claim. When the Member or ship’s master is in doubt about a particular problem, or when time does not permit them to make direct contact with the Club, they should contact a correspondent. When there is more than one correspondent in a port, there may be a question as to which one to contact. As a rule, the correspondent who deals with commercial matters should be contacted first. If there are any legal problems to sort out, they can direct the problem to the legal correspondent, if there is one for that port, or otherwise to a law firm that specialises in that field of work. Quality control of correspondents The performance of correspondents can have a significant influence on the satisfactory handling of incidents and claims. The choice of correspondents by a Club is therefore given high priority, to ensure that those listed are the best people in a given location and can provide the highest quality service. An individual within each Club is given the responsibility for managing its correspondents. 20 INTERNATIONAL GROUP OF P&I CLUBS  The background, history and development of P&I insurance The Clubs constantly monitor the service that their correspondents provide and, if necessary, they will ask a given correspondent to improve the quality of service. Alternatively, they will replace an under-performing correspondent with an organisation that can provide the quality of service required. The correspondents in their turn must ensure that any surveyors, consultants or lawyers they may engage on an incident are also of the highest calibre for the job. Supporting the correspondent network Such is the importance of the correspondent network that every Club is represented on the Correspondents Committee of the International Group. It is this committee that monitors the relationship between Group Clubs and their correspondents. The International Group has published some Guidelines for Correspondents, and these are available as a downloadable booklet from the International Group’s website www. igpandi.org. The Group and individual Clubs regularly conduct ‘Correspondents’ Conferences’ for the guidance and education of correspondents. Key employees of correspondents spend time in Clubs’ offices from time to time to train and familiarise themselves with Club practices and personnel. Overseas offices As mentioned earlier, a number of Clubs have established overseas offices in recent years. The work of many of them has been to act as a general correspondent for a particular region. Sometimes this means that the Club office will handle all the claims from the given geographical area; more frequently, it means that the Club office will supervise the work of other correspondents in the area. The advantage of this is that the network is subject to closer supervision from within the same time zone. Correspondents’ work in decline Over recent years as well, a number of developments have tended to significantly reduce the P&I work available for correspondents. These include: a general reduction of the number of claims in the shipping industry; the increase in deductibles in the Club cover; Clubs undertaking more work in-house; Members setting up local or regional claims hubs; and technological improvements in communications generally. The result of all these factors has been that some correspondents have merged with others, or even ceased to exist. Some have been obliged to diversify their business P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 21 into fields other than P&I. In the P&I field itself, some correspondents now accept appointments not only from other Clubs, but also from other mutual or fixed premium competitors to the Clubs in the International Group. Nevertheless, it is still true that without the network of correspondents the Clubs could not continue to deliver a worldwide claims service to their Members. The correspondent remains the public face of the Club within its jurisdiction. How correspondents perform their responsibilities has an impact on the standard of service that the Club can provide and on its overall reputation for competence in the market. They therefore continue to perform a very important role.  Module 2 CHAPTER 2 MUTUALITY AND THE COVER PROVIDED BY THE CLUBS Chapter 2 What you’ll learn in this chapter Mutuality and the cover provided by the Clubs Knowledge rating The concept of mutuality 3 P&I Club rules and cover 3 Standard exclusions from P&I cover 3 Concept of the ‘omnibus’ rule 3 Normal extensions of cover 3 Role of the Clubs in providing bail and other security 3 2.1 The concept of mutuality There are three ways of dealing with risk: Self-insurance. Self-insurance, certainly up to relatively high levels, if not for the whole risk, is not uncommon. Commercial insurance. Insurance provides security against the volatility of claims to organisations whose financial strength is insufficient to meet the challenges that today’s litigious climate presents. However, every commercial insurer charges an annual fixed amount of premium even if a particular insured has no claims. The insurer is in business to make a profit to satisfy its capital providers. Mutual insurance. The earliest Clubs described in Chapter 1 represented the simplest form of mutual insurance. Each claim was shared between the Members when the claim was due to be paid. The Club levied a ’call’ on each Member pro-rata according to the size and number of ships insured by them with the Club. No annual premium was charged and