The Airline Risk Management Survey, a new piece of research commissioned by Airline Business and leading airline insurance broker Aon, is the first detailed study into airline risk management issues
Airlines are spending at least $8.36 billion a year on risk management, with around 70% – or $5.86 billion – going on insurance premiums, according to new research into airline risk management trends. Insurance premiums fell significantly in 2005, but despite the expectation within the risk management community that this downward trend will continue in 2006, albeit less markedly, there is considerable anxiety about the cost of premiums. Some 60% of respondents highlight it as one of the most important insurance industry issues affecting the aviation business. Risk experts are linking this concern to the fragility of airline finances, plus newly perceived business and terrorism risks.
The first detailed snapshot of airline risk management issues, commissioned by Airline Business in association with insurance broking firm Aon, reveals that the legacy of the terror attacks in the USA on 11 September 2001 continues to have a significant impact on risk management. Aviation premiums are on average 15.5% higher than pre-9/11 levels and war terrorism insurance and restrictions on cover are the major risk issues facing the airlines, according to nearly a third of risk managers surveyed in the study.
In this climate, it is unsurprising that nearly half of the airlines surveyed are expecting to increase their overall risk management spend in 2006 and many are already planning to widen the range of insurances that they buy in the future, with computer crime topping the list of additional policy requirements.
The Airline Risk Management Survey 2005 was launched last autumn with the aim of gaining a better understanding of the issues and trends within airline risk management and to establish some industry benchmarks against which airlines can measure and monitor their own performance. For research breaking new ground among the airlines, the response rate was positive – 51 airlines took part, accounting for 41% of the world’s top 200 airlines by total revenue .
Risk strategies
The study shows that risk management has a high profile within airline businesses: not only do two-thirds of airlines have a company-wide risk management strategy, which, on average looks just over three years into the future, overall responsibility for risk is taken at boardroom level in 75% of airlines, with the chief executive’s office making the decision whether to avoid, retain or transfer risk in 45% of airlines.
Risk management, on average, accounts for 2.1% of airlines’ total revenue – apply that to the revenues of the world’s top 200 airlines and you are talking about a budget of at least $8.36 billion per annum, with an average of 70.1% channelled into insurance. But, as Aon’s global practice manager for aviation and aerospace Steven Doyle points out, 2% is a small amount of the industry’s overall costs when fuel and staffing each account for about 25%. “Seventy per cent of risk management spend is insurance, which highlights the fact that insurance is cheap and a good way of transferring risk,” he says.
The research shows that premium rates overall dropped significantly for the majority of airlines in 2005, with the greatest decreases on the aviation side and respondents are for the most part forecasting that rates in 2006 will remain unchanged or reduce slightly, with the greatest reductions again on the aviation side. The overall aviation (hull, liability, war and excess) premium unit cost for 2004-5 averages out at $157,000 per aircraft and $1.68 per passenger, reinforcing Doyle’s view that insurance is value for money. “There were about 1.6 billion passengers in 2001 and the market generated $4 billion in premiums, so it’s gone from about $2.50 per passenger to $1.68,” he says.
Aviation premiums are, on average, 15.5% higher than before 9/11, but although the industry’s loss record has been good in the last four years, traffic and passenger number have risen significantly, increasing the exposure to risk. “We estimate exposure has grown in the region of 30-40% since 9/11, so if the premium is only up 15% [airlines] are better off than they were, even if they are paying more dollars,” says Doyle.
Around the globe airline risk managers are surprised by this average hike. Eva Dahlberg, director of SAS Group insurance, and Toshio Akama, board member of Japan Airlines Capital, the financial services subsidiary of JAL, both say the figure is lower than they expected. “After 9/11 aviation insurance premiums jumped up. Gradually the premiums have come down, but due to the attitude of capital providers to the aviation insurance market, it is unlikely that premiums will return to the same levels that existed prior to 9/11,” says Akama.
At Iberia, chief financial officer Enrique Dupuy suggests that in Europe the level of premiums are substantially higher than the 15.5% research average, as premiums for excess third-party war risk liability (AVN 52), which did not exist pre-9/11, were not included.
But in the USA, Pete Fahrenthold, managing director – risk management at Continental Airlines, is not surprised by the level, observing that before 9/11 premiums were too low to maintain a stable market for the cover.
“The key trends impacting on the aviation market now versus pre-9/11 are the increase in exposure arising from the Airbus A380 [500-600 passenger loads and higher hull values/composite construction]; the higher returns available for capital placed to support other lines of aviation cover for airlines (eg property insurance or general aviation insurance); and the impact of 9/11 on the underwriter’s perception of where terrorism risks exist for a given airline – ie they exist everywhere now,” he says.
Airline anxiety about the cost of premiums – 80% of respondents cited it among the insurance industry issues affecting airlines and 60% placed it among their top three concerns – is complex. On the one hand, many insurance policies are mandatory ones that airlines hope not to claim against. “They are buying a commodity they never wish to use, so it will always be viewed as expensive,” observes Aon’s Steven Doyle.
But pressure to cut costs and the embattled financial position of many of the world’s airlines are also a factor colouring attitudes. “The environment for airlines is quite tough. We are all fighting bad financials and even if they get better, it is still a little bit fragile,” says Dahlberg. “The premium cost is substantial these days, some insurances are mandatory and if you have fragile finances, it is important that you can insure against risks.”
