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Transfer of Risk Definition and Meaning in Insurance

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

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What Is Transfer of Risk?

A transfer of risk is a business agreement in which one party pays another to take responsibility for mitigating specific losses that may or may not occur. This is the underlying tenet of the insurance industry.

Risks may be transferred between individuals, from individuals to insurance companies, or from insurers to reinsurers. When homeowners purchase property insurance, they are paying an insurance company to assume various specific risks associated with homeownership.

Understanding Transfer of Risk

When purchasing insurance, the insurer agrees to indemnify, or compensate, the policyholder up to a certain amount for a specified loss or losses in exchange for payment.

Key Takeaways

  • A transfer of risk shifts responsibility for losses from one party to another in return for payment.
  • The basic business model of the insurance industry is the acceptance and management of risk.
  • This system works because some risks are beyond the resources of most individuals and businesses.

Insurance companies collect premiums from thousands or millions of customers every year. That provides a pool of cash that is available to cover the costs of damage or destruction to the properties of some small percentage of its customers. The premiums also cover administrative and operating expenses, and provide the company's profits.

Life insurance works the same way. Insurers rely on actuarial statistics and other information to project the number of death claims it can expect to pay out per year. Because this number is relatively small, the company sets its premiums at a level that will exceed those death benefits.

Reinsurance companies accept transfers of risk from insurance companies.

The insurance industry exists because few individuals or companies have the financial resources necessary to bear the risks of the loss on their own. So, they transfer the risks.

Risk Transfer to Reinsurance Companies

Some risks are too big for insurance companies to bear alone. That's where reinsurance comes in.

When insurance companies don't want to assume too much risk, they transfer the excess risk to reinsurance companies. For example, an insurance company may routinely write policies that limit its maximum liability to $10 million. But it may take on policies that require higher maximum amounts and then transfer the remainder of the risk in excess of $10 million to a reinsurer. This subcontract comes into play only if a major loss occurs.

Property Insurance Risk Transfer

Purchasing a home is the most significant expense most individuals make. To protect their investment, most homeowners buy homeowners insurance. With homeowners insurance, some of the risks associated with homeownership are transferred from the homeowner to the insurer.

Insurance companies typically assess their own business risks in order to determine whether a customer is acceptable, and at what premium. Underwriting insurance for a customer with a poor credit profile and several dogs is riskier than insuring someone with a perfect credit profile and no pets. The policy for the first applicant will command a higher premium because of the higher risk being transferred from the applicant to the insurer.

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Transfer of Risks: Definition & How It Works

Businesses rely on critical connections with customers, suppliers, vendors, and contractors. Agreements are reached and written contracts are negotiated in these situations.

Contracts where one party agrees to take over the obligations of another party are becoming more common. Business owners that are savvy understand the advantages of assigning potential liability to others and arranging contracts in their favor. What does this mean for a company’s bottom line, though?

This is where a transfer of risks comes into play.

But what exactly is a transfer of risks?

Read on as we take an in-depth look at everything you’ll need to know.

KEY TAKEAWAYS

  • A transfer of risk moves responsibility for future potential losses from one individual to another.
  • The insurance industry is built on the business model of accepting and managing potential risks.
  • Transfer of risk works effectively since many risks can go beyond what most businesses and individuals can handle.

What Is Transfer of Risk?

A transfer of risk is a type of business agreement that’s put together. It works by having one party pay another party to take on the responsibility for potential financial risks and business risks. Basically, the party that is paid agrees to mitigate specific losses that may or may not occur. 

In a lot of ways, the transfer of risk plays a big role in the insurance industry, especially when it comes to risk assessment. A variety of risks can be transferred from individuals to insurance companies, between two individuals, or even from an insurer to a reinsurer. 

For example, when a homeowner purchases property insurance, they’re basically paying an insurance company to take on potential risks that can come with homeownership. This plays a big role in potential financial losses from an adverse outcome.

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How the Transfer of Risk Works 

If you were to go and purchase insurance, the insurer you purchase it from would agree to compensate you up to a certain amount. This is in the case of a specified loss, or even losses, and is in exchange for your payment. 

The easiest way to think about how the transfer of risk works is with insurance companies. They undergo an assessment of risk and collect premiums that are paid on policies from millions of customers. By doing this, they generate a pool of cash that’s then available to cover potential costs of damage to property or destruction. And this can be for a business owner or an individual.

It works well because there is often only a small percentage of policyholders that need to have their insurance cover damage. As well, premiums that get paid also cover operating and administrative expenses, which in turn generate the company’s profits. 

The insurance contract is a common method to ensure customers have insurance for accidents and it’s also common in the life insurance industry. Purchasing insurance premiums is based on statistics that can forecast the number of death claims that might have to get paid each year, or the burden of risk. 

Since this number can be low, the insurance company establishes its premiums at a higher level to help exceed the death benefits. 

Risk Transfer to Reinsurance Companies 

Even though insurance companies regularly rake on risk, some risks are just too big to handle alone. This is where reinsurance comes into play. 

If there comes a time when an insurance company doesn’t want to or isn’t able to assume a lot of risks, they then transfer the excess risk to a reinsurance company. The complexity of risk can vary and often it can depend on the current risk status.

For example, one insurance company might regularly have policies that limit its maximum liability to $5 million. However, if it takes on additional policies that have a need for higher maximum amounts, it can transfer the excess risk to a reinsurer. This can be important if a major loss ends up occurring from common risk. 

Ways to Transfer Risk 

There can be a few ways to undergo the process of transferring risk. One of the main ways is through an insurance policy, which is the most common method. When a policyholder takes out insurance from an insurance agent, they transfer financial risks to the insurer. 

In exchange for doing this, the insurance companies often charge a fee, or the insurance premium. 

Another way to transfer risk is through indemnification clauses in contracts. The contracts would include a clause that outlines assurances for potential losses. It will specify that any potential losses will be compensated. 

It’s worth mentioning indemnification clauses are separate from insurance coverage. They can also get referred to as a save-harmless clause or a hold-harmless clause. 

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Benefits of Transferring Risk 

By transferring risk, you can remove any liabilities from your business and have an insurance company look after them. This is done through insurance or a contract with an indemnification clause. 

If you don’t have these in place then an injury or property damage caused by a third-party can lead to a claim situation. Undergoing risk transfer properly will help allocate risk equitability. Plus, it will designate certain risk responsibilities for certain parties. 

Ultimately, the biggest benefit of transferring risk is to protect your business from financial liabilities. 

Transfer of Risk Example 

One of the most common examples of risk transfer happens with property owners. For example, a commercial property owner faces a wide range of potential risks and challenges with their tenants. 

This is why most property owners include an indemnity clause or hold-harmless agreement. Having these in place releases you from general liabilities or any consequences that arise from the actions of a tenant.

Taking out an insurance policy and paying an insurance premium is meant to provide peace of mind. When you do this, you’re basically transferring risk from yourself to the insurance carrier. For example, by taking out homeowners insurance, insurance liabilities are then covered by the insurer if property damage or physical damage occurs. 

It also works the same way in life insurance to help provide insurance for accidents should death benefits happen. If the risk becomes too great, there can be a management of risk from insurance companies to a reinsurer.

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Frequently Asked Questions

The first form included in risk transfer is the insurance policy. The second is the indemnification clause that’s included in the contracts. These contracts can be helpful to help an individual transfer risk.

Essentially, the main purpose of risk transfer is to pass the financial liability, such as legal expenses or damage costs, to an insurer that would be responsible should something happen. It’s common in the insurance industry.

