Jun 10 | 2022
CFR and CIF Introduce Separate Risk, Cost Points in the Movement
In a continuing series by former Halliburton Vice President of Global Logistics John Vogt, you’ll gain the critical information needed to reduce shipping risks to your company whether you’re the buyer or shipper. Look for John's new installments in BreakbulkONE each month.
We have arrived at the point in this series where we understand the domestic movement rules of EXW, FCA, FAS and FOB – or at least I hope so! We should realize that for these rules, risk and cost transfer to the buyer at the named place.
We have also looked at adding to the named place a period to define when goods must be delivered, the aspect of ‘customary to the port’ as well as an introduction to trading while in motion. This starts to show the ways Incoterms® rules can be utilized and augmented to help with a trade.
With this understanding in place, we are now able to explore the four ‘C’ rules, which stands for Cost in the case of the two water-only rules, and Carriage in the case of the two all modes rules. These are different in concept from any other rules as the risk transfers at a different place than the named place. And yes, the rules are not all nice and consistent with the named place, risk and cost in the same place and time!
For a simple introduction, we will focus on the two water-only rules of CFR (Cost and Freight) and CIF (Cost Insurance and Freight) which define the water movement from port to port. These are rules that have been in existence since the inception of the Incoterms® rules as the primary method of long-distance movement in those days was by ship. Movement by ship is governed by Maritime Law, which is very different from the legal systems of countries, as it was created by seafaring nations to protect the ships and the owners of the ships and cargos. When we discuss the insurance aspects shortly, we will see that Maritime Law has a part to play in the risks and coverage.
The rules CFR and CIF are between a loading port to a discharge port. Let’s look at CFR, with a note that the only difference between this and CIF is a requirement that the seller obtains specific insurance. The CFR rule has a named place which must be the discharge port for the goods from the ship. However, the risk transfers on the loading of the ship at the loading port, which is a major difference from other rules we have discussed. This is potentially thousands of miles away and days or weeks in time. The seller must deliver onto the ship at the loading port at its risk, but once on board the ship, the risk transfers to the buyer. The seller must procure onward movement via a vessel or vessels to the named place, which is the port of discharge, so the seller’s cost extends to the port designated in the named place.
The Incoterms® rule does not specify the port of loading, nor the route, nor the carrier or carriers. One can look at this in an extreme case to emphasize the point that these allow very different behavior from the rules we have looked at previously. I was approached by a company to assist them to find and expedite the delivery of their goods as they had been in transit for more than two months. They had agreed to a CFR rule with the seller in Africa, using the imprecisely specified named place as USA. What the seller did was route the goods for the cheapest cost and used shipping lines which transshipped in Germany, again in the UK, and then delivered to New York. Three different shipping lines were involved! This move complied with the Incoterms® rule chosen as there was no period specified, or port of discharge, and the C rule does not specify the route. Even more disastrous was that the goods arrived in Tampa, Florida, in the U.S. Southeast, and the buyer had to unexpectedly contract a road delivery from Tampa to New Jersey in the U.S. Northeast. If the buyer had chosen the CFR rules with a specific New Jersey port as their named place and added a period for delivery, they would have received their goods on time. Sloppy or imprecise specifications will eventually cost you money, as will not having a deep understanding of the Incoterms® rules.
Insurance
Insurance is another aspect that needs some thought and understanding. In the CIF rule, the seller must obtain the limited insurance specified in Clause (C) of the Institute of Cargo. The value of the insurance is set at 110 percent of the value of the goods. The value will be taken from the purchase invoice, or Commercial Invoice value, and that is the maximum that could be recovered from insurance.
Beware of this value. I know of a case where a company sent expensive equipment and it was lost. However, the value that was on the Commercial Invoice was the fully depreciated cost (20 percent of its original value) and not the replacement cost. Of course, the company was unhappy to discover the insurance payout was less than 20 percent of a new piece of equipment! It covers the risks most often found in movement such as physical damage, or fire and explosion and General Average, which we will explore shortly, but many risks are not covered.
The following (and other) situations or risks are exempted:
• Consequential loss or loss of profits for the buyer.
• All-risks.
• Strikes, war and so on.
• Vessel that is not fit for the cargo or is not seaworthy.
• Poor or inadequate packaging which must ‘withstand the ordinary incidents of the insured transit.’
