P&I Renewal 2013/14 - POST RENEWAL REPORT

One month later......

INTRODUCTION
The renewal season is over and owners, their brokers and the clubs are attempting to recover from what was generally accepted as being one of the most complex and difficult anniversaries in recent memory. Our Report looks to set the scene behind the 2013 renewal, examine the renewal itself and to anticipate the key drivers for the 2013/14 year. Much of our analysis is based on informal discussions with the P&I clubs, posing to each a set of key questions about the 2013 renewal. Where clubs have not been forthcoming on specific questions we have used average results. Our conclusions are based on those discussions but it must be stressed that the responses are based on unaudited figures. We do not identify individual clubs within this document but rather use the information to look at general market results and trends. We have limited our thoughts to owned P&I exclusively.

BACKGROUND TO THE RENEWAL

The renewal season begins with the publication of the individual club General Increases. The drivers that make up the specific were outlined in last years (2012/13) Post Renewal Report and we reproduce in synopsis the sentiment of the clubs from a year ago:

Claims Generally the outlook was benign with a majority of clubs anticipating a neutral or even positive attritional claims pattern for 2012.

ONE YEAR AGO (P.L. Ferrari Post-Renewal Report, March 2012)

suggested that claims were, and continue to be, neutral year on year.

would

suggested that the claims were benign and the outlook was cautiously positive. pointed to significant back year deterioration and that claims would continue to increase for 2012.

All clubs noted that for major claims (above $2m.) whilst the frequency was stable or even declining the values were inflating significantly: a trend that has been evident for at least 4 years and thus no surprise and, presumably, controllable through precise reserving and budgetary discipline.

Investment Income Last year we suggested that investment return for 2012, given market volatility and ever more conservative club portfolios, would be unlikely to exceed that of 2011s market average of 3.93%. As we show later on in the drivers for 2013 our straw poll indicates that, in fact, just over 4% was achieved and with a range from 2% to 7.75% the performance spread significantly extended from the previous year (0 to 5%).

INVESTMENT INCOME

Churn/new buildings We anticipated that the new for old churn would continue to dilute club premium bases during 2012 (with new tonnage typically attracting a lower rating than the tonnage being replaced) but that, again, this phenomenon was a known risk and one that could be controlled with careful underwriting management. Indeed, whilst older (higher premium paying) tonnage continued (and will continue) to be scrapped the spate of new deliveries was starting to slow and this critical factor should be controllable and abating. P.L. Ferraris own analysis of churn for the 2012 year confirms that the issue is slowing albeit only to a degree.

With the tripartite outlook broadly stable it was with bemusement that, in the third quarter of 2012, anticipating the General Increase round, most clubs started to indicate that claims were rising. It would be egregious to suggest that the market was being talked up but the alternative conclusion was the one we drew last year: whilst we recognised that claims would be a significant driver for the year any disparity between forecast and reality would be a function of poor reserving and forward budgeting (P.L. Ferrari Post Renewal Report, March 2012).

A quiet silence surrounded the better than expected investment return (for the market as a whole) but a lot of noise emanated about the churn and the consequent premium dilution. This noise was clearly justified for a number of clubs with visible growth strategies but less understandable from those that had exhibited generally neutral growth.

That bemusement turned to concern when the Britannia, the first of the clubs to announce, called for large double digit rise and, like mutual vultures to a ship owner carcass, one by one the balance of the clubs, with exceptions, followed suit. This at a time when the membership continued to face extremely poor trading conditions: a disconnect that we reflected on in our Annual Market Review in December 2012. It would be unfair, though, not to comment that a number of clubs did acknowledge the hardship of their members and introduced, with the General Increase, more sympathetic premium calling systems aimed at spreading or deferring the premium over a longer period to assist members cash flow.

