Report and Accounts For the year ended 20 February 2007

Transcription

1 Report and Accounts For the year ended 20 February 2007

2 Contents 2 Chairman s statement 5 General information 8 Managers review 24 Report of the Directors 26 Appendix to the Report of the Directors 28 Independent Auditor s Report Financial statements 30 Consolidated balance sheet 32 Consolidated income and expenditure account 33 Notes to the financial statements 33 Accounting policies 35 Other notes to the financial statements 45 Class 1 Policy Year position 47 Class 2 Policy Year position 47 Average expense ratio 48 Notice of meeting

3 The West of England 1 The West of England is a leading P&I Club in the International Group with a broad spread of entered tonnage and free reserves of over $200 million. Meeting Members needs remains the Club s key business objective through a combination of financial stability and a broad range of tailored services. With strong support from its membership the West of England has successfully created a secure financial platform from which to continue to deliver a high quality insurance product and related services to the shipping industry.

4 2 The West of England Chairman s statement For the past two years I have made reference to two concerns which continue to have an immediate and direct effect on both our own Members and the P&I industry as a whole. The first, which is of particular impact, is that the substantial rise in both the frequency and severity of large claims in the industry has continued. The second, which is reflected in regulatory change anticipated within the coming years, is that most, if not all, Group Clubs will have to carry progressively higher surplus capital margins than have been considered necessary or appropriate in the past to cover claims liabilities and operating risk. The financial measures which your Board implemented last September are a major step towards meeting these challenges. Not only have total net assets increased this February from $551.9 million to $658.8 million, but, more significantly, free reserves are up by more than $72 million from $132.5 million to $204.7 million. Your Board will continue to keep the Club s required capital margin under careful review. In particular, future underwriting and investment results over the next two years will determine whether or not all or part of any remaining call set last September for 2006 will be necessary. Also on the positive side, the overall investment return on total assets for the year at more than 12% was very satisfactory and exceeded our expectations. Financial Highlights at 20 February ($ million) Net assets* Outstanding claims (371.2) (374.9) (407.3) (419.4) (454.1) Free reserves * including forecast additional calls On the other hand the cost of claims involving the International Group s Pool for 2006 is projected to exceed our original forecasts substantially. Indeed, it now seems inevitable that for 2006 Group Clubs will be faced with the most expensive year in the Pool s history. This follows 2004 and 2005 which are likely to be the second and third most expensive years, and confirm your Board s view that since 2003 P&I claims appear to have undergone a step change when compared with the start of this decade. The reasons for the escalation in the cost of claims can be complex and varied. Two elements are no doubt of particular significance. First, the increase in the size of ships and the extraordinary strength of the world s freight markets, sustained now for a number of years, has greatly increased the values of the world fleet and the cargoes that are carried. Although sustained profitability is a cause for satisfaction for shipowners, where either cargo or vessels are damaged or lost, liabilities based on their increased values and any loss of use are substantially higher than in the past. At the same time regulators and governments are less tolerant of any environmental impact or damage that is associated with the operation of ships. It is no longer acceptable anywhere in the world to avoid the consequences of any kind of maritime casualty especially where loss of life, personal injury, wreck removal or damage to the environment are concerned. The on-going strength of world freight markets and the increasing volume of world trade make it highly likely that the overall cost of claims will continue to rise for the time being. Long-term weakness in the value of the US Dollar also continues to have a negative impact not only because some 30% of the Club s claims are incurred in non-dollar currencies but also because annual administrative costs are largely in sterling. The result is that premium income in future will have to continue to increase to levels that meet these new demands. As advised in December, when setting the Club s strategy for the 2007 renewal and future policy years, your Board reaffirmed that the level of premium to be charged shall as far as possible balance forecast claims costs and operating expenses. Investment income shall then be available to further strengthen the Club s overall free reserves. Implementation of the strategy was applied rigorously for the 2007 renewal with the result that premium income on renewed entries is about 10% higher for the year. A consequence of a more stringent approach to renewal is that mutual tonnage entered in the Club for 2007 is down by about 12.5% from about 63 million GT to about 55 million GT. However, your Board believes that this reduction in the Club s relative size may prove beneficial if it ensures that premium rating levels for all our Members will match the likely cost of future claims and expenses now and in the long-term. Apart from the direct and immediate impact of more frequent and more severe claims, we continue to face other less immediate but nevertheless profound challenges to our mutual system. For a number of years national and international initiatives have been underway which will inevitably increase the liabilities to which our Members are exposed. Changes to