the cost to each Member was not fixed but varied with the amount of claims incurred. Having no capital providers other than the insureds themselves, the mutual insurer is not profit driven. Mutuality today As a form of collective self-insurance, it is the objective of mutual insurance that liabilities and costs incurred are shared equitably between the assured Members. Each Member of a mutual should, over the long term, contribute the same in calls paid to the mutual as the Member recovers by way of claims. Clubs have moved on from the era when all the Members of a particular P&I Club operated broadly the same type of ship, of the same size and age, engaged in the 24 INTERNATIONAL GROUP OF P&I CLUBS  Mutuality and the cover provided by the Clubs same trades and being manned by the same number and quality of crew, and achieving such a balance would be relatively straightforward. Clearly, that level of similarity is unlikely to be realistically achievable nowadays. Today, adjustments are made to the premium paid by different shipowners to ensure that they are as fair as possible, as between one Member and another, to reflect the risk that each owner brings to the Club. For example, an owner of a large oil tanker trading to the USA would probably be paying more than the owner of a small bulk carrier trading around Europe. In a modern P&I Club with its widely diversified membership exposed to today’s levels of liability, the process of ensuring equity between Members is highly sophisticated but fairness between Members remains the overall objective. It is an important feature of the mutuality of P&I Clubs to ensure that no one shipowner Member or type of shipowner unfairly subsidises, or is subsidised by, the other shipowners of the particular P&I Club. Breaking even – or building a reserve Although a P&I Club does not need to make a profit to service third-party capital providers, it is very important that it does not make a loss. Furthermore, statutory regulation has in recent years increasingly required the Clubs to show levels of surplus broadly comparable to those required by commercial insurers. In addition, the level of surplus is an important factor for the rating agencies in assessing the relative financial strength of the Clubs. The end result is that nowadays most Clubs aim, at worst, for a breakeven position on their underwriting account and look to investment income to build up their reserves to the necessary level. The surplus in a Club is often referred to as the ‘reserves’ of the Club. This can be confusing, because the Club holds ‘reserves’ against its outstanding liability for claims and other expenses. The expression ‘free reserves’ (that is, reserves not held against any liability exposure) is sometimes used instead of ‘surplus’. For a long time now, the size and sophistication of the P&I Clubs has demanded that the tradition followed by some of the Clubs in the past, namely that of calling in funds only as and when a claim needed to be paid, has been abandoned. Because it is inevitable that claims will arise and will need to be paid, the practical requirement has been to create first a fund out of which claims are then paid. What remains essential, though, is that – after due allowance has been made for the level of surplus required – claims and contributions broadly balance. If the claims exceed the calls, the Members may need to pay more to top up the funds; if the available funds exceed the claims, the surplus is put to reserve. It can also, in theory, be returned to the Members. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 25 Chapter 2 The theory of insurance at cost If we leave aside the necessity to hold a given level of surplus in the Club to comply with regulatory requirements, the essence of mutuality is a sharing of claims. This is best illustrated by the so-called ‘mutual equation’: Calls = Claims In practice this is expanded into: Calls + Investment Income = Claims plus Expenses where the investment income earned on the Club’s funds is added to one side of the equation and the expenses of managing the Club and its administration are added to the other. The ‘Claims’ in such an equation are net claims, that is, claims less any amount recovered from reinsurers. The ‘Expenses’ include, in addition to the management and administration costs, the costs of reinsurance purchased by the Club. The key distinction from commercial insurance is the absence of the element of profit that a commercial insurer must make to satisfy its shareholders. In a mutual, any surplus of calls over claims is, as explained above, either kept in reserve or returned to the Members. Conversely, if the claims in a mutual exceed the calls and other income, the shortfall must either be funded from the surplus or by a further call on the Members. If, on the other hand, a commercial insurer incurs a loss, it meets it out of its surplus, namely its shareholders’ funds, or becomes insolvent, unless, like syndicates at Lloyd’s, it can have access to some external guarantee fund, such as Lloyd’s Central Fund. In most Clubs, the Member’s obligation to pay calls to the Club is unlimited in amount. That means, at least in theory, that a Member is liable to meet whatever call the Club may make upon it. Funding Historically, the Clubs’ approach to funding has very much mirrored the underlying concept of ‘insurance at cost’. This resulted in a ‘pay-as-you-go’ system of funding designed to cover, first, the level of claims