Basically, transferring risk means putting the responsibility of handling the liabilities or damages that come with a potential risk to a third party. Risk sharing, on the other hand, involves the need to cooperate with another party to increase the probability of risk.

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Contractual Risk Transfer: The Basics

Upper tier contractors seek to avoid the financial costs that can arise out of bodily injury or property damage to a third party caused by a lower tier (subcontractor) for which they (the upper tier) could be held vicariously liable. Further, when allowed by statute, and sometimes even when not allowed, upper tier contractors attempt to avoid the financial consequences arising out of injury or damage for which they and the lower tier contractor are jointly liable. In extreme cases upper tier contractors may even contractually endeavor to relieve themselves of financial responsibility for liability arising from their sole negligence.

Vicarious Liability

Vicarious liability is created when one person or entity is or can be held legally liable for the results of another person’s or entity’s actions. Such indirect liability (also called imputed negligence) can arise out of a relationship (parent/child, employer/employee, etc.), position or contract. To be held vicariously liable, a person or entity must have the right, ability or duty to control the actions of the directly liable party. Without the opportunity or responsibility to control another’s actions, there can be no vicarious liability.

Owners and general contractors (the upper tier) hold a position with a certain amount of control over and responsibility for the actions of lower tier contractors. This control leaves them vulnerable to being held vicariously liable for the actions of lower-level entities. Every state allows vicarious liability to be transferred back to the at-fault lower tier contractor (known as limited transfer ).

Joint Liability

Joint liability, as the name suggests, is injury or damage caused by or attributable to both the upper tier and lower tier contractor. The term does not consider the “percentage” of fault assignable to each party, only that the actions of both parties resulted in the injury or damage. Approximately 19 states allow the upper tier contractor to contractually transfer joint negligence back to the jointly-liable lower tier contractor (known as intermediate transfer ).

Sole Negligence

Sole negligence and liability exists when only the upper tier is found to be negligent and legally liable for the injury or damage. In sole negligence situations, there is no assignable negligence or legal liability to the lower tier contractor. According to the International Risk Management Institute (IRMI) only 10 states allow the contractual transfer of sole negligence from the upper tier to the lower tier (known as broad transfer ). However, there are strict guidelines for such transfer in the states that allow this level.

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Accomplishing Financial Risk Transfer

Upper tier contractors have access to and utilize several “tools” to accomplish the financial risk transfer they desire. Insurance professionals see these attempts and requests daily; so much so that it is likely the intricacies of each tool are not carefully considered. The four most commonly requested financial risk transfer “tools” are:

  • Contractual risk transfer (indemnity agreements);
  • Additional insured status for the upper tier;
  • Waiver of subrogation endorsement requests; and
  • “Primary and noncontributory” requirements related to additional insured status.

Contractual Risk Transfer

Contractual risk transfer is a non-insurance contract/agreement between two parties whereby one agrees to indemnify and hold another party harmless for specified actions, inactions, injuries or damages. This risk transfer accomplishes objectives found in both risk financing (finding a source to pay the cost of a claim) and risk control (developing a means to avoid or lessen the cost of a loss).

The ideal use and true purpose of contractual risk transfer is to place the financial burden of a loss on the party best able to control or prevent the incident leading to injury or damage. Presumably, the entity(ies) directly and actively participating in the activity have the best opportunity to prevent or avoid the loss; thus they are contractually required to protect an “innocent” supervising or non-participating party from financial harm following injury or damage.

Indemnification, Hold Harmless and Waiver: The Heart of Contractual Risk Transfer

Contractual risk transfer through the use of indemnification wording (referred to as “indemnity agreements”) require the lower tier to “ indemnify and hold harmless ” the upper tier for the upper tier’s legal liability arising out of some action or inaction of the lower tier contractor. Legal liability is liability imposed by the courts through common law or by statute on any person or entity responsible for the financial injury or damage suffered by another person, group or entity.

Indemnification is the contractual obligation placed on the lower tier contractor (aka, transferee, subcontractor or obligor) to return the upper tier contractor to essentially the same financial condition that existed prior to the loss or claim; or to stand in the transferor’s (upper tier’s) place as the source for financing the legal liability. (A person or entity can be held “legally liable” without committing a negligent act.)

Hold harmless wording requires the lower tier shield the upper tier contractor from the effects of the legal liability assignable to upper tier (aka, transferor or obligor). Essentially, the lower tier stands in place of the upper tier, taking onto themselves the legal liability that would have been placed on the upper tier. But the extent to which the lower tier subcontractor can stand in place of the upper tier is a function of individual state statute. States often limit the amount of “blame” a transferor is allowed to contractually transfer to the lower tier (limited, intermediate or broad – as mentioned previously).

Contractual waiver of subrogation is the third “leg” of the contractual risk transfer stool. Construction contracts nearly always require the lower tier to waive its right of recovery against the upper tier contractor. An insurance carrier’s subrogation rights flow from the right of the harmed party to be made whole by the party responsible for the injury or damage. If the right of the lower tier contractor to recover from the upper tier contractor has been contractually waived, then the insurance carrier has no right to recover from the upper tier contractor.

Additional Insured Status

Beyond the contractual risk transfer provisions found in construction contracts, the lower-tier subcontractor is nearly always required to endorse the upper tier contractor onto its CGL as an “additional insured.”

Because the upper tier is an additional insured protected as an additional insured by the named insured’s (lower tier contractor’s) insurance coverage for any claim caused in whole or in part by the named insured, the insurance carrier cannot seek recovery from the upper tier. As an insured, the upper tier’s policy will not be asked to contribute to the loss or even respond in subrogation.

Note : The 2007, “ in whole or in part ” wording protects the additional insured against its vicarious liability for the actions of the named insured, plus joint liability when both the named insured and additional insured are legally liable for the injury or damage. However, the 2013 version of the construction-related additional insured endorsements limits the breadth of protection extended to the additional insured to the level allowed by the subject state’s anti-indemnification statutes. If the state is a “limited transfer” state, the upper tier is protected only for its vicarious liability for the actions of the lower tier. In “intermediate transfer” states, the protection extends to include both vicarious and joint liability. A “hiccup” exists when the parties are in a “broad transfer” state. Neither the current nor the revised additional insured endorsements seem to extend protection all the way to the sole negligence of the upper tier.

Waiver of Subrogation Endorsement

Contracts appear to become “overly protective” when contractual risk transfer provisions, contractual waiver of subrogation and the requirement to extend additional insured status to the upper tier contractor are followed by the requirement to endorse a waiver of subrogation in favor of the upper tier contractor onto the various polices (CGL, auto, work comp and umbrella/excess). This is a “ belt and suspenders” approach bordering on unilateral self-preservation by the upper tier contractor.

As noted previously, subrogation rights flow from the injured party’s right to recover from the at-fault party. If the contract requires the waiver of subrogation rights the insurance carrier cannot subrogate against the upper tier anyway.

By attaching the waiver of subrogation endorsement in favor of the upper tier, the insurance carrier, for the third time (because of additional insured status), is blocked from seeking recovery from the upper tier contractor for its actions in causing injury or damage.

Generally insurance carriers freely grant these endorsements for all underlying coverages (CGL, auto and work comp); however, some carriers balk at endorsing a Waiver of Subrogation onto the umbrella or excess policy. Such withholding makes no sense. Why would a carrier willingly give subrogation rights away in the underlying coverage but then want to retain subrogation rights in the umbrella? If the carrier is going to waive subrogation, all subrogation rights should be waived (granted, if the umbrella coverage is provided by a different carrier, this could become a legitimate issue).

