Unbelievable as it may seem, buyers and sellers don’t always have the Incoterms in mind when they take out freight insurance.
Assuming that insurance will automatically cover your consignment until it reaches its destination is a common (and costly!) mistake.
How can you make sure that you purchase the right insurance coverage? By understanding how much risk you sustain based on the Incoterm negotiated.
What are Incoterms?
Incoterm® stands for International Commercial Terms. They are a set of trade rules, of voluntary use, created by the International Chamber of Commerce (ICC) back in 1936.
They specify the conditions to which the buyer and seller agree in a trade transaction, with a twofold purpose:
- Standardising trade practices worldwide
- Avoiding misunderstandings and confrontations between exporters and importers
Let’s call a spade a spade. In any line of business, each party looks out for their own benefit. And international trade is no exception.
That’s why it’s crucial that all stakeholders can rely on a set of unified criteria governing the rights and obligations on which seller and buyer agree.
Incoterms are stated in the sales contract, so both parties know beforehand who bears which risks and expenses with respect to the transport and delivery of the goods sold.
How do Incoterms affect you?
International sale of goods implies a number of risks, expenses, and tasks that are split between the buyer and seller:
- Paying the cost of freight
- Incurring other expenses, such as loading and discharging
- Clearing customs
- Loss or damage to goods
- Arranging cargo insurance
Incoterms play a crucial role in outlining who’s responsible for every step of the transport chain.
How are Incoterms linked to marine cargo insurance?
When negotiating a trade agreement, buyer and seller are free to decide who sustains the risk and eventually takes out the required insurance.
The fact is Incoterms don’t require the seller or buyer to provide marine insurance (with the exception of the CIF and CIP terms).
However, they do define whether it’s the seller or buyer who will bear responsibility for any loss or damage that occurs during transit. Surely, it’s worth playing it safe and having this exposure to financial loss insured against.
Now, there’s something you must take into account:
A marine cargo insurance policy can only legally pay out on goods the policyholder has an insurable interest in.
Wondering what “insurable interest” implies in this context? In plain words, it means you own the goods or bear the risk. So, in the event that the cargo got damaged, you’d suffer a financial loss.
If the Incoterm specified in your sales contract points to the other party as the cargo owner, then your policy won’t pay your claim.
What does each Incoterm mean?
According to the latest edition of the Incoterms (2020), there are 11 different trade rules. They are divided into 4 categories, based on the risk, responsibility and fees each party bears: E, C, F and D.
Out of them, 7 rules are applicable to any transport mode (multimodal terms), whereas 4 are “waterway only” .
The seller makes goods available to the buyer at their premises. The buyer takes full responsibility for the transit through to the final destination.
FCA (Free Carrier)
The seller delivers the cargo to a carrier selected by the buyer at a named place. As the delivery point could be anywhere in the country of origin (e.g., a freight terminal), the contract of sale must specify where and to whom the cargo is to be delivered.
FAS (Free Alongside Ship)
The seller makes the cargo available alongside the vessel at the port of shipment, arranging export clearance and covering origin charges. The buyer bears all subsequent expenses and risks.
FOB (Free On Board)
The seller loads the cargo on board the vessel and clears it for export. After this, responsibility shifts to the buyer.
CFR (Cost and Freight)
The seller pays all costs up to the named port of destination. However, risk passes over to the buyer when the goods are loaded on the vessel.
CIF (Cost, Insurance & Freight)
This is one of only two INCOTERMS which contains an obligation to provide insurance (the other one is CIP). The seller agrees to provide coverage for the buyer’s risk of loss or damage from the place of origin to the final destination.
CPT (Carriage Paid To)
The seller agrees to pay freight costs to the destination, until the cargo is delivered into the custody of the first carrier. The buyer arranges onward transport and pays tax and duty.
CIP (Carriage and Insurance Paid To)
In a nutshell, the same as CIF. However, the goods are made available to the carrier at a named place in the country of destination (as opposed to the port under CIF terms).
DAT (Delivered At Terminal)
The seller is responsible for all charges until the cargo is delivered to the agreed terminal (e.g., port, airport or any other hub). Once the cargo is unloaded, the risk passes over to the buyer.
DAP (Delivered At Place)
The seller delivers the goods to the buyer’s location. The latter is responsible for the import process, including unloading the goods at the destination.
DDP (Delivered Duty Paid)
The seller is responsible for the entire process, including import clearance and payment of any applicable taxes and import duty at the destination.
Still wondering why you should know your Incoterms?
Mastering and using Incoterms effectively is key to reducing misunderstandings and, ultimately, conflicts in international trade.
Think about it: if each party’s responsibilities aren’t outlined in writing, you’ll struggle to argue your case in the event of a claim on a marine cargo insurance policy.
Because you may be as good as your word, but that won’t suffice during a claims review, where the parties involved have financial motives.
So, here’s our piece of advice: make sure you understand how much risk you’re taking based on the Incoterm agreed upon. Plus, insure your cargo for your part of the transit.
Last but not least, if you ever find yourself in a dispute due to practising wrong Incoterms, our expert legal team is there to help you solve it.