anticipated on each policy year and second, an adjustment after the end of the policy year to reflect the level of claims actually received. This meant that, at the commencement of the policy year, the Clubs would have provided their Members with their Estimated Total Call or Cost (ETC) broken down between that part of it payable in advance (advance call) in anticipation of a certain level of claims, and the ‘adjusting’ element of the ETC (the additional or supplementary call). Underlying this approach was the fundamental belief that Members should not be asked to pay more than was necessary to fund the claims actually received: 26 INTERNATIONAL GROUP OF P&I CLUBS  Mutuality and the cover provided by the Clubs insurance at cost. But it is an oversimplification to describe the advance call as wholly attributable to the anticipated level of claims and the additional or supplementary call as wholly attributable to the adjustment factor. In many respects the different terminology simply acknowledged that calls were payable in instalments and that the final instalment was only going to be an estimate until it became payable sometime after the end of the particular policy year on which it was to be levied. In recent years, the distinction between advance and additional or supplementary calls has become blurred by the development of the idea by some Clubs of simply calling what is termed the ‘mutual premium’ in certain instalments, some of which may be payable after the end of the policy year. The terminology has also been confused when it has been necessary for some Clubs to call in excess of their original ETC in order to fund the level of claims actually received. These unforecast, unbudgeted additional/supplementary calls are to be clearly distinguished from anticipated additional/supplementary calls, for which Members should have budgeted. Release calls A further gloss on the funding of claims by calls on the Members is to be found in the shape of release calls. Members have an obligation to pay supplementary calls until the policy year is closed. This usually happens two years after the end of the policy year when the directors are happy that the calls/claims equation is broadly in balance. In certain circumstances, such as a sale of the ship or its withdrawal from the Club, a Member may, or the managers may, require the Member to, buy out its future exposure to additional calls by paying an amount straight away. This amount is called the release call (a call to release the Member from further obligation to the Club in respect of that ship). It usually consists of any as yet unpaid estimated supplementary calls on the open years, plus a surcharge to cover possible volatility in the figures. Historically, this surcharge was set at 5% of premium ratings. The level of the release call is assessed by the Club directors at the beginning of each policy year in accordance with the guiding principles now set out in clause 8 of the International Group Agreement (IGA) 2020 and is periodically reviewed during the year. Instead of paying a release call, a Member can provide a bank guarantee for any additional calls that may be levied before a year is closed. The amount of the guarantee is usually the same as the current release call. Action step: Familiarise yourself with the terms of clause 8 of the IGA. Look to see how the various Clubs deal with release calls in their rules. P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 27 Chapter 2 The strengths of the mutual Clubs The concept of mutuality is not limited to the manner in which the Club is funded. It also implies an approach to the insurance business that is, in some respects, markedly different from that prevailing in the commercial market. There, the key objective is to make a profit for the capital providers. If marine insurance does not show the capital providers an adequate or sufficient return they can redeploy their capital elsewhere. An investor’s commitment to the insurance can therefore be described as expedient, and the pricing of its insurance product tends to reflect more the current cost of capital rather than the risk and record of the individual assured. In the mutual context, however, the whole reason for the creation and existence of the Club is to meet the insurance needs of its Members. Under the leadership of the board of directors, who are themselves Members of the Club, the whole focus is on the Members and their insurance needs. This commitment tends to give rise to a culture of service in the Clubs to a greater extent than in the commercial market. Whereas a Member belongs to their Club and, as a Member, has status and rights accordingly, an insured in the commercial market is simply a buyer, protected only by the terms of their policy and such goodwill as their insurer chooses to show them. In cases of ambiguity in the policy wording, the commercial insurer will tend to take the advantage for itself, whereas the philosophy of the Club is usually to give the Member the benefit of the doubt. The essence of mutuality, as we have seen, is the sharing of risks and claims. That sharing only works if those facing the risks are confident that they face the same or similar risks as their fellow Members of the Club. For example, it makes no sense for a shipowner to share third-party risks with, say, a toy manufacturer. The risks are totally different and the financial consequences of claims may be very different. To be successful, a mutual needs to operate within a specialist sector which involves a number of operators facing the same types of risks. In the case of the P&I Club Members, it could be called the unity that comes from dependence on the sea and the dangers that it entails. Shipowners recognised the benefits of sharing risks a long time ago and that concept is as strong today as it ever was. Nowadays, the importance of P&I cover to the Club Members is so great that it is equivalent to a ‘ticket to trade’. Without P&I cover, a shipowner would find it very difficult to trade their vessel on an international basis. 