The “Primary and Noncontributory” Requirement

“Primary and noncontributory” is an “inclusive” contractual requirement that can be met only if the protection extended to the upper tier contractor is provided on both a primary basis and a noncontributory basis. Analyzed in the context of a construction contract, the supposed goal of the “primary and noncontributory” requirement is the protection of the upper tier contractor’s financial resources from the effects of the lower tier’s individual or joint negligence in causing injury or damage to a third party.

Theoretically, the “primary and noncontributory” requirement applies to only the protection extended to the upper tier as an additional insured.

Upcoming Class

Thursday, March 19, The Academy of Insurance hosts the class, “ Strong Contractual Risk Transfer Requirements: What Makes the Best CRT Design .” The capstone of the upcoming webinar is a discussion on what makes the best contractual risk transfer program. Three “levels” of CRT are presented; these are:

  • What constitutes a minimally acceptable CRT program;
  • What is required for an above average program; and
  • The steps that must be taken to have a superior CRT program.

If you deal with contracts and contractual risk transfer, you want to be there on March 19. Everyone in your office can attend and only one registration is required (pull everyone into the conference room to take part). Register today.

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Written By Christopher J. Boggs

Chris Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA, CWCA, CRIS, AINS, is a veteran insurance educator. He is Executive Director, Big I Virtual University of the Independent Insurance Agents and Brokers of America. He can be reached at [email protected].

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Transfer of clinical responsibility and risk in advice and guidance referrals

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  • Carter Singh , GP partner
  • Willowbrook Medical Practice, Sutton in Ashfield, UK
  • drcartersingh{at}gmail.com

One of the key roles of the general practitioner is to stratify risk and manage multiple undifferentiated, covarying, evolving illnesses. The key objective is not always to arrive at a definitive conclusion or diagnosis, but to act as a gateway to further management.

Referral is a major part of both the GP’s role and the patient’s experience. Referrals are an important cost driver in the health architecture and are made for many reasons. The decision to refer is never taken lightly.

Referral usually involves a transfer of clinical responsibility and risk. Although advice and guidance can work well in some circumstances, some who view it through the lens of pragmatism or cynicism say that it is being used as a mechanism to avoid seeing patients, to cut costs and waiting lists, and to bounce the risk and responsibility back to the referring GP. 1

Quite often the caveat in the consultant letter back to the GP reads, “Please do let us know if you think we have missed anything.” This implies that if they decide not to see the patient and instead give the GP a 10 point list of actions then any errors are because of information the GP has omitted from the referral rather than the consultant’s decision making process. General practice is not an infinite risk sump.

My main concern is that patients will be caught up in this dangerous game of “who’s responsibility is it anyway” and the crossfire between consultants and GPs—and that lengthy delays and possible missed diagnoses will then occur. I fear that patients will be harmed and the medicolegal principles and responsibilities of the above processes will soon be tested in the courts.

Competing interests: CS is a Royal College of General Practitioners council member and chairman of Nottinghamshire Local Medical Committee.

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Table of Contents

Transfer of risk.

Transfer of Risk is a fundamental feature of insurance and investment contracts. It’s a strategy where financial risk is transferred from one entity or individual to another, such as from a policyholder to an insurance company. It’s a way to mitigate potential financial loss by allocating risk to different parties.

The phonetics for the phrase “Transfer of Risk” would be:Transfer: /trænsˈfɝː/of: /ʌv/ or /əv/Risk: /rɪsk/

Key Takeaways

  • Defined Responsibility: One of the main takeaways about Transfer of Risk is setting clear boundaries about who’s taking the responsibility. This often involves contracts where one party agrees to assume the financial risk associated with a particular event that may occur in the future.
  • Limits Financial Impacts: The second takeaway is the limiting of financial impacts. By transferring risk, businesses or individuals can protect themselves from potentially catastrophic losses. This could be through insurance policies, contractual agreements or other risk-transfer mechanisms.
  • Essential for Business Strategy: Lastly and importantly, risk transfer is a critical aspect of business and financial strategy. It enables businesses to focus on their core operations, knowing that they have measures in place to protect against potential losses. Those practices may increase business resilience and sustainability.

Transfer of Risk is a fundamental concept in business and finance that significantly impacts various transactions and agreements. It is important because it pertains to the shifting of financial risk associated with potential loss, from one party to another. A common example is seen in insurance policies where the insurer takes on the financial risk from the policyholder in exchange for a premium. This risk transfer is critical in management of potential losses and allows businesses to focus on their core operations without the fear of major financial setbacks. Moreover, understanding when and to whom the risk is transferred can avoid potential confusion and dispute regarding who is financially liable for a loss, providing financial predictability and stability.

Explanation

The purpose of risk transfer in finance/business is to manage potential losses that a business or individual might face due to unexpected events. These could include natural disasters, legal liabilities, or financial losses. By shifting the financial risk from the entity who cannot afford the losses to the one who can, effectiveness and control are maintained in the risk management process. The essence of risk transfer is to ensure that risk is carried by those best suited to absorb it, without fundamentally affecting their operations or financial health. It helps in reducing the negative impact of risk on businesses and individuals, and also spreads the risk across a broader base, thereby making it financially manageable.Risk transfer is commonly used in insurance contracts where the insured transfers the risk of potential loss to the insurer in exchange for payment of a certain premium. Here, the insurer pools the risks of different entities together, thereby reducing the impact of any single event. Businesses also use methods such as contracts and hedging to transfer risks to other parties. For example, a manufacturer might enter into a forward contract to sell its products at a fixed price at a future date, thereby transferring the risk of price fluctuations to the trader. Hence, risk transfer is a critical tool in robust financial management, allowing businesses and individuals to focus on their core operations without being unduly worried about uncertain, future potential losses.

1. Insurance Policies: This is one of the most common examples of risk transfer. An individual or business can purchase an insurance policy, such as life insurance, health insurance, or property insurance. The insurance company takes on the risk of a large potential loss in exchange for the regular premium payments from the individual. If the insured event occurs, it’s the insurance company, not the individual, who bears the financial burden.2. Hedging in investments: In financial markets, investors often use hedging strategies to transfer risk. For example, an investor may own stock in a company but is concerned about potential short-term losses. They can purchase a put option to sell the stock at a pre-determined price within a specified timeframe. Thus, they transfer the risk of the stock dropping below that price to the entity selling the put option.3. Outsourcing: Businesses often outsource certain operations to third parties to transfer associated risks. For example, a manufacturer could outsource delivery to a logistics company, transferring the risk of potential delivery delays, losses, or damages to the third-party firm.

Frequently Asked Questions(FAQ)

Transfer of Risk is a term used in finance and business, referring to the shifting of risk from one party to another. It is a risk management tool where the potential risk is transferred to another party, usually through a contract or insurance policy.

In the context of insurance, Transfer of Risk occurs when the policyholder transfers the financial risk of a potential loss to the insurer in exchange for a premium.

An example of Transfer of Risk would be automobile insurance. The car owner (holding the risk of potential damage to the car) transfers this risk to the insurance company by paying a monthly premium. Hence, in case of any damage, the insurance company bears the monetary loss rather than the car owner.

No, it’s not mandatory but it’s a common practice in many business setups. Companies often transfer risks to reduce potential financial liabilities and to protect their bottom line from unpredicted setbacks.

No, not all forms of risk are transferable. Pure risks, like the potential for a natural disaster, can usually be transferred through insurance. Speculative risks, like investment losses, generally cannot be transferred.