5 The West of England Chairman s statement continued 3 the Civil Liability (CLC) and Fund Conventions were finally implemented during 2006 with the introduction of a new voluntary agreement from shipowners to share equally with oil interests in much higher levels of compensation for the victims of an oil spill (TOPIA). In October 2006 revisions to the 1974 Athens Convention, which relates to the carriage of passengers, were formally agreed at the IMO. Under the 2002 Protocol per capita liability limits for passenger claims have been substantially increased. Significantly, mandatory certificates of financial responsibility from insurers and direct action for claimants against insurers are likely to be introduced together with the provision that shipowners shall be liable for claims caused by terrorism. This presents Group Clubs with a question to which there is, for now at least, no answer. Can we provide certificates on behalf of passenger vessel operators for war or other risks which we do not cover? A solution to the problem will not be of interest merely to the passenger vessel community. Draft international conventions governing wreck removal, hazardous and noxious substances (HNS) and bunker pollution are set to contain similar provisions. Once in force all three conventions are likely to require certificates without an exemption for liabilities caused by terrorism. Each convention will apply to all vessel types wherever it is implemented and so expose all shipowners to these difficult issues. Also during 2006, deliberations about the Athens Convention caused Group Clubs and shipowners to focus more clearly than ever on the significance of increased limits of liability generally and their possible effect on the value of the Pool and the International Group s excess of loss arrangements at a time when Group Clubs have retained more risk within the Pool. Your Board has been concerned that account should be taken of the fact that liabilities at the lower end of the Pool are escalating at the same time as the risk of an overspill liability at the upper end of the Pool is increasing. Overspill exposure today extends from $2 billion, the limit of the Group s reinsurance programme, up to about $5.7 billion based on the volume of tonnage entered in Group Clubs and the value of the US Dollar. For this reason, your Board has felt for some time that it is essential that the arithmetic of overspill should be looked at again. Increased liabilities for passenger risks and the substantial increase in passenger capacity for new passenger vessels have had a similar effect on other Group Clubs. A number considered last year that the possible scale of loss of life and injury from a casualty involving a large passenger vessel made the passenger risk disproportionate when compared with other mutual risks to the extent that they considered such claims should no longer be covered for overspill at all. For some Clubs the concern was as much in relation to the risks associated with large numbers of crew on passenger vessels as to the number of passengers. Given the diversity of thinking amongst shipowners within our industry, not all Clubs shared these views, but what was clear by the end of 2006 was that, in order to ensure that the Group s claims sharing system through the Pool was not put at risk through a lack of consensus, a compromise had to be reached. For 2007 Group Clubs have now agreed that two key changes should be made. For all vessels entered in Group Clubs a new $3 billion limit of Club cover has been introduced for passenger and crew risks combined with a sub-limit of $2 billion for passenger risks alone. To ensure that such claims would not be the subject of an overspill liability, the Group also agreed to reinsure the first $1 billion of overspill exposure in excess of the Group s $2 billion excess of loss reinsurance programme up to $3 billion for all P&I liabilities. For those Clubs that considered the passenger and crew risks to be too extreme to be accommodated within the claims sharing system, at least for overspill, the new limit of cover provides an acceptable solution. For those like the West of England who have long argued for a reduced exposure to the risk of an overspill claim of any kind, there is also some satisfaction. The overspill obligation for 2007 is technically unchanged but the first $1 billion of the overspill risk for all claims is now reinsured so that effectively the financial exposure of shipowners to overspill has been substantially scaled back. The imposition of higher limits of liability and a number of well publicised casualties has continued to focus attention on ship standards. The eradication of sub-standard shipping remains an industry wide priority. As I have said before, certificates of entry from an International Group Club are tickets to trade worldwide. We will continue to support any practical measures that may be taken to discourage poor quality operators from having access to them. Consequently, with effect from February 2007, any Club which provides cover to a vessel which has been designated by the International Group as being in unacceptable condition is obliged to bear a double retention of $14 million in the event of a major claim. In my last report I mentioned that one consequence of the drive to improve ship standards is that liabilities arising from discharges of oil residues or oily water overboard are not likely to be reimbursed even in cases of accidental discharge. Since then it is disappointing to note that cases of this kind have continued to occur despite the probable absence of Club cover.

6 4 The West of England Chairman s statement continued Where efforts are being made on behalf of shipowners to challenge what appear to be questionable initiatives by national legislators, for example to criminalise seafarers, the industry s ability to counter unilateral measures such as those proposed by the European Union is undermined if basic lessons are not apparently being learned. Your Board and our Managers will continue to work hard on these difficult issues in the coming year. In the autumn we shall complete a new five year business plan. It is not likely to contain any radical proposals, but will aim to further enhance our ability to meet the different demands on our industry and our Members in the future. We shall also complete a review of our Corporate Governance principles and practices. There may be changes to the way the Board and its committees are structured so that we meet the highest standards now expected of corporations in many parts of the world. Since my last report Messrs George Coumantaros, Khalil Al-Gannas, Bernard Sire, Li Shao De and George Kynigos have retired from the Board. On behalf of the Directors I would like to thank them all for their valued service to the Club. In particular I would like to express my great appreciation to George Coumantaros for his commitment and dedication for over 34 years as a Director, 29 of which he has served with distinction as Vice-Chairman. My colleagues and I will miss not only his wise counsel, but also his excellent and irrepressible sense of humour. During the year Mary Sloan, and Messrs Humoud Al-Ajlan, Kishore Rajvanshy and Sergey Terekhin have joined the Board; we wish them a very warm welcome. Finally, may I also thank our Managers on behalf of the Board. Their continued professionalism and dedication will help to ensure that the Club is fully prepared to meet a challenging future. Stephen Van Dyck Chairman