THE GENERAL INCREASES

INTERNATIONAL GROUP CLUBS PUBLISHED GENERAL INCREASES: 2013/14 RENEWAL

P&I

Notes Clubs highlighted in red have no advertised general increase. *WOE - Increase applies to mutual element only and not to the costs of the Group Excess of Loss contract.

Taking the advertised General Increases and applying them to individual club expiring premium income the intended result was an average General Increase of 8.54%.

Averaged Percentage General International Group 2013/14.

Increase

In real terms, this meant a desired cash uplift of approximately $260,000,000.

Combined projected premium product over the International Group after application of the published General Increases for 2013/14.

In addition to the cash requirement 7 of the 13 clubs required a specific increase in some or all of their basic deductible requirements. These increases are difficult to give a monetary value to but, we suggest, might have an equivalent cash comparison of a further 0.5% increase. For full details on the General Increases please see our Renewal Bulletin No. 15/12 (General Increases The Summary) which can be found at www.plferrari.com.

THE GROUP REINSURANCE PROGRAMME RENEWAL

The other key factor in concluding the renewal background was the renewal of the International Group Excess of Loss (GXL) reinsurance contract. There were changes to the structure: POOLING AND REINSURANCE THE GROUP STRUCTURE 2013/14

As we will comment on below there were major challenges (Rena and Costa Concordia claims) facing the programme with reinsuring underwriters looking to make short-term recouping of losses and anticipated losses. Clearly the environment was one where cash would be king but the Group did implement changes to structure and retention, in part to mitigate premium increases and, in part, better to reflect and anticipate the inflation in large value claims. It is worth mentioning that a key factor was the placeability of the contract which demands, given the huge limits, significant insurer participation. The need to avoid the problems of the 2012/13 reinsurance renewal (which culminated in a last minute loss AP to ensure the placements completion was paramount and the tension between reinsurers needs for cash and the ultimate buyers (the ship owner through the tariff mechanism) lack of cash required skilled negotiation. Indeed a number of major historic reinsurer participants declined to renew their share citing concern over pricing (in their view too low) versus risk (in their view too high). Fortunately new participants were introduced and the contract was fully completed.

The key changes were: Individual club retention increased from US$8m. per claim to US$9m. per claim.

An additional (third) pool layer was introduced to cover an additional US$10m. per claim in excess of the 2012/13 pool retention of US$60m. Thus the pool now stands at US$70m. per claim (in excess of the US$9m.retention).

The Hydra (International Group cell captive) co-insurance of the first layer of reinsurance increased from 25% to 30%.

Despite the 16% increase in horizontal retention (club retention plus pool) and 20% increase in vertical retention (Hydra co-insurance) the reinsuring market demanded and obtained their pound of flesh. The overall increase in the reinsurance cost was about 36% in cash terms. This was widely anticipated but the devil is always in the detail of the allocation between vessel types.

It was anticipated, therefore, that the offending categories (dry cargo and passenger) would face a tariff increase in excess of the cash rise and the non-offending categories (dirty and clean tankers) a lesser proportion of the rise. There was a suggestion that a new category might be introduced splitting container vessels out of the dry cargo grouping. Certainly it was recognised that reinsuring underwriters had increasing concerns about the spiralling costs of Removal of Wreck (the major cost component in both the Rena and Costa Concordia claims): as groundings/human error and consequent Removal of Wreck are risks common to all vessels, whatever their trade type, it was assumed, very wrongly as it turned out, that the penalty for the offenders would be considerate and that, similarly, the rise for non-offenders would be proportionate.

It was thus with incredulity that the passenger sector reacted to the actual tariff increases, with their sector increasing by 125%. Similarly non container dry cargo vessel owners reacted badly to an uplift of approximately 40% with no differentiation between them and the container community.

There has been a lot of speculation about how these figures have been arrived at and, in the welter of information and disinformation, concerns have been raised about the transparency of the process.

