Introduction
Approximately 80% of world trade currently travels by sea, representing around 93,000 merchant vessels, 1.25 million seafarers, and almost six billion tons of cargo. Since the end of the Second World War, seaborne trade has doubled every decade. In recent years, the international community has witnessed one of the world’s oldest crimes against this trade – piracy – reemerge and flourish.
Yet, we still do not have a clear sense of the cost of maritime piracy. This paper attempts to add to discussions held between industry representatives and academics alike over the global cost of piracy. Although it focuses on economic costs, there are also tremendous human costs associated with this crime. Over the past five years (2006-2010) there have been around 1,600 acts of piracy which have caused immeasurable harm to the world’s seafarers, including the deaths of over 54 individuals.
The following paper addresses:
a. The project’s framework and background, including some of the complex methodological difficulties we faced in conducting a study of this nature.
b. The direct financial costs of piracy, such as: ransoms, insurance premiums, the costs of re-routing to avoid piracy regions, deterrent security equipment, naval forces, piracy prosecutions, and anti-piracy organizations.
c. The secondary (macroeconomic) costs of piracy, such as: effects on regional trade, fishing and oil industries, food price inflation, and reduced foreign revenue.
d. A concluding section aggregates these global costs of piracy.
Project Framework
Some good efforts have been made to assess the global cost of maritime piracy. Most organizations, notably have estimated that piracy costs between $1 and $16 billion per year. These studies note the complex difficulties faced in calculating the cost of piracy, and most have been primarily focused on addressing first-order costs (such as the cost of ransoms, security deterrence equipment, and the presence of international navies). They have generally not looked at the knock-on secondary costs of piracy, such as affects on foreign investment in regional nations, or how piracy affects commodity price inflation.
Methodological Difficulties
The cost of piracy is notoriously difficult to calculate. A recent actuarial study on the same topic concluded, “the challenge to the actuaries involved in pricing maritime insurance products is considerable…information about the attacks issued by shipping owners is often vague. Understandably, shipping owners don’t wish to encourage further acts of piracy, but without knowing the full details we cannot come up with the true cost.”
There are also strong disagreements between different industry and government representatives over the costs of piracy. One study shows some of the key contentions between different representatives. It relays how a shipping investment specialist in New York says: “It’s no big deal – insurance covers it.” A maritime lawyer claims: “It’s putting a lot of pressure on costs at a time when the market is still quite depressed from where it was 18 months ago. Either you pass on those costs or it drops to the bottom line.” While an industry consultant asserts: “The insurance industry hasn’t completely got its hands around it.” Finally, “This whole thing is costing the industry billions.
Some of the toughest challenges that we faced in calculating the cost of piracy were:
- Data limitations: This study has faced difficult challenges in locating and assembling data on the costs of piracy. The project analyzed around 350 articles and papers on piracy and the shipping industry, but unfortunately there is still data missing. We have used proxies, averages, and estimations in some areas in order to fill some of these gaps. We welcome any data sources, suggestions, or information that academics, industry representatives, or others might have.
- Imperfect reporting on piracy: The IMB is generally accepted as the primary source of information on piracy in the world. However, the IMB is restrained by the volume of piracy attacks it is permitted to report and document. “In some cases the ship’s owners dissuade the captain from reporting an attack….They don’t want bad publicity or the ship to be delayed by an investigation. Others have suggested that “only an estimated 30-40 percent of pirate attacks on commercial ships are reported.” Piracy is downplayed by both governments and industry for both political and commercial reasons.
- Disaggregating effects from general financial/political instability: As is mentioned in different sections throughout this paper, it is incredibly difficult to disaggregate the effects of piracy on macroeconomic variables such as reductions in foreign direct investment (FDI), tourism, or commodity price inflation. Since piracy often surfaces in poor, developing, or failed states which are prone to political instability, we are forced to speculate over what impact piracy independently has. The current global economic recession is another complicating factor. How can we determine whether changes in shipping behavior is related to piracy, or an overall deflation of the industry?
The following cost estimations are therefore produced as accurately as possible, bearing these methodological difficulties in mind. We broadly divide the costs into direct costs, and secondary (macroeconomic) costs.
