Marine Insurance in Ship Finance Transactions: What Lenders and Owners Need to Know

Marine insurance coverage plays a pivotal role in ship finance transactions, ensuring operational continuity, protecting revenue flow, and securing the value of the financed asset. As vessels navigate through geopolitically volatile regions and operate under increasingly complex regulatory frameworks, both lenders and owners must pay close attention to how risk is managed through insurance.

We had the pleasure of speaking with Molly McCafferty, Senior Vice President at the American P&I Club, about the current insurance landscape. With more than 25 years in the marine insurance space, Molly offers valuable insights into what stakeholders should prioritize when structuring risk around ship ownership and finance. This article is Part II of our conversation with Molly.

Core Coverages Every Stakeholder Should Know About or Be Aware Of

Marine insurance is multi-faceted, with various types of coverage tailored to address the diverse risks associated with vessel operation and ownership.

1. Hull and Machinery (H&M)
H&M insurance covers physical damage to the vessel and equipment. H&M typically excludes wear, tear and maintenance, intentional damage, war risks, cyber-attacks, radioactive contamination, and maritime regulatory breaches.

2. Protection and Indemnity (P&I)
P&I insurance is a mutual insurance cover protecting against third-party liabilities, including cargo loss, collision, pollution, personal injury (including crew, passengers and surveyors), and third party property claims (including docks, bridges and fenders). P&I Clubs operate as not-for-profit entities pooling risk among members amongst the twelve International Group (“IG”) Clubs. The American P&I Club is the only U.S.-based member of the twelve IG Clubs which collectively pool risk on a not-for-profit basis.

3. War Risk
War risk policies are activated by geopolitical conditions and cover enhanced risks like piracy, rebellion, hijacking, and terrorism. These are often separately underwritten, and coverage is dictated by regions designated as high-risk—currently including conflict zones such as the Red Sea, Gulf of Aden, and Black Sea, which are designated “hot spots”.

4. Freight, Demurrage & Defense (FD&D)
FD&D insurance covers legal and investigative costs tied to commercial disputes not typically addressed under H&M or P&I. This includes issues like contractual disputes under charter parties, bills of lading or ship management agreements and other operational issues.

5. Loss of Earnings/Loss of Hire 
Loss of hire insurance compensates for revenue lost when a vessel is out of service due to an insured event. Although this coverage can be costly, it’s essential for operators in sectors where continuous operation is critical to profitability.  

6. Mortgagee’s Interest Insurance (MII) and Mortgagee’s Additional Perils Coverage (MAP)
MII and MAP are both lender-focused insurances. MII protects a lender/mortgagee when the owner’s H&M policy does not cover the loss due to the shipowner’s breach. MAP, meanwhile, supplements inadequate P&I coverage. These policies are negotiated by and for the benefit of the lender/mortgagee, not the borrower/shipowner, and are a crucial risk-transfer tool in modern ship finance structures.

7. Misdirected Arrow Coverage
This coverage protects co-assureds when a claim is made against the wrong party. Misdirected Arrow covers a co-assured as if it were named as the member (and covered directly) and is often purchased to protect financial owners and lessors of ships from liability if erroneously named in a claim.

8. Fleet Policies and Specialized Coverage
Fleet policies consolidate insurance, covering multiple ships owned by the same entity under a single contract, reducing administrative and premium costs. Specialized coverage for specific risks is often needed for certain vessel types such as passenger liability or luxury amenities for cruise ships, pollution liability for tankers, or structural exposure or environmental hazards for offshore rigs.

Insurance Documentation and Risk Structuring in Ship Finance Transactions: Securing the Lender’s Position

 Given that a vessel typically serves as collateral in a financing arrangement, lenders almost always require collateral assignments of all relevant insurance policies to secure rights to proceeds in the event of a loss or liability. These assignments must be “perfected”. A properly perfected assignment ensures that in the event of a loss or liability, the lender has a secured and enforceable claim to any payouts, which ranks ahead of the owner’s/borrower’s claim. 

To ensure enforceability and priority over proceeds, lenders should consider the following key documentation:

1. A collateral assignment of all key insurance policies;
2. Loss payable clauses stating that insurance proceeds will be paid to the lender/mortgagee as a named “loss payee;”
3. Notices to insurers;
4. Acknowledgments from insurers confirming the terms of the collateral assignment and agreeing to pay the mortgagee in the event of loss;
5. Undertakings by brokers regarding premium payments under the insurance policy and notifications of any policy changes; and
6. Endorsements that can be used to amend policies to reflect lender protections, such as naming the mortgagee as an additional insured or loss payee or to make other changes to ensure the lender’s interests are covered.

Insurance Considerations in Ship Sale and Purchase and Charters: Avoiding Gaps

 During vessel sales, insurance must remain in place continuously until the transfer of ownership is formally completed. Any incidents occurring between the signing of the sale agreement and the vessel’s delivery must be covered. This transfer of risk typically occurs at the moment of executing the Protocol of Delivery and Acceptance which marks the transfer of risk from seller to buyer.

In chartering arrangements, responsibilities for insurance vary by charter type. Under a bareboat charter, the charterer assumes operational control and is typically responsible for insuring the vessel since the charterer assumes full control of the vessel, though the terms of the charterparty would dictate. In contrast, under a time charter the owner retains operational liability and, therefore, maintains the insurance cover, like H&M and P&I, with the shipowner. Charterers under a time charter may still arrange cargo insurance or cover for operational risks.

Insurance as Strategic Risk Allocation

Since shipping is a high-risk, capital-intensive industry, insurance is not a back office consideration in a ship finance transaction. For both lenders and owners, marine insurance is integral to a financing strategy as it is critical to safeguarding the asset, operational continuity, and lender security. Whether through classic forms of insurance like H&M and P&I policies or more sophisticated lender-focused instruments like MII, MAP and FD&D, effective risk and insurance management is indispensable for all maritime stakeholders, including both financiers and shipowners.