2.2 The distinction between Group Clubs and Non-Group Insurers The International Group Clubs provide P&I cover for over 90% of the world’s oceangoing shipping, but there are certain sectors of shipping which fall outside the ambit of the Group. This may either be tonnage that the Group Clubs do not wish to underwrite or it may be tonnage that does not require the very broad scope and high levels of cover which the Group Clubs can provide, nor the international reach or expertise of their management services. The owners of this tonnage may prefer a 28 INTERNATIONAL GROUP OF P&I CLUBS  Mutuality and the cover provided by the Clubs more basic P&I cover, and seek a lesser price for it. The non-Group capacity certainly has its place in the market. There are a number of non-IG insurers specialising in P&I outside the International Group. The China P&I Club (CPI) and the Korea P&I Club are two examples. The China P&I Club has a co- insurance arrangement with different Group Clubs in excess of a deductible under which the CPI member also becomes a Member of the Group Club. The Korea P&I Club has no similar arrangement with any Group Club and buys its own reinsurance protection, particularly in the Korean market. Some of the fixed premium providers are themselves subsidiaries of substantial international insurers and, more recently, some Group Clubs have themselves set up fixed premium facilities to cater for certain types of owners and ships. Some non-Group insurers have come into the P&I market in the expectation of making a profit and have then found that the unpredictable and long-tail nature of P&I risks has tended to make such profits illusory. Nevertheless, the alternative markets remain attractive to certain classes of business and Appendix 3 contains a table showing some examples of those currently active. Action step: Which of the mutual and non-mutual competitors listed in Appendix 3 are the most important for your business? 2.3 The structure of P&I Club rules The rules of a P&I Club serve a similar purpose to the terms of a normal insurance policy. They have, however, a number of unusual features arising from the principles of mutual – as opposed to fixed premium – insurance. In addition to setting out the risks covered, the limitations and exclusions to the cover and claims procedures, the rules have to deal with a number of other sections relating to membership of the Club, cessation of membership, financing of the Club, management of its investments, respective powers of the directors and managers of the Club, and dispute resolution. The rules are, as one commentator has remarked, “an odd mixture of governance and constitutional matters, financial administration, operational procedures and policy conditions” The rules of the Clubs based in England, or originating there, are subject to English law. This means that they are subject to the Marine Insurance Act 1906 (MIA), and also the Insurance Act 2015, which in essence codify English law in relation to the practice of marine insurance contracts. A number of the provisions of the above Acts are directly relevant to Club insurance, as we shall see later in this section. Although the cover provided by the Clubs is, as we have said above, subject to limitations and exclusions, the philosophy of most Clubs in relation to cover is that the Member, provided they have acted in good faith, should be given the benefit of the doubt where doubt exists. On the other hand, whilst the rules are formally a contract between each individual Member and the Club, they are in a sense a contract between every Member of the Club and every other Member. Thus, when the Club P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 29 Chapter 2 tries to help a given Member, it must also remember that the funds that will be used to pay the claim have been contributed by all the Members of the Club. As a result, in the interpretation of the rules, there may sometimes be a tension between the interests of the individual Member and the interests of the Members collectively – a factor that everyone working in a Club, whether as underwriter or claims handler, needs to bear in mind. In this section, we will look at the overall structure of Club rules in order to draw out some general themes. The ordering of different Clubs’ rules differ, but all Clubs in the International Group have similar provisions in their rules. Without this high degree of homogeneity, reinsurance through the Pooling Agreement would not be possible in practice. Action Step: Find out how the provisions set out in each of the following sections relate to the rules of a particular Club. The basic conditions The rules start with an introduction, directing attention to the rule in which the standard cover is set out and pointing out that it is subject to conditions, exceptions, limitations and other terms to be found elsewhere in the rules. It