• Deliberate acts.
• Delays and so on.
The insurance is from a start point designated in the insurance to the end point, so these have to be carefully chosen. It assumes immediate loading and has a validity period. As one can see, this is not a simple insurance, and it must match the Incoterms® rule regarding port of loading and discharge, as well as the periods. It is always valuable to have an insurance expert look at the insurance and set a way forward for regular shipments as well as specific shipments. Many companies self-insure, but the risk must be understood for each shipment type and shipping lane as different lanes have different risks. Think about the shipment between the U.S. and Holland as compared with U.S and Angola. The route is past the northwest coast of Africa, which has a high level of piracy, while the lane between the U.S. and Holland does not. Please note that self-insurance is not ‘free’ but is merely a way for a company to reduce the cost via its own insurance capability, rather than via a broker. Many buyers may require more extensive insurance and, in this case, the CFR rule becomes useful with the specifically enhanced insurance added separately as part of the agreement between the buyer and seller.
One other issue needs to be addressed now we are doing movement internationally and specifically via vessels namely the Maritime Law concept of General Average. This is an interesting and sometimes scary situation. In principle if a ship encounters problems, the ship may call on the owners of the cargo on board to pay for the return of the ship to service. Consider a ship that has a fire in a hold, and deliberately runs aground so it does not sink. This is what happened in the Philippines, and my company had shipped some very expensive equipment on the ship. Senior managers were in my office the next day demanding that we sue the shipping company for loss of the goods and loss of profit. They were more than incredulous when I advised them not to pursue this, as they would be paying for the refloating of the vessel. They did not believe this could be correct, and sought external counsel opinion, after which they came back to ask me to please try and recover the equipment and minimize their costs. The same sort of issue must have gone through the minds of the cargo owners with the Ever Given, which blocked the Suez Canal for six days in 2021.
In summary then, these water-only C rules of CFR and CIF introduce separate risk and cost points in the movement. Risk transfers at the port of loading when goods are on board the ship, while costs are paid by the seller to the named place, which is the port of discharge. The seller chooses the carrier and the route, and contracts for the movement by water between the port of loading and the port of discharge. The limited insurance specified for CIF must be accepted with caution, and the use of CFR plus a separate clause to specify the insurance should be considered if specific insurance is required. Above all, the understanding of the Incoterms®, risk transfer point, insurance, and precision of specification of the named place with a period for delivery, are important to prevent issues with delivery or higher risks. As one can see, ignorance of any or all these issues can increase the risk enormously.
In the next article we will look at the remaining ‘C’ rules which are for all modes and build on the issues raised here. I will also pick up the conversation of trading on the water we initiated with the FAS and FOB rules and explore what should happen in principle including some thoughts about Bills of Lading.
Missed Jon Vogt’s Previous Articles? Find Them Here:
Why Everyone Needs a Better Understanding of Incoterms (January 11, 2022)
For Incoterms, Devil is in the Details (February 8, 2022)
Why Use Ex Works Incoterm Rule? (March 3, 2022)
When FCA Can Be a Four-letter Word (March 31, 2022)
About the Author
John Vogt has his own consulting company and, at the end of his 42 years in industry around the world, was the Vice President of Global Logistics for Halliburton. Thereafter he spent five years as a Professor of Record for the University of Houston-Downtown MBA for International and Supply Chain courses. He has experience as a Board Director and has traveled the world to improve trade.
In his career, he has driven the correct use of Incoterms as part of the trade improvements he has implemented to drive efficiency and effectiveness. In his role as a professor of record, he taught multiple courses on the use of Incoterms and trade-related agreements. He has published with colleague Dr. Jonathan Davis (Associate Professor, Supply Chain Management Chair GMSC Department, Marilyn Davies College of Business, University of Houston-Downtown), three formal research papers on Incoterms with two more in consideration, making him the most published Incoterms researcher. He has also published numerous articles, presented papers at multiple international conferences around the world on logistics, trade and compliance including Incoterms. He has served as track chair for multiple conferences as well.
Vogt has a Ph.D. (Logistics), an MBA, and a B.Sc. (Engineering), holds the title of European Engineer (Eur. Ing), is a Chartered Engineer (UK) and has been elected as a Fellow of the Institute of Engineering and Technology (UK). You can reach him at [email protected].
