Airlines spent less on managing risk in 2006, according to the Airline Risk Management Survey commissioned by Airline Business and airline insurance broker Aon, but new insurance challenges are expected to emerge
Managing risk got a whole lot cheaper for airlines in 2006, with a spend of some $7.2 billion per annum across the industry, compared with $8.3 billion the previous year. This reduction is largely thanks to the fall in the cost of insurance premiums, with the greatest decreases on the aviation side. Better still, the airline risk management community is optimistic that the downward pressure on premiums will continue into the 2007 round of insurance renewals.
A detailed investigation into airline risk management issues in 2006, commissioned by Airline Business, in association with insurance broking firm Aon, reveals that airlines have become more tightly focused in their strategic risk planning, with 64% reviewing their strategies in the last year and the length of time these strategies look into the future reducing to an average of 2.5 years, compared with 3.3 years in 2005.
The pace of change in the sector is a key driver and in responding, airlines are also looking to buy new types of insurance in the future. For example, while only 18% of airlines now insure against environmental pollution, the number buying these policies looks set to at least double in the next three years.
Now in its second year, the Airline Risk Management Survey sets industry benchmarks against which airlines can measure their own performance, with 50 airlines taking part - accounting for around two-thirds of the world's top 200 airlines by total revenue.
The study shows that the risk management budget accounts for an average of 1.6% of airlines' total revenues, compared with 2.1% in the previous year. Apply that 1.6% to the revenues of the world's top 200 airlines and you get a spend in the order of $7.2 billion, with insurance taking a 60.8% slice (down from 70.1%), most of which - 63% - goes on mandatory policies. Within aviation insurances (hull, liability, war and excess), the premium unit cost per passenger is below $1 for just over half of airlines, with the average $1.16, compared with $1.68, and the average unit cost per aircraft standing at $128,400 compared with $157,500 in the previous study.
Does that mean airlines have a surplus to spend on non-insurance measures? Not necessarily. Peter Fahrenthold, managing director of risk management at Continental Airlines, says that as insurance costs go down, so does risk management expense. However, at Japan Airlines, the insurance department of JAL Capital says the additional funds are being invested in security.
Primarily, airlines have benefited from increased competition in the insurance market, with more underwriters coming into the aviation sector, although the industry's good safety levels have also had an impact. Major insurers who have been active in other markets see aviation as a nice way of diversifying their portfolios, according to Steven Doyle, manager of Aon Global Aviation, adding that these players have come in because "they see airlines as a high return market - while it is a catastrophe market, it is measurable."
Divided opinion
Airlines in the study are fairly evenly divided about whether their risk management costs will go up, remain the same or go down this year. But thinking just about insurance premiums, airlines forecast these will continue falling in 2007, with aviation premiums leading the way. Looking into 2008 and 2009, JAL Capital says: "In terms of aviation insurance costs, a down trend will continue for a while. However, we anticipate that other risk management costs will increase." These increases will, adds JAL Capital, be security-related costs.
At Aon, Doyle cautions that the downward pressure on premiums may only last into October when it will bottom out. "The cycle runs October to October, therefore renewals that take place today are following the cycle that started in October 2006. I think everyone will get their bite of the cherry until October this year," he says. "That's when I think we will see a levelling off."
Other major changes in the aviation market could start influencing insurance premiums into next year and beyond, as the Airbus A380 and the Boeing 787 come into commercial service. "The A380 is unique primarily due to its size and the 787 due to its composite construction," says Fahrenthold. "The market may be impacted by the higher limits required by A380 operators and some insurers are expressing concerns about the possible higher cost of hull damage claims for the composite 787s. In addition, air traffic continues to grow on a global basis and new airlines are being launched. But if all these new issues unfold smoothly, the market should remain stable."
The risk profile of airlines changes with their business - new aircraft, new destinations and new security measures can either create new exposures to risk or modify existing risks. There is a feeling among airlines in the study that their risk profile will start making more of a difference to what they pay. While 92% say market forces influenced the decrease in premium in 2006 and just over half cited risk profile, for this year's renewals, 88% predict decreases will be a result of market forces and 60% risk profile.
Work on improving the risk profiles is coming at individual airline and at industry level. Continental, for example, is always looking for new ways to enhance its risk profile, from protecting facilities against windstorm damage to improving the security of computer systems. "Costs incurred to make these improvements are risk management costs in the ERM [enterprise risk management] sense, although they are not usually included in the traditional view of what constitutes risk management expenses," says Fahrenthold.
The ERM approach will be more common if IATA has its way. It replaced its safety management system guide in April with new advice, recommending that airlines break down the silos in which they manage their business in favour of an enterprise or integrated, inter-departmental approach to safety culture.
IATA's director of risk management and insurance, Carole Gates, would like insurers to place an even greater emphasis on the risk management activities of airlines when they produce their premium rates.
Over the past four years the IATA Operational Safety Audit has become a global standard for safety and, says Gates, airlines are seeing premium reductions as a result of IOSA registration. Now IATA is working with underwriters to produce a similar gold standard for ground operators, with a draft IATA Safety Audit for Ground Operators due to be unveiled this autumn and operational next year. Gates says: "The only answer to trying to reduce premiums is to reduce losses and the only way to do that is to handle risk better."
Implementing the ERM process has led Continental to take a long-term approach to its risk strategies, resulting in managers of key business functions being required to evaluate their risk profile at five- and 10-year intervals into the future, says Fahrenthold. But Continental appears to be bucking the trend that sees those airlines with long-term strategies of five years or more reducing to 14% among this year's survey respondents, compared with 39% before.
Over half of those surveyed have medium-term, two to three year strategies and 29% have reactive strategies of a year or less, compared with 12% in last year's study. The scope of their strategies is more tightly focused, and people resources are the highest priority - included by 87% of airlines, compared with 76% in last year's study.
Yet while 51% included business operations risks, 40% each included hazard and financial risks, all are down from 69%, and strategic business risks are included by 36%, previously 49%. But while 47% of airlines say aircraft safety-related risks are included, down from 94%, almost all insure against aircraft accident and aircraft-related war/terrorism.
"The pace of change happening now is at a much faster level than before," says Doyle. "Generally we have seen airlines focus more on their core business activities anyway and I think that's just resulting and reflecting in their risk management strategy."
Environmental impact
One change on the horizon that already seems to be influencing the risk thinking at airlines is concern about the environmental impact of aviation. The European Union's plans to include airlines in its emissions trading scheme from 2011 and its proposal to cap CO2 emissions on all aircraft using EU airports from 2012 will inevitably have global implications. Among the airlines surveyed, only 18% currently insure against environmental pollution, but another 22% say they will buy this insurance in the next three years.
JAL Capital, for one, is convinced that this focus on the environmental impact of aviation will influence other aspects of risk management strategies.
The requirement of airlines to control emissions could impact on the push for alternative fuels, lead to changes in route structure or flight profiles, or impact on the demand for specific aircraft or technologies, according to Fahrenthold. "This should also be viewed as an ERM risk management strategy," he says.
Over at IATA, Gates is not convinced that exposures such as environmental emissions can be insured against, saying she was not aware of any insurer that would insure against this type of risk. "It's something risk management will have to take care of and that's what we're trying to promote to airlines."
But new insurances may be available in the future. "Can you insure against emissions today? No. Do you need to today? No. Will you need to by 2011? Quite probably," says Aon's Doyle, predicting that as risk manager requirements evolve, the aviation insurance industry will come up with the required solutions.
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Source: Airline Business
