Hitting the High Seas? Check Your Pirate Insurance.

By Chadwick Matlin
Sunday, November 23, 2008

It took the original "Pirates of the Caribbean" more than a week to earn $100 million at the box office. It took the pirates of the Somali coast less than a day to seize $100 million worth of crude oil last week. Thar be pirates, indeed.

The pirates' seizure of the Sirius Star -- a Saudi oil tanker carrying 2 million barrels of crude -- has laid bare an issue that has long plagued maritime trade: More pirates equal less safety. Somali pirates have claimed 95 vessels this year, far surpassing previous years. The riskier the voyages become, the higher operational costs will be. Insurance plans will start charging higher principals, circumspect routes will be used, and financially burdensome security details may have to be hired. In all, though, consumers won't feel much pain, thanks to the unique economics of sea transport and the security blanket of naval power.

There are three tiers of pirate protection for every vessel. The price is set the same way any other insurance rate is: by a calculation of risk. The ship's key statistics -- size of ship, size of crew, length of journey, transport route, docking port, etc. -- are weighed and evaluated.

First, there's the basic hull insurance, which insures damage to the ship and its cargo from "marine perils." There's some debate about whether this covers damage incurred from a pirate attack, so there's another plan -- the ominously named "war policy" -- that is sure to protect you from violent damage. Just to be safe, there's also a kidnapping and ransom policy -- "K&R" to those in the nautical know -- that insures against losses of what the pirates are really after: money. Portfolio magazine has reported that K&R premiums at one leading insurer, Hiscox, are now 10 times the price they were a year ago, but Hiscox declined to confirm or deny that number to me. Brendan Flood, a member of Hiscox's marine staff, did confirm that "quite clearly rates have gone up" over the last six to nine months. None of the companies I interviewed for this story would share hard numbers on how much it costs to take out any of the insurance policies.

These costs have gone up mainly because the voyages in question steam through the Gulf of Aden, which has become a cantina of pirate activity. Via the Suez Canal, Aden is the main waterway for freighter-based trade between Asia and Europe; 20,000-plus ships go through Aden a year. The alternative is not ideal -- it's sailing all the way down the east coast of Africa, around the Cape of Good Hope and then back up the other side. Analysts say that a Cape of Good Hope route would add two to three weeks of travel time (an increase of 30 percent) and hundreds of thousands of dollars of cost to the endeavor. Complicating matters further, the Sirius Star hijacking took place while the Sirius was traveling not within the Gulf of Aden but on its way along the Good Hope route. If piracy flourishes along that route, it's not just Good Hope insurance premiums that will go up. So will the hijack count.

When it comes to pirates, if you can't avoid them, think about intimidating them. More than a dozen navies have been tasked to the region but have little to show for their efforts (despite India's success at cannon-balling a pirate mother ship last Tuesday). European Union reinforcements are on the way, which should help. But if the situation doesn't improve soon, shippers are prepared to take things into their own hands.

Blackwater Worldwide -- last seen questionably serving alongside U.S. troops in Iraq -- is prepared to step in and fill the void. The company's spokesman told me that over the past two months, Blackwater has received calls from 70 different companies interested in having Blackwater's ship escort them through the Gulf of Aden. The package includes the usual goodies -- 45 trained personnel, a host of weapons and an attack helicopter. Nobody has paid for a private escort, but Blackwater is thinking of sending the ship to the Gulf and contracting envoys ad hoc. The company says it's cost effective for everybody. If they latched onto Blackwater's protection, shippers' insurance premiums would drop, allowing them to afford the protection in the first place. Added costs, of course, would still be passed along to the consumer.

There are other options in this emerging market. Plenty of companies can provide hands-on service. The hired guns aren't all lethal, either. Daniel Walsh, the president of M-PACT, told me that there are "tools out there that shoot and generate heat, tools out there that shoot and generate sound. All sorts of measures that keep smaller ships at bay that are non-lethal, including the firing of rubber bullets or beanbags." Walsh said that since the Sirius Star was hijacked, M-PACT had received a half-dozen unsolicited calls inquiring about security options.

It's worth noting that escalating the defense measures is not smiled upon within the industry. The law governing sea violence -- unimaginatively called the "U.N. Convention on the Law of the Sea" -- allows for guns to be carried on civilian-owned and -operated ships, but industry practice is to avoid doing so.

Simon Bennett, a spokesman for the International Shipping Federation, says that wielding firearms around potentially flammable cargo is an explosively stupid idea, especially because nobody knows whether on-board weapons actually deter pirates. But considering the uptick in inquiries reported by firms such as Blackwater and M-PACT, self-interest seems to be superseding de facto industry standards.

All this means that transporting and securing commodities might start costing more. But it shouldn't be a painful increase. Take oil, for example. According to Bennett, gasoline costs only about 1 cent per gallon to ship. It costs much more to get the oil out of the ground than it does to take it across the water. A spike in insurance rates or security costs is negligible compared with the whims of OPEC and the market. This ratio applies to other commodities, as well. Even if shipping costs doubled because of piracy, it still wouldn't make much of an impact on consumer prices. None of the analysts I spoke with suggested that prices are due for a major rise.

The building momentum behind an international navy presence in the area is the real trump card. All of the naval activities won't translate into higher consumer prices; the Pentagon budget doesn't have much impact on the price of gas. Once the pirates are under control, insurance premiums will slide back to previous levels, and third-party security details won't be necessary. Unlike in the movies, the navy is still more powerful than a pirate militia.


Chadwick Matlin is the staff reporter for the Big Money.

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