Since overinsurance indicates a serious disregard of sound 

 insurance principles, further analysis of the situation is necessary. 

 In t'.ie first place, the argument may be advanced that the responding 

 vessel oimer underestimated the market value of his vessel. Tliis 

 argument may carry some weight, but it is doubtful that such is the 

 case. V/hile replacement value of vessels probably vas rising, the 

 pessimistic business outlook vas a depressing factor on market values. 

 In addition kno\d.ng that the probable presence of moral hazard existed 

 to a high degree, whether the owner underestimated the market value or 

 not may be of little consequencial importance. 



Second, overinsurance may result automatically through the 

 capitailization process. Once a vessel is built its market value is 

 lax'gely, if not exclusively, determined by its earnings rather than 

 by its replacement cost, \-lhen earnings go dD\m, the market value of 

 the vt;sr,cl declin^js and vice versa . For example, let us assume that 

 a vessel cost $50^000 to build. Hull insurance on the vessel is for 

 $'+0,000 lepresenting 80 percent of its construction cost. For a 

 nvunbex of years the eai'nlngs (not including managerial salaries or 

 other implicic costs) of this investment are quite satisfactory, 

 averaging ■ViS.OOO per year. Assujiiing a 5 percent rate of i-eturn, 

 the market vaxue of this vessel can be etitiraated at .'Iiu0,u00, and the 

 insurance a'^nount is about "jS percent of that value. li' earnings, droi 

 to $1,500 p^r y'E'r, the market value of the vessel for the same rate 

 of return ca.i be e.'^timated at $30^000, and the vessel will be over- 

 insxired for $.10/^00 unic-^o the insiuvonce amount is ad,iMsted 

 accordin.':;ly. 



Tnird, a frequently employed method ivlth vrhlch insurance broV.ers 

 attempted to inci^ease the revenue of insurer^s or compete in the 

 mark(it was by increasing the value of tlie policy. 'IIil:: iuci'easi-d th"> 

 premium, while the praaium rate remained the same or, very frt^queutly, 

 even declined. The ai'rongement was desirable to the vessel owner 

 himself or at least minimized his resistance to the hl^lior out-ox'- 

 pocket cost for insurance. In addition, poor depreciation practic^^s 

 and lack of knowledge of sound business practices made many an owner 

 compare the insiuance amount with the rising replacement cost and 

 resent any reduction in the value of the policy. Hence, under the 

 combined effect of the broker's practices and the desires of the 

 insured the amount of insurance kept rising at the time that falling 

 earnings pulled the market value of the vessels down (cf. tabltts 

 A-27 for New England and Gulf Area, and table A-65 in Appendix A) . 



Finally, a special inquiry into overinsurance made after the field 

 work ended disclosed that during 1950-5ij- insurers who kept the insurance 

 amount at 80 percent of market value or used dual valuation, i.e., one 

 value for estimating the premium and a lower value for indemnifying the 

 insurer in case of total loss, or employed some other similar method 



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