7 The West of England 5 General information Directors S A Van Dyck Chairman Tampa G S Coumantaros Vice-Chairman New York L Criel Vice-Chairman Antwerp M T Los Vice-Chairman London and Athens H A Al-Ajlan Riyadh S I Al Bassam Kuwait M S O Aldhaheri Abu Dhabi Chen Hongsheng Beijing A R C B Cooke London H I Donev Varna J A Drakos Connecticut M B Ergin Istanbul I H Heesom-Green Antwerp Huang Shao Jie Hong Kong E Kromann Copenhagen P G Livanos Monaco P R L Lorenz-Meyer Hamburg V A Mednikov Moscow T Petalas Monaco K S Rajvanshy Hong Kong M C Sloan Miami S A Terekhin Novorossiysk Wang Haiming Beijing M E Warren Miami G Woodford London Managers West of England Insurance Services (Luxembourg) SA (UK Branch) Tower Bridge Court Tower Bridge Road London SE1 2UP United Kingdom Telephone +(44) (0) Facsimile +(44) (0) mail@westpandi.com Secretary and principal office P A Aspden 33 Boulevard Prince Henri L-1724 Luxembourg Telephone +(352) Registered number RCS B 8963 Auditors PricewaterhouseCoopers S.à r.l. Réviseur d entreprises 400 route d Esch L-1014 Luxembourg Telephone +(352)

8 Maintaining strong relationships P&I is above all a service industry.

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10 8 The West of England Managers review Overview The predominant feature of 2006 has been the measures successfully taken to increase substantially the Club s capital and reserves. In an environment where the adverse impact of growth in large claims is being felt by the industry as a whole, it is pleasing to be able to report a considerable strengthening of the Club s overall financial position. As can be seen from the financial highlights on page 2 the Club s free reserves have increased by over 54% in the last year to over $200 million. Although net outstanding claims now stand at $454.1 million compared with a little over $419.4 million a year ago, the ratio of free reserves to outstanding claims has improved significantly over the period. The reduction in tonnage reported at the last renewal is reflected in a smaller number of owned entered vessels which may result in reduced exposure to claims. This in turn may result in a further improvement in capital ratios. The year s investment return at around 12% has also made an important contribution. The main aim of mutuality remains that Club funds should primarily meet projected claims costs, reinsurance and operating costs as opposed to less well recognised risks. There is however growing acknowledgement, underpinned by new regulatory requirements expected under Solvency 2 in the European Union, that like other businesses Clubs are subject to a wider range of risks for which immediately available capital may be required and which extends beyond pure underwriting risk. These risks include investment risk, liquidity and reinsurance risk as well as risks inherent in day to day operations. International Group Clubs will continue to argue vigorously that a major part of their capital resource should continue to derive from Members contractual commitment to provide capital as and when required through additional calls to mitigate these new pressures. Nevertheless the need to maintain larger reserve margins to meet all these requirements is now likely to be a permanent feature of the mutual system, not least because Members themselves are subject to more refined corporate risk controls and because those who assess and report on the overall strength of the P&I industry will be increasingly taking them into account. The task for the Clubs in ensuring appropriate capitalisation within the industry is to strike a reasonable balance between having capital in reserve and the right to rely on Members own capital resources. Meeting these capital requirements has made considerable demands on the Members both in terms of additional calls and of higher rates at the 2007 renewal. Their support during the year for the Club s long terms objectives and particularly through the renewal itself indicates a strong commitment to the Club s future. Looking forward, there will be a continuing need to maintain the increased capital base at levels which reflect future risk. If the current adverse claims trends continue within the industry premiums will need to rise further to cover claims, reinsurance and operating costs, leaving investment returns to play their full part in generating capital growth. Class 1 Vessels (Number of Ownership Entries) by Policy Year (Pro rata) Underwriting Progress towards achieving balanced technical underwriting results has proved difficult to achieve against a background of increasing claims volatility and the incidence of large claims whose occurrence is largely random, particularly those from the Pool. The results for individual policy years and closed years for both Class 1 and Class 2 appear on pages 45 to 47. This year for the first time the policy year positions form part of the financial statements rather than being presented as a separate appendix and are therefore covered by the full Audit Report. In September 2006 the Board reviewed all the policy year results and decided that, in addition to those originally forecast, calls on the open years 2004, 2005 and 2006 should be made in order to reduce the technical underwriting deficits in each of those years with only a small further allocation of investment income. Most of the investment income would then be available to strengthen the Club s capital reserves. In May 2007 the Board confirmed the decisions made in September The results for the various years can be summarised as follows:

