Client Question:

We buy CIF because the Seller’s insurance is cheaper. Is it that simple? What else should we consider?

Answer:

In a C-prefixed transaction, the Seller sells the Buyer documents evidencing the handover or dispatch of cargo.

A C-prefix contract is never to the Buyer’s advantage unless the Buyer intends to sell the documents on to another Buyer.

Effectively, the Buyer buys the hope that the documentation leads to the contract goods, but there is no guarantee given by the Seller that this will be the case.

Referencing the Incoterms rules, delivery in a CIF sale is the Seller handing over documents to the Buyer, of which some will evidence the loading of the contract goods onto the vessel at the port of shipment.

Notwithstanding that the Seller’s price includes the international carriage (the freight) from that port of loading to the intended port of destination, if the documents are correct then delivery takes place in the port of loading.

The continued existence of the cargo after that point is not the Seller’s concern.

To quote from the Rules directly “…the seller is taken to have performed its obligation to deliver the goods whether or not the goods actually arrive at their destination in sound condition, in the stated quantity or, indeed, at all…”

At law, a c.i.f./CIF sale is the sale of documents, it is not the sale of the underlying cargo the documents may reference, hence its compatibility with payment conditions like the L/C, where the beneficiary is paid for the presentation of conforming documents. The arrival or existence of the goods is not questioned by the bank.

If the Buyer is prepared to accept the inherent risks of the C-prefix contract, then the next step is to say that it is not in the Buyer’s interest to further let the Seller arrange the insurance cover; the very party who has no commercial obligation to supply cargo, and who has no insurable interest in the condition of the cargo.

Although the Seller has the cost of arranging cover, cover is taken out against the Buyer’s risk. The Seller has the cost, the Buyer has the risk.

Given this situation, it is possible (if not probable) that the Seller may opt for marine insurance that is cost-effective rather than appropriate.

For example, Incoterms cautions Buyer’s that the CIF Seller need only procure the minimum cover. If you read section A5 of CIF under Incoterms 2020, you will note that the minimum cover is calculated as the Seller’s invoice value, uplifted by 10%.

This has been the standard since 1906, long before the inception of Incoterms Rules, and there is a Seller-driven reason behind this arithmetic being the minimum, but from the Buyer’s perspective, generally, this will prove inadequate.

On the principle that we hope for the best but plan for the worst, the Buyer needs to consider their potential maximum loss.

For example, imagine if the Buyer opened a full container at the final destination warehouse only to find it empty. At that moment the Buyer will have exposure for the loss of the purchase price, but also losses in arranging import clearance and local transport activity. They will have already disbursed import duties, clearing and shipping agent’s fees, and a potentially long list of landside charges to facilitate the physical delivery of the empty container.

In addition, there are the potential losses from exchange fluctuation and a lost profit margin too, and perhaps the damaging commercial loss of failing to supply to their clients.

Not all of these risks may be covered, but to adequately insure when using the Seller’s invoice as the basis for valuation, the Buyer would at least need to calculate (or anticipate) what their total additional clearance and logistics disbursement will be as a percentage of the purchase price.

Broadly (and very generally) for manufactured goods this is often 15% – 30% rather than 10%. If these figures hold true, and if the Buyer leaves the Seller to insure for minimum cover only, the Buyer in the example will have a potentially large shortfall, suffering significantly in the event of a loss. Though they are insured, they are inadequately insured.

The concept of minimum cover also addresses the type of insurance indemnification the Seller must procure for the Buyer. Under the Incoterms rule CIF, the Seller’s arrangement might only cover the Buyer for total loss of the cargo.

This means that in the event of partial loss (through pilferage or damage say), the Buyer has no valid claim at all. Partial loss is not total loss.

Additionally, frequently under minimum cover the incident of total loss, if it arises, must be the consequence of a fire or explosion. A total loss because of another peril or incident is normally not covered.

Finally, on this point, there is no guidance at all on what the insurance excess might be.

Certainly, if the Buyer allows a large ‘multi-national’ Seller to arrange the insurance, the excess (that amount of the claim that the claimant will bear) might already exceed the total value of the order.

There would, in fact, be no cover at all.

However, trumping the minimums, the Seller must do what is agreed in the sales contract. The minimums apply only in the absence of instruction.

Accordingly, if the Buyer needed the Seller to arrange insurance at (say) cost plus 25%, and further requested a more inclusive cover (addressing most risks, partial loss, theft, and so on), the Buyer is advised to make the Seller contractually obligated to procure this higher and more inclusive cover a clear condition of the sales agreement.

Ah, but there’s the rub.

By outlining the type of cover, the value of the cover, the tolerable excess and other factors which ‘shape’ an insurance arrangement, the Buyer may find that the Seller’s price increases, because the premium the Seller will incur for such a tailored indemnity also increases.

Note then that if the Seller’s insurance looks cost-effective it may be because they have insured for minimum values and minimum risks, and with a maximum excess.

In summary: as a general proposition, it is never in the Buyer’s interest to procure on a C-prefix but, if they must, then the Buyer should try to avoid letting the Seller arrange insurance. Rather (if they were using Incoterms Rules) they might buy CFR (Cost and Freight) and arrange the insurance cover themselves.

But, if the Buyer must buy on C-prefixed terms and, further, must allow the Seller to arrange insurance, then the Buyer should at least instruct the Seller on how much cover and what type of cover they require, and what sort of excess they can tolerate.

In other words, the Buyer must drive the conditions of insurance – remember, in respect of the cargo, cover is for the Buyer’s risk not for the Seller’s risk. The seller is selling documents alone.

The Seller only has the cost; the Buyer has the risk.

Once the Buyer understands the risks, then if they still wish to take them and to procure on Incoterms rules CIF unmodified then, on the basis that any informed decision is the best decision, the Buyer must proceed, and position themselves accordingly should the contemplated risks arise.

Just remember that nobody loves you when you’re down and out. It is fine if all goes well – every marriage is grand. But insurance is about when things do not go well, and while marriage is grand, divorce is generally at least a hundred grand.

Source: Freight Training