Understanding the Basis of Valuation in Marine Cargo Insurance

Global trade thrives on the efficient transportation of goods across borders, but the risks associated with shipping are unavoidable. Marine cargo insurance offers crucial protection against potential financial losses. 

However, the actual value of this insurance is determined by one key factor—the basis of valuation. But what does this term mean, and why is it crucial in marine cargo insurance?

What is the Basis of Valuation in Marine Cargo Insurance?

The basis of valuation refers to the method used to determine the insurable value of cargo. This valuation sets the amount claimed for loss or damage during transit in marine cargo insurance. 

It includes the cost of the goods and other expenses such as freight, duty, and sometimes even an additional profit percentage.

According to the Marine Insurance Act of 1963, Section 18 (3), “In insurance on goods or merchandise, the insurable value is the prime cost of the property assured plus the expenses of and incidental to shipping and the charges of insurance upon the whole.” The insurable value is thus made up of three core components:

• The prime cost of the property: The basic cost of the goods being shipped.
• Expenses of and incidental to shipping: This includes costs like inland freight, clearing, forwarding charges, export fees, overseas freight, and customs duties.
• Charges of insurance: The insurance cost itself, which forms part of the overall value.

The Marine Insurance Act of 1963 forms the legal framework for determining the insurable value, ensuring businesses have a clear structure to follow when assessing their shipping risks. 

The challenge often lies in calculating the "expenses of and incidental to shipping," which vary based on the terms of sales contracts or Incoterms. Depending on the agreement, the buyer or seller may bear these costs, influencing the overall valuation.

Also Read: Understanding Shipping Insurance and Coverage for 2024

Understanding the Importance of Accurate Valuation

Accurate valuation is the foundation of any successful insurance policy. The basis of valuation directly affects how much compensation the shipper can recover in the event of a claim. 

A miscalculation could result in insufficient reimbursement, leading to a significant financial loss for the business.

Why is it crucial?

• Under-insurance: If the valuation is too low, the shipper may not receive full compensation for the goods in case of loss or damage.
• Over-insurance: If the valuation is too high, the shipper will pay unnecessarily high premiums without any additional benefit.

Different Valuation Methods

Different methods are used to calculate the basis of valuation in marine cargo insurance. The most commonly used techniques include:

• Cost, Insurance, and Freight (CIF) is the most popular valuation method. In this method, insurance covers the cost of goods, freight, and the insurance premium, often adding a markup to account for potential profit.
• Free on Board (FOB): In this method, the insurance only covers the cargo until loaded onto the shipping vessel, after which the buyer assumes responsibility for the risks.
• Cost and Freight (CFR): This method includes the cost of goods and freight but excludes insurance. The shipper is responsible for the cargo until it reaches the destination port.

Each method has advantages and limitations, and businesses must choose the one that best fits their shipping and insurance needs. 

Impact of Basis of Valuation on Claim in Marine Cargo Insurance

In marine cargo insurance, the basis of valuation is a critical factor in determining the payout of an insurance claim. The chosen valuation method directly impacts how claims are assessed and compensated. 

Simply put, you can only recover the insured components listed in the policy, and any misstep in valuation can result in an incomplete settlement. 

Here, we’ll explore the provisions under the Marine Insurance Act of 1963 and their impact on claim assessments.

Basis of Valuation and Its Direct Bearing on Claims

The Marine Insurance Act of 1963 provides clear guidelines for the extent of liability an insurer has in the event of a loss, whether partial or total. Understanding how claims are calculated based on valuation can help businesses protect their financial interests.

Key Provisions in the Marine Insurance Act, 1963:

1. Section 67 - Extent of Liability for Loss:

• In an unvalued policy, the assured can recover up to the full extent of the insurable value.
• In a valued policy, the insured can recover the full amount fixed by the policy.

2. Section 68 - Total Loss:

• For valued policies, the total loss settlement equals the value agreed in the policy.
• For unvalued policies, it corresponds to the insurable value of the goods.

3. Section 71 - Partial Loss:

• For partial loss, the settlement is proportionate to the insurable value of the part lost. This applies both to valued and unvalued policies.

4. Section 73 - General Average Contributions and Salvage Charges:

• If the insured has paid a general average contribution, they can recover the full amount if the subject matter is fully insured. However, if it is underinsured, the settlement is reduced proportionally.

These sections emphasize that the sum recoverable in any claim is strictly tied to the basis of valuation stated in the policy. If any key component of the valuation is missing, the insured will face gaps in coverage.

Also Read: Essential Elements and Principles of Marine Insurance Contract

Impact of Valuation on Different Types of Claims

1. Particular Average Claim

For claims related to partial loss, the sum recovered is calculated based on the proportion of the goods' insurable value. The insured will not be fully compensated if the valuation basis is incomplete. 