11 The West of England Managers review continued 9 Closed years There has been a small improvement in the closed policy years as a whole Projected net claims on the oldest open policy year 2004 (now closed) increased over the year by $11 million to about $194 million. Although 2004 was at the time the worst ever in terms of the total cost of claims by Clubs on the International Group Pool, West of England Members have incurred no Pool claims in the year. However, claims between $500,000 and the $5 million Club retention cost considerably more in 2004 than in prior years. The further additional call of 15% charged in 2006 together with a total allocation of investment income of $19 million enabled the year to be closed with a small surplus in May 2007 with no further call For 2005 projected net claims increased over the year by $5 million to about $189 million. In contrast to the previous year the Club s Members incurred 5 Pool claims. Although a smaller number of claims (38 against 54) were incurred between $500,000 and the Club retention of $6 million, the overall claims cost has been high. The further call on the year of 15% charged in 2006 together with investment income allocated to date has reduced the projected deficit for the year to about $10 million. The year is due to be closed in May 2008 after a further allocation of investment income. The current release percentage is 10%. The Club s stop loss arrangements Class 1 Tonnage by Policy Year provide protection against any significant further increase in projected claim costs for the year Claims by all Clubs on the Pool in 2006 have so far exceeded those in any prior year, even though 2004 and 2005 were each showing record levels of Pool claims at the same stage of development. About 25% of the West of England s gross projected claims cost for the year consists of other Clubs claims on the Pool. The net projected cost is slightly below $195 million after taking account of recoveries under the Club s stop loss policy which limits further increases in net claim costs for the year. In contrast with a very high level of Pool claims, Members own claims are at similar levels to the average of the past three years and slightly lower than for An additional call of 35% for the year will be payable in August 2007 which includes the 15% further call set in September last year. The Board has also set a further additional call of 35% but will determine whether or not all or part of it will be charged over the next year or two in the light of future underwriting and investment results and the Club s capital requirements. A contingent release of 15% also applies. Claims trends Ship size and the strong freight market appear to have a major impact on claims costs. In the case of collision liability and cargo damage the correlation between the value of the property damaged and size of a claim is self evident. Similarly, since larger vessels tend to carry greater quantities of oil and other potential pollutants, whether as cargo or otherwise, the cost of environmental clean up and restoration will tend to be higher as sensitivities to environmental damage increase globally. Less obviously, scientific and technological advances play a part in increased claim costs. Pollutants may be removed more effectively from sunken vessels at greater depths than before. Complicated wreck removal operations are now considered more feasible than in the past. At the same time medical advances have increased survival rates from accidents as well as life expectancy of victims. Human error as opposed to technical or structural failure also appears to play a significant part in large claims, but qualified and experienced manpower is in high demand in the current market. Shipowners have less choice as to who man their vessels and, despite improvements in training and safety management, it seems likely that until this situation changes, the number of accidents caused by human error will at least remain at current levels.

12 A global perspective The ever increasing burden of liability falling upon shipowners now extends to every trading region.

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14 12 The West of England Managers review continued International Group Pool Number of claims Policy Year Months from inception (at 12 months from inception) Value of claims ($ million) Policy Year Months from inception (at 12 months from inception) Figures exclude International Group co-insurance within the excess loss layers Renewals 2007 In a volatile claims environment underwriting methods face a number of challenges. For the 2007 renewal the Managers introduced a number of new underwriting processes aimed at achieving as quickly as practicable a break even underwriting result across the membership as a whole. These will be refined and further developed over time for future renewals. Large claims, including those from the Pool, continue to have a major impact on the Club s underwriting result. So long as their incidence remains largely random, even though their size and type are more predictable, underwriting on historical claims performance alone may often prove insufficient. Members own claims records may be reasonable indicators of routine claims performance but not necessarily of the likelihood of larger claims. Future rating will need to better address both the likelihood of individual Members incurring a large claim and how the cost of large claims can be most equitably shared across the Club as a whole. Moving the emphasis on rating in a constructive manner from reliance primarily on past performance to realistic assessment of future risk represents a significant challenge for the Managers and Members alike. Class 2 Including unallocated investment income the reserves for Class 2 remain substantially the same as a year ago at just under $20 million ($21 million in 2005). There was a modest reduction in the surplus on closed years to just under $14 million. Claims costs in the open years 2002 to 2004 have increased a little whereas 2005 shows a small reduction. The latest year, 2006, shows higher claims costs than prior years but the increase is about 6% when compared with 2005 at the same stage. Overall the underwriting result remains stable and no changes have been made to present additional calls or releases. Pooling and Group Reinsurance The Club continues to participate in the International Group Pool. The Pool s effectiveness and importance remain key for the P&I industry and that importance has again been underlined by the record level of claims to which it has responded for For 2007, a number of changes have been made to the Group reinsurance programme in respect of overspill liability and limits Entered Tonnage by Area of Management (Class 1 Owner Entry) at 20 February 2007 Entered Tonnage by Vessel Type (Class 1 Owner Entry) at 20 February Europe inc. Russia 48.2% 2 Middle East, Asia & Australia 34.0% 3 Americas 16.5% 4 Africa 1.3% 1 Bulk cargo carriers 33.1% 2 Tankers & OBOs (inc LPG/LNG) 24.2% 3 Container vessels 20.2% 4 General cargo and reefers 7.7% 5 Ferries & passenger liners 8.5% 6 Specialist vessels & misc. 6.3%

