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Managing the Unique Risks of Yacht Ownership

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For individuals of substantial net worth, few pastimes offer more pleasure than cruising the oceans in the family yacht. With an onboard crew taking care of the actual sailing, and the ship’s quarters as posh as a Manhattan penthouse, relaxation is the sole order of the day.

There is one responsibility that the captain and crew will not take care of, however. And that’s ensuring that the complex risks of yacht ownership are carefully managed and expertly transferred to a specialized insurer. For this, one needs access to a savvy insurance broker like John J. Gaffney, who has spent his entire life around fine boats.

John and I enjoyed a recent discussion about his career and the unique perils confronting high-net-worth owners of yachts. For the past year, he has been senior VP of insurance broker Marsh’s yacht practice. Before that, he sold the vessels and assisted his clients in designing and having them built. “This is a total relationship business, and I have a lot of relationships with the people in it,” he said of his new role.

Sales of yachts, particularly those in the mega-size class, are up substantially in the last few years, as are the prices to buy them. But, John warned about the thorny risks in a new form of fast growing yacht proprietorship. Called fractional ownership, the financing strategy calls for two or more individuals to share in the ownership of the yacht, along with the commensurate risks.

When the titleholders are members of the same family—a father and adult son, for instance—this is a bit less of a concern, given the familial bond. But when they’re friends or business associates, severe problems can arise, chief among them the threat of being uninsured for a major loss.

“Fractional ownership is one of the riskiest ways to experience yachting,” John said. “Every scenario of disaster is essentially doubled up and further compounded when you add more owners to the mix.”

Danger on the High Seas

Traditional yacht ownership is already rife with huge financial vulnerabilities, given the unpredictable nature of the weather and a patchwork quilt of international maritime laws. Yacht insurance policies covering damage to the physical hull of the ship and first party and third party liabilities contain various coverage exclusions, such as territorial limitations on where you can sail the vessel.  

“The policy generally states the latitudes and longitudes in which you are permitted to take your yacht,” John explained. “If you wander outside these limits and something bad happens, you can be out of luck, insurance-wise.” Owners who plan to travel beyond the stated territorial limits must reach out to the applicable insurer and apply for an endorsement to the policy permitting the travel, he noted.

Other policy covenants govern the proper physical condition of the yacht, which must be ship-shape and seaworthy. Improper maintenance of the vessel can trigger a policy exclusion restricting insurance coverage in the event of an accident. Other policy exclusions may forbid the use of the yacht in a race or its operation by non-crew personnel.

These are very serious considerations. Unlike automobile insurance, which does not deny coverage if a car’s condition is sub-par during the policy period, the owner of a damaged yacht found to have had a known degraded and rotting walkway or malfunctioning engine part will be denied coverage in a New York minute. “The onus is always on the owner of the vessel to constantly maintain the ship,” John said.

By and large, these various risks are well understood in the exclusive world of yachting, thanks in large part to insurance brokers like John and expert maritime attorneys. And it is not like these financial exposures have taken the wind out of the sails of the business. After a slowdown during the recession, mega-yacht sales are up 80% in the past four years. The average price of these big ships was $9.6 million in 2014.

What is considered a “mega-yacht” is also shifting. In 1985, a mega-yacht was considered to extend beyond 100 feet in length. At the time, there were only 300 vessels of this size traversing the seas. Today, the largest 100 yachts in the world are at least 225 feet long. Even this size is starting to look a bit meager. Twenty-three colossal yachts, 300 feet long and counting, are under construction, at present. Incidentally, the largest yacht in the world, the Azzam, is 590 feet long.

Status in some circles is equated with size, which may explain the migration toward private vessels the size of small cruise ships. Size may also be a factor in the rise in fractional yacht ownership. Two high-net-worth individuals may not have the means to acquire a spectacularly sized yacht, but they can buy the vessel if they share ownership.

When they do, they invite trouble.

Promises, Promises

Two friends or business associates who agree to fractionally own a yacht 50-50 also share in the related risks on the same proportionate basis. Since no two people are alike—even close friends can have dissimilar personalities—each owner is gambling that the other will maintain and operate the ship according to the insurance policy’s coverage terms and conditions.

Let’s assume two longtime business associates, Jim and Anand, share in a large yacht’s ownership, each man taking possession of the yacht on a season-by-season basis. Anand has some experience helming a boat, whereas Jim has none. The insurance policy requires that only the hired captain and crew can operate the craft.

One evening, while the captain is shoreside, Anand orders the crew to take the yacht out to sea. If the ship capsizes for some reason, both he and Jim are financially responsible for the entire loss—even though Jim had nothing to do with the decision.

Not to pick on Anand, but let’s say he decides to enter the yacht in a regatta, unbeknownst to Jim. The policy prohibits the use of the yacht for racing purposes. During the race, the captain accidentally bumps into a competing ship, resulting in damage to both vessels’ hulls. Jim now also can be held responsible for some or all of the costs to repair each craft.

If Jim is in possession of the yacht and decides to have the captain and crew sail it beyond the territorial limits stated in the insurance policy, Anand is now on the hook for potential hull damage and any liabilities.

Let’s say Anand is a neat freak but Jim is not—a Felix and Oscar, respectively. Jim may fail to address or postpone needed maintenance and repair issues. You can pretty much figure out the rest from here.

The Complications of Maritime Law

Compliance with maritime law is another complication. Yacht owners need to be sure that their policy provides for Jones Act coverage – which pays employee benefits similar to workers compensation to the captain and crew. This coverage may also carry some of the same exclusions found in a yacht’s liability and hull insurance policies. If a crewmember is badly hurt in an incident that is excluded from coverage, both owners are financially liable for the person’s medical, rehabilitation and loss of income expenses.

By now, you are probably thinking the solution is simply for Jim and Anand to have two sets of separate insurance policies, one set for each owner. Great idea, but not possible. “The private owner of a mega-yacht is a registered entity, typically an LLC (limited liability company),” John explained. “The yacht is insured under the name of the LLC, with each of its owners specifically identified as a separate insured under the policy. Each owner is subject to the other owners’ faulty operation and maintenance of the vessel.”

Obviously, the more owners of a yacht, the more complex the risk of loss becomes.  Families can be torn apart by a fractional yacht ownership strategy that founders, but at least the likelihood of post-loss litigation is decreased by familial considerations. On the other hand, when business associates engage in the transaction, an uninsured accident is virtually sure to result in protracted legal maneuvering.

No one is arguing against fractional yacht ownership. For some high-net-worth families, it may be the only means to take occasional possession of a mega-yacht. But the related risks must be clearly understood well before signing one’s name to the deal. In such cases, someone of John’s expertise and knowledge of maritime insurance is invaluable. Only then can one sail the seven seas free of worry: true relaxation.