The cost of airline insurance has peaked and is falling and, unless there is a catastrophic accident or a run of bad losses, is expected to continue to fall through 2012 and possibly into 2013. However, the insurance market remains very volatile and a period of poor loss experience could see insurance costs increase markedly again. A single disaster could turn the market overnight.
To say the insurance market "remains volatile" is to understate the situation; being volatile is the normal condition of the market. There has been no time in the past 30 years when insurance premiums have not been increasing or decreasing significantly.
From the point of view of an airline insurance buyer, it must be very difficult to produce any kind of reasonably accurate forecast of insurance costs from year to year.
While it might be nice to be able to tell the chief financial officer that your airline's insurance is going to be 20% or 30% cheaper this year, how is the boss going to react when, despite your best efforts and a clean claims record, the cost of insurance goes up by 20% or 30% from one year to the next?
Cheap insuranceNevertheless, airline insurance remains cheap. Overall the world's airlines paid an estimated $2.3 billion for their basic aviation insurances1 in 2011, representing about 0.5% of global airline operating costs for the year.
On average, insurance costs in 2011 were equivalent to about 80c (US cents) per passenger carried or $60 per flight. Insurance cost the airlines less than half of 1% of the price of the average passenger ticket and about the same as the packets of pretzels given away during the flight.
The written premium in 2011 for the main All-Risk Combined Hull and Legal Liability to Passengers and Third Parties airline insurance is estimated at $2 billion, a reduction of about 5% over 2010, brought about by an exceptionally benign claims experience for the year.
Losses incurred during 2011 are provisionally estimated at only $1.18 billion. This is about 45% less than the $2.15 billion incurred the year before and the lowest level of claims since 2004, when losses added up to only $1.06 billion.
The benign claims experience of 2011 brought to an end a run of three years when insurance costs were rising. Insurance premiums went up by a third between 2007 and 2010, from a low of $1.58 billion up to $2.1 billion before beginning to fall again in 2011.
While premiums reduced in 2011, the underlying insurance rates will have decreased even more markedly overall as the exposure, the value of the fleet at risk and the number of passengers carried, increased during the year.
The 5% decrease in written premiums in the year does not tell the whole story since, during the first three quarters of 2011, premium income, compared on a like-for-like basis with the same period in 2010, was still increasing - just. However, rates had already begun falling and any increase in premium in the first nine months was due solely to increases in exposure.
As noted earlier, unless the claims experience deteriorates very significantly or there is a catastrophic accident, it is expected that rates and premiums will continue to fall through this year and possibly into 2013.
In a recent Willis market newsletter, the broker categorised the current situation as a "soft market" and noted that "abundant [insurance] capacity" and few losses were "currently creating a market situation that is very favourable to [insurance] buyers" with "little to halt the slide in premium levels".
UNEXPLAINED CYCLE
This view is similar to AON's that "the market remains sympathetic and buyer friendly" with AON amplifying this by noting this was particularly the case for those airlines with "the brand and profile to leverage [insurance market] capacity".
Major aviation broker JLT also confirmed it expects to see rates and premium levels continue to fall and answered the question "is this the bottom?" with one word, "no".
For reasons that are unexplained and may be simply due to coincidence, there seems to be roughly a nine-year cycle in airline insurance costs from high to low to high again. Highs occurred in 1986, 1995, 2001 (the cycle was abruptly shortened by the 9/11 terrorist attacks) and in 2010.
Prior to 2010, the last "high", was in 2001 after the 9/11 atrocities. The market had begun to "turn" in 2000 in response to a deteriorating claims experience, with written premiums that year increasing by a third from $980 million to $1.3 billion.
The start of 2001 saw premiums continuing to rise and, at mid year, the written premium for the year was predicted at $1.6 billion, an increase of almost 25% on the year before and a 63% increase over 1999.
If the 9/11 attacks had not happened other incidents would almost certainly have pushed written premiums for the year above the predicted $1.6 billion and probably produced further increases in 2002. These include the loss of an American Airlines Airbus A300-600R, in which all 260 occupants died along with five people on the ground, when it crashed shortly after take-off from New York Kennedy airport in November 2001 and, to a lesser extent, the earlier collision on the runway at Milan involving an SAS Boeing MD-87 and a Cessna Citation business jet.
Yet with exceptionally low claims costs in 2002, 2003 and 2004, any increase would have rapidly been reversed and premiums would have fallen back markedly.
But 9/11 did happen. In one day incurred losses affecting airline policies exceeded the premium for the whole class of business for the entire year. Claims falling on airline all-risk policies2 during 2001 totalled almost $5 billion, three times the originally expected total premium for the year.