Other than insurance, risk can be transferred through hedging in financial markets, business contracts, incorporation of a business, and use of limited partnerships and limited liability companies etc.

The primary benefit of transferring risk is to protect against substantial financial loss. Other benefits include potential cost savings, reduced stress and worry, and greater predictability for budgeting and planning.

The cost of transferring risk primarily includes the cost of the insurance premiums or fees involved. However, the specific cost can vary widely depending on the amount and type of risk being transferred.

Related Finance Terms

  • Risk Retention
  • Insurance Underwriting
  • Reinsurance
  • Risk Pooling

Sources for More Information

  • Investopedia
  • Corporate Finance Institute
  • International Risk Management Institute, Inc
  • Business Standard

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Incoterms: who takes the risk?

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Incoterms are important when trading goods. Whether you are a buyer or a seller, it is good to have clear trading conditions. Who bears the costs if something breaks or gets lost on the way? In other words, who is at risk and when does this risk turn over to the other party? Use Incoterms to arrange everything regarding costs and insurance!

What are Incoterms?

Incoterms are used when importing and exporting goods and are important because they are known and accepted worldwide. By agreeing on an Incoterm, you know who is responsible for arranging the transport, who is responsible for the costs and who bears the risk of damage to or loss of the goods during transport. Simply said, Incoterms are the trade terms that the buyer and seller of goods mutually agree on during international transactions.

What is the actual meaning of Incoterms? Incoterms is an abbreviation of the phrase “ International Commercial Terms ”. Incoterms are also known as international trade terms. The Incoterms are published by the International Chamber of Commerce (ICC) and relate to international trade law. These are always stated on the documents that are sent with the shipment. The exact place or time at which an obligation passes from the seller to the buyer is called a critical point (c.p.).

There are several Incoterms with different obligations for seller (exporter) and buyer (importer). We will walk through all of these.

Are Incoterms mandatory?

People often think that Incoterms govern the transfer of ownership of goods. This is not the case. The transfer of ownership is made by issuing the transport document or by contractual arrangements. Therefore, Incoterms are not mandatory. To receive legal effect, they must be explicitly incorporated by the parties into their contract.

Incoterms is an abbreviation of the phrase “International Commercial Terms”. The International Chamber of Commerce came up with changed Incoterms in 2020.

List of Incoterms

There are 11 Incoterms. The most common shipping terms are EXW, DAP and DDP.

It is important to understand that not all rules apply in all cases. Some Incoterms can be used with all means of transport (road, rail, air, and sea). In addition, you also have shipping terms that only apply to sea/inland waterways. Below we will distinguish and explain them.

Rules for any means of transport

EXW stands for Ex Works (… named place of delivery).

  • The seller is solely responsible for getting the goods ready for pickup or to be released at his premises.
  • The buyer holds full responsibility as soon as he has access to the goods (including loading) and bears the rest of the costs and risks related to the shipping process.
  • The responsibility lies with the buyer when he has access to the goods, including loading.

Transfer of risk from seller to buyer: At pick-up or release location.

FCA stands for Free Carrier (… named place of delivery).

  • The seller must ensure that the goods are delivered to the buyer’s carrier at an agreed location and time. The costs are beared by the buyer.
  • The seller is obliged to clear the goods for export.

Transfer of risk from seller to buyer: Upon arrival at the buyer’s carrier.

Incoterms for any mode of transport, one of the most common shipping terms is Ex Works (EXW).

CPT stands for Carriage Paid To (… named place of destination)

  • The same sales responsibilities as with FCA, with one difference: the seller also pays the delivery costs.
  • As with FCA, the seller’s responsibility is to clear the goods for export.

Transfer of risk from seller to buyer: When the buyer’s carrier receives the goods.

CIP stands for Carriage and Insurance paid to (… named place of destination).

  • Same seller responsibilities as CPT with one difference: the seller also pays for the insurance of the goods.
  • The seller is obliged to pay the minimum cover.
  • If the buyer wants a more extensive coverage, they must arrange this themselves.

DAP stands for Delivered at place (named address/ place of destination).

  • The buyer is responsible for all costs and risks associated with unloading the goods and clearing customs to import the goods into the named country of destination.
  • The goods are noted as delivered when they arrive at the address and are ready for unloading.
  • The seller clears the goods for export and bears all risks and costs associated with delivering the goods to the named foreign destination not unloaded.

Transfer of risk from seller to buyer: When the goods are ready to be unloaded at the agreed address.

DPU stands for Delivered at place unloaded (…named place of destination). DPU is very similar to DAP except that the seller must pay for unlading the goods.

  • The seller bears the costs and risks of transportation until the products are unloaded at the agreed final destination.
  • It is the seller’s responsibility to clear the goods for export.

Transfer of risk from seller to buyer: Upon arrival at the final destination.

Delivered At Place is an Incoterm out of the list that is used a lot with international trade.

DDP stands for Delivered Duties Paid (… named place of destination). DDP is a risky term for the seller, because they may not be fully aware of the import clearance procedures in the country of import or how to find a competent local customs broker. 

  • The seller bears the costs and risks of transportation to the final destination, including the payment of Customs duties and taxes.

Rules for sea and inland waterway transport

FAS stands for Free Alongside Ship (… named port of shipment).

  • The seller bears the costs and risks until the goods are delivered to the quay along a ship arranged by the buyer.
  • It is the buyer’s responsibility to transport and clear the goods for export.

Transfer of risk from seller to buyer: Upon arrival at quay/ port.

FOB stands for Free on Board (… named port of shipment).

  • The seller bears the costs and risks until the goods are delivered on board of the ship.
  • It is the seller’s responsibility to arrange the export license for the goods.

Transfer of risk from seller to buyer: Upon loading on board.

The Incoterm Free On Board (FOB) is a shipping term that is used for sea and inland waterway transport.

CFR stands for Cost and Freight (… named port of destination)

  • The seller bears the costs and risks until the goods arrive at the port of destination.

Transfer of risk from seller to buyer: Upon arrival at the ship’s rail.

CIF stands for Cost, Insurance and Freight (… named port of destination)

  • CIF is equal to CFR, with the difference that it includes an insurance obligation, which is at least equivalent to the conditions of the ICC. The seller bears the costs and risks until the goods arrive at the port of destination.

Incoterms 2010 VS Incoterms 2020

Every decade, the International Chamber of Commerce (ICC) adapts or changes the Incoterms. These are recognized worldwide. Incoterms prevent confusion in foreign trade contracts by clarifying the obligations of buyers and sellers.

Some Incoterms apply to any Means of transport, while others apply strictly to transport on water.

A new list of Incoterms was established in 2020. If we look at the Incoterms 2010 VS incoterms 2020, not much has changed. We listed the five main changes for you:

  • DAT is now DPU . The term Deliver at Terminal (DAT) is now Delivered at Place Unloaded (DPU). As a result, there is more flexibility and efficiency for a chosen unloading destination.
  • FCA closes a gap. Now Free Carrier (FCA) makes it easier for sellers to obtain payment from a buyer’s bank. Sellers are often required to present a bill of lading to banks with an on-board note indicating the delivery of goods. The new term states that buyers can instruct carriers to issue bills of lading with onboard listings.
  • CIP increases insurance. The Carriage and Insurance Paid To (CIP) term now requires insurance coverage provided by Clauses (A) of the Institute Cargo Clauses.
  • The conditions now state that a seller can arrange transport if necessary. As a result, there is no need to hire external carriers, but the sellers can use their own methods to deliver goods.
  • Security increases for all. Import and export security requirements have increased exponentially since Incoterms® 2010. The 2020 edition comprises specific, new security responsibilities related to goods, cash, and documents under individual trade terms.