For instance, if only the invoice value is insured, and additional shipping costs like freight or duties are excluded, the claim will not cover these expenses, leaving the insured to bear the additional financial burden.

Example:
If cargo valued at $100,000 is insured based solely on the invoice price, but the true value, including freight and insurance, is $120,000, the insured will only recover $100,000 in case of a claim. The remaining $20,000 will not be compensated.

2. General Average and Salvage Claim

When a general average or salvage situation occurs, all parties involved in the shipping process must contribute to the loss based on the cargo's landed cost, including Cost + Insurance + Freight (CIF). 

If the valuation basis does not account for these components, the insured must cover the uninsured portion from their resources.

Example:

Suppose a claim is triggered during a general average situation, and the basis of valuation does not include freight or insurance. In that case, the shipper may have to cover those costs out of pocket. 

For example, in an Ex-Works sale, if the basis of valuation is set to the invoice basis, the insurer will not compensate uninsured components (freight and insurance).

Also Read: Definition and Meaning of Cargo Insurance Certificate in Shipping Terms

Costs Involved at Different Stages of Shipping

The costs involved in a shipment can vary depending on the terms of the sale. The costs are minimal in an Ex-Works sale, where the seller's responsibility ends when the goods are available at their premises. 

On the other hand, if the seller is responsible for delivering the goods to the port or beyond (e.g., FOB or CIF terms), additional costs such as inland freight, export clearance charges, and handling expenses must be factored into the valuation.

Here’s a breakdown:

• Ex-Works Sale (A): The cost is limited to the warehouse price of the goods.
• FOB Sale (A + B + C): Additional costs, such as inland freight, port charges, and export clearance fees, increase the overall value.

Ensuring that all these components are included on a valuation basis is essential for businesses to avoid paying out-of-pocket expenses during a claim.

Frequently Requested Basis of Valuations in Marine Cargo Insurance: Are They Sufficient?

One of the most critical decisions when dealing with marine cargo insurance is determining the basis of valuation. Commonly requested valuations include Invoice Value, Invoice + 10%, Stock Transfer Note, and as per Incoterm. 

However, the question arises—are these components sufficient to cover the client's full exposure? To fully understand these valuation methods, we must explore them through real-world scenarios and their implications.

Basis of Valuation as “Invoice Basis”

The Invoice Basis is one of the most frequently used valuation methods. However, is it enough to provide full coverage for the insured? Let's examine how this method performs in different sales conditions.

Ex-Works Sales (Incoterm)

In an Ex-Works sale, the seller delivers the goods at their location, making the buyer responsible for all additional expenses, including freight, forwarding charges, insurance, duties, and inland freight. The invoice value reflects only the cost of the goods at the seller's location.

Scenario:

If the buyer suffers a loss during inland transit after import clearance, the buyer’s exposure goes beyond the invoice value, covering:

• Cargo cost
• Overseas freight
• Customs duties
• Inland freight
• Insurance, and more.

If the insurance is based solely on Invoice Value, the buyer would not be compensated for these extra costs, such as freight and duties. 

To ensure full protection, the client should opt for a more comprehensive valuation basis like “Invoice/Cost + Insurance + Freight + Customs Duty + Incidental %” to cover all possible risks.

Also Read: Exploring Different Types of Marine Insurance Clauses

FOB (Free on Board)

In FOB Sales, the seller delivers the goods to the port (FOB Point), and the invoice typically includes the cost of goods plus any expenses incurred up to that point (e.g., inland freight, export clearance charges). The buyer then assumes responsibility for overseas freight, insurance, and other costs from the FOB point.

Scenario:

If damage occurs during transit after the goods leave the FOB point, the buyer’s exposure includes overseas freight, customs duties, inland freight, and insurance. 

If the basis of valuation remains at the invoice value (covering only FOB expenses), these additional costs remain uncovered. 

Therefore, for full protection, a better approach would be to opt for “Invoice/Cost + Insurance + Freight + Customs Duty + Incidental %.”

CFR (Cost and Freight)

In a CFR sale, the seller covers the cost of goods, inland freight, and overseas freight but leaves the buyer responsible for insurance and other post-arrival costs.

Scenario:

If damage occurs after the goods are delivered to the destination port, the buyer’s exposure will include insurance, port clearance, customs duty, and inland freight costs. The invoice value typically only covers the basic cargo cost and overseas freight. 

As a result, customs duties and insurance remain uncovered, so clients should seek more comprehensive coverage like “Invoice/Cost + Insurance + Freight + Customs Duty + Incidental %”.

CIF (Cost, Insurance, and Freight)

In CIF sales, the seller’s invoice value includes the cost of goods, insurance, and freight, covering the goods until they reach the destination port. However, the buyer must cover customs duties, inland freight, and other incidental charges.