15 The West of England Managers review continued 13 of cover for passenger and crew claims. They are summarised in the Chairman s statement. In addition, individual Clubs retentions have increased to $7 million. Group Excess of Loss Reinsurance Programme 2007 ($ million) Apart from these modifications the fundamental structure of the Pool remains unchanged as does the International Group s longer term objective of maintaining stability in the cost of reinsurance which it buys from the commercial market. Hydra Since its activation in 2005 Hydra has reinsured risks that fall within the upper Pool for losses of $20 million in excess of $30 million together with risks which are retained within the 25% co-insured proportion of the first layer of the Group s reinsurance programme. Expectations reported at this time last year that Hydra would over time be able to accumulate a transparent capital base to enable the International Group to retain progressively more risk within the Pool have yet to be fulfilled. The experience of both these layers in 2005 and 2006 has mirrored that of the Pool. More claims have occurred at the level of these two layers in 2005 and 2006 than was the case before Hydra began operations. The combined projected claims cost covering both those years is $162 million against net premiums of $119 million. In April 2007 Hydra therefore called upon its parent Group Clubs to provide $50 million of additional capital by way of contributed surplus in order to maintain future solvency and underwriting capacity. A review is being undertaken of Hydra s current reinsurance arrangements and the premium to be charged for risks it will insure in the future. Retention Reinsurance and Stop Loss The Club continues to buy long term reinsurance in addition to its membership of the Pool. Subject to an annual aggregate deductible, Swiss Re, Partner Re and Endurance reinsure losses in excess of $500,000 up to $2 million and Munich Re, Partner Re and Endurance reinsure losses in excess of $2 million up to $6 million.the cover has been renewed for 2007 on substantially the same terms as for For 2007 the Club is continuing to place its long term aggregate stop loss policy with the Munich Re. There is likely to be a significant recovery under the 2006 policy, demonstrating that the Club s own reinsurance programme has provided a significant benefit to the West of England since its introduction. The stop loss arrangement remains a pure reinsurance contract and is not therefore exposed to the disadvantages often found in alternative risk transfer (ART) arrangements or subordinated debt. War Risk P&I and Terrorism For 2006 the Club continued to provide excess market war risk P&I cover for a maximum of $500 million in excess of an insured vessel s proper value. Cover was automatically available to all Members at a rate of $ per GT for owned and $ per GT for time chartered entries charged as part of the International Group s excess of loss reinsurance premiums. For 2007 cover has been renewed on the same basis and the corresponding rates are $ and $ The cover continues to exclude nuclear risks and claims caused by chemical, biological, bio-chemical or electromagnetic weapons. There is limited cover available from the Group s supplemental Pool on the same basis as last year.

16 Moving forwards The Board and Managers have taken initiatives that will consolidate the West of England s position and help drive the business forward.

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18 16 The West of England Managers review continued The West of England s own aggregate policy for all P&I chemical, biological, bio-chemical or terrorist liabilities was maintained for 2006 but not renewed for No other Club provides such cover. An issue which Group Clubs may need to resolve in the near future is whether or not they will need to increase the extent of war risk P&I cover which is offered at present. By issuing certificates of responsibility under the Civil Liability Convention Clubs already guarantee some war and terrorism risk liabilities in the case of oil pollution. Similar requirements may be made in the hazardous and noxious substances, wreck removal and bunker liability conventions. If this form of certification becomes more widely required, it may be logical for the Clubs to extend their war and terrorism liability cover, at least to the extent that certified risks have to be insured. Investments The return of 9.7% for the latest financial year on all asset classes excluding property was significantly better than last year s 7.2%, but the relative return that is the return achieved in excess of the Club s customised investment benchmark decreased to 0.5% compared with 2.9% for the previous year. Including property, the overall investment return was in excess of 12%. All the individual asset class returns exceeded their respective benchmarks, with the exception of the fixed income asset class which had a return below its benchmark. The absolute return asset class continued to perform well with a return of 10.1% compared with 12.0% for the previous financial year. While this is far less than the 22.2% return achieved on the overall equities portfolio, it is nearly twice that on the fixed income asset class. The absolute return class continues to demonstrate its value not only in its own terms, but also both as an important diversifier for the overall investment portfolio and as a protective strategy when traditional equity and fixed income returns are low or even negative. The latest financial year is now the fourth year in succession in which the Club s overall investment portfolio has significantly outperformed its benchmark with much of this outperformance coming from the absolute return class. Since the last US Dollar rate increase to 5.25% set by the Federal Reserve at the Federal Open Market Committee meeting of 29 June 2006, the central bank has been on hold and has maintained the Fed Funds target rate at that level. Despite repeated assessments in statements issued after each subsequent FOMC meeting that the Committee s primary concern remained the risk of inflation and despite regular hawkish speeches by Federal Reserve officials along the same lines, the consensus opinion in financial markets since the Summer of 2006 has been that the central bank would have to start cutting interest rates in the near term. This had the effect of keeping Treasury bond yields relatively low, with ten year yields generally ranging between 4.50% and 4.75%. The yield curve maintained the flat to inverted quality it had exhibited for many months and Mr Greenspan s famous conundrum whereby long term US Treasury yields actually fell despite the Federal Reserve s raising of short rates also stayed well entrenched. However, at the beginning of May 2007 Treasury yields started to rise and the trend accelerated in June with ten year yields having risen by some 70 basis point by the middle of that month to 5.32%. In this quite dramatic process both the inversion of the yield curve and the Greenspan conundrum were resolved. The long end of the curve rose more sharply than the short end as the market priced out the possibility of rate cuts in the medium term. The bull market in equities which began in the spring of 2003 continues, with US and pan-european indices approaching a return of 10% for the first six months of 2007 and emerging markets doing significantly better. At the time of writing, there Investments by Currency (Excluding Property) at 20 February US$ 70.1% 2 Euro 15.3% 3 Sterling 4.0% 4 Yen 1.4% 5 Other 9.2% Investments by Asset Type (Excluding Property) at 20 February Fixed income 44.6% 2 Equities 24.7% 3 Absolute return 21.4% 4 Cash 9.3%

