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The Actuary The magazine of the Institute & Faculty of Actuaries
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GI: Piracy - All at sea

Pirates are the highwaymen of the seas, spotting — with little apparent planning — a potential victim on its travels, moving in swiftly, attacking, overcoming and disappearing with prey or treasure on board as rapidly as they had arrived. Pirates have been doing this for thousands of years, despite the best efforts of navies and world powers.

There have been a number of high-profile cases recently and, with the costs to intercontinental shipping rising, a team of actuaries came together to investigate. Over the centuries, some facts have changed little. Pirates need:
>> Safe havens on land — the government acquiesces in piracy or is unable to suppress it
>> Support services on land — an impoverished population with no alternative source of income can come in handy
>> A ready supply of attackable vessels — they come in all shapes and sizes
>> Access to weaponry
>> A market for the onward sale of vessels or cargo.

Currently, these features are most noteworthy in Somalia. Somali pirates are preying on ships off the Horn of Africa. All ships travelling between the Mediterranean Sea and the Indian Ocean through Suez, Egypt, are exposed, as well as ships hundreds of miles offshore in the Indian Ocean. However, piracy is a global problem and there are many other hot spots, such as the Malacca Straits and Nigeria.

The marine piracy working party presented a paper to the 2010 GIRO convention, which traced the evolution of this maritime crime from the earliest times to the modern day. In particular it discusses Somali pirates and estimated the costs they impose on the shipping industry.

While actuaries commonly gorge on an overabundance of statistics (life or motor insurance), the group immediately faced the difficulty of obtaining base statistics in trying to assess the cost of piracy. Perhaps more than in any other insurance, underwriters have very good reasons for not releasing frequency and severity statistics for the world’s prying eyes. Shipowners have little incentive to publicise the fact that they have been attacked and it is in no-one’s interests to publicise amounts paid in ransom or the value of stolen goods. Also, reporting the near misses may affect the owner’s insurance premiums. Exposure data is not readily available. What is available requires judicious extrapolation.

Risk identification and management were uppermost in the working party’s thinking. It is important both to avoid incidents and to minimise their impact when they do occur. There is clear evidence that planning and taking prompt action when an incident occurs reduces losses. There have been a number of cases where this has frustrated pirates. For instance, the use of safe rooms has enabled ships to be recaptured from pirates and using a ‘safe corridor’ in the Red Sea, patrolled by international forces, reduces the likelihood of a successful attack.

As an emerging issue, we have tried to understand the risk and the factors that drive it, sought risk management solutions and derived some initial costs from statistics.

Because of its topicality, the ability to use transits of the Suez Canal as a proxy for exposure and, by way of illustration, the paper estimated the costs relating to kidnap and ransom (K&R) by Somali pirates. Using judgment rather than strict financial modelling, the working party projected that in 2010 an ‘average claim cost’ (ransom and ancillary expenses) of around $9m, with a hit rate of about 2.2% combined with a ‘success’ rate of 29% combining to produce a ‘claims frequency’ of approximately six per mille. The estimate of the K&R cost per vessel came to about $60,000; this is in line with other analyses of the same insurance cost.

The group explored an alternative: that of sailing around the Cape of Good Hope and found that, despite the increasing risk around the Horn of Africa, there was still economic advantage to be gained from the Suez passage with adequate insurance, as the Cape sailing might cost an additional $0.7m.

The lack of data and other issues place considerable uncertainty around the cost of mitigation. We are now better placed to comment on this uncertainty. But perhaps one lesson that history has taught us is that piracy in general can only be solved by land-based solutions, in particular finding work opportunities for those in coastal communities and ensuring a stable government is in place.

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Yves Colomb is a property and casualty consultant for Towers Watson; Darren Farr is a pricing analyst at Munich Re Underwriting Ltd for the Watkins Syndicate; Peter Hinton is a general insurance actuary working in the Prudential Insurance Policy Department at the Financial Services Authority; Neil Hilary is the UK Profession’s staff actuary specialist in general insurance.