P&I Renewal 2012/13 - Post renewal report

One month later......

INTRODUCTION
February 20th.2012 is now a date in history, the arguments have died away, fleets have renewed and the dust has settled sufficiently, at least, to see the broader landscape. The Report looks to set the scene to the 2012 renewal, examine the renewal itself and to anticipate the key drivers for the 2012/13 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 2012 renewal. 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. Although there was some posturing by clubs seeking to talk the market up prior to the executive decisions the actual General Increases all fell within a narrow range and were, we believe, a reflection of club boards recognising the deep financial pain and difficult trading conditions the membership were, and continue to be, enduring.

International Group Clubs published General Increases: 2012/13 renewal

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

The General Increases, between 0 and 5% for the second year in succession, were low in value and narrow in range. Cynics might (and did) suggest that this was an example of market price fixing and of possible interest to the ongoing European Union investigation into the IG clubs. This would be a shallow conclusion: as already mentioned the relatively low General Increases were a reflection of board/member empathy and, yes, competition: some clubs were minded to demand more, to offset back year claims deterioration, but, as their peers announced low General Increases the need to remain price attractive overrode those desires. Clear proof, if proof were needed, of active inter-club competition and to the benefit of the consumer: the ship owners that the clubs serve.

Taking the advertised General Increases and applying them to individual club expiring premium income the intended result was an average General Increase of 3.93%.

Averaged Percentage General Increase International Group 2012/13.

In real terms, this meant a desired cash uplift of approximately $115,000,000.

Combined projected premium product over the International Group after application of the published General Increase requests 2012/13.

In addition to the cash requirement 8 of the 13 clubs required increase in some or all of their basic deductible requirements. These increases were small and difficult to give a 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. 14/11 (General Increases The Summary) which can be found at www.plferrari.com.

The other key factor in concluding the renewal background was the renewal of the International Group Excess of Loss reinsurance contract. There were changes to the structure:

POOLING AND REINSURANCE THE GROUP STRUCTURE 2012/13

With individual club retention and Lower Pool remaining unchanged the Hydra (International Group captive) increased its participation with 100% of a new second layer Lower Pool (individual claims from $30m. to $45m. in value) and 90% of a new Upper Pool (individual claims from $45m. to $60m. in value) the 10% balance being directly insured as individual club retention. The effect was to maintain the clubs individual and collective (via Hydra) retention to $60m. but reconfigure the primary layering.

So far so good and the new tariff reinsurance rates were duly published on 13th. January, 2012:

REINSURANCE RATES Tonnage Category Dirty Tankers Clean Tankers USD Dry Cargo vessels Passenger vessels 2012 Rate per GT USD 0.6515 USD 0.2798 USD 0.3561 USD 1.3992 2011 Rate per GT USD 0.7038 USD 0.3055 USD 0.3709 USD 1.4780 US$ Change - 0.0523 - 0.0257 - 0.0148 - 0.0788 % Change - 7.43% - 8.41% - 3.99% - 5.33%

The news was good: despite an indifferent claims record on the first General Excess Layer (to $500m.) the individual tariffs were reduced year on year. This reduction was, in part, due to the anticipated increase in world fleet during 2012 (a subject we will come back to later in this document) which enabled the total premium to be divided up amongst a greater number of vessels.

However the story was not over and we will examine the consequences of 2 claims that impacted the completion of the placement in the Drivers for 2012 section of this Report.

THE RENEWAL
The renewal was characterised by generally tough underwriting (with a low General Increase requirement clubs were determined to deliver the GI) set against an industry desperate to save every cent on their operating expenses. The renewal was protracted and most clubs reported a much higher percentage of members not renewing until the final week leading to 20th. February (compared to previous years) P.L. Ferrari do not comment on movements between clubs at renewal. We believe that this is a private matter between the member, his broker and the clubs concerned. We also balk at the idea that a club which has lost vessels to another club is necessarily a loser and, conversely, that the acquiring club is a winner. Lists of named ship owners who moved clubs was, as always, widely reported in the trade press. We do, however, conduct an informal poll of the clubs to ascertain their unaudited sense of how the renewal has gone. That poll suggested that in percentage terms the clubs achieved a 2.99% increase (against the 3.93% desired market average)

Estimate of % increase actually achieved by the International Group against the averaged General Increase, at 2012/13 renewal.

and so in cash terms an additional $87m.