Financially hard-pressed carriers generate a climate of concern among their staff, shareholders and their insurers, which makes it harder to keep the lid on costs. “Approximately 50% of US airline capacity has been/is in bankruptcy. This creates trepidation and uncertainty on the part of insurers for executive liability lines such as directors’ and officers’ liability and fiduciary liability because shareholders and/or employees become dissatisfied and may file suit,” says a US airline source, pointing out that insurers typically react to this situation with a combination of charging more, cutting back on capacity and/or withdrawing from providing the coverage as a whole.
“Workers compensation claims for employees injuries sustained on the job typically increase for companies in financial duress as employees become more concerned about layoffs and the personal financial outlay to meet medical plan deductibles increase,” adds the US airline source. “Also the internal functions associated with the management of these types of claims become outsourced and the level of scrutiny for cost containment may not [be] at the same level when company staff is monitoring the claims.”
New risks
Terrorism and new business risks are also fuelling airline concern about premiums. Iberia’s Dupuy says the threat of dirty bombs, plus the lack of stable, competitive capacity for war and terrorism risks, will have an impact on future insurance costs. “Additionally new perceived risks – directors’ and officers’ responsibilities, credit risks, overbooking and operating risks, loss of uses, credit card acquirers risk etc – will increase the components of the insurance bill and make it difficult to come back to the glory days of pre-9/11.”
With terrorism risks at the forefront of everyone’s mind, it is not surprising that 24% of risk managers in the study cite war and terrorism in general as the major risk facing the aviation industry and a further 30% believe it is specifically war terrorism insurance and restrictions on cover. The majority – 55% – believe that government insurance/limitation of liability is the most realistic way forward.
The backdrop to this issue are moves within the commercial insurance market to reduce cover for weapons of mass destruction through policy endorsements and the fact that airlines around the globe are not competing on a level playing field: the US government continues to provide its own carriers with third-party war risk cover while most of the other governments in the world are not willing to bear this risk. The varying levels of optimism among risk specialists about the likelihood of achieving the airlines’ preferred resolution seems to reflect their geographical perspective.
Liability limitation
“European governments have not intervened, they have even become stricter in the legal insurance requirements after 9/11. I do not think they will in the short term accept a limitation of liability for airlines,” says Dupuy. “Although they accept that terrorism has and could use our industry [our aircraft] to target governments, they do not want to act as insurers, even insurers of last resort. Their view is that they will act reactively, when there is an insurance market failure as a consequence of a major accident and possibly when the airlines are about to stop flying.”
At Continental, Fahrenthold is a firm advocate of governments around the world providing coverage or at the very least, a backstop to the insurance market’s terrorism cover. “A liability cap is also necessary if the commercial insurers are to be expected to provide any useable level of coverage. I think that various governments would be willing to provide a cap under the right circumstances,” he says. “Discussions have been ongoing between IATA, ATA [US Air Transport Association] and ICAO on possible structures that would be a blend of commercial insurance, governmental guarantees and a liability cap, and an ICAO proposal is being drafted.”
Although overall risk management costs declined in 2005 – the research shows they decreased for 48% and stayed the same for 26% this year – 44% of airlines are forecasting their spend will increase in 2006 and 35% expect costs to stay the same. JAL suggests security issues and avian flu may be driving up risk spend. Dahlberg at SAS suggests some of the increased spend may be going on education to ensure teams are up to date and on information systems – echoed by Dupuy at Iberia, who says the new international accounting standards and corporate governance risk guidelines imply new investments in software and consulting.
Another factor may be high jet fuel costs resulting in more airlines having to develop fuel hedging programmes or hedging more intensively. “I think that the growth of airline travel [low cost] and the setting of new airlines in emerging economies [India, China, Latin America] might be increasing the need for risk management solutions associated with higher levels of hedging,” says Dupuy.
According to the research, the top five insurance risk priorities are aircraft accident, aircraft-related war/terrorism, property damage, general liability and directors’ and officers’ liabilities. This is not very surprising considering that insurance covering most of these risks is mandatory for many airlines. But looking beyond operational essentials, airlines are earmarking extra risks to insure against in future, with 37% planning to insure against computer crime, 30% against credit risks and 22% against loss of reputation.
“The increase in web-based ticketing and the greater use of check-in kiosks at airports and online check-in has increased our need for ‘network risk’ insurance. The insurance market for these products has been evolving and improving and I believe that we will purchase some form of this cover in the near future,” says Fahrenthold.
Changes in the structure of the travel agent network and the growth of online sales has also increased awareness of credit risks, threats to liquidity and cash flow and Dupuy points out a number of airlines are now managing agency credit risk.
Brand and reputation risks
Although loss of reputation is at the bottom of current airline insurance policies, branding is an increasingly big issue for airlines and fears about loss of brand and reputation can be tied in to the emergence of highly branded low-cost carriers and frequent flyer branding for the big alliances. Aon’s Steven Doyle points to the example of Virgin Atlantic Airways which delayed delivery of its A380s because Los Angeles International airport was not going to be ready. “They did not want to compromise passenger experience, so brand is very important,” explains Doyle.
There is also increasing awareness of the “fragility of reputation in our sector and the big negative impact that can be derived from a reputation problem,” according to Dupuy. “In my view our industry is looking with much more care and attention to these new reputation and image risks.”
This emerging risk will be one of the ones to watch in next year’s Airline Risk Management Survey as the research starts to tease out the forthcoming trends and the study establishes itself as the leading benchmark for risk management. ■
GILLIAN JENNER / LONDON
Full survey results on CD
The complete research results of the Risk Management Survey 2006 will shortly be made available on CD, priced $450, providing full responses to all of the survey questions together with a commentary and extra information.
Carriers that took part in the survey receive the CD free of charge. The 2007 survey will begin towards the end of this year. For further details please e-mail us at airline.business@flightglobal.com
Source: Airline Business
