Who pays if something goes wrong?

Get free expert insight into how Incoterms affect your need for insurance

When you first start out with international shipments, there are many things to consider, some of which can seem quite complex. Customs clearance most often requires local expertise, and handling dangerous goods requires training. Documentation can seem daunting too.

But those are all reasonably visible things that need attention. Something that can easily get overlooked until it’s too late is who is liable for the goods during shipment. And as a consequence, who needs to arrange for insurance.

It gets more complicated with cross-border trade where the shipment of goods can involve numerous logistic challenges and various different methods of transport as well as customs clearance. So whether you’re buying or selling goods, you need to make sure you understand what are known as Incoterms, which are set out by the International Chamber of Commerce. They define who has control (possession) and who bears risks during the process of transporting goods from seller to buyer. And these influence your need for insurance.

When the iPhone 6 was launched, a video of an excited owner dropping his new phone outside the shop went viral. Fortunately, the iPhone didn’t get damaged, but if it had been, no one would have expected Apple to replace it – it was the buyer’s bad luck and his own risk.
But what if he hadn’t collected it from the shop and it had been shipped to him? At what point in the delivery process does the risk transfer from seller to buyer? 

Insurance? Doesn’t someone else deal with that?

Maybe – or maybe not. The key things to remember are that:
  • You can have possession of something you neither own nor are liable for.
  • You can own something you neither have possession of nor are liable for.
  • You can be liable for something you neither own nor have possession of.

Is that clear? Maybe – or maybe not.

It all comes down to which Incoterms apply in each case. Agreed contractually between seller and buyer of goods, they clearly delineate when control and liability (risk) switch from one to the other.

Know the timing

As control, ownership and liability do not necessarily transfer from seller to buyer simultaneously, it’s important to be aware of when you take on or hand over risk, in other words when the responsibility for insuring the goods transfers to you from the other party in the transaction or vice-versa. This may not happen when you think it does – indeed it may be much earlier, or much later.

For example, if the Incoterm agreed is EXW (ex-works), then liability for the goods transfers at the seller factory or premises as soon as the goods are made available for collection. The fact that you arrange collection two days later, and that delivery to you takes place several weeks later after a long sea voyage in a container, has no influence on the transfer of risk and liability and thus the need to decide whether you should insure the goods.

Ex-Works is somewhat analogous to purchasing something in a shop. You take on liability and control in the actual shop, although legal ownership might not immediately transfer to you if you make a credit agreement to pay later.

At the other end of the scale are Delivered at Place (DAP) and Delivered Duty Paid (DDP). With both of these, transfer ofcontrol and risk take place at the buyer’s premises only once the goods are unloaded – in other words at the same time as the seller takes delivery of the goods. So it is the seller who has to arrange insurance – or of course self-insure – all the way to that point.

You can consider Delivered at Place to be analogous to ordering something for delivery to your home. You are paying for delivery, and you expect the seller to be liable for the goods until they are safely delivered to you.

Incidentally, transfer of ownership is out of scope for Incoterms.

Make sure the Incoterm you choose fits your logistics

As with any deal, the terms you can negotiate will ultimately depend on how significant a customer or supplier you are to the other party in the transaction. You may have to take what’s on offer, or you may be able to get something more favourable.

But be careful that you do not get Incoterms which hinder your business. Ex-works means you are responsible for arranging all freight and bear all risks once the supplier has made the goods available to you at his own premises. If you want to control the supply chain from that point on, then it could be that this is a good solution for you, although it is unlikely that suppliers will be happy if you effectively use their factory’s loading areas as extra warehouse space – there will likely need to be an additional agreement about when goods have to be collected.

Ex-works is common in the automotive industry, where just-in-time and just-in-sequence manufacturing mean that automotive manufacturers want as much control as possible over the suppliers in the chain. Another Incoterm may be prevalent in your industry.

Things that can go wrong

Here are a few common mistakes it is worth knowing about:

Not being specific enough about the place

  • Be as specific as you can. The name of a city or port is not enough – a supplier might deliver to a dockside or airport in the city named, while you are expecting delivery to your door.

Not thinking about duty and customs

  • Who pays for customs clearance and duties? With DDP (Delivered Duty Paid), clearly it is the seller who does so. With CFR (Cost and Freight) and CIF (Cost, Insurance and Freight) it is the buyer who pays. CFR and CIF mean your goods will be unloaded from the ship at the port of arrival, at which point you take over.

Assuming that ownership = liability

  • Incoterms make no mention of ownership, strange as it may seem if you are new to the concepts. Incoterms only define when possession, control and risk transfer from seller to buyer.

Passing the ship’s rail is not the same as set down in the ship.  If a crane drops and damages a container in between passing the rail and being set down, then it does not count as having been handed over to the buyer, and is still the seller’s responsibility.

When is insurance needed for each Incoterm?

The table above shows when risk (yellow bars) and insurance (red bars) transfer from seller to buyer for each Incoterm.

As you can see, they both transfer simultaneously expect with CIP (Carriage and Insurance Paid To) and CIF (Carriage, Insurance and Freight).In both these cases, the seller pays for insurance as far as an agreed place – either the final destination or the port of unloading.

Note that the last four Incoterms in the table (in light blue) only apply to transport by sea or inland waterway.

What else is there to know?

Buying insurance needs to be an informed choice, and who has liability only tells you whether you are the one who needs to decide if you want insurance.

For more details about what other factors to consider when deciding about insurance and gain a better understanding of the difference between insurance and carrier liability, see our White Paper about Cargo Insurance.

In conclusion

Incoterms appear complex at first glance but are in fact quite straightforward once you get used to them, especially the more frequently used ones.
The key to successful import and export is closely related to agreeing the most appropriate Incoterms for your circumstances. Make sure you know which apply, which you prefer when negotiating and that you are adequately insured.

About the author

Stine Monefeldt Holm is Marine Insurance Manager at DSV. She is an attorney specialised in transport law and has eight years of underwriting experience in marine insurance both in Denmark and UK, building up the AIG Marine Insurance Centre of Excellence in London.

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