We hope you are now fully prepared to export! Would you like more information about international trade, for example about EUR.1 documents or the difference between T1 and T2 ? Read our blogs !

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How to use Incoterms® proficiently: risk, responsibility, and transfer operations

Business-to-business (B2B) transport and delivery practices are governed by Incoterms®, published by the International Chamber of Commerce (ICC). A typical contract for export/import is based on the Incoterms® rules and the contracts that surround it. 

By Holly Piggott

Last modified Tuesday February 6, 2024

transfer of responsibility risk

Estimated reading time: 7 minutes

Business-to-business (B2B) transport and delivery practices are governed by Incoterms ®, published by the International Chamber of Commerce (ICC). A typical contract for export/ import is based on the Incoterms® rules and the contracts that surround it. 

This covers:

  • The obligation: which party organises the carriage and insurance of the goods, obtains shipping documents, customs clearance and export of import licences;
  • The risk : which party bears the risk in the event of loss or damage to the goods at any specific point within the international journey, and at what point the risk is transferred;
  • The costs: which party is responsible for which costs. For example, transport, packaging, loading or unloading costs, and checking or security-related costs.

The Incoterms® 2020 rules explain a set of the eleven most commonly used three-letter trade terms, e.g. Costs of Insurance and Freight ( CIF ), Delivered at Place ( DAP ). They should always be accompanied by the year of the publication of the Incoterms® referred to, and, most importantly, the precise place of delivery. 

All Incoterms® other than DAP, Delivered at Place Unloaded ( DPU )––a 2020 update to Delivered at Terminal and Delivered Duty Paid ( DDP ), are likely to subject the importing company to port and terminal handling charges at deep sea ports. Additional fees may include; handling and storage fees at the airport even if the exporter has paid for freight charges. 

The term Ex Works (EXW) may imply a lower cost price, but it can present importers with a hurdle of challenges when booking freight forwarding and shipping in unfamiliar territory, requiring the buyer to arrange both export and import clearance. 

Proficient importers may prefer to encourage the term Free Carrier–Shipper’s Address ( FCA ), in which the seller has a higher level of responsibility, but transportation obligations and risk end at the origin.

Shipping Container

When moving goods under the FCA Incoterm®, the seller will be responsible for loading the goods, obtaining a despatch document and also for the export declaration––but not the transit documents if the goods are entering third countries prior to reaching their destination––particularly relevant for road freight. 

A benefit for UK exporters that adopt FCA Incoterms rather than EXW, is ready access to the proof-of-export documents required to support zero-rated import VAT charged to overseas buyers. 

Proof of export documents is a legal obligation to hold on file, used for supporting a claim to zero-rate overseas VAT. Simultaneously, buyers benefit from increased customs accuracy, as the exporter will have also had to have completed much of the same information required for import.

Free on board (FOB) is a frequently misused Incoterm® that should only be applied for non-containerised waterway transport. 

In actuality, it is widely applied to containerised and air cargo. Its misuse may represent a higher level of risk for the seller, particularly the period between delivering the cargo to the harbour or airport and the cargo being transferred to the ship or the aeroplane by a crew external to the seller.

Incoterms to look out for 

Cif and cip.

Cost of Insurance and Freight (CIF) implies a minimum insurance cover complying with Institute Cargo Clauses (C). 

In this Incoterm®, the seller covers the costs of transportation to the destination; however, the risk of loss or damage to the goods transfers when the goods are on board the vessel. 

It is possible that carriage may be transferred through several carriers for different legs of the sea journey. For example, first, by a carrier operating a feeder vessel from Hong Kong to Shanghai, then on to an ocean vessel from Shanghai to Southampton. 

The question arises here whether the risk transfers from seller to buyer in Hong Kong or in Shanghai: in other words, where does delivery take place?

CIP Carriage & Insurance Paid To Diagram 2022

The parties would be advised to determine this in the sale contract itself. 

Where there is no agreement, Incoterms® 2020 states the default position is that the risk transfers when the goods have been delivered to the first carrier (i.e., Hong Kong), increasing the period during which the buyer incurs the risk of loss or damage. 

Should the parties wish the risk to transfer at a later stage, they should specify this in the contract of sale.

The CIF rule is to be used only for sea or inland waterway transport; when more than one mode of transport is used, which is common when transporting containerised cargo, it is advisable to use Carriage and Insurance Paid To ( CIP ) rather than CIF. 

Under CIP a default level of insurance cover must be provided under Institute Cargo Clauses (A). The insurance shall cover, at a minimum, the price provided in the contract plus 10% (i.e. 110%) and shall be in the currency of the contract.

Another term to be used subject to careful consideration is “Delivered Duty Paid” (DDP), which may be the easiest to sell, but also may present as the most difficult to cost. 

In situations where DDP is used, the exporting party must have established registered premises––and an Economic Operators Registration and Identification number (EORI) in the importing territory––or have confirmed a customs broker willing to act as an indirect representative in advance.

DDP Delivery Duty Paid Diagram 2022

Indirect representation will occur when a company that does not have a registered UK presence appoints a customs agent to act as their UK representative. 

HMRC identify that “if an agent makes a customs declaration as an indirect representative of the principal, the agent and principal will be jointly liable for any customs debt. HMRC may seek payment from either the agent or the principal.” (HM Revenue & Customs, 2016/2021). 

Therefore indirect representation incurs a high level of risk to the importing customs agency as they are likely to have to pay a professional indemnity (PI) insurance premium for offering this type of service, as only direct representation––where the principal has sole liability for the customs debt, is covered in a standard PI policy. 

SBLC Trade

Customs valuation compliance and DDP Incoterms®

As DDP Incoterms® present a higher likelihood for indirect representation to occur, the customs agency is likely to scrutinise the customs valuation methodology. 

For low-value imports conducted on a business-to-consumer (B2C) basis on behalf of an established company, with a readily auditable compliance trail––for example, reputable e-commerce companies where a sale for export is evident and the price list is visible on their website––this may not present an issue. 

For international branch transfers of goods (i.e., when an international branch sends goods to a third-party logistics (3PL) warehouse), the customs broker is likely to conduct significant due diligence concerning the customs valuation method of the goods, as there is an increased potential for an underestimate of values to occur.  

For one-off shipments, high-value goods, excise, and for companies new to trading with little or no trading history, it may prove challenging to locate a customs broker willing to act as an indirect representative/Importer of Record due to the increased potential of fraud.

When presented with the option of DDP Incoterms® by an overseas seller, VAT-registered importers would be advised to suggest an alternative term such as DAP, and register for a CDS account with access to a cash account to pay customs duty if liable directly to HMRC, and adopt the use of postponed accounting (PVA). This is likely to result in a significantly lower invoiced price.

About the Author(s)

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Holly Piggott

Holly Piggott is director of Alinea Customs – a UK customs brokerage. Alinea Customs provide import and export clearance at ports across the UK, and have in-house legal expertise, providing consultancy support across all areas of customs and border-related activities.

Related Posts

  • Motivations and rationale for variation of Incoterms® rules (14th June 2022)
  • Delivery for the maritime Incoterms® rules – FAS, FOB, CFR, CIF (17th May 2022)
  • Incoterms® 2020 – 7 key changes you need to know [update] (15th October 2019)

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  • ASD GROUP > BLOG > Understanding Incoterms: The rules of international trade

Understanding Incoterms: The rules of international trade

  • Customs obligations
  • Published: 24 May 2023
  • Updated: 24 May 2023

Looking to understand the Incoterms rules? Find out how they define the transfer of risks and responsibilities between buyer and seller in international trade transactions.