draws attention to the possibility of so-called ‘special cover’ being also provided. It states that all cover provided by the Club is subject to such terms as have been agreed between the Member and the Club managers, and that these may exclude, limit or otherwise alter the cover available under the rules. The overall effect is to give a wide discretion to the managers to fit the cover available to the needs of the individual Member. The introduction may also capture the principle that all contracts of insurance effected by the Club are, unless otherwise agreed, subject to all the provisions of the rules. The introduction also sets out three basic conditions of P&I cover generally. A Member is only covered against loss, damage, liability or expense incurred by them which arises: out of events occurring during the period of the entry of the ship in the Club – P&I insurance is therefore a ‘losses occurring’ type of policy; in respect of the Member’s interest in the entered ship (the insured vessel); in connection with the operation of the ship by or on behalf of the owner (a defined term, which can include a charterer). 30 INTERNATIONAL GROUP OF P&I CLUBS  Mutuality and the cover provided by the Clubs Interpreting the conditions Each of these three basic conditions can give rise to difficulties of interpretation in practice. How, for example, does one determine the time of the occurrence of damage to cargo when the cause of the damage is progressive over time? The pragmatic answer adopted by the Clubs is to take the date of discharge, but problems then arise if the voyage during which the damage occurred spanned 20 February in a year in which the ship changed Clubs. The solution adopted by most Clubs is to apportion the claim over the whole time of the voyage in accordance with the number of days before and after the changeover date. And what is meant by the phrase ‘in respect of a Member’s interest in the entered ship’? It is easy to understand that an owner has an interest in the entered ship; similarly with a charterer, whether of the whole or part of the ship. Again, how far can the expression ‘arising in connection with the operation of the ship’ be stretched? What is the position where cargo being carried under a multi-modal bill of lading is damaged during the course of inland carriage by road or rail? What is the position where a crew member is injured in a fight in a bar ashore outside port limits, or is involved in an accident on their way to join the ship in a foreign port? What is the position where a passenger is injured on a shore excursion because the bus in which they were travelling was involved in an accident, or is involved in an air accident on their flight home from the cruise ship? We will find the answers to these questions in the later modules. Giving Members the benefit of the doubt While each claim will turn on its own facts, it is fair to say that, in line with the general ambition to give Members the benefit of the doubt, the Clubs interpret each of these three basic conditions of cover positively, in favour of Members. Nevertheless, it is necessary, on occasions, for Club underwriters and claims handlers to remind Members that these conditions do exist. Pay to be paid The introduction to the rules will then provide that the insured owner is bound to pay calls to the Club or, in the case of a vessel entered on fixed premium terms, the fixed premium. The introduction then concludes with a specific exception to the ‘pay to be paid’ principle on which P&I Club insurance is based; where an owner has failed to discharge their legal liability to pay damages or compensation for illness, injury or death of a seaman, the Club will itself discharge that liability directly to the seaman concerned or their dependants. Furthermore, the Club, in so doing, will not be able to rely on its right to set off (reduce) its payment deducting sums owed by the owner to the Club. There is a specific exception in the ‘set-off’ rule to this effect. This exception was introduced into Club rules with effect from 20 February 2009 to accommodate concerns expressed at the International Maritime Organization (IMO) P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 31 Chapter 2 and International Labour Organization (ILO) that there was no international regime providing for certificated compulsory insurance of shipowners’ legal liabilities to pay compensation for death or personal injury of seafarers, nor any right of direct action against insurers. However, the 2014 amendments to the Maritime Labour Convention (2006) which came into effect in January 2017 now require qualifying ships to carry certificates of financial security for payment of these liabilities which are usually issued by the P&I Club. Moreover, whilst the Clubs have long made it their practice not to rely on the ‘pay to be paid’ principle to avoid seafarers’ legitimate claims, this exception now crystallises that practice in writing. The statutory endorsement of this exception was given effect under English law by the Third Parties (Rights against Insurers) Act 2010. The introduction also specifies the proper law clause of the contract. For the Clubs based in Bermuda, the UK and Luxembourg, English law applies. Poolable cover It is common for the next Club rule to be that which contains the ‘standard’ cover available from the Club. We will look at this more closely later. It is important to note here a fundamental distinction between ‘standard’ cover, which is common to all the IG Clubs, and therefore ‘poolable’ under the terms of the Pooling Agreement between the Clubs, and ‘special cover’, which is not. The rule opens with a further reminder of the ‘pay to be paid’ principle: Unless and to the extent that the Directors otherwise decide, an owner is only insured in respect of such sums as he has paid to discharge the liabilities or to pay the losses, costs or expenses referred to in those sections; It then continues with a warning to the Club Members that the maximum amount which an owner can recover from the Club will be limited by the various limits on cover referred to later in this module. Non-poolable cover The rule that follows introduces the concept of ‘special cover’, which is non-poolable. It provides that the special terms may be to the effect that the risks insured may arise otherwise than in respect of the entered ship or otherwise than in connection with the operation of the entered ship. This is another indication of the wide discretionary powers given to the managers with whom all special terms have to be agreed. The rules go on to set out the terms on which special cover can be agreed in certain specific cases. These are: charterers – charterers’ liability for the loss of or damage to the chartered ship and 32 INTERNATIONAL GROUP OF P&I CLUBS  Mutuality and the cover provided by the Clubs loss of or damage to charterers’ bunkers; specialist operations – such as salvage services, drilling operations, dredging and pile-driving, cable-laying, professional oil-spill response, waste disposal, submarine and diving operations, hotel and restaurant services, the operation of accommodation vessels (in respect of the risks to third-party personnel) and heavy- lift operations (as regards the risk to the cargo involved); passenger ships – in respect of excursion risks, compensation paid on cancellation of future cruises as a result of a casualty to the ship, and by reason of failing to provide facilities on board in breach of contract. 2.4 General conditions applicable to P&I Club cover One of the most important rules is that which sets out the general conditions, exceptions and limitations that apply to P&I Club cover. We will examine these in more detail later in this Module. Applying for and agreeing the insurance The next group of rules deals with: applications for insurance; agreement on the premium rating (the basis on which calls are payable) for the entered ship, or on any fixed premium payable in respect of it; joint entries and cover for group affiliates of the owner; the certificate of entry and endorsement slips – equivalent to the policy of insurance and endorsements in the commercial market; reinsurance – including the right of the managers to accept inwards reinsurance and to effect outward reinsurance, including the right of the Club to be party to the Pooling Agreement. Utmost good faith and the insured’s duty of disclosure – ‘fair presentation’ ‘Utmost good faith’ is the name of a legal doctrine that governs insurance contracts. This means that all parties must deal in good faith, making a full declaration of all material facts, when entering into an insurance contract. Under the Marine Insurance Act 1906 (MIA), as part of the overall duty of utmost good faith to the insurer, an insured’s duty was to provide all information that would be material to the risk, whether or not the insurer requested that information. The Insurance Act 2015 is intended to update English insurance law. It came into force P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 33 Chapter 2 in August 2016 and applies to the eight International Group P&I Clubs whose rules are subject to English law, including the MIA which, in most part, remains in force. The Act repeals sections 18, 19 and 20 of the MIA which dealt with disclosure by the insured, or their broker, and pre-contract representations. Section 3 of the Act modifies the duty of utmost good faith by introducing the new duty of ’fair presentation’. This requires the insured or their broker to either (a) disclose to the insurer ‘every material circumstance’ which the insured knows or ought to know, or (b) provide the insurer with ‘sufficient information’ to put a prudent insurer on notice that it needs to make further enquiries into those ‘material circumstances’. Sections 4, 5 and 6 of the Act set out detailed provisions explaining what constitutes the knowledge of the insured and the insurer. Section 7 of the Act retains the old MIA definition of what is considered ‘material,’ which states that a circumstance or representation is material if it would influence the judgement of a prudent insurer in determining whether to take the risk and, if so, on what terms. Avoiding the contract The Insurance Act 2015 recognises that it would be appropriate for insurers operating in a sophisticated non-consumer industry, such as marine insurance, to be given the right to opt out of certain provisions of the Act that are specifically aimed to protect the rights of consumers under contracts of insurance. All eight P&I Clubs decided to contract out of the Act’s provisions on remedies for breach of the duty to make a fair presentation. Therefore, these eight Clubs will keep the MIA remedy of avoidance in respect of any breach of the duty to make a fair representation of the risk. Avoidance requires both parties to be put back into the position they were in before the contract was concluded. This involves the