The New Cold War
In late September 2018, the Venta Maersk arrived at the port of Saint Petersburg, Russia, following a five-week voyage from South Korea through Arctic waters north of Siberia.
It was a significant milestone, the first container ship from Maersk to successfully navigate the Northern Sea Route. Officials at the Danish shipping giant described the trip as a onetime event, intended only to gather data. But climate change could soon turn the once-impassable route into a busy maritime highway for oil tankers, liquified natural gas carriers and perhaps ships carrying consumer goods. The Arctic is now losing ice at a pace of about 13% a decade, and some models project a near-complete absence of ice in the summertime as soon as 2030—and almost certainly by 2070.
Among those watching the Venta Maersk’s trial run closely was Captain Andrew Kinsey, a 23-year veteran of the U.S. Merchant Marine who now serves as a senior marine risk consultant for Allianz Risk Consultants (ARC). The potential opening of the Northern Sea Route is a “monumental” event, says Kinsey, whose father was also a mariner and whose son attends the Maine Maritime Academy.
“I grew up in the industry, and we literally are sailing the same courses and transiting the same routes as Magellan in many regards,” Kinsey says. “A new shipping route is unprecedented in my lifetime or my father’s lifetime, so the impact for us is quite astonishing, really.”
But for both mariners and insurers, that sense of astonishment is tempered by many unknowns.
“You’re starting with a blank slate,” Kinsey says of ships navigating around icebergs. “You don’t have current charts, you don’t have bathometric data, you don’t know what is under your keel, literally.”
One thing is for certain: if the Northern Sea Route does develop into a heavily traveled shipping option, the insurance industry will play a major role in defining the scope and the timing. In fact, determining the future of the passage is just one of several ways marine insurance is shaping the geopolitical risk map and, in turn, the shipping industry.
Traversing the Ice
Globally, marine insurance totals close to $29 billion a year, with $6.9 billion spent on hull insurance and $16.1 billion on cargo coverage, according to the International Union of Marine Insurance. The interplay between insurance and the shipping trade shifts as new developments—changes in a trade route, limits on carbon emissions, political disruptions that raise risks in volatile regions—factor into the mix.
The stakes in those interactions are high and affect consumers worldwide. Shipping accounts for 90% of global trade and involves more than 50,000 merchant ships around the world, according to Allianz’s 2018 Safety and Shipping Review.
“It’s a continually changing landscape, and it tends to highlight how delicate at times this supply chain that we rely on can be,” Kinsey says. “We tend to think of it as a very robust transportation network, but it doesn’t take much for overall supply chain disruptions to have a far-reaching impact.”
Maersk officials say they’re happy with the results of the Venta Maersk journey. “The trial allowed us to gain exceptional operational experience, test vessel systems, crew capabilities and the functionality of the shore-based support setup,” Palle Laursen, the company’s senior vice president and chief technological officer, said in a company statement after the ship reached port.
But Laursen also said the company doesn’t see the Northern Sea Route as a viable alternative yet because passage is feasible only three months a year and requires large, ice-classed vessels, which would necessitate an additional investment. The Venta Maersk is a Baltic feeder, one of the world’s largest ice-class vessels, but it needed an escort by a Russian nuclear-powered icebreaker at some points during the journey.
While Maersk plays wait-and-see on container ships, others in other industry segments are venturing ahead. Early last year, the Eduard Toll, a liquid natural gas tanker designed for Arctic travel, became the first commercial ship to traverse the Northern Sea Route in the winter without an icebreaker leading the way. The trip from South Korea to France via northern Russia was about 3,000 nautical miles shorter than it would have been via the Suez Canal. It encountered ice about six feet thick.
Others are also making the journey, though usually with icebreakers as companions. Cargo volumes along the Northern Sea Route rose to 9.7 million tons in 2016, an increase of 40%, according to the Russian Federal Agency for Maritime and River Transport. The tonnage is expected to jump to 40 million by 2022 and to 70 million or 80 million by 2030, thanks to growth in oil and gas fields.
Russia and China are eager to see use of the route increase. Russia, in particular, stands to benefit because the shallow waters near Siberia have less ice for longer stretches of the year. Vessels must apply for permits to pass through Russia’s economic zones and pay fees to be accompanied by an icebreaker. China, a near-Arctic state, is hoping to develop an “Arctic Silk Road” in areas opened up by climate change.
