Pirate insurance

It’s so tempting to be glib about insuring against pirate attacks, so go ahead. I’ll wait……..

[Insert humming of sea chanty here.]

However, I’ll refrain because, after all, it is serious stuff. Modern piracy is on the rise, mostly off Somalia, of course. And piracy is a covered peril in marine policies. Heck, it’s why property/casualty insurance got started in the first place. Lloyd’s was created so aristocrats could hedge the risk of the voyages they sponsored.

Today’s Business Post Online reports on how UK actuaries are pricing for piracy. And, according to a report to be forthcoming at this month’s General Insurance Research Organization (GIRO) conference, the lack of data makes the rating both simple and imprecise.

Actuary Neil Hillary at The Actuarial Profession (the Institute and Faculty of Actuaries public face) notes that since 2006 piracy has increased more than 125%. Even so, that doesn’t add up to a lot of events.

And the details are vague. Victimized ships owners don’t talk a lot about what happened, so public information is wanting. But it’s pretty clear that a typical loss runs into the millions of dollars.

So you have a low frequency/high severity coverage. (You don’t get a lot of claims, but when you do, it’s a doozy.)

So the actuarial analysis is pretty short. You estimate how often the claim happens (actuaries call that frequency) and multiply that rate by the average size of a claim (severity), then divide by the target loss ratio adequate to cover expenses, risk and profit.

Frequency: About six claims per 1,000 vessels passing through the Suez Canal.

Severity: The average claim size is about US$9 million.

Expense load: Judging by the Post story, the analysis targets a 60% loss ratio (though the story skimps on the details).

So rate = frequency*severity/risk load.

(6/1000)*(9,000,000)/(0.60) = $57,000 per vessel.

Usually ratemaking is much, much more sophisticated. But when the data is sparse, judgment becomes more important.

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