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1. The possibility of insuring cargo was introduced earlier. How does the situation change, as far as incentives are concerned, when companies can insure their transported goods against possible shipwrecks?
First of all, the companies’ most important aim is to safe money. Therefore if they have to deliver their goods from on place to another, they are intent on taking care about their products. Transportation companies comprehend that it is by no means more efficient to teach their staff to carry out good safety on board than leaving the ship in own responsibility and hoping that craft and cargo will arrive without a damage. In no doubt it is quite expensive to hold a good quality of security and seaworthiness. Preparing the stuff, checking the ship and everything cost time and money. The whole situation changes if the company has now the option of insuring the cargo against potential ship wrecks.
The term moral hazard, originated in the insurance industry comes to light. It is a form of post contractual opportunism which arises when a contract or some kind of a contract has be signed. The main point of the theory of moral hazard is that people with insurance tend to change their behaviour in a way that harms the insurance companies.
Before it has been a major point to worry about security and since the transportation company is insured this astonishing moral hazard problem occurs and it seems that security is a new term for the business. Being insured may make people do not mind about precautions which could prevent some happenings.
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One example for this phenomena might be the situation when you rent a small motorboat during the holidays. Normally insurance is included in the rent and you do not have to care about possible dangers. You would likely to be more careful in using a rented motorboat if you would be financially responsible for all possible damage. Certainly you want to check the boat before driving it, which is not the case if you would be insured against everything. In that case doing a security check is regarded as wasted time because you would get the money when something happened. If you are fully insured, then being careful brings you no extra benefits.
Principally such a moral hazard problem occurs if people are likely to transmit false information or when they are tempted to take an inefficient action. Unfortunately there is a big difficulty to hold back the passing on of false information because you would have to monitor your clients constantly and this is sometimes simply not possible. So the insurance company has to react in a different way. It may not suffer any losses from moral hazard if it sets the insurance premium high enough to cover the extra costs. This is one successful solution.
. Discuss a situation in which the same company owns both the ship and the cargo (say for instance a substantial amount of crude oil). If this entity is insured against a shipwreck, who stands to lose the most if an accident does occur?
In my opinion there is no possibility to answer this question in only one genuine way. I will try to give an insight into the �costs` for both, the company itself and the insurance company.
I found a sentence which I would say, is an appropriate point in the situation, where a company looses its cargo or even its ship
“The market value of real property reflects the opportunity to use the property immediately. The change in a property’s market value after a loss reflects the loss of this opportunity”.
So, the loss of not having the cargo now is an important point to name. Even when the lost cargo and the ship are replaced, there are probably lost earnings, caused of the effect of the loss.
I would mention here a possible fact that the business partner is already waiting for the company’s cargo. He could be a manufacturer who needs these items to go on in producing. Someone has also to compensate for these costs that the machines are left empty. If the manufacturer would have to pay this loss by himself, he would probably break up his business relationship. So there is the cost of loosing its reputation, because nobody wants to risk something in building up a relationship with a company which is likely to have difficulties in bringing its cargo to the right place at the right time.
All these sorts of costs a company has to finance by itself. Normally the insurance contract includes only the money for restoration or replacement of the vessel and its cargo and there is nothing written about paying for these extra costs. With offering an insurance benefit for the damaged cargo and the ship, insurance companies often face this problem You would be better off as a business man by damaging your old ship if you would have received an amount of money which is of the value of a new one. Selling your ship would not be so effective. To control this way of behaviour, insurance contracts often include the condition of requiring replacement for getting an insurance benefit.
An additional solution of controlling as an insurance company this problem, would be, in my opinion, not to pay the whole current market value, but with the reduction of depreciation, depending on the years the ship is already used.
Therefore, trying to weigh up all these facts I would say that finally the company looses the most, because these are losses you cannot have under control easily and they can exceed the costs of the ship plus cargo. The company faces also costs which may come up later, like the risk of loosing its reputation and you are hardly able to define the arising disadvantages from a lost partnership.