Today, with the influx of goods and the specifics of international trade, it is important to understand the role of Incoterms in trade . Whether you are a buyer, a seller or a carrier, Incoterms 2020 came into force in January 2020 and subjects every trade transaction to a series of rules and standards that govern the transfer of risks and costs between the two parties. In this article, we find out in more detail what the updated Incoterms mean.

Incoterms, a contraction of the English term “International Commercial Terms”, are international trade terms used to organise transport. These rules define the responsibilities and obligations of the seller and buyer parties, as well as the transfer of risks and costs between them. Incoterms can also be used to determine the primary mode of transport, place of delivery, port of destination and customs clearance procedures.

What are Incoterms?

Incoterms 2020 (content in French) are updated international trade rules, put in place to simplify the understanding between sellers and buyers regarding the transfer of risks and costs associated with the carriage of goods in an international sales contract. These rules are linked to the value for duty, allowing the parties involved to clearly understand what their obligations will be under the chosen Incoterm.

Read more on the same subject What are Incoterms?

Incoterms types and classification

There are 11 Incoterms in 4 categories:

  • Category E (departure),
  • Category F (main carriage unpaid),
  • Category C (main carriage paid),
  • Category D (arrival).

transfer of responsibility risk

What’s new in Incoterms

Incoterms 2020 has made some notable changes to its previous versions. There are several new provisions relating to the correct use of Incoterms, such as :

  • EXW (Ex Works) : The selling party assumes minimal responsibility – it only has to deliver the goods to the agreed point in accordance with the contractual specifications;
  • FCA (Free Carrier) : The seller bears all costs until the goods are handed over to the carrier chosen by the buyer;
  • CPT (Carriage Paid To) : In this Incoterm, the seller bears all costs up to the agreed place where the goods will be delivered;
  • CIP (Carriage and Insurance Paid To) : Here, the seller not only pays the transport costs to the agreed location where the goods are delivered, but also insures the goods during transport.

How do Incoterms affect international trade?

transfer of responsibility risk

Incoterms are essential for organising efficient international trade. They clearly define the responsibilities of buyers and sellers , as well as the transfer of risks and costs between them. Incoterms can also be used to determine the primary mode of transport, place of delivery, port of destination and customs clearance procedures.

Responsibilities of sellers and buyers

Depending on the Incoterm chosen, the responsibilities of the seller or the buyer will be different. For example, if you choose FCA (Free Carrier), this means that the seller is responsible for arranging transport to the point agreed in the sales contract and will pay all associated costs. On the other hand, if you choose CIP (Carriage and Insurance Paid To), it means that the seller assumes all responsibilities until the goods are handed over to the buyer at the agreed port.

Transfer of risks and costs

Another important consideration is the transfer of risk and costs between the seller and the buyer . If you choose EXW (Ex Works), for example, then this indicates that the seller will not be responsible for any damage to the goods after they leave the shipping point. On the other hand, if you choose DAP (Delivered At Place), then this means that the selling party will assume all risks associated with the transport until the goods arrive at their destination.

Main mode of transport

The primary mode of transport varies according to the Incoterm chosen . For example, if you choose FOB (Free On Board), then this usually involves a ship as the primary means of transporting your goods. Whereas if you choose CPT (Carriage Paid To), then it will be a truck or car.

Place of delivery

Like the primary mode of transport, the place of delivery will also depend on the type of incoterm chosen . If you choose CIF (Cost and Freight), then this usually involves delivery to the agreed port of destination, whereas if you choose DAP (Delivered At Place), then the goods will be delivered to the address specified in the sales contract.

Port of destination and customs clearance procedures

Incoterms can also be used to determine the port where the goods are to be delivered and the customs clearance procedures. If you choose FCA (Free Carrier), for example, this will usually indicate that the goods should be delivered to the agreed port and that the seller will have responsibilities for customs clearance.

How to choose the right Incoterms?

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There are several factors to consider when making a choice:

  • Main mode of transport: The main mode of transport is one of the main criteria to be considered as it may vary according to the Incoterm chosen;
  • Responsibilities of the involved parties : You need to have a clear understanding of the responsibilities of the different parties involved so that you know who will pay for what;
  • Place and port of destination : You must know the place and port where the goods will be delivered before choosing an Incoterm;
  • Transfer of risks and costs : You need to know which party will be responsible for transferring the risks and costs of the goods.
Read also on the same subject Overview of the concept of Incoterms

Benefits of Incoterms

Just like any other form of trade agreement, each type of Incoterm has its advantages:

  • A better understanding between the parties of the obligations and responsibilities regarding the goods;
  • Easier management of shipping costs;
  • More accurate monitoring of international trade.

ASD Group assists companies in their international development with all customs and tax issues. To find out more, contact our experts !

Source: www.douane.gouv.fr (in French)

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Incoterms 2020. Point of Delivery and Transfer of Risk

What are incoterms rules, who publishes the incoterms rules, why use incoterms rules in international trade, what does "incoterms®" stand for, exw - ex works, fca - free carrier (named place of delivery), cpt - carriage paid to (named place of destination), cip - carriage and insurance paid to (named place of destination), dat - delivered at terminal (named terminal at port or port or plase of destination), dap - delivered at place (named place of destination), ddp - delivered duty paid (named place of destination), sea and inland waterway transport, fas - free alongside ship (named port of shipment), fob - free on board (named port of shipment), cfr - cost and freight (named port destination), cif - cost, insurance and freight (named port of destination), when were icc's incoterms rules last updated.

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Incoterms Explained

Free Carrier (FCA)

Can be used for any transport mode, or where there is more than one transport mode. A very flexible rule that is suitable for all situations where the buyer arranges the main carriage

For example:

  • Seller arranges pre-carriage from seller’s depot to the named place, which can be a terminal or transport hub, forwarder’s warehouse etc. Delivery and transfer of risk takes place when the truck or other vehicle arrives at this place, ready for unloading – in other words, the carrier is responsible for unloading the goods. (If there is more than one carrier, then risk transfers on delivery to the first carrier.)
  • Where the named place is the seller’s premises, then the seller is responsible for loading the goods onto the truck etc. NB this is an important difference from Ex Works EXW

In all cases, the seller is responsible for export clearance; the buyer assumes all risks and costs after the goods have been delivered at the named place.

FCA is the rule of choice for containerised goods where the buyer arranges for the main carriage.

Free Carrier: Read More

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Incoterms® 2020 Explained – The Complete Guide

Incoterms 2020 chart for import export

Incoterms® 2020 Explained, how they will affect global trade.

The  International Chamber of Commerce  have published new Incoterms® 2020 that have come into effect from the 1st of January 2020.  The ICC originally published Incoterms® in 1936 and have continually made updates to reflect the changes to the Global Trade environment.  It’s important that all parties involved in trade clearly understand the changes and how they apply to global supply chains.

Incoterms® play such a vital role in the world of global trade.  Incoterms® 2010 or Incoterms® 2020 may seem complicated, but it’s imperative that buyers and sellers clearly understand how they work and their own obligations along the supply chain.  In this article we explain the updates made and provide simple explanations, along with an Incoterms® infographic to explain Incoterms® 2020.

Note: The content of this article and chart is only for general information purposes and shall not in any circumstances be considered bespoke legal advice or professional advice.