Rather than add to the speculation, P.L. Ferrari are reviewing the facts surrounding the drivers behind the GXL renewal and the logic for the ultimate tariffs as well as the governance that surrounds the decision making process. We will return to this matter in more detail in our mid-year Market Review. The 2013/14 GXL rates were published on 10th. January 2013 are reproduced below.

REINSURANCE RATES Tonnage Category Dirty Tankers Clean Tankers Dry Cargo vessels Passenger vessels 2013 Rate per GT US$ 0.7565 US$ 0.3245 US$ 0.4942 US$ 3.1493 2012 Rate per GT US$ 0.6515 US$ 0.2798 US$ 0.3561 US$ 1.3992 US$ Change + 0.1050 + 0.0447 + 0.1381 + 1.7501 % Change + 16.12% + 15.98% + 38.78% +125.08%

THE RENEWAL
The renewal was polarised between some clubs (the minority) who, either because of relatively robust finances and/or because of a sensitivity (the connective responsibility we have mentioned frequently over the last 6 months) towards their memberships economic hardship, retained a level of humanity and those that didnt. It was the toughest renewal in a generation: and the relative inexperience of many callow underwriters, not having experienced a hard renewal before, was translated into rigidity and inflexibility. P.L. Ferrari does not comment on movements between clubs at renewal. We firmly believe this is a private matter between the member, his broker and the clubs concerned. We also balk at the popular concept that a club that has lost vessels to another club is necessarily a loser and, conversely, that the acquiring club is necessarily a winner. There was however a greater than normal level of high profile moves, both whole fleets and part, which is an unsurprising by-product of the extreme renewal environment (and not, as one particularly overwrought underwriter croaked, the death of mutuality). The mutual environment we still consider to be robust, and certainly are ardent advocates of, but the world has changed since 2008 and for many members short-term practical necessity (to ensure financial survival) has to take precedence.

We do, however, conduct an informal poll of the clubs to ascertain their unaudited view of how their renewal has gone. That poll suggests that the clubs, en masse, achieved a cash increase of 6.58% (against the originally desired 8.54%).

Estimate of % increase actually achieved by the International Group against the averaged General Increase, at 2013/14 renewal.

And so in cash terms an additional $202m (against the desired $261m.).

Estimate of premium increase actually achieved by the International Group against the combined projected premium product at 2013/14 renewal.

This renewal was notable for the higher than usual incidence of owners trading cash increases for term changes. Historically the swap was limited largely to members taking higher deductibles but, at this renewal, there was a surge in condition changes e.g. placing primary crew cover in domestic markets. The value of this term change trade was over double a normal years average and clear empirical evidence of the financial stress many owners are under and looking to make savings wherever possible. Our unaudited straw poll gives a percentage value for such terms changes of 1.82% which combined with the cash increase gives a value total of 8.40%, a shade below the desired 8.54%.

Estimate of % increase including an allowance for change of terms/deductibles actually achieved by the International Group against the averaged General Increase, at 2013/14 renewal

And thus generating an as if premium uplift of $258m., close to the originally desired $262m.

Estimate of as if premium increase including an allowance for change of terms/deductibles actually achieved by the International Group against the combined projected premium product at 2013/14 renewal

A veil needs now to be drawn over the renewal to allow for mental and physical recuperation. Yet memories are long and lessons do need to be learned. Lessons that require some additional remedial tuition; given that a number of clubs immediately on renewal conclusion indicated that they would be focusing heavily on credit control, thereby exhibiting a predictable, but depressing, lack of sensitivity and connectivity. The logic that ties together the inference that we are worried about your financial health Mr. Ship Owner, so we are going to put your premiums up eludes us.

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DRIVERS FOR 2013

The drivers are generally predictable as they largely reflect those we anticipated in our Post Renewal Report last year and our, more recent, Market Review 2012.

R/I structure and cost (P.L. Ferrari Bulletin No.16 2013) The Reinsurance programme will continue to be under cost pressure as the market further seeks to recover losses. As we have mentioned, we will be examining in more detail the issues that surround the reinsurance programme, in our next Market Review for 2013. However the Reinsurance SubCommittee (which has representatives from each of the clubs) has already met and this early convocation is indicative of the seriousness with which the reinsurance programmes integrity and cost is being taken.

