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LONDON (Reuters) - A dramatic fall in pirate attacks off the Somali coast is forcing down the cost of piracy insurance for commercial ships, taking the shine off a fast-growing and lucrative market for London-based insurers.
International navies have cracked down on pirates, including strikes on their coastal bases, and ship firms are increasingly using armed guards and defensive measures on vessels including barbed wire, scaring off Somali seaborne gangs.
That reduced the number of incidents involving Somali pirates to just 69 in the first half of 2012, compared with 163 in the same period last year, according to watchdog the International Maritime Bureau.
"The chance of pirates being able to carry out successful hijackings are now very slim, which is probably deterring many would-be pirates from going to sea," said Rory Lamrock, an intelligence analyst with security firm AKE.
War torn Somalia is next to the Gulf of Aden's busy shipping lanes, and poverty has in recent years tempted many young men to take up piracy, storming commercial vessels and holding their crews and cargo to ransom.
Last year, they netted $160 million, and cost the world economy some $7 billion, according to the American One Earth Future foundation.
The drop in Somali pirate activity is weighing on the market for so-called marine kidnap and ransom insurance, which has grown for scratch to be worth about $250 million in little more than five years, according to informal industry estimates.
Spending on marine K&R cover, which indemnifies shipowners against the cost of paying ransoms and recovering vessels and crew, has halved compared with two years ago, estimates Will Miller of Special Contingency Risks, a unit of insurance broker Willis WSH.N.
"We are seeing a softening in the rates that underwriters are charging for piracy cover," Miller said.
"The key driver is the implementation of more robust security measures on board by the shipping community."
Brokers and insurers say a key factor in the downturn is the spread of on-board armed security, which has allowed shipowners to negotiate discounts of up to 50 percent on their premiums in recognition of the reduced risk of being hijacked.
Guards equipped with guns are seen as the best deterrent as no ship carrying them has ever been seized, although critics say they risk escalating conflict with heavily-armed pirates.
Governments including Britain last year dropped their opposition to armed maritime guards, triggering a big increase in their use. SCR's Miller says about two thirds of his clients now deploy armed security, compared with just 10 percent in 2010.
While the cost of piracy insurance is falling, the drop in the number of hijackings will reduce claims, helping to preserve insurers' profits.
That is encouraging a string of new entrants amid lackluster conditions elsewhere in the insurance market, ratcheting up competition and putting prices under further pressure.
"More people are competing for the same slice of cake," said Michael Sharp, an underwriter at Lloyd's of London insurer Beazley BEZG.L.
"With so many people writing the same business, that's driving prices down."
Still, insurers are confident demand for piracy cover will remain buoyant, pointing to other trouble spots including the Gulf of Guinea on the other side of Africa and the Straits of Malacca in Asia.
"If Somali piracy goes away, sadly there seems to be a number of other hot spots around the world where protection is needed," said Sean Woolerson of insurance brokers Jardine Lloyd Thompson (JLT.L).
Many in the industry also warn that it would be premature for shipowners to let their guard down in the Gulf of Aden. Somali gangs have responded to the drop in successful hijackings by ratcheting up their ransom demands, and the inflationary spiral is expected to tempt retired pirates back into business.
"As far as the pirates are concerned, they are being paid more for less work," said J. Peter Pham, Africa director with U.S. think tank the Atlantic Council.
The average ransom payment this year is $6.5 million, up from between $5 million and $6 million in 2011, according to Peter Dobbs, head of asset protection at Lloyd's of London LOL.UL insurer Catlin CGL.L.
"I don't think piracy has gone away," he said.
Editing by James Jukwey