Backers of the Northern Sea Route pitch it as a cheaper, shorter alternative to the Suez and less tumultuous than sea lanes in the Gulf of Aden, the Indian Ocean and the South China Sea. Last summer, the first shipment of liquid natural gas left Russia’s new Yamal production facility and reached its destination in China 16 days faster than it would have via the Suez Canal.
But there’s substantial debate about the wisdom of introducing large volumes of maritime traffic to the Arctic’s already fragile environment along a route that is largely controlled by the Russian government.
The complications pile on for insurers assessing coverage for ships. “You’re dealing with unknown weather patterns,” Kinsey says. “You’re dealing with a harsh environment, in terms of the crew and the ship and the cargo. There are tremendous amounts of exposures, and there are tremendous amounts of risks that have to be properly evaluated.”
It’s not exactly smooth sailing. According to Allianz’s safety report, there were 71 shipping incidents in Arctic Circle waters in 2017, a jump of 29%. More than 1,000 icebergs were reported in North Atlantic shipping lanes in 2017, according to the International Ice Patrol, a U.S. Coast Guard-affiliated organization that has been tracking ice since the sinking of the Titanic in 1913. Last year was the 19th most severe in the past 100 years and the fourth consecutive year classified as “extreme.”
“Such extraordinary conditions require complementary training for crew, as well as additional routing support,” Arnaud Gibrais, a senior marine risk consultant at AGCS, noted in the Allianz report.
Kinsey believes the Northern Sea Route will see continued growth but says it isn’t likely to cause a significant shift in existing routes. “I don’t see a major impact on either the Panama Canal or Suez Canal traffic,” he says, “but I do expect to see continued utilization of a new and viable shipping route.”
Stephen Harris, a senior vice president at Marsh with more than 40 years of experience in marine insurance, shares that skepticism. He took part in a meeting of the All Party Parliamentary Group (APPG) for the Polar Regions at the British Houses of Parliament last fall, and much of the discussion was about the geopolitical implications of ships passing through Russian waters. “There’s been an awful lot of press about increased use of the Northern Sea Route,” he says. “However, we have to be realistic in the expectations of growth of traffic going through the NSR.”
For starters, Harris says, many vessels are simply too large to navigate those waters. “We understand that in the East Siberian Sea, which is on the northeast part of the Northern Sea Route, there are places where it’s not possible to get a vessel with a draft of more than 10 meters—about 31 feet deep—through the water,” he says. “We are never really likely to see the big container ships and the big oil tankers ever using that route simply for the physical reason that they can’t get through. It’s not because of the ice. It’s because of the shallowness of the water in certain places.”
There is potential, however, as Russia’s numbers indicate. “Perhaps the oil and gas industry is the area where we will see growth,” Harris says. “Russia seems very keen on developing their Yamal Peninsula and their oil and gas terminals.”
The Polar Code
The insurance industry is preparing for some impact. Shipping in the Arctic region is guided by the International Code of Safety for Ships Operating in Polar Waters, known as the Polar Code, which took effect this year. The code, established by the International Maritime Organization, sets requirements for design, construction, equipment and training for operating ships in polar regions.
But Kinsey and others believe the code, used by both the shipping and insurance industries, must be updated more quickly than IMO guidance for other parts of the world, a process that can take five years or more. “This is a fast-changing route, it is an unknown route, so I feel it is critical that the data we capture from successful voyages, the routing of those vessels, is shared,” Kinsey says.
The shipping industry also needs to shift away from its focus on analyzing what goes wrong in a voyage, according to Kinsey. “We don’t spend nearly enough time studying voyages that go right,” he says. “In this age of big data and the internet of things, we have to start to change our mindset. We have to start utilizing existing data to understand why that voyage was successful and simulate that, rather than identifying voyages that aren’t successful and saying, ‘Don’t do that.’”
Harris says the Polar Code, while still new, is already serving a valuable role. “Frankly, a vessel that is not strong enough, that is not well enough equipped, and crews that are not adequately trained in dealing with Arctic and Northern Sea matters should stay out of the waters,” he says. “That’s essentially the message of the Polar Code, and underwriters, I’m quite sure, will welcome that because it will actually help them minimize the risk of insuring those who do go through those waters.”
Technology may be developed to reduce risk. For example, drones equipped with cameras could play an increasing role in assessing hazards at sea, according to the Allianz report on safety. “If there is an incident, drones could also be used to assess damage, helping to mitigate losses, avoid loss of life or limit any potential environmental impact,” Volker Dierks, head of marine hull underwriting for Allianz in Central and Eastern Europe, says in the report.