On the contrary the insurance company takes the risk of having to pay an insurance benefit into account and it has already in advance the ability to handle with particular numbers.
. Section . ends with a short note on how the insurance companies have an incentive to somehow monitor the seaworthiness and safety of the insured vessels. How are the insurance companies doing this and how do insurance contracts work in the case of cargo carrying vessels?
Based on a paper from the Internet about marine cargo insurance I will try to give an insight in the nature of insurance contracts concerning vessel transportation.
Generally there are many international sales transactions, with goods having to be transported over long distances. Therefore a ship accident, result in the total or partial loss of the cargo or even with the loss of the vessel, is quite possible.
Marine cargo insurance helps to remove the financial burden of the risks of loss or damage regarding to the transportation of these goods.
In earlier times the Marine insurance used to refer just to the limited insurance of ships and their cargoes, but nowadays it takes the risk also for the movement of cargo which involves no ocean transport at all. The specialists, in assessing risks relating to goods in transit within the marine insurance are called Marine underwriters.
An insurance company employs underwriters who transact business on behalf of the company. The main functions of the Marine Insurance are Spread of Risk, Aid to Security, Aid to Credit, Source of Employment, Source of Capital and Loss Prevention. Spread of Risk is explained by the sentence “Share the losses of a few among the many”.
In this case you can mention the notion ‘indemnity’, which means that the insured must not be better off after a loss, but therefore also not worse off. He will be put back into the same financial position as just prior to the loss. The function aid to security wants to say, that the insured has not to fear a potential financial loss.
Coming now to the different kinds of losses, there is to say that the insurance covers in no case loss damage or expense arising form unseaworthiness of vessels or cargo. Losses can be one of two types total loss or partial loss.
The first type total loss is divided into actual total loss, which means a loss or damage to the entire property, the constructive total loss, which refers to the fact that the cost of recovering the goods would exceed the insured value, or when the property is abandoned, because its actual loss seems unavoidable. Total loss of part is when there is a loss of one part, but the rest is without damage. The second type partial loss, where the loss is less than total amount of insurance, can be divided into general average loss and particular average loss. “Average” means partial loss. In the case of general average loss, the loss of the cargo is caused through a voluntary action of the ship-owner, for example to save the ship he throws the jettison overboard to lighten the ship.
A particular average loss is not caused through a deliberate action of the owner, it refers to a loss which is for example caused during the loading of the vessel. One of the most important points with reference to an insurance contract is that the insured person is obliged to pay to the insurance company the premium due for insurance. In case of non-payment of the premium the insurance company has the right to refuse payment of the insurance benefit.
By the way, there are four basic principles of the Marine Insurance to mention. The insurable Interest, the indemnity, the utmost good faith and the subrogation. Primarily “The insured must have financial interest in the object of insurance. A person has insurable interest in property when he will be financially prejudiced by its loss or damage and when he will financially benefit from its continued existence.”
The point ‘indemnity’, I already mentioned before, is about the fact that the insured will be in the same financial position like before the incident. The part ‘utmost good faith’ is about the requirement to the insured to give full information of every material fact in respect to the risk. Finally the fourth principle ‘Subrogation’ “The right of an insurer, after paying a loss, to assume the rights of the insured to recover this loss from the responsible party.”
Generally the insured is obliged immediately as he becomes aware of changes in risk, to inform the insurance company. Changes like, delay in shipment, deviation from the route or change of manner of shipment are concerned. Sooner or later when there happens an accident, the insured is obliged to take all possible measures for salvage and preservation of the damaged cargo or ship. If the insured then gets also money form a third party he has to report this. The insurance company will only pay the difference between the compensation and the money the company got already from a third party.
In the end, it would be quite attractive to know if these kinds of reports from the side of the insured were credible. The only solution could be monitoring, but normally this is simple not feasible. Monitoring is related to excessively many costs, like the cost for an inspector on every ship, or cameras and observers who check these cameras continuously. Therefore, I think a good solution would be taking single checks which are left to chance. This can be very effective, because there is also a deterrent effect behind it.