Estimate of premium increase actually achieved by the International Group against the combined projected premium product at 2012/13 renewal.

A number of renewals will have swapped a cash increase for higher deductibles. Calculating the value of those fleet specific deductibles (and not allowing for the effect of mandatory increase in basic deductibles as demanded by 8 of the 13 clubs) suggests that the percentage rose to 3.92% i.e. almost exactly in line with the originally advertised market average of 3.93%

Estimate of % increase including an allowance for change of terms/deductibles actually achieved by the International Group against the averaged General Increase, at 2012/13 renewal

and, obviously, close to the market average premium requirement

Estimate of as if premium increase including an allowance for change of terms/deductibles actually achieved by the International against the combined projected premium product at 2012/13 renewal

In conclusion the renewal was a tough one and the clubs came very close, on initial survey, to achieving their requirement. To contextualise this we would refer to our findings for the 2011 renewal (see P.L. Ferrari P&I Market Review, October 2011 at www.plferrari.com ): then the market average requirement was 3.82% but the achieved result, with cash and terms, was little more than 1%. Another feature of the renewal was that most clubs maintained a rigorous and inflexible approach right up to the 20th. February deadline.

DRIVERS FOR 2012

Anticipating next years renewal on the 20th. February, 2013 eleven months ahead will be, inherently, speculative. That said, there are clear influences that will, or will continue to, manifest themselves and doubtless drive the thinking for next year. This is not the place to discuss the European Unions investigation, a painfully slow and time consuming process. Nor is it the place to discuss sanctions, or new maritime legislation all of which we have commented on in detail (www.plferrari.com for a comprehensive archive of our bulletins, circulars and publications). We will continue to update on these items but now concentrate on the basic drivers affecting the mutual equation (income versus expenditure). Reinsurance We have described above the new programme structure and 2012 tariff rates. As we hinted this was not the end of the story. A number of owners had concluded their renewals by the time the Reinsurance tariffs were published. A majority, though, had not. We reference an extract from the Japan Clubs circular dated 22nd. February, 2012 (Report on the 576th Meeting of the Board of Directors)

.After the IG largely agreed on the renewal rate of the captioned reinsurance for the 2012 policy year and officially announced the rate to the Members, the grounding incident of the COSTA CONCORDIA, a large passenger vessel, occurred in Italy, and there was a significant deterioration in the loss value of the RENA, a container vessel which grounded off New Zealand in October 2011. After these unpredictable casualties it became clear that it would not be possible to complete the First Layer of the IG reinsurance programme without payment of an additional premium. The amount of the premium has been agreed at US$ 40 million, to be divided between all the IG P&I Clubs. Since the P&I insurance renewal for the 2012 policy year had been in the process save for the extra reinsurance costs, Members are kindly asked to understand that the Association will first pay its share of the additional reinsurance premium (c. US$ 3 million) for the 2012 - 13 policy year, and afterwards consider how to adjust our account with Members for policy year 2013 - 14 onwards

The bald facts are that the reinsurance programme time table follows a sequence of renewal terms being negotiated with the leader(s) and once accepted by the IG Reinsurance Sub-Committee the tariffs are announced (this year on January 13th., 2012) and an order is given to renew with the balance (and majority) of the market. That evening the Costa Concordia suffered its tragic accident, an event that was played out throughout the worlds media. Shortly thereafter the latest , already significant estimate for the grounded container vessel Rena was dramatically reviewed and increased; both events occurring after the renewal order for the reinsurance had been given (and rates advertised) but BEFORE the placement had been completed. Whilst the Costa Concordia was a dramatic and very public event, in real terms the uplift in the Rena estimate represented, to the reinsuring market, a very real and quantifiable additional loss exposure.

