Risk reduction strategies for exporters
Making an export sale can be difficult enough, but then there’s the delivery to organise and ensuring you get paid for your efforts. Here are some important insurance issues your exporter clients need to consider when negotiating their terms of trade.
With globalisation now a reality, many Australian companies are looking to offshore markets to sell their merchandise, especially Asia. According to Austrade, Australia’s top three merchandise-export markets in 2007 were Japan, China and Korea, with China and Malaysia being two of the fastest growing markets.
What do we export? While raw materials and primary produce top the list as you’d expect, Australian businesses are now exporting everything from live lobsters to destinations like Dubai and Japan to technologies used in the production of banknotes to central banks, neurological scanners to the US army and saltwater crocodile skins to exclusive French fashion houses.
If you have a client considering selling their goods offshore or who is relatively new to the export business, it’s important they familiarise themselves with the basic tenets of some commonly used ‘Incoterms’. Devised by the International Chamber of Commerce, Incoterms are the standard trade definitions that are commonly used in international sales contracts. The terms specify who is responsible for clearing goods for export, freight costs, arranging insurance and at what point in the delivery/exchange process the buyer assumes the risk from the seller for loss or damage to the goods.
Some useful definitions
While there are 13 Incoterms in total, the ones that we encounter most frequently in our Australian dealings are ‘Ex works’, ‘Free on Board’, ‘Cost and Freight’ and ‘Cost, Insurance and Freight’. Here’s a brief overview of what each of these terms means.
Ex works (EXW): This contract term imposes the minimum obligation on the exporter, because the buyer takes full responsibility and risk for the carriage of the goods from the seller’s premises or another specified pick-up point (eg a factory, warehouse etc).
Free on Board (FOB): The seller is deemed to have delivered the goods when they pass the ship’s rail at the port of shipment. The buyer arranges and pays freights costs and bears the risk from that point onwards.
Cost and Freight (CFR): As with FOB, the seller is deemed to have delivered the goods when they pass the ship’s rail at the port of shipment. The seller pays for the freight to the destination port, while the buyer assumes the risk for the goods on delivery.
Cost, Insurance and Freight (CIF): As with CFR, the seller is deemed to have delivered the goods when they pass the ship’s rail. But the seller must pay for the freight costs and arrange the marine insurance to cover the goods to the destination port.
FOB isn’t always the best option
When you’re dealing with overseas trading partners, selling EXW isn’t usually a practical option. And whereas selling FOB may look like the most attractive trade term – given the exporter is only required to deliver the goods to the vessel – it leaves the exporter with less control, less commercial flexibility and greater risk exposure.
To manage risk effectively, you have to be in a position to control it. For exporters, this means retaining control of the transport chain and the cargo insurance arrangements. Much of Australia’s commodity exports have traditionally been sold FOB but astute exporters are increasingly selling on CIF terms.
Why? Because one of the downsides of FOB sales is that the buyer controls shipping and it may well suit them to delay sending a vessel to collect the goods. This can leave the exporter with extra costs, delayed payment or even an aborted sale.
The advantages of CIF for sellers
One of the pluses of selling CIF is that the trade terms oblige the buyer to accept delivery at a port in his country or risk incurring demurrage (detention of freight) and/or storage charges. The exporter is far better off with goods piling up at the buyer’s expense overseas rather than at his own expense while awaiting shipment.
Under CIF sales, warehouse to warehouse protection is achieved as the cargo insurance covers the insurable interest of the exporter until risk in the goods passes to the buyer from when it covers the buyer’s interest. This is provided the insurance has been assigned by the exporter – usually by stamping and signing the reverse of the insurance policy or certificate. To be effective, it is essential this be done before risk in the goods passes to the buyer (ie before loading onto the vessel or aircraft), the legal rule being you can’t assign something you no longer have.
Another advantage of having the goods insured by a local insurer is that you won’t be stymied by language problems, time zone differences and other such obstacles should something go wrong and you have cause to claim.
A local insurer will also be able to offer advice on the best course of action in the event of an unforeseen problem, such as a shipping line going bankrupt while your goods are in transit or a port being closed for an extended period due to a strike. Either way, your goods can end up being delivered to a destination that you had never intended them to go to.
While insurance covers you for the physical loss of goods, this kind of expert advice can help you avoid potential reputation damage that can occur in these circumstances if the problem isn’t dealt with efficiently and effectively.
The potential problems with CFR
If the exporter fails to include cargo insurance in their sales terms and elects to sell CFR, they face extra exposure and extra insurance costs. This is because the cargo insurance arranged by the buyer will only protect their interest and not that of the exporter.
Whilst the buyer’s cargo insurance may appear to cover the goods from warehouse to warehouse, in fact cover only attaches at the point of the buyer’s risk (and thus his insurable interest) under the sales contract. As noted, this is usually from loading on board the vessel or aircraft.
With all FOB and CFR sales, the exporter is exposed to cargo loss or damage risks from warehouse to loading on board and needs to arrange cargo insurance on an annual basis to cover these risks. Also, in case for any reason the risk in the goods fails to pass to the buyer, the exporter needs seller’s contingency insurance for all FOB and CFR sales to ensure they don’t become exposed whilst uninsured to any unplanned risk of cargo loss or damage in transit.
By selling CIF, the exporter avoids the need for and the cost of these separate cargo insurances designed to protect their interest only. Instead, the cost of insuring both the seller’s and the buyer’s exposure can be charged to the buyer in the CIF price. As the cost of insurance doesn’t need to be separately invoiced, the exporter also has greater flexibility in setting CIF prices.
Choosing a marine insurer
Given the variety and complexity of transport and marine insurance law and practice, it is important for an exporter to carefully select a marine cargo insurer with the requisite knowledge and expertise plus a high reputation for efficient and caring claims handling.
Zurich Marine is widely acknowledged as a market leader in marine cargo, transit and ship insurance both in Australia and the Pacific region.
© Zurich Financial Services Australia March 2009.
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Incoterms are the international rules for the interpretation of trade terms used in international trade, formulated by the International Chamber of Commerce.