Scenario:

If the insurance valuation is based solely on the invoice (CIF), it will not cover additional costs like duties and inland freight, partially exposing the buyer. 

A more appropriate valuation would include Invoice/Cost + Insurance + Freight + Customs Duty + Incidental % to cover all costs.

Stocks Transfer (Goods Transfer Note)

A Stocks Transfer Note often mentions the nominal value of goods, which does not always reflect the true cost exposure. In this case, the exposure includes at least the cost of goods plus freight, which should be accounted for in the valuation.

Scenario:

If the transfer note lists a lower value than the actual landed cost, the insured will not receive full indemnification in the event of a claim. Thus, using the landed cost (the total cost of goods, including all freight and incidentals) for valuation is crucial for comprehensive coverage.

As per Incoterm

It is important to clarify that Incoterms and Basis of Valuation are two separate concepts. Incoterms define the responsibilities between buyer and seller—who bears which costs and when risk transfers—while basis of valuation determines the insurable value of the goods.

Example:

Choosing the Invoice Basis without considering freight and other incidental costs can leave the client underinsured. The insured should always ensure that the valuation fully captures all components of their financial exposure beyond just the terms of the Incoterm.

Basis of Valuation and Declaration

It’s also essential to align the declaration with the chosen basis of valuation. For example, in an Open Policy/Cover, the declaration should accurately reflect these values if the valuation basis is Cost + Insurance + Freight + 10% + Customs Duty. 

For Sales Turnover Policies, declarations should be based on Sales Turnover + Incidentals, ensuring the policy covers the full exposure.

Also Read: Understanding Marine Cargo Insurance and Freight Liability

Conventional CIF +10% Valuation

The Cost, Insurance, and Freight (CIF) + 10% method is widely recognized in the marine cargo insurance industry. It adds a 10% margin to the total invoice value, including the cost of goods, freight, and insurance. 

This is a common practice because it offers a financial buffer for unforeseen circumstances or small, incidental expenses that are not directly related to the primary costs. 

The added 10% acts as a safety net, providing additional coverage for minor losses during transit, such as administrative costs, exchange rate fluctuations, or extra handling fees.

This valuation method helps companies avoid underinsurance, particularly when hidden costs are difficult to estimate upfront. In international trade, where minor delays or mishandling can lead to unexpected charges, the CIF +10% ensures the insured party is more comprehensively covered.

Coverage of Small Hidden Expenses

One of the key benefits of the CIF +10% valuation is its ability to cover hidden expenses that are not immediately apparent when goods are shipped. These hidden costs can include:

• Extra documentation fees.
• Currency conversion charges.
• Minor administrative costs.
• Freight handling surcharges.

Insurer’s Expectations Regarding the Additional 10%

Insurers often expect the additional 10% margin to be used as a buffer for potential extra costs rather than to over-insure the goods. The additional 10% should not be viewed as an increase in the goods' value but rather a practical way to ensure that minor and incidental costs are covered.

For example, if minor damage or loss occurs that doesn't exceed the value of the original shipment, the CIF +10% valuation ensures that these additional charges, like extra handling fees or minor repairs, can be reimbursed. 

Both insurers and insured parties must understand that this additional percentage is intended to facilitate smoother claim processes and provide a more accurate representation of overall costs, particularly for goods in transit over long distances.

Also Read: Comprehensive Guide On Marine Insurance: Clause, Coverage

Limitations and Issues with CIF +10%

1. Limits on Insurer's Liability to the Insured Amount

While the CIF +10% valuation provides a buffer for incidental costs, it has limitations regarding the total liability that the insurer assumes. The CIF +10% is designed to cover minor cost discrepancies and administrative fees but is not a catch-all solution for any substantial discrepancies between the insured amount and the actual loss.

The primary limitation is that insurers will only cover the agreed valuation amount. The policyholder may still face out-of-pocket expenses if significant losses or damages exceed the CIF +10% valuation. 

Moreover, if the market value of goods significantly changes, such as a price hike or supply chain disruption, the additional 10% may not be sufficient to cover the increased replacement cost.

2. Coverage Scenarios such as Total Loss at Manufacturer’s Warehouse

A significant challenge with CIF +10% is its inadequacy in cases of total loss where the loss occurs at or before the goods reach their point of departure (such as at the manufacturer's warehouse). 

Suppose goods are destroyed or damaged before shipment. In that case, the CIF +10% valuation often becomes irrelevant because the entire value of the shipment, including the cost of insurance and freight, is no longer applicable. 

In such cases, the insurer's liability is restricted to the insured amount (which may not fully cover the value of the goods if additional factors like local taxes or inland transport costs are involved).