4. This paper argues that a shipping company in financial distress might be tempted to neglect safety issues in order to cut down on costs. Should there be a system similar to that applied in banking that would establish minimum requirements on the financial solidity of a shipping company?
The main question here is if a financial solidity would be as important for a shipping company as for customers requiring loans from a bank. Concerning the banking nature, such a financial security is necessary. Otherwise the financial institutions would be ruined. It would cause a big mess if everyone was allowed to borrow money in form of credits from the bank, without having any security. In lack of financial strength for the loan the bank might not get the money back. So, in banking it is highly demanded to own a financial solidity, at least as high as the given loan, to get financial help from your bank. Now it would be quite possible to think about of importing a similar system in the character of safety and seaworthiness. For setting up a transportation company it could be required to have a particular amount or a specific percentage to spend on checking the safety and seaworthiness of the vessel. The advantage of this requirement is that the transportation company looses its excuse of not having enough money to do precautions before leaving the port. But is this the right way?
This financial strength could also be seen as a barrier to get into the shipping business, especially for small companies. Therefore you could mention the fact of fewer competitors in this business, but this is not the reason to bring in a minimum amount.
The difficulty is whether they really will ensure safety just because of having the money for it. There is no regulation which says that they have to do the check. The important thing here is just to have the money. So it could be quite possible that some shipping company can enter the business but have no security controls at all.
In my view it is relatively more effective to have a system which demand a particular safety and seaworthiness check, which is for everyone the same.
It does not matter for the supervisor whether the company has the money or not, it has to have this security standard. Therefore it is clear that they have to spend a particular amount of money on having such a standard.
As a result, I think it is wasted time to control the financial solidity and it is much better to have an organization which takes time to make controls concerning the required safety standard.
5. How could the EU, for instance, improve the safety and seaworthiness of oil tankers in traffic within its territory? The tendency today is that shipping companies register their vessels in less developed countries to cut costs.
“On the 1. Nov 00 the Prestige, a 6-year-old single hull oil tanker flying the flag of the Bahamas and carrying 77000 tonnes of heavy fuel oil, ran into serious trouble off the coast of Galicia.”
These kinds of accidents cause a serious problem of pollution, but even worse is the fact that there would have been ways to prevent most of such catastrophes. Primarily I thought about, the importance of having a system where you always know which ships are where located at a specific time, like in the case of aeroplanes. I found out that this already exists, the Community vessel traffic monitoring system, known as “Safe Sea Net”.
It includes a European database and a network between the Member States for exchanging data concerning the identity, position and routing of a particular ship.
The nest step could be now to find these vessels which are lack of safety. There is one interesting way to manage this, written in a paper of the Commission of the European Communities.
The topic of this document is about improving accidents in response to the Prestige accident. So I will have something to compare my ideas with the facts which are based on reality.
It talks about using the pilots in a port. In the view of their daily dealing with vessels, they often have more information about ships than anyone else. That is why they are under an obligation to inform the appropriate authority if they realize an absence of safety in an EU-port. A ship which is reported by one of theses pilots will be checked by inspectors. If it is then identified as a substandard vessel it will be kept out of ports of the Member States. By the way, usually most of these kinds of vessels avoid ports in the Union anyway.
So it came the possibility to my mind to sign these ships which got checked by the European Union and which have a certificate of safety. Perhaps this would be an incentive for the rest to get such a certificate and it would be easier to recognize these ones with no conferment of being safe. A similar effect to spur on the rest of the ship owners to make safety checks could also be to punish these ones heavily which caused marine pollution, no matter if it has been accidental or not.
In my opinion a very good concept, mentioned in the paper, is the decision of building a fund for compensation for oil pollution incidents. The fund has to cover damage up to EUR 1 billion and has to be fully operational before the end of 00. The idea is that all coastal Member States participate in it from the start.