The Direct Economic Costs of Piracy
The following section addresses the main direct costs of piracy, including: the cost of ransoms, piracy insurance premiums, deterrent equipment, re-routing vessels away from piracy risk zones, naval deployments in piracy hot zones, piracy prosecutions, and organization budgets dedicated to reducing piracy.
The Cost of Ransoms
One of the most spectacular increases in the costs of piracy in recent years has been the increasing price of ransoms paid to release hijacked ships. Ransoms are generally sought by Somali pirates. Pirates in other regions have more often stolen the vessel or cargo, rather than ransoming the value of the seafarers’ lives and their ship.
In November 2010, the highest ransom on record, $9.5 million, was paid to Somali pirates to release the Samho Dream, a South Korean oil tanker. Indeed, 2010 set a remarkable record for the cost of ransoms, with the year kicking off to a $7 million ransom paid in January to release the Greek supertanker MV Maran Centaurus, which had been carrying $162 million of crude oil from Saudi Arabia to the United States. The ransom demonstrated the exponential increase in the price of ransoms in recent years. In 2005, ransoms averaged around $150,000. By 2009, the average ransom was around $3.4 million. In 2010, ransoms are predicted to average around $5.4 million.
Problematically, increasing ransom payments appear to be lengthening negotiations, and therefore the duration seafarers are held hostage. The average length of negotiations has more than doubled over the past year as pirates seek, and receive, larger ransom payments. Ships were held for an average of 106 days between April and June of 2010, up from just 55 days in 2009, and the last four ships released in November 2010 were held for an average of 150 days. Seafarers now face the likelihood of three to four months of captivity.
The total cost of ransom is estimated to be around double the value actually paid to pirates. The total cost is duplicated by a number of factors, such as: the cost of negotiations, psychological trauma counseling, repair to ship damage caused while it is held captive, and the physical delivery of the ransom money, often done by helicopter or private plane. Finally, large costs result from ships being held and out of service. For instance, it costs around $3 million for a cargo ship to be held for two months at a charter hire rate of $50,000 per day.
The increasing disease of piracy and its impact mostly to seafarers, shipowners, international traders and of course Underwriters, is the distraction that piracy causes to world trade and its financial cost to owners and marine insurers is the major point of discussion for rather long time. Actually, whatever theme might have chosen, we would have had to bring in piracy because it is something that is very much on the current agenda for all marine underwriters. It’s relevant to our ability to respond to the needs of our clients and our ability to be there with financial security when it is required.
A growing problem
Underwriters says piracy is a growing problem and could remain a high priority for the industry for the foreseeable future. A major concern for marine underwriters is the broader area in which ships are being taken. It seems the area of operation of the pirates is spreading and, therefore, it encompasses a greater number of ships.
Obviously the internal politics and law of Somalia is something that is difficult for marine insurers to deal with, primarily we have to try and get our ships and cargos released. But we would like more engagement from international governments whose ships are affected by this to try and find a solution, whatever that may be. Unless there is action I think piracy is going to remain on the agenda for a number of years to come.
The loudest organization calling for government action is the Save our Seafarers (SOS) campaign. It is unprecedented that a group of so many leading maritime industry associations have combined forces in such a way to raise awareness of the issue of piracy.
The combined membership of the SOS steering committee covers almost the entire maritime world. While other groups within the industry are focusing on the practical necessity of dealing with how to protect the ships and seafarers, they are not lobbying for governmental action like we are.
SOS is urging governments to take a firmer stance against piracy, especially in Somalia and the surrounding regions. The organization estimates that 2000 pirates are operating in 130 well-organized and well-armed gangs. Somalia remains the critical threat to shipping, with reports that more than 400 seafarers are currently being held on 20 vessels. Additionally, according to reports, there are now 21 countries affected to some degree by piracy off their shores.
Policing waters
Trying solving the problem of piracy requires changes in the ability of Somalia to govern and control its waters. In the meantime, insurers have gained experience from dealing with the consequences of attacks.
Property insurers and specialist kidnap & ransom underwriters have been at the forefront of helping shipowner’s source expertise for dealing with ransom negotiations. P&I Clubs deal with claims pursued against shipowners for crew injury or distress, cargo damage or disputed general average contributions.
