Protection and Indemnity Insurance
The Borrower covenants to ensure that the Vessel shall be and shall remain insured at its expense against protection and indemnity risks and liabilities (including, without limitation, protection and indemnity war risks) for the highest amount (if any) from time to time available in the international marine insurance market for vessels of a similar age, size and type to the Vessel.
What is it and what does it do?
Protection and indemnity insurance (often referred to as “P&I” insurance) is a liability insurance coverage. It covers maritime liability risks, including, notably:
- Collision liability
- Damages to or loss of cargo
- Liabilities imposed after pollution or oil spill
- Wreck removal
P&I coverages are distinguished from hull and machinery insurance which covers risks against physical damages to the vessel.
Why is it there and how is it relevant to shipping?
Mutual P&I club insurance coverages are unique to the maritime industry. The origin of it goes back to 19th century London where shipowners sought indemnity insurance for cargo liability. Faced with insurance underwriters hesitant to take on such risks, shipowners formed mutual P&I clubs to insure themselves. The concept spread through the world, and many major shipping jurisdictions have their own P&I clubs, including the United States, South Korea, Singapore, Japan, China, and of course, the United Kingdom. Thirteen of the major P&I clubs now form the International Group of P&I Clubs, or IG P&I, which provide P&I insurance for the overwhelming majority of the world’s ocean-going vessels.
Marine insurance claims, particularly for wreck removal and oil pollution, may be very significant. For example, it is common for a P&I insurance policy for a major ocean-going vessel to have up to one billion dollars of coverage for pollution claims. The IG P&I spread the risk of such major claims across the IG P&I members by pooling claims and arranging for group reinsurance. Given the risk of major claims and the significant pooled resources of the IG P&I, it is a common requirement in a loan agreement that (a) a borrower maintain P&I insurances with one of the IG P&I member clubs, and (b) that such coverage extend to the highest amount available from the IG P&I member clubs.
In addition, virtually every claim that P&I insurance covers might, if unpaid, represent a maritime lien ranking higher than a vessel mortgage (subject, of course, to the laws of the relevant local jurisdiction). Therefore, a lender needs to ensure that sufficient P&I coverage exists in order to prevent such unpaid claim against the shipowner coming ahead of the lender’s mortgage lien in an enforcement scenario.
How is it negotiated?
While most financing agreements relating to vessel finance have extensive insurance provisions, including relating to P&I coverages, they are typically not subject to much negotiation because insurance terms are perceived to be standardized. Vessel owners also lack the negotiating leverage against P&I clubs or other insurance underwriters to change the terms of the P&I insurance policy in any significant manner or to compel P&I clubs to agree to any undertakings that differ from such P&I club’s standard practice.
A lender has an important interest in the vessel’s insurances, in that in the case of a loss or claim against the vessel (which may comprise the lender’s sole or most significant collateral), the lender needs to be able to step in and assert its interest in the proceeds of any insurance pay-out. Where there is some level of negotiation between a lender and a borrower is the contours of the terms of the insurance assignment that sometimes trigger additional expenses or efforts on the part of the borrower. For example, P&I insurance being a liability coverage sometimes includes other co-insureds that have the benefit of the policy, including third party vessel or crew managers or entities affiliated with the vessel owner that provide some ancillary services to the vessel. A lender may further protect its interest in the insurances by insisting that such co-insureds limit and/or subordinate their claims against the insurances.
A more fulsome discussion of insurance assignments has been covered in a previous edition of Simply Speaking, which can be found here.