Ronald Gift Mullins reviews the fortunes of the aviation insurance market since 9/11

Fasten your seat belts, it looks like it'll be a bumpy year for aviation insurance. Bumpy, because the aviation insurance market, though small in both premium and clients, exerts a powerful and far reaching influence on the airline industry, as was dramatically demonstrated following 9/11, when aviation insurance was severely curtailed and commercial and general aviation were grounded. As the airline industry is concentrated and highly visible, any actions that have a strong bearing on the industry affect the aviation insurance market strongly and quickly, and vice versa.

Further, though the number of commercial clients for aviation insurance is limited, each insured has a gigantic potential exposure. It is a line of insurance that should negate the law of large numbers. But the aviation industry is made insurable because losses, though colossal and tragic when they occur, are rare. In addition to insuring commercial airlines, aviation re/insurers also underwrite general aviation, the products liability of airframe, engine and component manufacturers; liability for airports; corporate fleets, as well as the more exotic flying machines - helicopters used for sightseeing, crop dusters and water bombers. Aviation underwriters also have undertaken to insure the launching and orbital flight of commercial satellites.

Lowering rates

US aircraft direct premiums had been level at about $1.2bn per year from 1998 to 2000, according to AM Best & Co. Then in 2001, premiums increased to $1.5bn and almost doubled in 2002 to $2.3bn and $2.4bn in 2003. Rates for aviation insurance had been on the rise prior to 9/11, due to negative growth of the stock market, and they quickly escalated following that horrendous day. Coupled with fewer losses due to heightened security surveillance, reduced capacity and the withdraw from the market by several underwriters, the aviation insurance industry has enjoyed a few profitable years since then.

But with the lowest levels of losses in recent airline history in 2003, the competitive urge began rising among re/insurers and rates fell an average of 18%, according to a report by Aon. Terrorism, however, continues to be an ever-present threat to the fragile aviation sector and the ongoing risk to airlines, airports and civil aircraft remains at a high level.

Although some insurers got out of providing insurance for airlines in 2003, capacity levels were still sufficient to meet demand.

Commenting on the report, Doug Peterson, chairman of Aon's aviation division, London, said: "Despite the reducing levels of premium, the future direction of the aviation insurance market remains uncertain. With the ever-present potential for further losses, insurers pulling out of the market and the growing impact of terrorism, the aviation insurance market is in a precarious position. It is unlikely that insurers will maintain the 2003 premium rate reductions that we saw throughout 2004."

Flight to quality

Adding to the uncertainty for purchasers of airline insurance is the potentially unstable financial situation for some aviation reinsurers.

A Swiss Re report states that there is clear evidence from other market cycles that shows a definite correlation between a period of inadequate premiums coupled with high losses and subsequent insolvencies of insurance companies. In recent years, the aviation insurance industry has seen "growing claims volume, inadequate pricing, fluctuating capacity volumes and a rapidly changing cast of market players."

These factors combined with the current negative capital markets have all affected long-term market stability. Some specialist insurers and reinsurers have already been forced into insolvency, while others are fighting for survival. Andreas F Peter, Swiss Re's global head of aviation and space, Zurich, said: "Price has for too long been the overriding factor in purchasing decisions - now it's time for insureds to think more seriously about the quality of the insurance cover they are buying."

Florian Karner, global aviation leader, GE Insurance Solutions, Munich, commented: "We are not seeing a flurry of new entrants into the market. So pretty much the insurers that have been here are staying. Twenty to 25 years ago, there were 50 insurers, today not more than 15 to 20. Security of insurers and reinsurers has improved. Flight to quality has become important. After all, aviation insurance is a long-tail business, so it is important that purchasers of aviation insurance have adequate security on placement."

Rate factors

The repercussions of the terrorist threat have convinced several airlines to purchase liability limits up to $2bn for any one occurrence. This strains the capacity of the aviation re/insurance industry and increases the competition for coverage, which can raise rates. The major underwriters of airline insurance, of course, lay off a substantial portion of each risk to a host of reinsurers with quota share and excess of loss programmes. As limits rise, the availability of reinsurance capacity becomes vulnerable and reinsurance becomes more expensive, which gives a prime kick to the volatility of airline insurance rates.

Other factors that influence the future availability and pricing of aviation insurance include higher costs of labour and parts borne by maintenance facilities to repair damaged aircraft, claims costs that are mostly passed on to insurers. Also, increased products liability insurance costs have resulted from numerous products liability lawsuits and heightened court awards. The value of airplanes is soaring, not only the commercial aircraft, but the micro jets designed for the general aviation market. And at the same time, the market itself for aviation insurance is shrinking. With fewer aircraft sales, there are simply fewer aircraft to insure which makes the unit cost higher.

Lower losses a trend?

Mr Karner of GE Insurance Solutions observed that, looking back two and a half years, there has been an absence of major aviation catastrophes, which has led to good financial results for aviation insurance and reinsurance.

"So, it is fair to assume that brokers will use this trend as leverage to try to reduce prices," he said. "This poses the question: Is this reduction justified or not? We ask ourselves: Are we living in a new world where airplanes will not fall out of the sky? No, we do think there will be accidents, even though airlines are very careful and safety is critical and paramount." He also mentioned that aircraft manufacturers have made progress in designing equipment and performing maintenance to increase safety.

