Incoterms: How Do They Affect Marine Insurance?

Establishing standardized protocols is crucial for smoothly executing international transactions. Among these protocols, Incoterms© stands out as fundamental pillars, ensuring clarity and consistency across borders.

Primarily, they are designed to define three critical aspects of international commerce precisely: the allocation of logistic costs between the seller and buyer, the transfer of risks during the transport of goods, and the necessary customs documents and procedures for foreign trade operations.

Refrigerated shipping containers stacked at a port, illustrating the application of Incoterms in international trade of perishable goods.
Incoterms-Compliant UTC Cooling Tech in Port Containers (Photo: United Technologies).

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 a consignment until it reaches its destination is a common (and costly!) mistake.

Cargo insurance and regulations operate within the Incoterms© framework, as the risk of loss or damage to goods during transit significantly influences insurance policies and terms.

The delineation of responsibilities and risks, as specified by Incoterms©, directly impacts the coverage and claims process, making an understanding of these terms essential for all parties involved in the international trade of goods.

This article delves into the essentials of Incoterms©, their significance for various stakeholders, and their implications on cargo insurance.

Incoterms© Explained: Key Questions

What are Incoterms©?

Incoterm® stands for International Commercial Terms. They are a set of trade rules, of voluntary use, crucial for the global trade of goods.

The purpose of Incoterms© is to precisely delineate three aspects of international commerce:

  1. The allocation of logistic costs between the seller and buyer.
  2. The transfer of risks during the transport of goods.
  3. The necessary customs documents and procedures for foreign trade operations.

The sales contract states the Incoterms©, so both parties know beforehand who bears which risks and expenses with respect to the transport and delivery of the goods sold. 

For Whom Are Incoterms© Relevant?

These rules are crucial for international sellers and buyers, but also for intermediaries in global trade, including carriers, lawyers, and significantly, cargo insurers.

International sale of goods implies several 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 (except for 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 to 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 Incoterms© specified in your sales contract points to the other party as the cargo owner, then your policy won’t pay your claim.

How Do Incoterms© Rules Help?

Incoterms© provides clarity as to the parties’ obligations in key areas, enhancing the predictability and security of international trade. However, they do not cover every aspect that should be in a sale contract. Certain Incoterms© only apply to sea/inland waterway transport, while others can be used for all types of transport, making some more relevant for specific shipments.

Are They Compulsory?

The use of Incoterms© in sale contracts is recommended but not compulsory. They offer a framework that parties can choose to apply, to clarify the terms of their trade agreements, thereby reducing misunderstandings and disputes.

Origin and Evolution

The first edition of Incoterms© was published in 1936, with successive revisions and updates (usually every ten years) leading up to the current version, Incoterms© 2020.

This latest version was launched in September 2019 after a revision process that began in 2016, incorporating feedback from stakeholders, including the International Union of Marine Insurance (IUMI), and national ICC committees.
These updates reflect modern commercial practices, ensuring that Incoterms© remain relevant and useful tools for international trade.

Who Defines Incoterms©?

The International Chamber of Commerce (ICC) is the authority that defines and updates Incoterms©. This global organization undertook the revision of Incoterms© 2010 in 2016, incorporating views from stakeholders, including the International Union of Marine Insurance (IUMI), and national committees of the ICC.
The Incoterms© 2020 were launched as a result in September 2019, offering key updates to reflect modern commercial practices.

What is covered by the Incoterms ® rules?

They cover various aspects of the trade process, including:

  1. Licences/Authorisations/Security Clearances and Other Formalities: Incoterms® set out responsibilities for obtaining necessary export and import licences, authorizations, and security clearances. However, the specifics of these obligations depend on the chosen Incoterm.
  2. Contracts of Carriage and Insurance: While Incoterms® specify which party is responsible for arranging and paying for the carriage of goods and insurance, they do not govern the contractual details of these arrangements.
  3. Delivery: They define the point in the transaction where the risk of loss or damage to the goods transfers from the seller to the buyer, which is crucial for understanding delivery obligations.
  4. Transfer of Risk: This is a key feature of Incoterms®, delineating when the buyer takes on the risk for the goods, which can impact insurance requirements and responsibilities.

2. Classification and Categories of Incoterms 2020

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” .

EXW (EX-Works) 

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 applicable taxes and import duty at the destination.

For more information on the remaining set of Incoterms©, keep an eye out for our upcoming articles. If you ever find yourself in a dispute due to practicing the wrong Incoterms©, our expert legal team will help you solve it.

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