The market reacted to this unprecedented event, which occurred shortly before the start of the main renewal season, by immediately withdrawing all outstanding quotes. Notice of cancellation was issued on all insurance policies so that they could be re-issued incorporating a new sub-limit (initially just $50 million) for liability to third parties as the result of a deliberate act of violence.
On 1 October 2001 a special $1.25 surcharge per passenger per departure was introduced for passenger airlines and a 10% surcharge on the combined hull and liability premium on cargo airlines. The underlying rates also increased markedly.
Perhaps the most significant of these changes was the introduction of the $50 million sub-limit for liability to third parties as a result of a deliberate act of violence, which would have resulted in almost all airline operations being grounded because of inadequate insurance.
However, various government-backed schemes were rapidly put together to make good the shortfall until adequate insurance became available again. In due course a new insurance "market" came about to cover this shortfall, the Excess Third Party Legal Liability (War) market.
TERRORIST ATTACK
All of this resulted in airlines paying much more for their insurance in 2001. All-risk insurance premium (including the surcharge) jumped from $1.3 billion in 2000 to $3.6 billion in 2001, premium for excess third party (war) came in at about $750 million (all additional) and hull war rose to $410 million (up by $350 million) although much of this increase was caused by the terrorist attack on Sri Lanka's Colombo airport earlier in the year rather than the events of 9/11. In all airlines paid about $3.4 billion more (an increase of 250%) for their insurance in 2001 than 2000.
At the time, many in the market thought the cycle had been broken. Capital providers, the institutions that put up the money that makes insurance possible, had, so the story went, found that their exposure to aviation risks could come back and bite them very hard. Therefore, they would not be so cavalier with their money in future and would only support "proper, technical underwriting", market capacity would reduce and insurers could charge the "right" technical rate for the risk.
This view did not survive long. The year 2001 was followed by a run of exceptionally benign claims years and rates and premiums began to fall back almost immediately. They continued to fall for the next six years until, eventually in 2007, incurred losses exceeded the premium written during the year and the market began to turn.
PRICE HOSTAGE TO CLAIMS
However, this most recent rally has not lasted long. Capital and therefore market capacity seems to be readily available, possibly because insurance offers the least bad home for investment in a turbulent world, and the resulting competition for market share and a relatively good claims year has softened the market.
The price of insurance remains hostage to overall claims experience and changes in the availability of capital rather than the actual risk and the cycle continues round again.
Even leaving aside the unprecedented events of 9/11, all-risk insurance premiums can still produce some very large movements over relatively short periods of time as the market reacts to "normal" events. For example, all-risk premiums increased by 400% in real terms in the five years between 1990 and 1995. There are, of course, many factors, which can affect the price that an airline pays for insurance.
Unfortunately, with the possible exception of its own loss experience, an airline probably has little chance of influencing many, or possibly, any of the most significant of these. There are a number of factors, which are completely outside the airline's control but can have a major effect on the cost of insurance.
There are several key factors that can affect insurance rates:
Money and Insurance market factors
- The availability of capital (capacity) to support insurance;
- Interest rates and available rate of return on investments available to insurers;
- The availability and price of re-insurance; Competition strategies within the insurance market.
- Competition strategies within the insurance market
Factors applicable to the class of business or an airline in general
- The claims experience for the class (all airlines) as a whole;
- The size of the exposure for the airline. Primarily, fleet value and number of passengers carried;
- Types of aircraft operated and their age;
- Country/region of the world where the airline is domiciled;
- Specific exposure profile (exposure to the different legal liability regimes).
Factors specific to the airline
- Specific claims experience;
- Technical factors such as management, crew training, maintenance, equipment, safety culture and financial health.
How to get very cheap insurance - be a very large, well-established, well-run airline operating modern jet equipment with a good claims record.
How not to get cheap insurance - be a small, unknown, tramp cargo airline operating old Soviet turboprop equipment on ad hoc domestic charter flights in Sudan or the Democratic Republic of Congo. If this is you, you probably have an insurance rate some 200 times that of the "best" airlines.
1All-Risk Hull and Legal Liability to Passengers and Third Parties - $2 billion, Hull War - $100 million and Excess Third Party Legal Liability (War) - $200 million.
2The aircraft hulls lost on 9/11 were borne by the insurance war market but the liability for passengers and third parties, as is normal practice, had been 'written back' into the all-risk policies and fell on the all-risk market.
- Paul Hayes is director of air safety at Flightglobal's data and consultancy arm Ascend
Source: Airline Business