There’s another factor that insurance industry and mariners should consider in Arctic waters, Harris says. At the APPG meeting in the British Houses of Parliament, he brought up the question of who will rescue ships as they ply dangerous waters.
“Where are the salvage and rescue services that would come to assist a vessel that gets in trouble?” he asked. “That is a serious concern for underwriters. It’s all well and good making sure that the vessel is well crewed and trained and the ship itself is sound, but if ships break down—ships do have accidents—where is the help going to come from?”
Harris says the question needs to be considered not only by cargo ships but by cruise ships carrying passengers. “Yes, it looks very attractive in a brochure from a cruise company, but the risks are considerable,” he says. “And when you have that many non-mariner people—i.e., the passengers—involved, should an accident happen, there is concern what the results might be.”
On Board with Sanctions
Icebergs aren’t the only now-you-see-them, now-you-don’t challenges facing underwriters. The insurance industry also must navigate sanctions imposed against rogue nations by the United States, the European Union, the United Nations and others. The list of target countries and prohibited goods can change frequently in the course of the year. At the moment, the United States has more than two dozen active sanctions programs, roughly triple the number 20 years ago.
The current list, maintained by the U.S. Treasury’s Office of Foreign Assets Control, includes Venezuela, Cuba, Syria, Sudan and other countries that pose a threat to peace in their region or have compiled a long record of human rights abuses. Others, like Iran and North Korea, are targeted because they’ve sought to obtain weapons of mass destruction.
In November, for example, the United States reinstated trade sanctions against Iran after the Trump administration withdrew from a 2015 deal designed to prevent the nation from developing nuclear weapons. The oil, banking and transportation industries were targeted, and the move hit Iran’s oil exports the hardest, dropping shipments by nearly a million barrels a day.
Insurers must pivot quickly when such a change is made and must wind down coverage involving sanctioned nations. “The sanctions on Iran mean we are no longer involved in the U.S. market in the coverage of Iranian tankers or the cargo of Iranian crude,” Kinsey says.
Eight unnamed countries were granted exemptions by the Trump administration, and they reportedly include Japan and South Korea. For insurers handling coverage for shippers based in the United States and the European Union, though, the course is clear. “There are tensions caused by the fact that there are still some countries in the world that still wish to deal with Iran,” Harris says.
For the shipping industry and its insurers, compliance with sanctions requires vigilance. In November, the Office of Foreign Assets Control issued an advisory to the marine petroleum industry warning about the risk of breaking sanctions against Syria. “Countries such as Iran and Russia have been involved in providing Syria with petroleum,” the advisory said. “Those who facilitate the financial transfers, logistics or insurance associated with these or other petroleum shipments are at risk of being targeted by the United States for sanctions.”
The advisory specifically warned shippers to be on guard against tactics used to obscure the provenance of shipments to Syria, such as falsifying cargo and vessel documents, transferring cargo from ship to ship at sea, and disabling automatic identification systems, or AIS.
“Ship registries, insurers, charterers, vessel owners, or port operators should consider investigating vessels that appear to have turned off their AIS while operating in the Mediterranean and Red Seas,” the advisory said. “Any other signs of manipulating AIS transponders should be considered red flags for potential illicit activity and should be investigated fully prior to continuing to provide services to, processing transactions involving, or engaging in other activities with such vessels.”
Such warnings are fairly common for sanctions, including the latest round against Iran. “It’s a concern that things may be masked in order to conceal the fact that they are Iranian-origin goods that are either being directed to Iran or being exported from Iran,” Harris says. “The ingenuity of people to mask the true provenance of goods becomes even more of a problem. The maritime industry has to be extremely careful that oil coming from anywhere in that region didn’t originate in Iran.”
Technology plays a significant role in detecting deception. Oilfields, Harris says, leave a fingerprint on the oil they produce. “A simple surveyor’s test of the oil will very quickly tell which fields that oil came from,” he says.
Doctoring documents to circumvent sanctions—the subject of the Office of Foreign Assets Control warning about Syrian goods—has become more difficult in the computer age. “Changing registries to try to hide a nation of origin is very rare,” Kinsey says. “You can find out where a vessel is from and where it’s been. They have a long history.”
