The Perfect P & I Club
As the anniversary of the P & I clubs passes on 20th February, we
offer some reflections concerning what is now for shipowners their
biggest insurance cost.
MutualityP & I clubs are said to be ‘mutual’ insurers.
There is no risk transfer to a third-party underwriter, according to
the classical definition. The shipowners themselves share the risks
covered, mutually among themselves. There is no limit to what they may
have to pay in order to meet the club’s liabilities. If there is not
enough in the pot to pay the liabilities due, then ‘supplementary
calls’ are levied in order to balance the books.
Now however the amount of risk actually retained within a mutual
arrangement, so that the members share the claims, is a small
percentage only. Not only do the clubs in the International Group, for
example, reinsure each other in a pooling arrangement (which is a form
of mutuality), but they all collectively buy a reinsurance contract,
the International Group Excess Reinsurance contract, which is said to
be the biggest single reinsurance contract, by scope of cover and
premium volume, in the world. Then in addition each separate club buys
reinsurance to protect its retention, both against the impact of each
claim and usually also against the aggregate of claims exceeding a
The objective is to make the cost predictable, to minimise the
likelihood of supplementary calls.
Cost/ProfitMutual insurance differs from market underwriting
in that a mutual does not make profit, but simply aims to break even.
In the classical model, if the mutual takes too much in advance, there
will be a return of calls to the members.
However in market underwriting, the underwriter accepts risk in return
for a premium, which is calculated to provide enough to pay claims and
to make a profit for the underwriter.
All other things being equal, therefore, a mutual should cost less than
a market cover, as there is no profit element. However, to the extent
that the clubs reinsure with the market, the reinsurance cost will
include an element for the reinsuring underwriters’ profit.
Comparison of the figure for claims paid under the reinsurance with the
premium ceded by the clubs will show the amount of the profit margin.
It is considerable.
All P & I underwriting is done by reference to certain common
criteria, as follows.
The ‘burning cost’ for a member’s fleet is predicted. This is the
likely cost of his actual claim payments in the year. The prediction is
done by looking at the member’s record, and assessing how likely it is
that history will repeat itself. Students of Thucydides will recall how
fallacious this can be. Then the club’s reinsurance cost and the cost
of administration are shared out between the members, so that typically
a member will bear such proportion of these ‘overheads’ as his fleet
size, compared with the club as a whole, bears, modified by the
proportion which his claims record bears to the average in the club. So
if he has 10% of the tonnage in the club, and his record is twice as
bad as the average, he will pay 20% of the overheads.
Underwriting is essentially predicting the future. However, P & I
underwriters do not employ statistical theory to assist in their
predictions. It is taken for granted that the samples upon which
predictions would be based would be too small to allow reliable
statistical extrapolation. So, ideally the club cover works to protect
an owner against his liabilities, on the assumption that his record
will repeat itself. In case this does not turn out to be the case, the
club reinsures, by itself facultatively, with the International Group
Pool, and through the Group Excess Contract. Ultimately, it falls back
on its ability to collect supplementary calls.
But supplementary calls are seen as something to be avoided.
Predictability is the goal. But again, the edifice is based upon a
fallacy, that history will repeat itself. So, in the absence of any
other rational basis of prediction, clubs fall back on creating ‘free
reserves’ which some commentators even call ‘profits’. This brings into
focus the fact that now there is a logical confusion at the heart of P
& I underwriting. On the one hand, it is said to be mutual,
non-profit-making sharing of risk by collective self-insurers. On the
other, in practice it can only be made to work by the use of a profit
Mathematics and StatisticsIt is suggested that it might be
fruitful for the clubs to commission research into the statistics of
small samples, such as the likelihood of particular risks obtaining.
There are a certain number of ships of each type sailing: a certain
number of them have claims or accidents of particular types each year.
Is it really true that ‘… in this world nothing can be said to be
certain, except death and taxes. ’? If not, perhaps at last P & I
could be truly mutual, but still avoid nasty surprises.
24 February 2004
Hugh Bryant and the Bryant Hamilton & Co team have considerable expertise in all forms of marine and commercial insurance.
Contact +44 (0) 20 7702 1156, or email email@example.com