19 The West of England Managers review continued 17 seems to be no reason to believe that this will change in the near future. The global economy appears robust and would probably survive a mild slowdown in the US. Inflation remains benign and valuations appear reasonable in historical terms and relative to bonds, despite the recent rise in yields. All this might change quite quickly if the price of oil were to rise abruptly possibly in response to any significant deterioration in the situation in the Middle East or in response to a large rise in bond yields. Neither of these possibilities seems likely to materialise in the remainder of this year. In line with its usual practice the Board reviewed the strategic and tactical asset allocation of the Club s investment portfolio continually during the last financial year and decided to increase the strategic allocation to the cash asset class by 5% and reduce that for the fixed income asset class by the same amount. The strategic allocation to the equities and absolute return asset classes remains unchanged. These changes were made in view of the relatively high interest rates available on cash coupled with significantly diminished prospects for bonds. Pollution In 2006 limits of liability under OPA 90 in the United States were increased with differentials for single and double hull tankers. The new limits for single hull tankers are $3,000 per GT with a ceiling of $22 million for vessels over 3,000 GT and $6 million for vessels of 3,000 GT or less. Correspondingly lower limits of 1,900 GT and $16 million and $4 million were set for double hulls. For all other vessels, the new limit is the greater of $950 per GT or $800,000. The European Union Environmental Directive has recently come into force in a small number of European states. It does not override any IMO conventions enacted in a Member state and has no impact therefore on oil pollution liabilities under the CLC and Fund Conventions or on STOPIA 2006 and TOPIA It functions, however, as an interim measure until the bunker and HNS Conventions are ratified and come into force. The Directive borrows many provisions of OPA 90 in respect of reinstatement and natural resource damage assessment. Third Maritime Safety Package Otherwise known as Erika III this is a package of proposals being considered by the European Parliament and Council of Ministers in order to improve maritime safety. Many of the proposals are not particularly controversial although the need for them and their likely effectiveness in promoting maritime safety are perhaps open to question. Some of the proposals do little more than reflect current practice among the Clubs in providing certificates of insurance and in being prepared to provide guarantees to allow vessels to enter ports of refuge following a casualty. Among these proposals is a draft Civil Liability Directive which would require European states to enact the internationally adopted London Convention on the Limitation of Liability for Maritime Claims 1996 (LLMC 96) in a modified form. It appears to be advocating that under this modified form of LLMC 96 a shipowner s right to limit liability under the Convention should be lost if there is conduct which shows an unusual lack of due diligence and care on the part of a shipowner or failure to act in a professional manner. This is a far less precise description of conduct forfeiting an owner s right to limit his liability than exists in LLMC 96 and one which is likely to lead to significantly more litigation about responsibility rather than focussing upon the creation of a limitation fund to provide compensation quickly and efficiently to claimants. Non-European vessels would also have to provide Certificates of Financial Responsibility for twice the limit of liability under the Convention. The International Group has together with other industry bodies argued strongly that, to the extent its intentions can be understood, the Directive will not improve maritime safety and that LLMC 96 is already an effective system for fixing limits of liability. It is perhaps not surprising that there seems to be little consensus among European legislators themselves as to the value of the proposed directive. Cargo Liability The development of a new Convention governing the carriage of goods by sea now appears close to completion. The new Convention is intended to replace the Hague/Hague Visby and Hamburg Rules as well as the US Carriage of Goods Act The draft Convention, which is sponsored by the United Nations Commission on International Trade Law (UNCITRAL) is scheduled for a final reading later in 2007 with a view to its adoption by UNCITRAL in the summer of It is possible that the final reading may now be deferred to the spring of 2008 in which case adoption is likely to take place in the summer of If ratified the Convention will significantly increase the burden of liability of shipowners and maritime carriers in respect of the cargoes they carry. In particular the long established exclusion of nautical fault will be lost in its entirety. Maritime carriers will be responsible for physical loss or damage resulting from delay but not for economic loss, unless subject to agreement between the carrier and shipper. Current limits of liability per package or unit of weight may be increased. Shipowners and

20 On the right course A strong capital base is a key requirement to meet the challenges of an increasingly adverse liability environment.

