Recent aviation losses and overcapacity seem to be leaving the market in neutral. But as one major loss threatens to trigger reinsurance programmes and experts warn that profits must be made soon, hitting cruise control just isn’t an option

At 1pm on 10 June, a large fire broke out in the Saudi Arabian Airlines warehouse in northern Jeddah, Saudi Arabia. Members from 13 civil defence taskforces and rescue teams spent four hours battling the inferno. No loss of life was recorded but the 18,000-square-foot building was reduced to rubble – destroying or damaging nearly all of the insured’s aircraft and ground equipment spare parts.

While loss adjusters are still totting up the costs of the damage, there have been some suggestions that it will be as high as $365m, though this figure could reduce. Such a loss could have a significant bearing on the outcome of the upcoming aviation renewal season.

If the final figure is in line with current rough estimates, it will trigger primary aviation insurers’ excess-of-loss reinsurance programmes, and could mean rates will only fall by around 5%, according to Ian Wrigglesworth, managing director, aviation at reinsurance broker Guy Carpenter. However, if the figure is lower than currently expected, excess-of-loss policies will remain untouched and primary insurers will retain the loss.

“If the final figure reduces down below the attachment points of the aviation excess-of-loss programmes, there will be no brake on pricing,” says Wrigglesworth.

“That means direct aviation underwriters are able to look for reductions of their excess-of-loss programmes between 5% and 10%.”

Below trigger point

Apart from the June fire, reinsurers have got off relatively lightly so far this year in terms of aviation losses. “There has been a multitude of losses – around $900m worth of hull and spares losses during 2010,” Wrigglesworth says. “But reinsurers haven’t been affected. Almost all have been below the attachment points of major risk excess-of-loss programmes. Despite the losses in the primary market, the excess-of-loss market has been comparatively unaffected.”

Some primary insurers will be affected more than others by the recent run of aviation losses, of course, as Wrigglesworth says that those writing a global, diversified book of business will have fared better than those focusing solely on international airlines business, which he highlighted as a

loss-making area.

By contrast, the US airlines, products and factories business lines have performed comparatively well. As a result, reinsurers have enjoyed profitable proportional treaty relationships with the vast majority of clients, on top of not having to pay losses on excess-of-loss contracts.

There is also ample capacity in both the insurance and reinsurance markets. Wrigglesworth says the reinsurance market has held 200% capacity for more than five years.

But the market is not without its challenges. Some feel that with high capacity and falling rates, something has to give. Aon senior business analyst Magnus Allan says capacity levels in both insurance and reinsurance will need to produce a return in the coming months or risk cutbacks. “I think people will look at it and think: ‘Right, we need to get a profit in 2011.’ Or else there could be a reduction in capacity in 2011 and 2012,” he says.

A further challenge is that primary insurance rates are also under pressure, which is influencing reinsurance prices. On 6 February, the roof of a hangar housing corporate jets at Dulles Airport in Washington, DC collapsed under the weight of snow, causing insured losses of approximately $440m. However Wrigglesworth said the primary US general aviation market had been unable to push up their rates despite the loss, because of overcapacity. This has, in turn, limited reinsurers’ ability to charge more.

Some observers believe the significant losses in May and August will keep primary insurance price growth around the 5% mark. However, broking group Willis’s business development manager Steve Doyle says: “We are in a situation where the capacity and the losses are currently presenting opposing forces that are bringing the markets to a largely neutral position.”

A clearer view

There are positive signs for aviation reinsurers in these tough market conditions, however. While rates may be falling, underwriting is becoming more sophisticated, potentially giving greater protection against future losses.

Aviation insurers and reinsurers generally have little difficulty in gathering information to support their underwriting because a lot of the data they use is available in the public domain. But, according to Wrigglesworth, underwriting is being reshaped by actuarial data, which has been used increasingly over the last three years to paint an even clearer risk picture for reinsurers.

“The interesting part is how we process risk using actuarial model-driven analysis. This means reinsurers have a sophisticated approach to how they rate their business,” says Wrigglesworth.

Wrigglesworth says the increased actuarial data use in aviation underwriting is being influenced by the models employed in other specialist lines being written by reinsurers.

“Demand to write aviation reinsurance has been increasing because people have come into aviation who write many other specialty lines, and other specialty lines are model driven,” he says. “A good management tool is making sure a robust model is used, meaning there is fairness in quoting.”

Despite the increasing sophistication of aviation underwriting, however, there are always going to be unknowns and surprises that the models cannot account for, financial crises being a particularly good example.

However good the aviation reinsurance market’s underwriting, it is to an extent at the mercy of forces governing the aviation industry itself. As Doyle at Willis says: “The economic issues around the aviation industry are going to be the economic challenges of the insurance market.” GR

Across the globe

Underwriting global aviation business has become more challenging in light of sanctions between countries, which are resulting in changes to contract wordings. Several sanctions and embargoes have been broadened this year, which Wrigglesworth says both the insurance and reinsurance markets will have to appropriately comply with.

“Some regulatory framework has come through in which there has now been a more robust enforcement of sanctioned areas, for example Iran,” says Wrigglesworth, adding that discussions are currently taking place to ensure underwriters and brokers comply with the sanction requirements.

And while rates are falling for reinsurers, exposures are increasing in certain areas. According to Wrigglesworth, there was a degree of contraction in the global airline fleet during the economic crisis, including a number of older aircraft that were decommissioned.

Different parts of the world are recovering from the crisis at different rates, which will result in exposure changes in certain regions. “There continues to be delivery of new aircraft and the airline market continues to expand,” says Wrigglesworth. “There are areas in the world where the expansion continues at pace and other areas where there has been economic slowdown and so fewer deliveries of aircraft.”

Major 2010 aviation losses

25 January: Ethiopian Airlines passenger jet crashes into the sea with 89 people on board shortly after take-off from Beirut.

6 February: The roof of a hangar housing corporate jets at Dulles Airport in Washington, DC collapses under the weight of snow. No loss of life but an estimated damage bill of $440m.

10 April: A Tupolev 154 plane carrying Polish president Lech Kaczynski crashes near the Russian airport of Smolensk, killing more than 90 people on board.

10 May: Fire destroys a Saudi Arabian airlines warehouse in northern Jeddah, Saudi Arabia. No loss of life is recorded, but all the insured’s aircraft and ground equipment spares are damaged or destroyed.

12 May: An Afriqiyah Airways Airbus 330 crashes while trying to land near Tripoli airport in Libya, killing more than 100 people.

22 May: An Air India Express Boeing 737 overshoots a hilltop airport in Mangalore, southern India, and crashed into a valley, bursting into flames and killing 158.

28 July: A Pakistani plane on an Airblue domestic flight from Karachi crashes into a hillside during poor weather while trying to land at Islamabad airport. All 152 people on board are killed.

16 August: A Boeing 737 Airis Colombia passenger plane carrying 127 people crashes while landing in poor weather at San Andrés Island, and the fuselage breaks up on impact. One passenger is fatally injured and a second passenger dies later in hospital.

24 August: A Henan Airlines Embraer ERJ-190 passenger plane overshoots the runway at Yichun City’s airport in the north-eastern Chinese province of Heilongjiang, killing 42 of the 91 people on board.