In the case of the Prestige accident it concerns a single-hulled tanker which was already quite old and still carrying heavy fuel oil, which is among the most polluting types of oil.
Because of its relatively small risk of fire or explosion, it is regularly carried in older tankers nearing the end of their economic lives. So, the last point I want to mention about improving safety is that the Commission intends to set up regulations for prohibiting the transport of heavy fuel oil in single-hulled tankers, between 005 and 01, which are on their way for or leaving EU ports.
According to the tendency that shipping companies register their vessels in less developed countries, there is to say that it would be one solution or at least a try, to give them special incentives if they register their ships in the European Union, like having more advantages and more scopes in EU ports. First I also thought about punishing them in some way, like not letting them enter EU ports, if they do not register in the EU, but I gave it up again, because I think this would only cause big barriers in trading. Therefore I am not going to change my mind and I still think that giving incentives is the better way to convince somebody of doing an action.
6. The bribing of inspectors discussed earlier does not have to be that straight forward, it can be done in more subtle ways than actually handing the inspector a bundle of cash. Discuss the incentive issues involved in such a bribe.
Corruption is already an ancient problem. It used to be the demander of a good that might be willing to bribe to get access to a good, not the supplier. The demander of an insurance benefit may in most circumstances be willing to bribe to get access to its resources, not the insurance company paying a customer to accept its services. Corruption can be seen as very differential, because social norms are very different in different countries. What is regarded in one culture as corruption may be considered a part of routine transaction in another culture.
In my view they have in common that bribery is something to convince somebody to change his mind or even to lie.
In the case of bribing I mention three parts. On the one side there is the supervisor who wants to control a company regarding for example security. On the other side there is the company which should have these security standards to be able to leave the port or to get registered. These two parties are connected through an inspector. If the shipping company did precautions and has the demanded safety standard, it has nothing to fear from the inspectors, they will do their job well and will report it to the regulator. Everyone will be satisfied.
What if the situation is changed and the company knows of its lack of safety? The inspectors would report this information to the controller and the ship had to stay in the harbour until the safety conditions are completed. This could be a real problem for the shipping company when there are business partners who are already waiting to trade.
Probably they are manufacturers and there is no possibility to wait any longer, so they will change their partner and will finish the relationship with the company.
This could have been avoided if the company had bribed the inspectors. The company’s advantage would be to get registered without complications and the advantage of the inspector would be the extra money or whatever he got for his action.
So, bribing seems to be the perfect solution.
But a problem will arise when the inspector has to fear to be monitored. If he would be caught getting bribed he would loose his job and would have to pay a fine. The risk would be much higher in comparison to before, where he could be sure not to be controlled by the regulator.
The inspector would probably take this risk just for a higher corruption charge. This extra payment has to be high enough to be equal if he got discovered. If the company can resign to this higher price the solution is good. But what if this corruption fee is higher than the costs the company would have because of their lack of safety?
Bribing is not always that easy it looks like. There are always the pros and cons to mention if the risks of bribery pay off.
7. Discuss the different ways of ‘punishing’ the shipping company after an accident has occurred and the company has been made liable. Which are the pros and cons of the different methods, for instance jail sentences or fines. What kind of incentives do these create for the responsible decision makers?
Concerning an occurrence of a ship accident, there will be examinations if the incident was caused in order of carelessness brought about the ship company or of another reason. If the inspectors come to the decision that the transportation company is liable, she will have to ‘pay’ in return somehow. The most common way to compensate is the fine. The company in question has to pay a particular amount of money and has no other disadvantages. Generally I would set this kind of payment quite high for eluding the effect, that these companies count this fine already for their expenditure. If they do not have any problems, speaking from a control or an accident, they are lucky and if they would have to pay, it would not be that big problem, because they took this amount already into their balance sheet. By the way, if the fine would be an amount which could be a real danger for the future of the company, especially for small companies, the effect of deterrence would be much higher. This is the first advantage I want to mention, deterrence.
