Understanding Incoterms and how they determine whether a client should arrange insurance cover

Understanding Incoterms and how they determine whether a client should arrange insurance cover

International Commercial Term (Incoterms) are standardised trade rules published by the International Chamber of Commerce (ICC) that define the responsibilities of buyers and sellers in international trade, including insurance obligations. They indicate quite clearly when control, possession and risk, transfers from the seller to the buyer. This transfer point is critical for determining who should arrange the insurance cover.

Should a client in South Africa be importing goods from overseas by either sea, air, rail or road, it may often seem easier to agree to the supplier/seller purchasing the insurance. However, it is important for the client to understand that it is the ICCs Incoterms that determine who is responsible for insuring the goods based on: When does risk transfer from seller to buyer?

Importing goods involves far more than arranging transport from one country to another.

From the moment goods leave a supplier’s premises until they arrive at their final destination in South Africa, they may travel by road, rail, air or sea, pass through ports and terminals, change hands several times and be exposed to damage, theft or loss.

If something goes wrong along the way, who carries the financial risk?
The answer depends largely on the Incoterm agreed between the buyer and seller.
Most importantly from an insurance perspective, Incoterms establish the point at which the risk of loss or damage transfers from the seller to the buyer. Understanding this transfer point is essential. It determines when a South African importer needs to have appropriate insurance cover in place.

Cost, risk and insurance are not the same thing. One of the most common areas of confusion is the assumption that the party paying for transport carries the risk throughout the journey – which is not the case. An Incoterm deals with several different responsibilities including:

• Who arranges and pays for transport
• Who handles certain customs formalities
• Where the risk of loss or damage transfers from seller to buyer. These responsibilities do not always transfer at the same point.

For example, a seller may pay to transport goods all the way to a South African port while the risk of damage to those goods has already transferred to the buyer at the overseas port of shipment.

This is why the Incoterm should be agreed before the goods are shipped and discussed with the buyer’s insurance broker before insurance cover is arranged.

For example, let’s follow the journey of goods
Consider a South African company importing machinery from a factory in China to its premises in Johannesburg. The machinery may pass through several stages:

• The goods are collected from the factory in China
• They are transported to the port
• They wait at a terminal before being loaded
• They are loaded onto the vessel
• They travel by sea to South Africa
• They are unloaded at the Port of Durban
• They pass through customs and port handling processes
• They are transported by road to Johannesburg
• They are delivered to the buyer’s premises

**The critical question is: At which point does the risk become the South African buyer’s responsibility? It all depends on the Incoterm agreed in the sales contract.

When does risk transfer to the South African buyer?**

Incoterms and when insurance risk passes to the buyer

It may be more appropriate for the buyer in South Africa to agree that the Incoterms should be such that the buyer takes responsibility for organising the insurance for the whole journey e.g. Ex Works. By doing so, and then purchasing the cover with a local insurer, a number of potential issues can be overcome as:

• Dealing with the insurer in South Africa is far easier than with an insurer based overseas who may not be able to communicate in English – especially in the event of a claim being lodged
• A single insurer is insuring the goods for the whole trip and there will be no argument as to where any damage occurred. Even if the damage is discovered at the end of the journey, (for example a container being opened) there is no argument as to which insurer is responsible for honouring the claim should damage only be discovered at the conclusion of the journey
• There will not be any delays due to a surveyor having to inspect the goods for damage prior to one insurer coming off risk and another coming on risk for a second leg in the journey. This may need to occur when goods are being imported CIF
• Should the goods being imported be machinery for installation in a factory, then insuring for any damage with a local insurer would make it easier to insure for:
  Delay in Start Up (DSU) / Advance Loss of Profits (ALOP) insurance due to loss of anticipated profits and fixed costs if transit damage to this important machinery delays the scheduled profit generation of the new machine.

It’s important to note that any DSU/ALOP claim can only be triggered if the physical damage to the machinery is covered by an underlying Marine Cargo policy with, in the vast majority of cases, the same insurer.

One very important issue to remember is that the South African buyer of the goods should only insure for the leg of the voyage for which the Incoterms make them responsible to insure. If a buyer insures for the whole journey, when Incoterms only dictate that they should insure for part of the journey, then any damage incurred will not be paid for by their insurer if it occurred during the part of the journey, they were not responsible to insure.

It is important that the buyer ensures that the Incoterms agreed with the seller, dovetail with the insurance they (the buyer) purchase.

Example: A client is importing goods from the factory in China to their premises in Johannesburg with Incoterms CIF (Durban). This makes the seller responsible for the goods from their origin in China to Durban Port. If the buyer had insured the goods for the whole journey from their origin in China to their final destination in Johannesburg, then it will be difficult to get their insurer to pay out for any loss that occurred prior to arrival in Durban.

Based on the above, if a buyer wishes to insure with a South African insurer for the whole journey, then the Incoterms that are agreed between buyer and seller should be Ex Works, C&F or FOB.

A final point to note is that where the buyer is purchasing the insurance, then the supplier and/or logistics company or transporters should take any insurance costs out of their quote to the buyer to avoid paying twice for insurance for the voyage.
Please speak to your OLEA broker for more clarification.

Robert Southwell - Senior Consultant | OLEA South Africa