Micro-monitoring of ships also is a safeguard. “On the vessel side of it, we have the AIS, the automatic ship identification system, which allows us to track vessel movement either by VHF if they’re within sight of land or by satellite,” Kinsey says. “You can look at where the vessel is, where the vessel is going, its current course, its current speed.”
The detail is even more granular. “The technology has gotten to the point where we can literally track individual cargo shipments and identify where they are and what their conditions are, how they’re being handled, what types of conditions they’re being exposed to,” he says.
Port-state inspections, which generally adhere to stricter conventions than flag-state inspections, also help protect against subterfuge. “What that does is give us a level playing field to evaluate risk on vessels,” Kinsey says. “Everything is apples to apples rather than having flag states impose their own criteria on vessels.”
Earlier in the year, the United States also layered another set of sanctions on North Korea, barring trade with dozens of North Korean shipping companies and North Korea-flagged vessels, as well as international shipping companies. Russia also has become a frequent target of sanctions.
“If we look the sanctions that the U.S. and the EU have on Russia, the oil and gas technology industries are featured quite prominently,” Harris says. “Insurers are having to be extremely careful about just what they’re insuring in Russia in order to avoid sanctions. The tougher the sanctions get, the more underwriters will retreat from dealing with that country.”
Insurers do have recourse when deception is discovered. “If at the time of a claim, it comes to light that the bill of lading has been amended, tweaked or changed, or is actually fully fraudulent, then of course that gives underwriters good reason to deny paying a claim,” says Harris, who describes the standard sanctions clause as “very cleverly worded.” Essentially, the clause states that insurance is nullified if the goods are under sanction at the time a claim is filed. “The power at that point is with the underwriters because they’re the ones who either will or will not pay a claim,” Harris says. “And if they say, ‘We will not pay this claim because we believe to do so would be a breach of sanctions,’ there’s not an awful lot the claimant can do about it.”
New Pollution Standards
By New Year’s Day 2020, the shipping industry must abide by new pollution standards set by the 173 countries that form the IMO. The insurance industry is at the forefront of those changes, too, advising ship owners on what they need to do to prepare and what non-compliance could mean for their insurance coverage.
The standards—known as Annex VI of the International Convention for the Prevention of Pollution from Ships (MARPOL)—establish stricter limits on nitrogen oxide emissions and require the use of fuel containing less sulfur. The sulfur content in fuel oil must be 0.5% or less, down from the current 3.5%. The aim is to reduce maritime emissions by 50% by 2050.
Shippers have several options: they could use lighter, low-sulfur fuel; install scrubbers that reduce the sulfur content; or switch to natural gas. Some companies, like Maersk Tankers, have chosen to install scrubbers after analyzing fuel supply and equipment costs. The restrictions are expected to increase fuel costs by one third and are said to have contributed to a recent downturn in growth in container shipping. Maersk has estimated demand for container shipping will rise between 1% and 3% this year, down from 4% last year and as much as 8% per year a little over a decade ago.
The effect of the new measures on insurance isn’t settled yet, but it appears ships that fail to adapt to the new standards quickly enough risk losing coverage. “It’s been a matter of huge debate,” Harris jokes. “If you ask four or five underwriters, you’ll get six or seven opinions, because it’s a lawyer’s paradise.”
Marsh has been advising its clients not to assume coverage will continue if a ship doesn’t meet the standards.
“If a vessel fails to comply with the requirements of the Convention, then it would effectively be in breach of the flag state national law, and the vessel’s MARPOL certificate may be withdrawn, or at least suspended, by the flag state,” the company stated in a report last year. “Such action could have considerable significance for the vessel’s continued insurance cover, as historically a breach of warranty within marine insurance conditions has had dire effects on the insurance.”
Marsh points out that nearly all marine hull and machinery policies on commercial cargo vessels, as well as most protection and indemnity insurance associations and most fixed-premium P&I, include a classification warranty, which requires a vessel to remain in class throughout the insured period.
A vessel may be arrested after Jan. 1 if it fails to meet the 0.5% limit. “Hull insurance or machinery insurance that the ship owners buy does not cover the full ship arrest normally, because it’s a physical loss or damage policy,” Harris says. “However, there is another policy that ship owners buy—hull war risks and strikes policy—that does offer arrest of the vessel scenario coverage.”
That coverage, however, contains an exclusion for breaching trading or customs regulations. “Underwriters, I think, are reasonably confident that, on that score of vessel arrest, their exclusions are pretty strong,” Harris says.
