What is Residual Value Insurance (RVI)?
As part of our new asset class, Marine Finance, certain vessel acquisition offerings will contain a Residual Value Insurance (RVI) provision. In this article, we will explain what RVI is and how it helps protect downside in a Marine Finance investment. Standard in the aviation industry for insuring jet engines, we believe this is the first time RVI will be used during the acquisition of a marine vessel. Before getting into RVI we recommend reading our intro article or video on Marine Finance.
What is Residual Value Insurance?
An RVI policy gives the owner of a vessel downside protection by guaranteeing the value of a properly maintained vessel. At the end of the policy, if the market value of a sale price for the ship is below the insured amount, the insurer would make up the difference or purchase the vessel for the insured amount. The main benefit of purchasing RVI is that vessel value risk can be transferred from the ship owner to the insurer. This provides a floor on the future value of the ship. The underwriter takes a percentage (usually around 80%) of the projected future value of the ship to be insured.
YieldStreet Founder Michael Weisz explains how RVI will be used during Marine Finance Acquisition I
RVI does not provide coverage for expenses related to damage to the vessel (the ship’s Hull and Machinery insurance covers that). The owner and insurance company typically agree that the vessel must be in good structure and condition, similar to the preliminary valuation, with reasonable wear and tear permitted. A standard policy covers 3-5 years but can be longer for newer vessels.
Why Purchase RVI?
As discussed in our Intro to Marine Finance article, the value of a ship can increase or decrease in value depending on the current state and projected outlook of charter rates. The value of a dry bulk vessel can actually increase as the Baltic Dry Index (BDI) strengthens because its worth is derived not only from the value of its parts and infrastructure, but also from its future earnings potential. If there is a healthy supply/demand balance in the available vessel fleet and the global economy is projected to grow, the BDI should increase, as should a ship’s value and the cost of transporting goods.
A ship owner would purchase RVI to protect downside in case of a dramatic downward swing in shipping demand, which would cause the ship value to decrease during a ship’s time charter. At YieldStreet, for vessel acquisition opportunities, we look for offerings that have the first year of the time charter already fully contracted out.
How Does RVI Work?
An insurance company typically works with a valuations firm to estimate the future value of the vessel. If the ship’s value is less than that future estimated amount at the end of the policy, then the insurer is obligated to purchase the ship at a previously agreed upon value (typically 80% of the ship’s estimated future value). As is standard in the insurance industry, the insurer makes money when things go well, and a policy claim is not triggered (typically, if a ship’s value appreciates or stays the same). An insurance company would lose money if they are forced to buy a ship below the insured amount.
To begin, the insurance company undergoes a thorough underwriting process to obtain the current value of the ship. They will work with a marine valuation firm that helps them project the ship’s future value at the end of the insurance policy term, taking into consideration factors like: type of vessel, vessel age, ship builder, policy length, tonnage capacity, and more. Towards the end of the RVI policy, a ship owner has a few options. If the vessel has maintained its value, and the shipowner decides to keep the ship, the contract simply expires and the policy is terminated.
Regardless of the ship’s value, if the ship owner decides to sell the ship, he or she can trigger the RVI policy. The ship’s ‘marketing period’ begins after the ship owner gives the insurance company 12 months’ notice. When the marketing period begins, the ship owner must provide reasonable commercial efforts to sell the vessel, with the insurer approving any offer. The insurer has the right to step in after nine months and assist with the sale. If no suitable offer is reached by the end of the policy’s term, the insurer will pay the ship owner for the previously agreed upon residual amount, and title to the ship passes to the insurer. If however, an offer is made that the insurer approves and is below the insured amount, the insurer will provide the difference to the shipowner. If the sale price is above that residual amount, the ship owner keeps the excess funds.
Here’s a Hypothetical Example of How RVI Works
- A ship owner, Monty’s Maritime, approaches an insurance company, Coconut Grove Insurance, to insure a vessel currently valued at $10 million for 3 years.
- Coconut Grove Insurance works with a vessel valuation company and determines that they will insure the vessel at $9 million at the end of three years.
- A series of tariffs between two major trading economies softens the global economy, dragging down the ship’s value. The ship is now worth $8 million after two years.
- Monty’s Maritime gives notice that they will be making a claim on the RVI and must reasonably market the vessel, with Coconut Grove Insurance approving any offer.
- No compelling offers come forward, and, after a careful inspection of the vessel’s physical state, Coconut Grove Insurance purchases the vessel from Monty’s Maritime for $9 million.
Benefits of Residual Value Insurance
RVI helps protect ship owners from unpredicted economic swings and helps guarantee their asset at a specific future value. Regardless of the ship’s value, the ship owner has the security that there will be another party helping market their ship if necessary. On the investor side, RVI helps protect downside by securing a significant portion of the investor’s principal.
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