3. Obsolescence of the Additional 10% with Modern Logistics and Technology

With the advent of modern logistics technologies, the additional 10% margin is becoming somewhat obsolete. Today’s supply chains benefit from more accurate tracking systems, digital invoicing, and real-time communication, significantly reducing the likelihood of small, unaccounted-for expenses. 

With more precise cost estimations and risk management tools now available, shippers are more likely to opt for valuation methods that provide exact coverage without relying on blanket percentages.

Also Read: Understanding Freight Insurance Costs and Requirements

Relevance of Additional 10% in Inland Transit Policies

1. Irrelevance of Additional 10% in Inland Transit

The CIF + 10% valuation method, while traditionally useful in international marine shipping, is limited in relevance to inland transit policies. 

In the case of inland transport, many of these costs are either non-existent or significantly lower. Inland transit routes are often shorter, more predictable, and subject to fewer external risks than international voyages, making the extra 10% margin largely unnecessary.

For instance, inland transit usually involves a domestic supply chain with well-known logistics costs and less variable. 

As a result, including an additional 10% rarely justifies the premium cost in these policies. Clients purchasing inland transit insurance may be better off choosing a basic valuation method without the 10% margin to optimize costs.

2. Denial of Additional 10% for Partial Losses Involving Machinery

The additional 10% might not apply in situations involving partial losses, particularly for high-value items like machinery. 

Machinery that suffers partial damage during inland transit often requires significant repairs or even partial replacement of components. This may not align with the small, incidental expenses the extra 10% margin intends to cover.

Moreover, insurers tend to deny the application of the additional 10% in cases where partial damages are identified and do not result in a total loss. This practice makes sense from a liability perspective, as the additional coverage is primarily meant for unforeseen minor costs rather than repairs or complex machinery losses. 

This further emphasizes the irrelevance of an additional 10% in inland policies where large claims are unlikely to benefit from the small buffer this valuation provides.

Also Read: Inland Marine And Ocean Marine Insurance Comparison: Coverage, Benefits, Difference

Misinterpretations Regarding the Additional 10%

1. Incorrect Beliefs about Coverage for Customs Duty

One common misconception regarding the additional 10% margin is that it covers customs duties in case of a claim. This is a significant misunderstanding in the marine cargo insurance field. Customs duties are a separate component of shipping costs, often not included in the standard CIF +10% valuation. 

As a result, businesses that mistakenly assume the additional 10% will cover duty costs may find themselves underinsured during claim settlements.

To prevent this, companies must ensure they include a Duty Clause in their policies. The duty clause guarantees coverage for customs duties in case of cargo loss or damage. Without this, customs duties remain uncovered even if the CIF +10% valuation is used.

2. Importance of Factoring Customs Duty and Attaching a Duty Clause

Businesses must factor in customs duties as part of their insurance plans for marine cargo and inland transit policies. This involves adding a Duty Clause to ensure coverage for customs charges incurred if the cargo is damaged or lost during transit.

By including a Duty Clause, organizations can ensure that both the invoice value of the goods and the customs duties are covered, preventing any gaps in coverage. This is especially important for high-value goods that may incur significant customs fees upon entry into a foreign market. 

The Duty Clause protects companies from bearing these costs out of pocket, especially when goods need to be replaced or re-imported.

Also Read: Top 5 Marine Insurance Policy Providers In India

Valuations Higher than CIF +10%

1. Scenarios Requiring Higher Valuations like Government Contracts

In some cases, particularly in government contracts or when dealing with highly valuable, sensitive goods, companies may need to consider valuations that exceed the standard CIF +10%. 

For example, government tenders often require strict compliance with regulations that demand higher coverage limits due to the sensitive nature of the cargo or the high risk involved in the transaction.

These contracts may include clauses that mandate coverage for additional costs, such as:

• Risk of obsolescence (especially for tech or machinery goods).
• Extended insurance periods that cover longer delivery timelines.
• Additional handling costs.

In these cases, businesses must consider customized valuation models extending beyond CIF +10%, ensuring that all possible exposures, including customs duties, legal fees, and unforeseen operational costs, are covered.

2. Enlightening Organizations to Eliminate Unnecessary Additional Percentages

Educating organizations about the limitations of CIF +10% and the benefits of adopting tailored insurance valuations can help eliminate redundant costs. 

By opting for more accurate and relevant valuation models—based on their specific logistics needs—businesses can significantly reduce their insurance premiums while ensuring adequate coverage for their goods in transit.

For example, instead of adding an arbitrary 10%, companies may opt for valuations that cover precise costs, such as:

• Total landed cost (cost of goods + freight + duty).
• Cost + insurance (excluding extraneous fees).
• Risk-specific policies for high-value cargo.

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