Underinsurance – General Average in a Hull Policy

One of the topics examined in  the Fellowship examinations of the Association of Average Adjusters Examinations¹ is on the effect of underinsurance for insurance payouts in a Hull policy for General Average (“GA”) after the application of a deductible. As there appears to be limited literature available to explain the basis of the apportionment of the deductible for both a Particular Average (“PA”) and GA loss, this article will provide the basis of the workings and also consider the possibility using a spread sheet/formula to derive the payouts. We admit that this topic may be of limited interest as most of the policies contractually provide for the Insurers to  be liable for GA as if the Hull is insured for its full contributory value.

1. Types of policies: S 27ⁱⁱ of the English Marine Insurance Act 1906 (“MIA 1906”) provides that a policy may either be Valued or Unvalued. A Valued policy is a policy which specifies the agreed value of the subject matter insured whereas an Unvalued policy does not specify the value but leaves it to be determined after the loss (S 28ⁱⁱⁱ of the MIA 1906). Invariably, Marine Hull policies are insured on Valued Policy basis.
2. Deductible: Insurers would generally require risk participation by the Insured and would accomplish this by way of a deductible and which is basically the first portion of the loss borne by the Insured themselves. The deductible also  eliminates small (attritional) claims. There is an inverse relationship between the deductible and the premium i.e. the higher the deductible, the lower the premium. Hence, Owners may agree to a high deductible (say USD 1 million) to get a lower premium.  Under the ITCH 1/10/83, there would be the application of the deductible to all claims except for Total Loss (both Actual and Constructive) and for sighting the bottom after stranding, if reasonably incurred^iv.
3. Indemnity under the policy: As there are two types of losses i.e. Partial Loss and Total Loss, we consider the indemnity available under the policy below.
   1. Partial Loss – The indemnity available, subject to any express provision in the policy, is determined by S 69^v of the MIA 1906. It entitles the Insured to recover the reasonable costs of repairs, if repaired or the depreciation in the value of ship, if unrepaired on expiry of the policy but not exceeding the reasonable costs of repairs, subject to the value insured in the case of a Valued policy or the Insurable value in the case of an Unvalued policy. The recovery of these costs is irrespective whether the Insured Value in the case of a Valued Policy or the Sum Insured in the case of an Unvalued Policy is adequate or not with the only caveat that the Insured should not insure more than 25% of the value in other policies^vi.
   2. Total Loss – In the case of a Total loss^vii the indemnity available for a Valued policy would be the sum fixed by the policy and for an Unvalued Policy, it would be the insurable value which would be determined by using S 16(1)^viii of the MIA 1906.
4. Underinsurance:
   1. Vessel values fluctuate depending on the state of the market. Hence, during the period of risk, the value of the vessel may appreciate due to market conditions and which may then give rise to Underinsurance.
   2. Alternatively, in order to save premium costs, Owners may insure the vessel for a lesser value under the Hull & Machinery policy with the balance being insured under a Total Loss cover (due to the likelihood of a Total Loss appearing to be lesser vis-à-vis the other risk elements available under a Hull & Machinery policy, the premium levels on the Total Loss cover would be much lesser).
5. Application of Deductible: Clause 12 of ITCH 1/10/83 provides that the policy would respond only after the application of a deductible for ¾ Collision Liability, General Average (“GA”) & Salvage and Sue and Labour. With respect to some losses (¾ Collision Liability, GA, Salvage and Sue & Labour), the amounts recoverable under the Hull policy would be adjusted to consider the adequacy of the sums insured. In case, there is under insurance, the recovery under the policy would be adjusted to consider the under-insurance. The adjustment is not particularly complex with the recovery being made on pro-rata / proportionate basis IV^ix/CV^x with respect to ¾ Collision Liability and Sue & Labour.  However, if an incident gives rise to both a PA and a GA, given that the deductible would have to be “shared” between both the PA and GA, this may indeed be complex ( there would be an application of one deductible as there is one accident). In particular,  the adjustment has to factor the proportion of deductible for the PA loss so as to work out the amounts payable for the GA.
6. The subject of Hull and Machinery Policy Deductibles (Difficulties, Dilemmas and Delights) was  covered in the Address of 1986 by the then Chairman of Association of Average Adjusters Mr. K V Wood. He mentioned in his speech “When I first entered the profession of Average Adjusting and came across this problem, I was told by one of the senior members of staff in the firm that he had devised a formula capable of solving the difficulty at a stroke but presumably because of my tender age he must have considered me to be an unworthy repository of such precious information that I was not informed of the magic secret. Unfortunately, the gentleman concerned met an untimely death carrying with him as far as I was concerned his undisclosed secret. For me and I suspect, many others the solution to the problem lies in the age-old procedure of ‘trial and error’.”