The risk of claims for crew suffering has grown with longer hi-jack periods and greater use of violence. While insurers and shipping associations have collective experience of dealing with incidents, so do the naval forces operating off Somalia. Sharing information to study what has worked to defend ships, and what has gone wrong, translating this into practical advice and keeping it updated this is key to reducing the effectiveness of pirates.
Generally there’s more of a move towards acceptance of armed guards as a protection but I don’t think that is the whole answer. It’s a very difficult issue and marine underwriters can’t solve the problem, all we can really do is try and control the risk. The solution to piracy will be on shore, it’s not a solution that is going to be found at sea. What we must do is work with our clients to try and make sure the risk we are writing is as controlled as possible.
Marine underwriters are in the job of assessing the risk, pricing it and then responding to the consequences, so we do have a vested interest in understanding what our clients are doing to manage those risks themselves.
On the major issue of piracy, this is certainly an area where I shall be looking to bring home some insight. It will be interesting to hear the latest developments, particularly in relation to the legality of armed guards, the pros and cons of their use, and the legality of ransom payments together with the problems of their delivery.
We have to understand those risks as best we can and then price them. That is where I think the instability that is present in an international hull underwriter’s portfolio is quite considerable now big asset values on some very complex vessels and I am not convinced that that sort of step change in technology and scale has been taken into account in pricing levels over the past five to 10 years.”
We need to concentrate hard on the risks we as Underwriters are writing, understand them and properly select those for our portfolio. As technology develops it becomes more and more important to do so.
The Piracy Project & its Cost
At the end of 2010, around 500 seafarers from more than 18 countries are being held hostage by pirates.
Piracy clearly affects the world’s largest trade transport industry, but how much is it costing the world?
The focus has inevitably been on the costs of Somali piracy because this is the region where contemporary piracy is most highly concentrated and is the greatest source of current data and information. The project primarily analyzes direct costs, but also considers some secondary (indirect) costs. We hope the model, report, and calculations produced by this study will be a useful tool for analysts and policy makers working towards solutions to piracy. The project is designed to be a collaborative effort.
Ransoms
Over the past five years, ransoms paid to Somali pirates have increased from an average of $150,000 in 2005 to $5.4 billion in 2010. The largest known ransom payment was for the South Korean oil tanker, the Samho Dream. This vessel was ransomed for a record $9.5 million in November 2010. By the end of 2010, approximately $238 million was paid in ransoms to Somali pirates in that year alone.
Insurance Premiums
Shippers purchase four main types of insurance as indemnity against piracy: war risk, kidnap and ransom (K&R), cargo, and hull. The most significant increase in premiums has been in ‘war risk’ and K&R. The Gulf of Aden was classified as a ‘war risk area’ by Lloyds Market Association (LMA) Joint War Committee in May 2008, and is therefore subject to these specific insurance premiums. The Cost of Piracy Model calculates the additional cost of insurance to the shipping industry by using a lower bound estimate (10% of ships purchasing these insurance premiums) and an upper bound estimate (70% of ships). From these calculations, we estimate that total excess costs of insurance due to Somali piracy are between $460 million and $3.2 billion per year.
Forces Guarding the Vicinity
By our calculations, around $2 billion is spent each year on naval operations off the coast of Somalia. The cost of naval presence comes in two forms:
(1) The cost of each contributing naval vessel. We calculate these costs by using approximations of the cost of deploying a ship per steaming day, and multiply this number by the number of vessels deployed each year (currently around 43);
(2) The administrative and staffing budgets of the ‘big three’ naval operations:
i. Operation Atalanta
ii. Operation Ocean Shield, an
iii. Combined Task Force 151.2
Prosecutions in respect of Piracy
Over 750 Somali piracy suspects have either been tried for piracy, or await trial in more than 11 countries. To calculate the cost of piracy prosecutions, we worked out the number of prosecutions held in three regions: Africa and the Indian Ocean, Europe, and North America.
We have then multiplied this number by an approximation of the average cost of prosecutions for piracy or similar crimes in each region. The project estimates the cost of piracy trials and imprisonment in 2010 to be around $31 million.
Organizations which should be activated
A number of intergovernmental organizations are dedicated to working towards a solution for maritime piracy. These funds represent operating costs as well as established trust funds. The total budget of these organizations is around $24.5 million.
This presentation is been taken from various Insurance Magazines and Newsletters.
Takis Kalogerakos
Marine Underwriter
