The airline insurance picture - last year's nightmare - is looking considerably brighter. Questions remain, however, about the most practical way to insure against terrorism and the role government should play in this little-understood sector
For a product meant to put minds at rest, insurance continues to cause sleepless nights for airline managers. But although the situation remains in a constant state of flux, the past year brought several positive changes, with airlines and insurers alike reporting progress in the campaign to find mutually acceptable packages of risk coverage. However, a solution to the central riddle - third-party liability war risk - has yet to emerge.
For insurance providers, the fact that 2002 featured only one fatal crash in the USA or Western Europe was a tonic at a time when industry needed it most. For the first time in years, premium revenues eclipsed the liabilities their clients generated. The relative lack of disasters meant outlay was limited, while the high premiums generated in response to the prior year's world-changing events meant that some headway was made toward fixing the balance sheet damage inflicted by years of low premiums and multiple accidents.
"It's a much more stable market than it was at this time last year," says Nick Brown, deputy chairman of the Aviation Insurance Offices' Association (AIOA), which represents insurers in the London market. "Capacity has been repaired following some severe shortages and there's a sense of renewed confidence by capital providers. Those in the market last year will have achieved a good result."
Mark Lawrence, deputy chairman of Aviation Consultancy and Reinsurance Services at brokerage Aon, is more blunt, saying that "2002 was a fantastic year for insurers".
Airline relief
For airlines too, the insurance picture, while not rosy, is no longer the painful issue it was in the recent past. Relief for them is evidenced by premiums having begun to move in a direction they can live with and third-party liability war risk becoming manageable, if not exactly agreeable.
For the insurance providers, the reason behind the year's good result lies in a capacity-yield formula that airline managers know entirely too well. AIOA's Brown says that "because aviation insurance is a small and volatile sector, the cycles are exaggerated: good years draw in new capacity very quickly, resulting in lower premiums". He adds that last year's positive performance has drawn in masses of new capital with predictable effects on premium levels.
This capital influx, coupled with three fatal air crashes in the first three weeks of January, causes Brown to remark: "2003 is not off to a great start."
The return of capacity is, of course, music to airline ears. Aon's Lawrence observes that costs are well down from the last quarter of 2002. He points to global hull war premiums, which, at $300 million and on a downward trend, are considerably lower than last year's near-$400 million score. He adds that there has also been significant amelioration of all-risk premiums.
Third-party liability
The central issue however, as it has been since September 2001, is that of third-party liability war risk. While showing some improvement, it is an issue that continues to worry all sector participants. For the carriers, the big improvement has been in the fact that there is now cover available from the market at feasible rates and it is not cancellable.
The first point is critical because of the apparent demise of the key government-airline-market solutions tabled last year. ICAO's Global Time appears stalled at well under the requisite 51% member approval level, while Equitime - a pool-fund concept championed by the US lobbying group Air Transport Association - has for now been obviated by US legislation.
The not-cancellable element is critical because the threatened revocation of policies with a week's notice last year threatened to ground the world's fleet indefinitely and resulted in severely strained relations between the airline and insurance industries.
Even with improvement in the situation, however, premiums are unanimously seen as expensive. Howard Goldberg, director of taxation and insurance at IATA, explains that the current average third-party war risk charge to the airlines is about 75-80¢ per flight coupon, bringing the carrier cost for a single-connect, round-trip ticket to $3.00-3.20.
Aon chairman Jonathan Palmer Brown speaks for his airline clients when he complains that while "the picture is better for the airlines than six to eight months ago, it's still a dark outlook. How long they will have to pay so much for something that had never exceeded $50 million before 11 September?"
There are different perspectives on why this is the case, but they all seem to revolve around a lack of reinsurance cover for third-party war risk. Ian Hart, senior vice-president with insurance giant Marsh, contends that the reason no reinsurance market of any size has developed behind this type of risk is largely due to the fact that it is still an immature part of the market. He is confident, however, that it is just a matter of time before a functioning market develops for the product, which previously was folded into all-risk policies.
