Insurance premiums eased again last year as airline accidents hit a 20-year low, but the threat of terrorist attacks still looms
Last year was another exceptionally safe year for commercial airlines, the third consecutive year where fatal accident numbers fell, and the third year too of low insurance claims levels. That meant that insurance premiums continued to fall from their 2001-2 highs, but whether premiums will continue to fall in 2005 is open to question. Even barring a major incident, premiums may be reaching their cyclical low, and other trends in the insurance market could start pushing them up again.
In 2004, the news was almost universally good, however, with airline crash fatalities at a 20-year low. According to analysis from sister magazine Flight International, there were 28 fatal accidents worldwide, of which only 11 were passenger flights (see graphs over page). None involved mainline airliners registered in North America, Europe or Australia, maintaining a three year clean sheet.
Insurance claims also remained at a low level, although they were marginally higher than in 2003. Aviation broker AON calculates a total of just over $1 billion in claims in 2004 including attritionals (minor bumps and scrapes), which is more or less in line with the last couple of years. That follows the nightmare year of 2001 when the 11 September terrorist attacks adding some $3.5 billion to the underlying industry losses, to push total claims above $5 billion. The average in claims for the last five years, excluding terrorism, is $1.3 billion, compared with $2 billion of annual losses that the insurance industry uses as an informal benchmark.
All of this was good news for carriers during the key fourth quarter renewals season, when over half of airlines, accounting for 78% of total annual premiums, renew – December alone accounts for 60% of annual premiums. By the end of the quarter, AON was calculating that rates for hull insurance had fallen by 14% over the year, and for liability insurance by 15%. That follows a 16% fall for hull rates in 2003.
Nick Brown, chairman of the Technical Committee for the International Underwriting Association in London, says that hull rates are now slightly lower than pre-9/11 levels. Liability rates remain slightly higher, however, after they soared 55% in 2001 and 162% in 2002, according to AON. The fall in liability rates in 2003 is less easy to calculate due to market changes that year and the introduction of a $1.25 per passenger surcharge for liability.
Settlements soar
There are also potentially worrying trends in liability claims. Brown says 2004 saw two relatively small commuter aircraft crashes, which nevertheless look to be heading for high liability claims. "The trend in liability settlements is very sharply upwards. We have seen a big escalation in settlements to passengers," he says.
Exacerbating the problem is the fact that the 1999 Montreal Convention not only removed the limits on passenger liability that had existed under the old Warsaw Convention (even though these had already been voluntarily waived in many cases during the 1990s), but allowed for a "fifth jurisdiction" over claims. This means that relatives of a person who is resident but not a national in a country can pursue a claim against an airline there for an accident, even if it happened on a route between two other countries. This gives extra ammunition to plaintiffs trying to get their cases heard in US courts – traditionally the source of higher settlements.
While there are no immediate sgns that these factors are affecting liability rates, which fell as fast as hull rates last year, one concern is that a combination of increased risk and falling rates may start to put off the financials institutions who provide capital backing for aviation insurance – what the industry refers to as "capacity".
Both Brown and Steven Doyle, director at AON's aviation and aerospace global practice group, say that capacity is not in short supply – indeed, Doyle says there will be some new entrants to the market this year. But both recognise conditions could be approaching for a traditional upswing in the cycle, where returns to capital providers fall and capacity drains away from the market. "Capital providers recognise that aviation has big exposure and they have no appetite to take on this risk for low premiums," says Brown. "If prices are pushed down too far in the current cycle, it could be a problem."
At the moment, however, underwriters seem to be moving in the opposite direction, taking on more risk to keep premium levels up. This explains why despite rates falling by double digits in 2004, premiums – that is the total amounts actually paid to underwriters – fell by only 7%, to $2.4 billion. That is still higher than the $1.6 billion in premiums in 2000, but the trend that year was already upwards, says Brown. This partly reflects a rise in fleet values – AON estamtes a 5% rise in 2004 – but it is also due to underwriters including more war-risk third-party liability cover in policies. "Post-9/11 this was capped at $50 million, but more underwriters are now offering $150 million as a way to offset premium reductions," says Doyle.
War-risk cover
Third-party war-risk cover – under clause ACN52E – was the big topic following the events of 9/11. Before then, it was covered by normal policies. Afterwards, the $50 million limit was introduced, and carriers looked for government assistance or to pooled risk schemes to cover the remaining liability. For a time pooled schemes between carriers such as Equitime in the USA and Eurotime in Europe looked to be the way forward. ICAO then proposed a scheme called Globaltime, which was designed to offer a worldwide solution.
However, in December 2002, the US government offered its own carriers coverage of about $100 million, which still remains in place to this day, although renewed annually by Congress. That sucked the wind out of Globaltime It still remains on the table but as yet states representing only 12% of ICAO's budget have supported it, well short of the 51% needed to put it into effect.