insurer returning the premium it has received and the insured repaying any claims it may have made. This can give rise to great difficulties in practice. It is always open to the insurer to affirm the contract, either expressly or by conduct. Where the insurer affirms despite a non-disclosure, that is the end of the matter. Where a Club does avoid a policy under the MIA, it may still be left with the problem of outstanding commitments to third parties, for example, under a letter of guarantee issued in respect of a claim that arose before the policy was avoided or under a letter of undertaking issued pursuant to an international convention or treaty. Cover for affiliates The terms of cover in relation to group affiliates need some explanation. Under Club rules, the word ‘affiliates’ is not specifically defined; it therefore has its usual meaning in the English language, namely a company in which another company owns a minority interest (less than 50%) or a company that is related to another company in some other way. The term ‘group affiliates’ within the rules refers to companies affiliated or associated 34 INTERNATIONAL GROUP OF P&I CLUBS  Mutuality and the cover provided by the Clubs with the ‘owner’. While the benefit of the owner’s cover can be extended to group affiliates, that benefit is limited to reimbursement of claims relating to liabilities, costs or expenses that they incur to the extent that the owner: would have incurred the same loss if the same claims had been made against them; and would have been entitled to reimbursement from the Club under the ship’s terms of entry. One of the objects of this wording is to preserve for the Club any right of limitation that the owner might have had if the claim had been made against them directly. A further provision limits the total liability of the Club to the owner and to all group affiliates in respect of any one event, to the sum that would have been recoverable from the Club by the owner in respect of that event. The rights of Members There are also rules that deal with the concept of membership. They provide that every owner entered in the Club on mutual (as opposed to fixed premium) terms becomes a Member of the Club, with rights to attend and vote at general meetings of the Club, as more explicitly set out in its constitutional documents, namely the Bye- Laws in the case of the Bermuda-based Clubs and the Memorandum and Articles of the UK-based Clubs. Where the entry is on a fixed premium basis or is an inwards reinsurance, the rules give the managers the discretion as to whether or not to grant the owner or insurer membership status. Rules such as these are peculiar to the mutual Clubs; commercial market policies do not contain such provisions. A related rule – headed ‘Assignment’ - emphasises the personal nature of the contract between the owner and the Club by forbidding assignment of the cover without the consent of the managers. The period of insurance There then follow rules dealing with: the period of insurance, which is usually from noon GMT 20 February in one year to the same time and date in the next; variations of the contract – giving the directors of the Club the right to set a general increase in the premium ratings of all ships entered on mutual terms for the coming year, and the managers the right to give, by 20 January in any year, notice of a change in premium rating required for a given ship for the year commencing next 20 February. Such a provision would not be found in a commercial market policy; P&IQ | MODULE 2 P&I INSURANCE: HISTORY, OPERATION AND PRACTICE 35 Chapter 2 notice of termination, by which the directors (not usually the managers, although some Clubs allow this) may ‘in their discretion and without giving any reason’ give an owner notice that their cover will not be renewed into the coming year. An owner may, in similar manner, give such a notice to the Club. Note that, save with the agreement of the managers, a ship may not be withdrawn from the Club nor may any notice of termination be given at any other time. Calls The next set of rules is also unique to the mutual Clubs. They cover the power of the directors to levy calls upon the mutual Members of the Club and the objectives for which such calls may be levied. These calls may be levied as advance calls, supplementary calls, release calls or overspill calls. The rule dealing with overspill calls is very detailed. The wording of the overspill calls rule is identical for every Club, as its provisions are of the highest importance in ensuring that an overspill claim, should it ever arise, can be paid. Overspill calls are covered in more detail later in this module. Calls, reserves and closing policy years The next group of rules, which are again unique to the Clubs, provide for: the way in which calls of whatever type are to be paid, on what dates, in what instalments and in what currency; the right to set off claims against calls is specifically denied. Calls not paid by the due date are subject to interest, but it is unusual for the Club to exercise this right in practice; a right of lien against the ship in respect of any amounts that the owner owes to the Club. Without such a provision, a Club – under the legal systems of most countries – might have difficulty in arresting a ship as security for a claim for unpaid calls; under English law, claims for unpaid premiums do not give rise to a statutory right in rem (which entitles the claimant to arrest the ship as s