A possible disadvantage could be when the decision maker, the ship-owner, knows if an incident arises and he probably has to pay a fine that he does not want to spend a big amount on a safety check, for the reason he does not want to pay the protection and the fine together. So it could be that he likes to take the risk of not having a problem because of the not done examination and if he would have to pay, it would not be that bad for him, because he saved already money with no checking the vessel before.
Another familiar way of punishing a ship company is to give them jail sentences. Concerning deterrence, jail has a very good effect. The positive part of having jail sentences as a deterrence factor is that a shipping company in contrast to the fine effect will definitely prefer investing more money in security on board than having problems afterwards which results in going to jail. In my opinion jail, as a form of punishment harms in no doubt the reputation of the transportation company by far more than having to pay just a fine. As a customer or even as a business partner from such a company which had serious problems in a ship accident, the penalty ‘jail’ stays longer in your mind. If you would compare two companies which had for example the same accident with because of the same lacks of safety on board and one of these two will be punished with a fine and the other one with jail sentences, you would automatically connect the latter one with a worse crime. That is why, if I had the opportunity to choose my punishment in such a situation, I would always prefer to pay the fine as saving money and going to jail. Normally there is no opportunity to choose and these two penalties jail and fine are often seen combined.
As a disadvantage of punishing a transportation company with jail I would mention the fact that this company is taken out of business for a particular time. So this kind of punishment does not only harm the concerned company but probably the whole business chain where the punished one is in the middle. There are also costs for the rest of this chain to find a new member which replaces the particular company. Instead of jail I thought about stripping someone of his power to sail at all, but this kind of punishment would be certainly too hard and it would not make any sense, because the concerned person has not chance anymore to improve himself. Regarding this idea it would be quite effective to strip someone of his power just for some time. So, the punished does not have to go to jail, which is good for his reputation, but cannot continue his business for a couple of days.
The only problem here is that this causes the same effect, already said before, that the whole business chain has to pay. So you could change this notion to a temporal prohibition just for particular routs and this is in my mind one of the best solutions. The shipping company can continue its business but probably with more work. If it is no big deal to take another route, the incentive of the ship-owner would be to cut down the expenditure in examinations, so it is important to embargo these routes where the ship-owner is better off in making security checks before than taking such an afford of taking the long way round, which is also connected with costs.
Nowadays where a lot of ship traffic is already present, this would simultaneously be a solution to ease the traffic on the main routes.
If someone does not respect this sort of punishment, the consequence could be jail.
8. Reputation is important, at least in passenger traffic. But is it as important in cargo traffic, given the possibility of insurance? Discuss!
In my view, reputation is the key to trust. You will always connect good reputation with good quality and service. In general it is a long way to gain the trust of your consumers and to establish a good reputation of your company. Above all an expensive way. So the most important thing for companies is to care about their reputation and to maintain it. In passenger traffic it is of especially importance to have a well known reputation. As the view of a consumer f you enter a ship you would like to leave it again without any complications. It can be a decision between life and death which ferry you take to go on holiday for example. So you likely let yourself be guided from recommendations.
It is not the same now in the case of cargo traffic but I think reputation is still important. A good reputation can be the glue for business relationships like I mentioned already by answering some questions before. Also as a businessman you do not want to have a risk when you sign a contract. You do not have to fear of your life like in the case of consumers regarding passenger traffic, but you have many risks, too. As a result you will prefer to trade with these companies which are well known and from which you did not hear anything bad. When I think now about the possibility of insurance, I have still my opinion about the importance of a good reputation. As an insured company you probably loose risks like the risk of having to pay in the case of an accident, but the insurance will not care about your lost profit and especially not about your reputation. As a consumer you will hear about an incident where a ship sank with its cargo. If the time comes and you want to send a delivery somewhere, the name of the sunken vessel will come again to your mind and you will probably choose another transportation company. Even if you knew the fact, that the cargo was insured and everybody got his money you would like to avoid possible problems with taking another company.
I would say that reputation is as important in cargo traffic even if the opportunity of insurance is given.
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