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22 20 The West of England Managers review continued other maritime carriers will also become liable for the negligence of so-called maritime performing parties such as sub-contracted sea carriers, stevedores and terminals. The obligation to exercise due diligence in relation to seaworthiness of a vessel will be extended to the duration of the voyage. Although it is not possible to quantify the financial impact of these increased liabilities, there can be no doubt that shipowners will see a significant increase in the cost of liability claims and of their P&I cover. The effect of the new convention may not, however, be wholly negative. Its scope will extend to door-to-door carriage as well as tackle-to-tackle and port-to-port carriage. Many of the beneficial aspects of existing conventions and regimes are retained. Specifically, the new convention adheres to the concept of network liability whereby different types and levels of responsibility apply to different modes of transport. Equally, the convention retains the concept of fault based liability from the Hague/Hague Visby rules, although standards and burdens of proof overall may be more onerous for the carrier. The new convention looks forward by making provision for electronic commerce. It also allows parties greater freedom of contract in the liner trade and will generally not apply compulsorily outside liner trade. It will not for instance apply to charter parties whether used in liner or non-liner transportation. Loss prevention The Club has continued to operate its comprehensive programme of condition surveys, but there is growing recognition that the development of better manning and operational skills has an increasing part to play in helping to prevent accidents. In 2006, as in previous years, the Loss Prevention department carried out a number of safety management appraisals in response to requests from Members or because of operational concerns. Although the conclusions and recommendations following such exercises varied considerably, certain findings appeared common to many. At a time when qualified and experienced seafarers are in short supply, it appears that opportunities to provide on-board training may often be missed. Number of Mutual Members Claims per Policy Year over $2m and $6m at 20 February 2007 The new convention attempts to deal with jurisdiction and arbitration and, while details are yet to be finalised, appears to be trying to reach a middle ground between total freedom of choice of jurisdiction under the Hague/Hague Visby Rules and the overly restrictive provisions of the Hamburg Rules. Nevertheless, under the new convention cargo owners are effectively able to choose from a number of jurisdictions the court where they can sue the carrier and exclusive jurisdiction agreements contained in contracts of carriage do not on the whole have primacy. Overall this is an ambitious project which seeks to codify almost all aspects of maritime carriage. There seems little doubt that, if it is not ratified, the status quo of existing regimes will not remain, the likelihood being that the EU and USA would enact their own domestic legislation. That would potentially result in lack of uniformity and conflicts of liability regimes across the world. The cost of such a circumstance is impossible to quantify but it would have to be taken into account when considering the full impact of the new convention s increased liability environment for shipowners and carriers.

23 The West of England Managers review continued 21 Following an accident or near miss the safety management system (SMS) will almost certainly have been followed in terms of documenting the circumstances of the incident as well as the findings of the investigation and the corrective action taken. However, the next stage in the process may be less effective. For example, in the case of an injury the on-board investigation may conclude that the cause was carelessness on the part of a seafarer. While this may be factually correct and might satisfy an ISM auditor, a training opportunity may have been lost. The reason for the apparent carelessness needs to be determined and possible causes such as inexperience, complacency, fatigue or inadequate supervision examined. Once the root cause is understood, tangible corrective action in the form of specific training can then be applied. Opportunities for better use of internal SMS audits were also identified. Typically these audits use standard checklists, often resulting in the same predictable checks being made year after year. Internal audits may tend to focus on records and equipment at the expense of seafarers core skills. It also appears that internal auditors may not always witness key operations in order to verify compliance with company procedures. As a result opportunities for enhancing on-board training may be overlooked. Many vessels now have a safety committee, but not all these committees appear to review accidents, near misses and safety deficiencies with a view to preventing similar occurrences or identifying possible training needs. Some vessels were found not to include ratings in their meetings or had failed to post the minutes on ships notice boards, thus reducing the committee s effectiveness. It is customary for masters and chief engineers to evaluate the performance of their staff at least once during each tour of duty and, if considered necessary, for the evaluation to recommend further training for individual seafarers. The Club s safety appraisals found, however, that these training requirements are not systematically passed on to the seafarer s next vessel and may simply be left on file. The ISM Code contains many useful mechanisms for providing on board training, but it appears that in a number of cases these mechanisms may not yet be employed to their full capacity in terms of the potential benefits that might be achieved. It is hoped that shipowners will take the opportunity to make further positive use of the Code. The Club s loss prevention team will continue to support this type of initiative through the safety appraisal programme. Classes 2, 3 & 4 Claims activity in Class 2 has continued to be significant in Much of the work undertaken by the Club during the year has focussed on assisting Members with urgent problem solving rather than orchestration of longer duration litigation and dispute resolution. In a strong shipping market where delay is costly this shift in focus is not surprising. Arbitration in London as a means of dispute resolution has continued to raise some concerns with Members both in terms of cost and duration. Good arbitrators remain in high demand and their schedules are inevitably full.obtaining security for claims is a key part of dispute resolution strategy and defendants who have provided security are often more disposed to settle claims than those who have not. In the United States technology has added a new dimension to socalled Rule 2B attachments. This process for obtaining security has been available to claimants in respect of maritime claims for a long time. It allows the attachment of bank accounts in the United States under certain conditions provided service of proceedings is made on banks in time. Electronic service is now permitted by the courts and as a result the process is now considerably more effective than in the past. Larger claims for costs continue to be reviewed in detail at different levels by two specialist committees under delegated authority from the Club s Board. The committee consisting of Board Directors which considers higher value claims for costs made 47 decisions about support for proceedings during the year and at the lower level a committee of the Managers made 60 such decisions. Classes 3 and 4 remained available to provide cover for crew and port area strikes. There were no entries during the year. No claims were paid in the year and there are no outstanding claims. West of England Hamilton The West of England s wholly owned reinsurance subsidiary in Bermuda continues to provide valuable internal reinsurance protection. It participates in the Club s two P&I retention reinsurances and the programme of stop loss cover. It also provides FD&D stop loss and excess of loss cover for claims between $300,000 and $1 million. The projected surplus of Hamilton at 20 February 2007 was $81.5 million.