Claims Our straw poll suggests that, as last year, there are clear differences between clubs regarding the claims outlook. Their sense of the state of: Pre-2012 claims deterioration, Current 2012/13 claims , The forecasted environment for 2013/14 differed markedly from their generally optimistic view of a year ago. The outlook was more negative than last year but this possibly could be post-renewal justifying of the increases that have been achieved.

A YEAR AGO

suggested that claims were, and continue to be, neutral year on year

would

suggested that the claims were benign and the outlook was cautiously positive pointed to significant back year deterioration and that claims would continue to increase for 2012

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TODAY

suggested that claims were, and continue to be, neutral year on year.

would

suggested that the claims were benign and the outlook was cautiously positive. suggested that claims would continue to increase for 2013.

Investment income 2012/13 was a challenging year given market volatility but much more stringent investment policies have meant that, whilst average returns are lower than in the heady days pre-2008, they are more certain. We have already mentioned that our straw poll indicated an average investment return across the market of just over 4% for 2012 and we see no particular reason why this should change for 2013. The markets continue to be volatile, though, and certainty is never guaranteed It is salutary to remind readers of the power of the investment income. As a rough rule of thumb, 1% on investment return is equivalent to a 3% increase in premium. The approximate value, therefore, of the investment returns for 2012 is $380m. In other words about 50% MORE than the achieved renewal result. To be very simplistic, the product of the achieved premium increases at renewal and the investment pot is over $640m. of money into the system. This is a hyper naive view and club managers and boards will, rightly, argue that projected investment returns are factored into their calculations when setting the General Increase. However we would again, and with boring repetitiveness, make the point about disconnection between club expectations and owners reality.

Effects of churn This was a huge factor for 2012 and a number of clubs clearly needed premium uplifts to recalibrate hugely diluted premium bases. Older, higher premium paying, tonnage will continue to be scrapped, however the new deliveries are starting to slow and, with the general rate recalibration, this should not be as critical a driver as in recent years.

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CONCLUSION
The 2013 renewal was one that will live long in the memory. And the recollection will not be a pleasant one. Ship owners continue to face deeply challenging trading conditions. The Group reinsurance programme will be subject to further scrutiny and evaluation and, we fear, further increases. The reinsurance is stressed by the fact that very large claims, particularly those involving Removal of Wreck, are inflating exponentially. However frequency will remain low. Otherwise general claims inflation is upward but predictably so and the claims pattern for day to day claims will be average, neither higher nor lower in value than to be anticipated. This statement comes with the caveat that history shows that in times of financial hardship lack of cash leads to reduced maintenance. It follows that reduced maintenance leads to more claims. Investment returns will be low single digits.

And finally we repeat two predictions that we made in our Market Review 2012: The advent of the Maritime Labour Convention in August will be presaged by a last minute patching together of coverage solutions and a predictable panic over the process and execution of certification (as with the debacle that was the Passenger Liability Regime introduction at the end of 2012 some clubs will have been proactive but will be dragged down by other clubs inertia). Solvency 2 will still be shimmering on a distant horizon.

And, with no apologies, we also repeat our final statement from the Market Review:

What we cannot predict, but devoutly hope, is that Club Boards and Club Managers reconnect with their core membership and reflect better their needs and demands.

P.L. Ferrari & Co. S.r.l.

14th March 2013

www.plferrari.com
GENOA MONACO PIRAEUS NAPLES ISTANBUL LONDON NEW YORK (an exclusive cooperation with Crystal and Company)

This newsletter is intended solely as an overview of the Marine market and does not constitute any form of advice. It is based on sources believed to be accurate at the time of printing and we cannot be held liable for the omission or inaccuracy of any information within the newsletter.

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