What are Incoterms®?

Put simply, Incoterms® are the selling terms that the buyer and seller of goods both agree to during international transactions.  These rules are accepted by governments and legal authorities around the world. Understanding Incoterms® is a vital part of International Trade because they clearly state which tasks, costs and risks are associated with the buyer and the seller.

The Incoterm® states when the seller’s costs and risks are transferred onto the buyer.  It’s also important to understand that not all rules apply in all cases.  Some encompass any mode or modes of transport.  Transport by all modes of transport (road, rail, air and sea) covers FCA, CPT, CIP, DAP, DPU (replaces DAT) and DDP.  Sea/Inland waterway transport (Sea) covers FAS, FOB, CFR and CIF, which we explain below.

Why are Incoterms® vital in International Trade?

Incoterms® are referred to as  In ternational  Co mmercial  Terms .  They are a set of rules published by the  International Chamber of Commerce (ICC) , which relate to International Commercial Law.  According to the ICC,  Incoterms® rules  provide internationally accepted definitions and rules of interpretation for most common commercial terms used in contracts for the sale of goods’.

All International purchases will be processed on an agreed Incoterm to define which party legally incurs costs and risks.  Incoterms® will be clearly stated on  relevant shipping documents.

An overview of Incoterms® 2020 for 11 Terms, 7 for any mode of transport.

Exw  – ex-works  or ex-warehouse.

  • Ex works is when the seller places the goods at the disposal of the buyer at the seller’s premises or at another named place (i.e., works, factory, warehouse, etc.).
  • The seller does not need to load the goods on any collecting vehicle. Nor does it need to clear them for export, where such clearance is applicable.

FCA – Free Carrier

  • The seller delivers the goods to the carrier or another person nominated by the buyer at the seller’s premises or another named place.
  • The parties are well advised to specify as explicitly as possible the point within the named place of delivery, as the risk passes to the buyer at that point.

FAS – Free Alongside Ship

  • The seller delivers when the goods are placed alongside the vessel (e.g., on a quay or a barge) nominated by the buyer at the named port of shipment.
  • The risk of loss of or damage to the goods passes when the products are alongside the ship.  The buyer bears all costs from that moment onwards.

FOB  – Free On Board

  • The seller delivers the goods on board the vessel nominated by the buyer at the named port of shipment or procures the goods already so delivered.
  • The risk of loss of or damage to the goods passes when the products are on board the vessel.  The buyer bears all costs from that moment onwards.

CFR  – Cost and Freight

  • The seller delivers the goods on board the vessel or procures the goods already so delivered.
  • The risk of loss of or damage to the goods passes when the products are on board the vessel.
  • The seller must contract for and pay the costs and freight necessary to bring the goods to the named port of destination.

CIF – Cost, Insurance and Freight

  • The seller delivers the goods on board the vessel or procures the goods already so delivered. The risk of loss of or damage to the goods passes when the products are on the ship.
  • The seller also contracts for insurance cover against the buyer’s risk of loss of or damage to the goods during the carriage.
  • The buyer should note that under CIF the seller is required to obtain insurance only on minimum cover. Should the buyer wish to have more insurance protection, it will need either to agree as much expressly with the seller or to make its own extra insurance arrangements.

CPT  – Carriage Paid To

  • The seller delivers the goods to the carrier or another person nominated by the seller at an agreed place (if any such site is agreed between parties).
  • The seller must contract for and pay the costs of carriage necessary to bring the goods to the named place of destination.

CIP – Carriage And Insurance Paid To

  • The seller has the same responsibilities as CPT, but they also contract for insurance cover against the buyer’s risk of loss of or damage to the goods during the carriage.
  • The buyer should note that under CIP the seller is required to obtain insurance only on minimum cover. Should the buyer wish to have more insurance protection, it will need either to agree as much expressly with the seller or to make its own extra insurance arrangements.

DAP – Delivered At Place

  • The seller delivers when the goods are placed at the disposal of the buyer on the arriving means of transport ready for unloading at the named place of destination.
  • The seller bears all risks involved in bringing the goods to the named place.

DPU – Delivered At Place Unloaded (replaces Incoterm® 2010 DAT)

  • DPU replaces the former Incoterm® DAT (Delivered At Terminal).  The seller delivers when the goods, once unloaded are placed at the disposal of the buyer at a named place of destination.
  • The seller bears all risks involved in bringing the goods to, and unloading them at the named place of destination.

DDP – Delivered Duty Paid

  • The seller delivers the goods when the goods are placed at the disposal of the buyer, cleared for import on the arriving means of transport ready for unloading at the named place of destination.
  • The seller bears all the costs and risks involved in bringing the goods to the place of destination.  They must clear the products not only for export but also for import, to pay any duty for both export and import and to carry out all customs formalities.

Download an easy to understand chart of all Incoterms® 2020

This infographic states each Incoterm® and explains obligations and charges that are accepted by the buyer and seller.

IncoTerms 2020 chart

What are the differences between Incoterms® 2010 and Incoterms® 2020?

The main explanations of Incoterms® 2020 have remained the same, with a few key updates and changes.  The main change includes a new DPU term replacing DAT, along with other changes to Incoterms® as below.  It’s imperative that all parties involved in global trade understand these updates and how they may affect your supply chain.

New Incoterm® DPU Replaces DAT

The previous Incoterm® DAT (Delivered at Terminal) is now called DPU (Delivered at Place Unloaded.  It was decided to change the term to DPU to remove confusion that arose in the past. In the past, DAT required ‘Delivery at Terminal (unloaded)’, however the word “terminal” caused confusion.  The new term DPU (Delivery at Place Unloaded) covers ‘any place, whether covered or not’.

Different level of insurance cover between CIF and CIP

CIF and CIP are the only two Incoterms® that require the seller to purchase insurance in the buyer’s name.  Under Incoterms® 2010 the insurance cover for both CIF and CIP was required under Institute Cargo Clause C. Under the new Incoterms® 2020, CIP requires insurance cover complying with Institute Cargo Clause A.  Clause A covers a more comprehensive level of insurance which is usually suitable for manufactured goods, where Clause C would likely apply to commodities.

In summary:

  • CIF remains the same, it requires  ‘Institute Cargo Clause C’  insurance cover – Number of listed risks, subject to itemized exclusions.
  • CIP now requires an upgraded  ‘Institute Cargo Clause A’  insurance cover – All risk, subject to itemized exclusions.

Updated Costs and Listings

Costs became quite a problem with Incoterms® 2010 with some parties.  In some cases carriers were changing their pricing so sellers were often faced with new back charged terminal handling charges.  Incoterms® 2020 now provides much more detail around costs and now appear under the A9/B9 sections of the rule. This clearly states which costs are allocated to each party.

Increased Security Requirements, Allocations and Costs

In a world with increasing security requirements, the Incoterms® 2020 rules now provide more detail around security allocations and necessary costs.  For each Incoterm® rule, the security allocations have been added to A4/A7 and the associated costs have been added to A9/B9.

Buyer’s and Seller’s Own Transport

Under Incoterms® 2010 it was assumed that all transport would be undertaken by a third party transport provider.  Updates to Incoterms® 2020 allows for the provision for the buyer or seller’s own means of transport. This recognizes that some buyers and sellers are using their own methods of transport, including trucks or planes to get goods delivered.

  • This allows for the buyer’s own means of transport under the FCA rule
  • This allows for the seller’s own means of transport under DAP, DPU and DDP.