Some of the supporting reinsurance market took the view that the renewal terms agreed with the leading underwriter(s) were not sufficient and demanded an additional premium, ultimately negotiated at $40m.) to maintain their participation. Much rumour and speculation ensued (and our thanks to the Japan Club for going public on the sorry affair). We would ask the following questions: Are not stated benefits of the current reinsurance placement and the markets utilised ones of continuity, relationship and the consequent smoothing of price volatility? And how do those benefits in reality stack up against what some might view as an opportunistic market move to extract additional money? And why is the announcement (and, of course, the placement) made barely a month before renewal increasing the possibility of late policy year claims? Historically the structure (and the continuity of the reinsuring market relationship) was viewed as being robust enough to withstand multiple policy limit claims in one year and still be renewable (albeit at higher cost). More recent thinking moderated that optimism to just one, or possibly two, policy limit claims before the contracts future integrity was compromised. What, therefore, are the real benefits of maintaining the current structure, and indeed the current reinsuring market relationships, when an, admittedly significant, uplift in a single claim estimate for the Rena (an uplift nowhere near the policy limits) and a highly visible passenger vessel accident (and at time of reinsurance placement unestimated in quantum) are apparently sufficient for that market to withdraw its support? And does the apparent fragility of that market give cause for concern for Rating Agencies and regulators?

What is known is that immediately consequent on the acceptance of a loss AP some clubs looked to pass on their proportion of that AP to members who had not yet renewed, notwithstanding that the tariff rates had been published. Logic ultimately prevailed and that intent was largely neutralised however a number of clubs are actively seeking to claw back at least some of the additional cost on new vessels attaching during the course of 2012.

Our poll of the clubs suggests that there are three options to be considered by the 13 clubs; absorbing the additional cost levying an additional reinsurance cost to new vessels attaching in the policy year or keeping all options open

P.L. Ferrari would argue that the originally advertised rates are the rates for the year. Of course there will be adjustments to the reinsurance cost at the 2013/14 renewal: and that renewal date is the only practical time for those rates to be reset. It is invidious to think that an owner may pay one rate on his renewing fleet and another on subsequent attachments thereto. And what would be the new rate? There are so many practical problems inherent to make the relatively small amount of money generated non cost-effective and, as critically, there is a general sense of unfairness which is an anathema to the mutual system. We would implore club boards considering the matter to rest on the side of the angels. In conclusion it can be anticipated that reinsurance costs are likely to rise, probably significantly, at the 2013/14 renewal . It also can be anticipated that the International Group will be looking closely at the efficiencies of the current structure and underwriters. Claims Our poll suggested a disparity of view on back year claims, 2011 claims and the forecasted environment for 2012. Of the 13 clubs

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

Since all clubs note the decline in general frequency but a significant and continuing uplift in individual values we would conclude that claims will continue to be a powerful driver at the 2013/14 renewal and that, possibly, the disparity of views may be less a function of statistical oddity and more of a function of poor reserving and forward budgeting. Investment income It was clearly a challenging year. However an uplift in equities at year end gave a boost to those clubs with a high equity investment component. Our poll suggested that the range of performance for the 2011 ranged from a low of just above 0% to a high of 5% and a market average of 3.93% No one is anticipating significantly higher investment returns for 2012 and consequently the temptation to subsidise underwriting deficits with investment funds will be academic. Churn/new buildings This remains a massive driver on performance. 2012 will see another year of significant new building deliveries and a similarly large increase in scrapping. Thus, this year will again be affected by the new for old (the so called churn) problem the new tonnage attracting fierce price competition and replacing the old which typically have higher rates. Much of the premium gain at the 2012 renewal will be diluted during the course of the year as the new vessels come on and, again, will put pressure on ultimate underwriting performance.

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CONCLUSION

The 2012 renewal was protracted and hard negotiated. Ship owners continue to face deeply challenging trading conditions. The group reinsurance programme will almost certainly undergo reappraisal and it is likely that reinsurance rates will rise significantly at the 2013/14 renewal. Claims continue to rise in value but most clubs are prepared to monitor the claims inflation and to budget accordingly. Investment income will be unlikely to produce meaningful or significant returns for 2012. The churn effect will continue to put pressure on club balance sheets.

There will be other challenges without doubt. However challenges create opportunity and any gloom that this document may impart should be tempered with the fact that P.L. Ferrari will continue to stand shoulder to shoulder with our clients to develop practical and innovative solutions.

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

22
nd

March 2012

GENOA

MONACO

PIRAEUS

NAPLES

ISTANBUL

LONDON

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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