Meanwhile, a specialised commercial market has sprung up to offer excess war risk cover, with most non-US airlines seeking cover up to $1 billion by this route. Doyle says this can cost as much as 50% on top of normal premiums, and Brown puts the total premium figure for the market at $600 million, or around 25% of normal premium levels.
Although the increase of war risk limits in normal policies from $50 million to $150 million suggests that there is an appetite for returning this business to the normal airline insurance market, Brown defends the separate war-risk market, saying it offers carriers new benefits. "War risk in normal policies has always been subject to seven-day cancellation, which was the problem after 9/11," he says. "But the specialist market has developed non-cancellable products. This means that airlines can be sure if another 9/11 happens, they will not be left without cover. It is pretty difficult to predict how things will go, and it is a question of optimising savings while keeping optimal cover, but my opinion is that most airlines will prefer to keep the cover separate for that reason."
All of this suggests that the war-risk question can safely be left to the market, but there is another cloud looming on the horizon. In October 2003 the Joint Technical Clauses Committee of Lloyds and other London underwriters drafted a new clause – ACN48C – which would exclude cover for dirty bombs and other biochemical attacks from policies. In a speech to the OECD in November, Eugene Hoeven, director risk management and insurance at IATA, described this as "an issue that could potentially ground air transport".
The problem, as with the war risk controversy after 9/11, is that the Montreal Convention requires carriers to have adequate insurance to cover their liability to passengers and third parties. Without it, carriers cannot fly. But losses to third parties from a dirty bomb could be potentially huge, and underwriters do not feel they should be required to cover them. "The concern is that if terrorist deployed biochemical or similar weapons at an airport, the potential exposure could be more than the industry can afford," says Brown. Underwriters argue instead that such incidents should be classed alongside uninsurable risks as nuclear attacks, as indeed they already are in property and maritime insurance.
Dirty bomb stand-off
Hoeven agrees, and says IATA has been lobbying governments to this effect. But so far he says no state has replied in the affirmative or come up with a solution to that dilemma. "There is a limit to what the markets can do," he says. "This is a small and very specialised market and only has a very limited capacity, and at some point governments are going to have to come up with extra coverage." He thinks that there is a bit of a stand-off on the issue. "It is a question of who blinks first. The problem is that no state is willing to give a guarantee unless an incident occurs, but if cover is withdrawn, that would create a problem right away."
An alternative would be to introduce an amendment to the Montreal Convention excluding third-party liability in the event of a dirty bomb. One vehicle for this might be the Rome Convention of 1952, which covers liability for damage caused on the ground. The convention was not widely adopted, but there has been new interest in it since 9/11, and an ICAO committee is working on modernising it.
The European Commission is also talking to brokers, though it declines to comment beyond confirming that discussions are taking place. David Henderson, manager information for the Association of European Airlines, meanwhile, says it is "a passive party" on the subject: "We are aware that it is an issue to be resolved, but we are not part of the solution. We are waiting to be informed what the outcome is."
On the underwriters' side, Brown downplays the problem, saying that while insurers could withdraw cover, "I don't think we are at that stage". He points out that it is not in the insurance industry's interests to ground its customers and predicts that they will not act until a conclusion is found that satisfies all parties. "There has been a lot of lobbying about this, but I don't see anything happening in the near future," he says.
Back in the main airline insurance market, the key unspoken question is whether the low rate of claims will continue. No one wants to be a hostage to fortune by speculating openly, of course, but some wonder whether safety measures introduced after 9/11, or the shake-out of airline fleets it caused, with old aircraft being retired, has led to a paradigm shift in loss levels. AON in one of its reports calculates that the average age of the commercial airline fleet has fallen from 21 years to 15 years in the last five years, with a rise in the total fleet by 1,600 aircraft to 18,900 over the same period.
Doyle thinks that the investment in technology by airlines has "obviously made a difference" to incidents and fatalities, and points out that with sky marshals, passenger screening and cockpit doors, terrorist incidents are hopefully less likely. But one incident could change everything, he points out, as indeed another AON report also states: "Although (lower loss figures) are representative of the introduction of new industry safety initiatives, they are not a permanent guarantee of future low losses, with one fatal crash potentially doubling the losses in a year."
So while recent years have helped the insurance industry recover from its 9/11 losses, premiums are not yet going to become permanently lower as a result of three good years. Brown says actuaries look at results over a 10-year period, so would be need more good years before they changed their long-term outlook. Doyle, while calculating that underwriters are showing a $600 million profit on North American business over the past five years, points out that it is a very litigious region and could easily lose that in claims.
One trend he does see is more differentiation in pricing. "Certain underwriters are getting selective on risk – excluding some classes of operation or certain areas of the world," he says. "More and more the market is looking at where losses are coming from and taking a technical, actuarial approach." This, he says, could be good for airlines. "It should give more consistent pricing for each airline's level of risk. Like home or car insurance, airlines that have a better safety record will get credit for that."
BY PETER CONWAY IN LONDON
Source: Airline Business