Analysts at GE Insurance Solutions predict increased severity of some hull losses, especially when the largest commercial airliner ever produced, the twin-deck Airbus A380, which will seat 555 passengers, enters service in 2006. Currently, the Boeing 747 with 524 passengers is the largest commercial airliner. An accident will bring increased liability awards not just in the US, but globally, said Mr Karner.

As proof of the expansion of high liability awards outside the US, according to a survey commissioned by The Insurance Leadership Institute of GE Insurance Solutions and conducted by Tillinghast, "escalating tort costs (58%) and increased litigiousness (55%) top the list of major claims issues expected to affect European insurers in 2004/2005. Also, 83% of respondents agreed that the general increase in litigiousness in Europe would lead to substantially higher liability claims."

Commenting on the survey, Ron Pressman, chairman, president and CEO of GE Insurance Solutions, said: "It's interesting that the top emerging claims issues appear to be tort and litigiousness since they haven't been leading issues in Europe. In the past, these issues have been seen primarily as US-centric issues."

GE Insurance Solutions uses an analytical approach to underwriting aviation business. "Our underwriting decisions are made after considerable analyses of at least 15 years of statistical material we have gathered. Based on our analysis," Mr Karner explained, "we believe that loss levels are not coming down; they remain stable, and we feel we need to make sure that what we price the business at makes sense. We have built pricing models that reflect the pricing needs for losses going forward. We try to have a dialogue on methodologies with brokers to raise understanding of how the market looks at risk."

In broad terms, there may be some sectors where pricing is coming down, but overall prices remain fairly stable, according to Mr Karner. GE Insurance Solutions does see pricing for products liability business going up as there has been significant deterioration on old product liability policies.

However, there is not much product liability business up for renewal now as the larger accounts are renewed in the first eight months of the year.

No crystal ball

Thomas P Fry, principal of Howard Fry & Son, Inc, a general aviation broker in Carmel, Indianapolis, said: "There is no real crystal ball for the future, even 30 days from now. Rates can pretty much change overnight." In the general aviation business for 35 years, Mr Fry is also president of the Aviation Insurance Association (AIA), Kansas City, Missouri. "I think the trend for higher rates has levelled off and rates are decreasing. Liability is still up but hull is probably going down somewhat," he said.

"Airplanes manufactured now are getting more expensive, especially as the micro-jets begin coming on line. These can cost from $3m to $10m.

But with hull you can know pretty close to what your loss will be if there is a crash. But with passenger liability with more people in the airplane, when there is loss, the claims will be a lot bigger."

Economic swings determine what aircraft people are willing to buy, he noted. "When dot.coms were flying high four, five years ago, a lot of new millionaires were buying their first airplane or moving up to a bigger, more expensive craft. Then the recession hit, and a lot of those expensive planes aren't flying anymore. The last couple of years, the market has started to come back, but aircraft values have actually decreased. I have said that an airplane is one of the few toys that you can own and it appreciates in value, but not now."

Judging how the aviation insurance market will fare in the future, Mr Karner said: "I think it will depend on whether there will be loss activity from liability policies covering previous years or from new losses." Supporting Mr Karner's observation, on 10 September 2004, the day before the third anniversary of the 9/11 attacks on the US, London's QBE International Insurance and certain underwriters at Lloyd's of London who paid property claims for the loss of World Trade Center buildings sued American Airlines and United Airlines for $300m each for negligencee for allowing the two planes to be hijacked and crashed into the WTC Towers. Other defendants named in the suit are Boeing Co, Pinkerton's Inc, ICTS International NV and US Airways Group.

Terrorism - unknowable risk

According to the International Union of Aviation Insurers, the aviation insurance market continues to provide cover at pre-9/11 levels for all conventional, non-war risks. Full war risk cover remains in place for hulls and passenger liabilities. Because of the unprecedented extent of exposure revealed on 9/11, commercial insurance cover for passenger and third party business interruption and property damage war risks now costs more that pre-9/11.

Options exist in the commercial market to purchase separate policies to increase the $50m third party limit to $1bn for service providers and manufacturers and up to $2bn for airlines. This is in addition to the $1.5bn to $2bn that continues to be available for passenger liabilities.

Third party war risk covers made available by various individual providers are unlikely to change significantly in the short term.

"Rates have come down a lot since 2002 for war risk cover," Mr Karner said. "After 9/11 no one knew what was happening and policies were cancelled. But now there have been no attacks on airlines in three years and markets feel they can offer somewhat attractive prices. Still, airlines are clear targets for terrorist attacks."

Into the wild blue yonder

Gary Hicks, executive director, AIA, said: "I think that generally premiums that were being paid before 9/11 were too low for the risk. Since then, while the insurance market has been unstable, I think premiums are more appropriate to the risk. But maybe there will be a more competitive situation in a year or two than what it has been in the last couple of years."

"Generally, the main reason or cause for rates increases remains the traditional ones: what is the possibility of a loss," Mr Karner said.

"A large number of airplanes are 30 years and older and don't have electronic features that new ones have. These older planes are subject to increased rates. While terrorism is a concern and is priced into accounts, losses can still be from pilot error, mechanical failure and bad weather. These are not going to disappear and can be underwritten for."

"Basically the aviation business hasn't changed that much in 100 years and probably won't in the foreseeable future," Mr Fry observed. "You have a plane that goes up and eventually it comes down. Unfortunately, sometimes it comes down too hard. That is where aviation insurance comes in."