Sarah Goddard reports on recent changes in the aviation re/insurance sector.
Ayear ago, the aviation business was booming. Tourism was an ever-growing market, and airlines were reaping the benefits. Notwithstanding the occasional failure such as ValuJet - more a consequence of its safety record than trading conditions - airlines were riding high, predicting increasing passenger numbers, and anticipating a bright future. As a background to all this, however, the aviation insurance sector was faring less well, appearing unable to make a profit on its business.
As with many things, come September 11 and the aviation sector was fundamentally changed. Since that day, several airlines including Canada 3000 and Swissair have collapsed, and re/insurers have fundamentally changed the way they view the sector. One of the first moves in the wake of the US terrorist attacks was the withdrawal of terrorism cover beyond $50m, a situation dealt with - temporarily at least - by governments around the world. In a recent report, the Geneva Association, a risk and economics research body, commented that not just the loss of the four planes in the World Trade Center attack but consequential business interruption caused by the halt in US air traffic would be, at least in part, compensated by the insurance industry. "When approaching the point of insolvency, some carriers were helped by the injection of state funds," commented the association. "One of the questions to answer will be how the state, if and when acting as an insurer of last resort, should complement the functioning market place. How far does this provide a call option with a strike price to be variably set by the beneficiary in the form of underinsurance and heavy or `managed' exposure? Furthermore, does it make sense in a globalised world for a single state to bail out a company with capital owners, employees, customers and dependent suppliers in many different countries? Is the state really such a good insurer of last resort or do we need another system to complement what we cannot (or do not) want to organise in the market place?"
It is uncertain how long it will be until this question is answered. From September 24, the UK government introduced a scheme known as Troika to fill the hole in programmes following withdrawal of terrorism cover by the aviation re/insurance market. Troika provides cover for exposures above the $50m level for third party liability (war and terrorism) for airlines with UK operating licenses, to a maximum limit of $2bn. But the gap is about to reopen; Troika expires on March 20, and despite an offering from an AIG-led consortium for up to $1bn, at time of writing the commercial market was not looking set to move back into the sector. Co-insured with ACE, AXA, Chubb, Everest Re, GE Frankona, Glencoe, Hannover Re, Kemper, Liberty, St Paul Group, Tokio Marine, TransReCo, Travelers, XL and Zurich Re (Converium), the cover offers $150m in excess of $50m and up to $850m in excess of the $150m. For European airlines unable to find terrorism cover from the traditional market, the European commissioner, Loyola de Palacio, has said that either a mutual fund or some sort of joint state indemnity cover would be provided should the commercial market not provide sufficient capacity for the business. The cover would be funded by payments from passengers, operating with industry support and backed by guarantees from the relevant governments.
US airlines are working to the same deadline for the removal of government cover, currently provided under Chapter 443. Over recent months, US-based airlines have turned to the government scheme for cover rather than AIG's offering, or a similar product from Berkshire Hathaway. President Bush does have the option of extending the federal programme for another 60 days on March 20, though other options are currently being explored. According to recent reports, the Air Transport Association (ATA) in Washington, DC, is working with Marsh Inc to set up a risk-retention group for US airlines. Currently known as Equitime, the group would provide up to $1.5bn in combined limits for passenger and third party war risk exposures, retaining the first $300m and ceding the balance to the federal government in the form of the Federal Aviation Administration. As well as the 24 members of the ATA, airlines belonging to the Regional Airline Association, numbering around 50 in total, would have access to Equitime.
General market conditions
As well as the problems associated with terrorism cover, airlines have been facing sharp rate hikes following the worst-ever year for aviation losses, with total claims estimated at $5.8bn by Airclaims. This is dramatically higher than the second worst loss year, 1994, which saw claims reach $2.3bn. Paradoxically, removing the terrorism element of 2001, which included not only the US terrorism attacks but also the Sri Lanka Airlines losses in July, would mean the year would have been one of the safest on record, according to Paul Hayes of Airclaims, a UK-based aviation loss adjusting company. Nevertheless, with the aviation market recording consistent losses year-on-year from 1996, brokers and underwriters were agreed that rate rises were needed prior to September 11. Whether they would have been achieved remained speculative before the US terrorism losses.
In a special bulletin, Airclaims observed: "[Excluding the US terrorist attacks] we must be thankful that 2001 was, otherwise, a `good' year. We currently estimate that incurred insurance losses from airline accidents [fortuitous events] in the year total only about $1.2bn, making it one of the `best' years for some time. The past trend would have predicted accidental losses closer to $2 billion for the year."
In addition, there were only 18 fatal accidents worldwide during 2001, the lowest number since 1946. "Since the war, the annual number of fatal accidents has been gradually decreasing, from more than 50 per year in the early years (note data for Aeroflot prior to 1970 is incomplete) to about 20 per year now," noted the bulletin. "During this time, airline traffic has expanded greatly meaning that air travel is probably about 100 times safer now than in 1950. Although the number of fatal accidents (to passengers) has fallen considerably over the years, the aircraft involved in accidents nowadays are quite often larger and there is, therefore, the risk of more fatalities per accident. Nevertheless, despite increasing exposure and tremendous differences from one year to the next, on average the annual number of passenger fatalities has remained more or less the same for more than 40 years. On average, we might expect about 1,000 passenger deaths per year worldwide.
"Therefore, 2001, again, should be considered a relatively good year with only 715 passenger fatalities worldwide - there have only been three better years, 1984, 1990 and 1999, since the 1950s. If passenger fatalities on board airlines from the Soviet Union are excluded then, again, the year turns out to have been good. Only 495 passengers were killed onboard aircraft operated by airlines from the rest of the world during the year. There have only been two years with less fatalities since 1946, 1955 when 484 passengers died and 1984 when there were 257 fatalities. Traffic has more than doubled since 1984 so, outside the former Soviet Union, 2001 turns out to have been the safest year ever."
In a market report, London-based broker Jardine Lloyd Thompson Group PLC outlined the changes it has faced in the market. These were:
Although there has been some new capital into the aviation re/insurance sector - Endurance Specialty has said it has $30m for aviation liability and Axis has said it will underwriter aviation business - airlines have faced Himalayan rate increases. On average, increases have come in around 100% across the board, though American Airlines' renewal was up 600%. The failure towards the end of last year of Fortress Re has further constrained available capacity, though there are mixed feelings whether this had any real impact on market conditions.
All is not dark on the aviation front, however, and certain companies are looking towards a better-controlled future. At the beginning of this year, RISConsulting launched an online risk measurement and pricing product for aircraft financial risk. Founded in 1996 by the Insurance Corp of Hannover (a Hannover Re subsidiary) and Utrecht America Holdings (a subsidiary of Rabobank), RISConsulting has raised more than $5bn in non-recourse financing from re/insurers covering the various sales finance contracts. It now has three financial risk models available on its portal, AircraftRisk.com, aimed at allowing a full analysis, measurement and pricing of aircraft guarantees.
What the effect of the contraction of the international aviation sector will be is uncertain, but better valuations of individual aircraft and fleets is likely to become more pronounced as cases of underinsured airlines start coming into the open.
By Sarah Goddard
Sarah Goddard is the editor of Global Reinsurance.