7. While this “deductible problem” exists in both the Institute Time Clauses- Hulls 1.10.83 and Institute Time Clauses – Hull 1.11.95, it no longer exists in the International Hull Clauses 1/11/03. This is because Cl 8.1^xi of the IHC 1/11/03 provides that there would be no reduction in the amounts payable for GA in case of under-insurance. We also understand that Insurers may contractually agree to vary cover provided under ITCH 1.10.83 i.e. the policy would pay for GA without considering any underinsurance. However, given that there is a basis for the calculations and that some vessels continue to be insured under the ITCH 1.10.83 without any “underinsurance” provisions,  this topic may be still of interest and relevant.
   1. Trial and Error method: The only example of the Trial and Error method which we have sighted is in the book Marine Insurance Claims by JK Goodacre^xii. The apportionment of deductible can be arrived at by a Trial and Error method and which can be viewed at http://nau.com.sg/wp-content/uploads/2020/03/TE-Method.pdf.
   2. Spread sheet method: The use of spread sheets such as Microsoft Excel is ubiquitous and is now invariably used by adjusters for the preparation of adjustments. We sought assistance from Mr. Anant Poddar^xiii to help us in our endeavor in creating a spreadsheet which makes the process of calculation simpler. The spreadsheet can be viewed at http://nau.com.sg/wp-content/uploads/2020/03/Deductible-workings.xlsx.
   3. Formulae method: Again, Mr. Poddar was helpful in working out a formula as below:
      NCV = Vessel Value – PA (R)
      NIV = Insured Value – PA(R)
      GA(E) = (GA(E) * NIV ) / NCV
      Px = ( PA (R) * Excess ) / ( PA(Ra) + PA(NR) + GA(S) + GA (ExP) )
      GA(Ex) = ( GA(E) / NCV ) * (NIV + Px)
      1st trial – GA (ExP) , 2nd trial onwards GA (Px)
      Using data provided in the example provided in Marine Insurance Claims by JK Goodacre, the values would be as follows
      NCV= 95,000 – 15,000 = £80,000
      NIV = 70,000 – 15,000 = £55,000
      GA(ExP) = (10,000 x 55,000)/80,000 = £6,875
      Px = (15,000 x 5,000)/(15,000+0+10,000+6,875)= (15,000×5000)/31,875 = 2,353
      GA(Ex) = (10,000/80,000)*(55,000+2,353) = 7,169    Total payout would be PA+GA(S)+GA(Ex) = 15,000+10,000+7,169 = 32,169 less Deductible of £5,000 = £27,169 (there is a minor difference in the values and this could be explained by rounding off which we have followed in the other two methods).
8. We would welcome comments from readers on both the correctness of the approach taken and whether the process/formulae could be simplified further. While this topic may be of limited use, particularly if the hull policy were to pay the General Average Contributions without considering any underinsurance, we believe that the basis of adjustment should be studied and understood at least to develop the science of hull adjusting. 

ⁱ. https://www.average-adjusters.com/about/
ⁱⁱ.S 27: Valued policy.
(1)A policy may be either valued or unvalued.
(2)A valued policy is a policy which specifies the agreed value of the subject-matter insured.
(3)Subject to the provisions of this Act, and in the absence of fraud, the value fixed by the policy is, as between the insurer and assured, conclusive of the insurable value of the subject intended to be insured, whether the loss be total or partial.
(4)Unless the policy otherwise provides, the value fixed by the policy is not conclusive for the purpose of determining whether there has been a constructive total loss.
ⁱⁱⁱ. S 28 Unvalued policy.
An unvalued policy is a policy which does not specify the value of the subject-matter insured, but, subject to the limit of the sum insured, leaves the insurable value to be subsequently ascertained, in the manner herein-before specified.
^iv.12.1 No claim arising from a peril insured against shall be payable under this insurance unless the aggregate of all such claims arising out of each separate accident or occurrence (including claims under Clauses 8,11 and 13) exceeds _________________ in which case this sum shall be deducted. Nevertheless the expense of sighting the bottom after stranding, if reasonably incurred specially for that purpose, shall be paid even if no damage be found, This Clause 12,1 shall not apply to a claim for total or constructive total loss of the Vessel or in the event of such a claim, to any associated claim under Clause 13 arising from the same accident or occurrence.
v. S 69 of the UK Marine Insurance Act 1906 – Partial loss of ship.