24 Managing the claims environment There is an expectation of a worsening claims environment as activity in shipping continues at very high levels.

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26 24 The West of England Ship Owners Mutual Insurance Association (Luxembourg) Report of the Directors The Directors have pleasure in presenting their report together with the audited financial statements of the Association for the year ended 20 February Activities The principal activity of the Association continues to be the insurance and reinsurance of Members' protection and indemnity risks (Class 1) and freight, demurrage and defence risks (Class 2). In addition, the Association provides cover for strikes risks of ships' officers and/or crew (Class 3) and strikes risks in port areas (Class 4) although no business for these two Classes was underwritten during the year. The Association reinsures, through its wholly owned subsidiary International Shipowners Reinsurance Company SA, 90% of its risks for all Classes, and the reinsurance of The West of England Ship Owners Mutual Insurance Association (London) Limited, for past and current years. The West of England Reinsurance (Hamilton) Limited, a wholly owned subsidiary of the Association, reinsures various specific areas of the Association s business on both a stop loss and excess loss basis. West of England Insurance Services (Luxembourg) SA, which is wholly owned by the Association, provides insurance and claims handling services for the Association. The West of England Ship Owners Insurance Services Limited, which is wholly owned by the Association, acts as landlord to its tenant companies at its premises in London. The Association, along with the other members of the International Group of P&I Clubs, has established a Bermuda segregated cell insurance company called Hydra Insurance Company Ltd, to reinsure certain pool and quota share risks. The Association has contributed share capital to Hydra, and share capital and contributed surplus to the Hydra West of England Cell which is wholly owned by the Association and, during the year, participated in reinsurance activities. Future developments and events since the balance sheet date The Association will continue to maintain and develop its activities as above. No changes are envisaged to these. There have been no significant events after the balance sheet date. Financial risk management Luxembourg law requires disclosure, where material, of the risk management objectives and policy of the Association and of its exposure to price, credit, liquidity and cash flow risks. The Association issues contracts that transfer insurance risk. The Association is also exposed to financial risk through its financial assets, financial liabilities, reinsurance assets and policyholder liabilities. This is discussed in further detail in the Appendix to this Report of the Directors. Financial Statements These financial statements conform to the Luxembourg law of 8 December 1994 in all respects except for the fact that investments are stated at market value and land and buildings at valuation. Luxembourg legislation requires that investments, including land and buildings, are stated at the lower of cost or market value. The treatment adopted is consistent with the basis of accounting generally accepted by the other members of the International Group of P&I Associations. The financial statements are set out on pages 30 to 47 with the principal accounting policies summarised on pages 33 to 34. Financial statements conforming fully to the Luxembourg legislation are filed with the Luxembourg authorities: copies are available on request from our Principal Office. These statements show a surplus for the year of $58.6 million (2006 $0.9 million deficit) before the transfer to the Reserve Deposit Fund of $0.4 million (2006 $0.4 million) and the net transfer to the Class 1 Policy Year Reserve Account of $41.0 million (2006 $4.7 million). In addition the Revaluation Reserve increased by $13.5 million (2006 $0.9 million revaluation loss). Total reserves at 20 February 2007 were therefore $204.7 million (2006 $132.5 million). A more detailed review of the year is contained within the Managers Report.