FCA, FOB and the Bill of Lading Process

Updates were made to the previous Incoterms® 2010 to encourage exporters of containerized goods to use the FCA Incoterm®.  In reality most parties were still using FOB when they should have been using FCA. This is because even experienced sellers still wanted to use FOB because they wanted the contract to be under a Letter of Credit.

Therefore provisions have been made to the Incoterms® 2020 to state that the buyer must instruct the carrier to issue a transport document stating that the goods have been loaded – i.e a Bill of Lading with an ‘on board’ notation.  In the past carriers have frequently refused to issue a Bill of Lading with a notation to the seller if they have received the goods from an intermediary transport (such as a truck), instead of directly from the seller.

How to put Incoterms® 2020 into Practice on Sales Contracts

The new Incoterms® 2020 have come into effect on the ‘effective’ date of the 1st January 2020.  What does that actually mean for your business? Trading partners can still carry on using Incoterms® 2010 if they prefer to, which may occur when it is being used to confirm complex commercial agreements.

All parties must make it clear in contracts which Incoterms® version is being referred to in order to avoid any misunderstanding.  Different trading partners will incorporate Incoterms® into contracts at different times.

It is imperative that you check existing contracts to ensure that the Incoterms® edition year is included.  If there is no year stated then the following will apply:

  • Up to 31st December 2019 – Incoterms® 2010
  • From 1st January 2020 – Incoterms® 2020
  • If a different year is stated, for example Incoterms® 1990, then the respective terms will apply

The below is the structure that should be used on Sales Contracts:

[Incoterm® rule] [Named port/place/point] Incoterms® 2020

CIF Longbeach Incoterms® 2020

DPU 4300 Longbeach Blvd, Longbeach, United States Incoterms® 2020

transfer of responsibility risk

How to Prepare your Business for Incoterms® 2020

As Incoterms® are updated you should always take the time to assess how any changes may impact your business.  It’s much better to be proactive rather than reactive should some big issues arise with any of your orders or shipments.  Always refer to professional legal advice before making any changes to your business.  To prepare for the changes, here are a few things that you may consider: 

  • Identify the Incoterms® that your business typically uses
  • Audit any contracts that are extended into 2020 or that renew in 2020
  • If you are buying or selling under a Letter of Credit, you may consider the option to use FCA instead of FOB (refer notes above).  This will involve instructing carriers to issue Bills of Lading.  Always refer to professional legal advice before making any change.
  • Ensure that you make changes to any contracts and documents as necessary
  • Ensure that you are stating the Incoterms® edition year that both parties are referring to in sales contracts
  • Look further into the updated costs and listings to see if it has any impact on your landed cost calculations
  • Increase the level of insurance cover to satisfy the new CIP requirements
  • Structure tighter security for imports and exports
  • Understand who has the responsibility for loading and unloading charges
  • Know where the risk of loss is transferred
  • Contract professional legal advice from experienced supply chain and legal analysts to audit current procedures
  • Buy a copy of the official  Incoterms® 2020 book from the ICC here

Can Incoterms® be used in the United Kingdom?

Because the United Kingdom’s position, trade is regulated by the  ‘Uniform Laws of the Sale of Goods Act 1979’  and case laws.  However, the terms of trade can be agreed by both parties before the trade is to take place. Throughout sales contracts the buyer and seller can follow either the ICC guidelines of the Sales of Goods Act 1979’s enactments.

Get a copy of the official ICC Incoterms® 2020 book

You can purchase the official Incoterms® 2020 book from the  International Chamber of Commerce here .

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Ben Thompson

Ben is passionate about International Trade, Import/Export, International Shipping and connecting world markets. For the last 14 years Ben has specialized in importing and exporting goods around the world, and creating software solutions to streamline the import/export process.

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Incoterms 2020 cpt: spotlight on carriage paid to.

David Noah

Incoterms 2020 rules are the latest revision of international terms of trade published by the International Chamber of Commerce (ICC). They are recognized as the authoritative text for determining how costs and risks are allocated to parties conducting international transactions.

Incoterms 2020 rules outline whether the seller or the buyer is responsible for, and must assume the cost of, specific standard tasks that are part of the international transport of goods. In addition, they identify when the risk or liability of the goods transfer from the seller to the buyer.

In this article, we’re discussing the Incoterm CPT, also known as Carriage Paid To.

There are 11 trade terms available under the Incoterms 2020 rules that range from Ex Works (EXW), which conveys the least amount of responsibility and risk on the seller, to Delivered Duty Paid (DDP), which places the most responsibility and risk on the seller. The Incoterms 2020 Rules: Chart of Responsibilities and Transfer of Risk summarizes the seller and buyer responsibilities under each of the 11 terms.

For a summary of Incoterms 2020 and a short definition of each of the 11 terms, read An Introduction to Incoterms .

Carriage Paid To Responsibilities and Risk

Under the Incoterms 2020 rules, CPT means the seller is responsible for clearing the goods for export and delivering them to the first carrier or another person stipulated by the seller at a named place of shipment (usually a foreign freight terminal) at which point risk transfers to the buyer. The seller selects and pays the international carrier, and is responsible for loading and offloading goods at the named place of destination. Some buyers don't realize that though the seller routes the international carrier, the  buyer carries the risk during the main carriage. 

Since this is a standard export transaction , the seller or its agent is responsible for submitting the Electronic Export Information (EEI) through AESDirect on the ACE portal .

Get an overview of Incoterms 2020 that everyone can understand.

Carriage Paid To Transportation Options

The ICC has divided the 11 Incoterms into those that can be used for any mode of transportation and those that should only be used for transport by “sea and inland waterway.” Under Incoterms 2020, CPT can be used for any mode of transportation .

Using Carriage Paid To

With all of the C-group terms, including CPT, the seller is responsible for contracting international transportation. The named place where the transfer of responsibility occurs is always on the buyer’s side.

CPT is beneficial to the seller when a letter of credit is used or in other situations where the seller needs to control the export process.  

It may be advantageous for a buyer to use CPT when the seller has greater buying power and can negotiate better rates for transportation. 

Learn More about Incoterms 2020 Rules

If you are regularly involved in international trade, you need to understand the risks and responsibilities as defined by Incoterms 2020 rules, not just pick the term you always use. Start by getting a copy of ICC's Incoterms® 2020 Rules book.

For a more detailed understanding of which term or terms make the most sense for your company, register for an Incoterms® 2020 Rules seminar or webinar offered by International Business Training. If you don't want to attend a half-day class, you can get the book provided at these seminars and webinars: Incoterms® 2020 for Importers and Exporters .

Read our articles about all of the other Incoterms 2020 rules here:

  • EXW (Ex Works)
  • FCA (Free Carrier)
  • FAS (Free Alongside Ship)
  • FOB (Free On Board)
  • CFR (Cost and Freight)
  • CIF (Cost, Insurance and Freight)
  • CIP (Carriage and Insurance Paid To)
  • DAP (Delivered At Place)
  • DPU (Delivered At Place Unloaded)  
  • DDP (Delivered Duty Paid)

Like what you read? Subscribe today to the International Trade Blog to get the latest news and tips for exporters and importers delivered to your inbox. 

This article was first published in March 2017 and has been updated and revised based on the changes made with the release of the Incoterms 2020 rules.

About the Author: David Noah

David Noah is the founder and president of Shipping Solutions , a software company that develops and sells export documentation and compliance software targeted at U.S. companies that export. David is a frequent speaker on export documentation and compliance issues and has published several articles on the topic.

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Use this handy chart to quickly identify which fees and potential liabilities you face under each of the 11 international commercial terms.

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