Where a ship is damaged, but is not totally lost, the measure of indemnity, subject to any express provision in the policy, is as follows:—
(1)Where the ship has been repaired, the assured is entitled to the reasonable cost of the repairs, less the customary deductions, but not exceeding the sum insured in respect of any one casualty:
(2)Where the ship has been only partially repaired, the assured is entitled to the reasonable cost of such repairs, computed as above, and also to be indemnified for the reasonable depreciation, if any, arising from the unrepaired damage, provided that the aggregate amount shall not exceed the cost of repairing the whole damage, computed as above:
(3)Where the ship has not been repaired, and has not been sold in her damaged state during the risk, the assured is entitled to be indemnified for the reasonable depreciation.
^vi.21 DISBURSEMENT WARRANTY
21.1  Additional insurances as follows are permitted:
21.1.1. Disbursements, Managers’ Commissions, Profits or Excess or increased Value of Hull and Machinery. A sum not exceeding 25% of the value stated herein.
21.1.2  Freight, Chartered Freight or Anticipated Freight, insured for time. A sum not exceeding 25% of the value as stated herein less any sum insured, however described, under 21.1.1.
21.1.3  Freight, or Hire, under contracts for voyage. A sum not exceeding the gross freight or hire for the current cargo passage and next succeeding cargo passage (such insurance to include, if required, a preliminary and an intermediate ballast passage) plus the charges of insurance. In the case of a voyage charter where payment is made on a time basis, the sum permitted for insurance shall be calculated on the estimated duration of the voyage, subject to the limitation of two cargo passages as laid down herein. Any sum insured under 21.1.2 to be taken into account and only the excess thereof may be insured, which excess shall be reduced as the freight or hire is advanced or earned by the gross amount so advanced or earned.
21.1.4  Anticipated Freight if the Vessel sails in ballast and not under Charter. A sum not exceeding the anticipated gross freight on next cargo passage, such sum to be reasonably estimated on the basis of the current rate of freight at time of insurance plus the charges of insurance. Any sum insured under 21.1.2 to be taken into account and only the excess thereof may be insured
21.1.5  Time Charter Hire or Charter Hire for Series of Voyages. A sum not exceeding 50% of the gross hire which is to be earned under the charter in a period not exceeding 18 months. Any sum insured under 21,1,2 to be taken into account and only the excess thereof may be insured, which excess shall be reduced as the hire is advanced or earned under the charter by 50% of the gross amount so advanced or earned but the sum insured need not be reduced while the total of the sums insured under 21.1.2 and 21.1.5 does not exceed 50% of the gross hire still to be earned under the charter An insurance under this Section may begin on the signing of the charter.
21.1.6  Premiums. A sum not exceeding the actual premiums of all interests insured for a period not exceeding 12 months (excluding premiums insured under the foregoing sections but including, if required, the premium or estimated calls on any Club or War etc. Risk insurance) reducing pro rata monthly.
21.1.7  Returns of Premium. A sum not exceeding the actual returns which are allowable under any insurance but which would not be recoverable thereunder in the event of a total loss of the Vessel whether by insured perils or otherwise.
21.1.8  Insurance irrespective of amount insured against: Any risks excluded by Clauses 23, 24, 25 and 26 below.
^vii.S 68 – Total loss.
Subject to the provisions of this Act and to any express provision in the policy, where there is a total loss of the subject-matter insured,—
(1)If the policy be a valued policy, the measure of indemnity is the sum fixed by the policy:
(2)If the policy be an unvalued policy, the measure of indemnity is the insurable value of the subject-matter insured.
^viii.S16 – Measure of insurable value –
Subject to any express provision or valuation in the policy, the insurable value of the subject-matter insured must be ascertained as follows:—
(1)In insurance on ship, the insurable value is the value, at the commencement of the risk, of the ship, including her outfit, provisions and stores for the officers and crew, money advanced for seamen’s wages, and other disbursements (if any) incurred to make the ship fit for the voyage or adventure contemplated by the policy, plus the charges of insurance upon the whole:The insurable value, in the case of a steamship, includes also the machinery, boilers, and coals and engine stores if owned by the assured, and, in the case of a ship engaged in a special trade, the ordinary fittings requisite for that trade:
^ix. IV:  Insured Value
^x.CV: Contributory Value
^xi.This insurance covers the vessel’s proportion of salvage, salvage charges and/or general average, without reduction in respect of any under-insurance, but in case of general average sacrifice of the vessel the Assured may recover in respect of the whole loss without first enforcing their right of contribution from other parties.
^xii.We would recommend this book to be in every Marine Insurance practitioners’ library. We hope that an updated edition is soon published to consider the developments from the time this book was published.
^xiii. Mr Anant Poddar, an Engineer by qualification, is employed with Kofax, a global intelligence software company providing solutions to various industries. We thank him for his assistance and without which this article would not have seen light of.