Similarly, ship owners will have to demonstrate they’ve taken necessary steps to maintain their ships if they’ve transitioned to lower-sulfur fuel, which can cause more wear and tear on machinery. “The generally held view is that it is the responsibility of the ship operator, the manager of the vessel, to ensure that his vessel is regularly maintained and regularly checked and monitored,” Harris says.
What if the operator has acted diligently—“That is the key legal word, diligence,” Harris says—but still an accident happens? “Most underwriters I’ve spoken to have said, ‘In that situation, that’s what we’re there for,’” Harris says. “That’s what people buy insurance for.”
Maintenance records will be key. “Where there has been a lack of diligence on the part of the operators of the vessel—they just haven’t bothered to check to see if the pipes are corroding and so forth—I can’t see that the underwriter will be so generous,” Harris says. “An operator that fails to act diligently risks having the clams denied on the grounds of lack of due diligence.”
Kinsey, the Allianz consultant and Merchant Marine veteran, says the new standards could be a particular issue for hull and machinery coverage, especially for ships that opt to use lighter fuel rather than install scrubbers.
“One of the keys to understanding when you’re going over to light fuel from heavy is that you have to make up for that loss of lubrication somewhere,” Kinsey says. “I had a situation back in the early ’80s where we went from slow-speed diesels that were burning heavy to burning light just by the nature of the contract. Back then, there was quite a litany of liner failures until we got the lube oil settings right.”
Today’s technology should help more shippers identify potential problems before excessive wear takes a toll, Kinsey says. “We also have the manufacturers who have dealt with this situation, so it’s not an unknown,” he says. “We have the luxury of learning from our past.”
Kinsey says it’s critical for shippers to ensure they’ve made necessary upgrades and identified bunker suppliers for lighter fuel sources before MARPOL takes effect. Training the crew is also essential. “Get the crews involved early and use their feedback,” he says. “They’re the ones who know machinery because they’re operating it.”
Enforcement of the standards could vary from port to port. “This is a problem of global shipping—the rules can be signed onto by national governments, but they have to be policed locally,” Harris says. “Some places are more active, policing things more stringently than others. But, again, it’s the underwriter’s job, as part of what’s in the public domain, to know where those areas are and write risks accordingly.”
Kinsey says that, in many regards, the measure will be self-policing as shippers watch each other’s compliance. “If you have major operators who are doing this, they’re not going to be happy sitting by and letting other people surf,” he says.
Both Kinsey and Harris are concerned, however, that shippers won’t be ready.
Many in the shipping industry have assumed the changes would be delayed because it would be difficult and expensive for so many to comply. “Literally a year or so ago, we were warning our clients this one is coming in, this one is not going to go away,” Harris says. “Living in denial and not bothering to do anything is the wrong move.”
With the deadline rapidly approaching, ship owners must move quickly. “I’ve seen the press that there are queues beginning to form now at shipyards to get scrubbers put on,” Harris says. “The clock is ticking, and shipyards can only repair so many vessels at a time and put equipment on a vessel, and the equipment manufacturers can only make the equipment at a certain speed.”
Harris also says he fears too many ship owners will forgo installing scrubbers and decide instead to pay for the more expensive low-sulfur fuel—those supplies also may dwindle quickly. “We have visions of vessels being stuck in ports because the ports run out,” he says.
The question of supply isn’t just important to ship owners. According to Harris, charterers need to be clear on what their vessels are doing to comply with MARPOL. “If a ship arrives in the port that the charterer has asked it to go to and there are inadequate supplies of the fuel grades the vessel needs, the vessel’s just going to sit there,” Harris says, “and it is the charterer who will pick up the tab for it.”
Insurers, in turn, may be on the hook. “If a charter incurs a liability arising out of the charter party,” Harris says, “it’s the insurers who would have the problem, because that’s why a charterer buy charters liability insurance. It’s to protect him against the liability he incurs under the charter party, and if one of the charterer’s responsibilities is to provide adequate fuel for the vessel, it’s the charter liability insurers who end up picking up the final tab.”
Some ship owners, it appears, are still holding out hope that the start date for MARPOL 2020 will be delayed. “We don’t want this to slowly creep up on people and they’re caught unawares,” Kinsey says. “I think that people talking about it, yelling about it, arguing about it is good.”
“Unfortunately,” Harris says, “I think we’re going to see a mad scramble near the end.”