Lawrence at Aon disagrees, saying that the dearth of reinsurance for the activity largely owes to the risks involved in covering third-party liability war risk. "The aviation reinsurance providers," he says, "must compete with other, non-aviation, areas for capital. Because airline third-party war risk is perceived as riskier than other activities, it will need to have higher premiums to attract capital."
Furthermore, Lawrence adds, the risks involved with offering the cover are perceived to be sufficiently great that several high-profile reinsurance companies - notably led by stalwarts Munich RE and Swiss RE - have determined that they want to steer clear of third-party war risk altogether. These companies view the cover as bad business because it is too volatile, too difficult to rate and because potential losses are so high.
Andreas Peter, managing director of Swiss RE's aviation risk underwriting department, confirms this view. He explains that, owing to the impossibility of assessing the risks involved, his company has "no intention of entering" the [third-party war risk] market.
The effect of this relative absence of reinsurance backing severely restricts the number of insurance companies able to participate. As the vice-president for one insurer explains: "Because reinsurance is not currently available at feasible rates, in order for an insurance company to take on third-party liability war risk, it has to have a big balance sheet and an appetite for risk. It's not a field for the faint of heart."
In addition to raised costs, the smaller field of players raises the risk that, in the event of another incident, defection from the market would leave no provision for third-party war cover. "It's a small market, with only three players. And if something happens in 2003, that market will evaporate," warns IATA's Goldberg. Should this happen, the airlines will find themselves without the cover they are legally obliged to have to continue flying.
Even though they live in fear of such an event occurring, airlines seem to recognise what drives insurance community skittishness. In addressing the decisions they have facing them, Delta Air Lines vice-president and chief risk officer Chris Duncan speaks of questions surrounding the "long-term viability of insuring an unpredictable - both in terms of frequency and severity - risk such as terrorism."
Duncan adds: "The uncertainty of war with Iraq, a near-miss missile attack in November, and ongoing terrorist threats make offering insurance a tough decision [There are signals] that the aviation insurers don't want to be in the business of insuring terrorism, and I can't really blame them."
This situation in part led the US government to implement a programme that - in common with most global issues these days - puts it at odds with the rest of the world.
In November, the US government enacted the Homeland Security Act, which provides US carriers with both third-party liability and hull war risk cover for about 20¢/flight coupon. The programme, which is due to expire in August but is extendable to the end of the year, has provoked the ire of foreign airlines and governments, which charge that it represents an unfair advantage for US carriers. Unfair legislation or not, the act has catalysed healthy debate on the future of third-party war risk cover.
Goldberg at IATA believes that the programme is a model all governments should follow: "Airlines should not be liable for acts of war or have to insure against them."
Not surprisingly, this point of view strikes a chord with airlines everywhere, who feel that government ought to play a role in the provision of war risk cover, or even take it off carrier books altogether. Perhaps more surprisingly, even some insurers have joined the ranks.
Reduced exposure
Nick Brown of the AIOA says that, although the insurance community revenues have doubtless been harmed by the withdrawal of the US carriers from the third-party liability market and also the war hull pool, in which they represented 25% of global premiums - they also feel the consequent loss of exposure is a positive. This is especially so given the uncertainty surrounding a possible war in Iraq.
On more philosophical grounds, Brown says that the AIOA has members in both camps, with some feeling government should not be a competitor to market players willing to provide insurance cover, and others believing political activities are something for which governments should assume responsibility. Leaning more toward the latter viewpoint, Peter at Swiss RE calls for a "public-private solution" to the problem.
Whatever happens in Iraq, or when the Homeland Security Act lapses in August, it is unlikely that the subject of airline insurance will retreat to the background anytime soon.
REPORT BY RICHARD PINKHAM IN LONDON
Source: Airline Business
