Four years of rate cuts in aviation reinsurance isn't putting off new entrants, says David Whiter.

The world of aviation is full of paradoxes. On the one hand it is big business, with insured hull values exceeding $600bn, greater than the entire GDP of Switzerland, flying passengers over four trillion individual kilometres. On the other, with only 350 airline insurance placements of any size, the insurer's potential client base is limited. This, coupled with the need to provide huge hull and liability insurance limits, inevitably leads to a highly volatile marketplace.

In the early 1990s, premiums fell to only one third of that required to cover an average year's losses, while in the aftermath of 9/11 they rose to over double. Since then the industry has experienced few losses, particularly in the expensive US and European regions, which has encouraged strong competition and seen premium levels halve.

So why are views on the health of the market so divergent; from those who have withdrawn citing the illogicality of four successive rate cut years, to others who have recently hired experienced teams and entered?

It is often simplistically thought that rising markets are profitable and falling ones not. However, this is not necessarily the case – the pre 2001 aviation insurance market used to run in eight year cycles with pronounced peaks and troughs. Assuming experience over the cycle was in balance (which it rarely was but that's another subject) the first two years of decline from the peak would actually present greater profit opportunities than the first two rising from the trough. It could be argued that underwriters so overreacted to 9/11 that even after the recent rating reductions the business still offers attractive margins. Additionally, the non-accumulating nature of aviation business can appear attractive in light of recent natural disasters.

However, the industry is increasingly held hostage by the US legal system, where a single lost life can result in several million dollars of compensation. Therefore a single accident involving a medium-sized aircraft causing significant death and injury in the US could cost the market a significant percentage of the available premium income: three or more would result in a large deficit. So who's right, the optimist or the pessimist? Potentially both, but with emerging new challenges, such as the Airbus A380, and continued past year deterioration in reserves even the optimist would need to be wary.