CHRIS KJELGAARD / WASHINGTON
With government-provided coverage in danger of drying up and commercial rates rocketing, airlines may have to provide their own war-risk insurance
The US terror attacks of 11 September changed the world for airlines and passengers in some very visible ways, notably with the appearance of intensified and federalised security at airports. But one of the most dramatic shifts in airlines' operating environment happened behind the scenes.
Since September, airlines around the world have been able to operate only because of the continuing support of their governments in providing adequate war-risk liability coverage to compensate for an insurance market that, on 11 September, dried up overnight. But as governments become uneasy in their roles of emergency insurance providers, the airline industry is coming up with its own alternatives.
Without the requisite high amount of war-risk coverage, no airline is legally allowed to operate services. The commonly accepted view is that a per-incident limit of $1.5 billion is necessary, but the largest carriers say they need more. A week after 11 September the world's airlines faced a situation in which, suddenly, virtually no war-risk liability coverage was available.
To protect their own survival as the scale of the human and financial catastrophe in the World Trade Center towers' collapse became clear, the commercial insurers that had previously supplied war-risk liability cover to the airlines cancelled their contracts. Invoking a largely overlooked clause in the standard contractual terms of the airlines' policies, the commercial underwriters gave the world's carriers seven days' notice of cancellation. Each was immediately left with non-cancellable annual war-risk cover of just $50 million.
The airlines immediately realised that, unless they could find alternative and affordable arrangements within a week, they would have to ground themselves. In the circumstances, there was no real alternative to government involvement. The governments of the USA - which had suffered the attacks and whose airline industry was the worst-hit by their aftermath - and its neighbour Canada were quick to react. So too were the governments of Europe and the major Asia-Pacific nations.
Immediate governmental assistance came in two ways. Agencies such as the Department of Transportation (DoT) in the USA (through the Federal Aviation Administration) started providing the levels of war-risk liability coverage that the airlines could not obtain otherwise, either free or at a cost no higher than what the commercial insurers had charged.
Legislation
At the same time, new legislation was rushed through to limit to $100 million the airlines' third-party liability in war risks incidents - for example, their liability to claims by people in buildings hit by a hijacked airliner. Governments assumed responsibility for third-party claims in excess of this amount either by agreeing to indemnify the airlines for claims above $100 million or by agreeing to create special funds to settle directly with claimants.
Thanks to the ad hoc efforts of governments worldwide to provide adequate insurance coverage, the airlines managed to take to the air again quickly and for several months the new arrangements worked well - helped by the fact that no major aircraft-related terrorist act took place. But, inevitably, pressures on the interim war-risk coverage arrangements began to build.
Before the end of 2001, two major commercial underwriters, the USA's largest commercial insurer American International Group (AIG) and a little-known subsidiary of General Electric, announced they were prepared to provide high levels of war-risk liability coverage to US carriers. They offered initially to provide coverage up to $950 million, on top of an airline's $50 million base cover. The catch was that AIG and its partner wanted well over $3 per passenger to provide the cover, five or more times what most carriers had paid previously and a premium the already struggling airline industry insisted it was unable to afford.
In addition, although the two underwriters said eventually they would be able to raise the coverage limit to $1.5 billion, their initial offer required the government to continue providing the $500 million of coverage needed to meet the $1.5 billion limit. Furthermore, even if the commercial underwriters did eventually raise their liability coverage level to $1.5 billion, they planned to insist on it being an annual, rather than a per-incident, limit.
Not surprisingly, airlines round the world said they would adhere to the much more affordable and less conditional coverage their governments were providing. Salomon Smith Barney stock analysts Brian Harris and Daniel McKenzie have calculated that the average cost per passenger to the USA's nine largest airlines for $1.5 billion of coverage is $1.33. The FAA accounts for most of this through a $7.50 fee per departure and a per-passenger charge.
Even though AIG subsequently dropped its proposed war-risk liability coverage fee to $2.25 per passenger, Harris and McKenzie estimated this would cost the nine US carriers a total annual premium of almost $1.32 billion, compared with the $779 million a year they calculate the FAA arrangement is costing the nine airlines.
Nine months after the terror attacks, however, it is becoming clear the world's governments are growing increasingly uncomfortable with their unwanted role as insurers of last resort to the airline industry. In addition to the pressures some governments are facing to fund additional security measures at airports and in the skies, the commercial insurers are not taking their setbacks lying down.
AIG chief executive Maurice Greenberg has lambasted the DoT on several occasions for its continuing agreement - now given through June - to extend war-risk cover to the US airlines. AIG is unlikely to suffer serious financial difficulty as a result of the government's support of US airlines' insurance arrangements, but Greenberg's argument that the DoT's intervention is preventing commercial insurers from restoring competitiveness carries weight.
In some cases, only the prospect of immediate airline groundings is keeping governments agreeing to renew cover. Governments will take heart, however, from two developments that indicate new ways could soon be available to provide war-risks liability insurance to the world's airlines, at prices they can afford.
One solution, first proposed by the Air Transport Association (ATA), which represents US majors, would essentially be a public-private partnership for its first several years, but would then become a purely private-sector programme that would be responsive to commercial market conditions. As such, it might meet relatively little resistance from commercial insurers.
Captive insurance
This programme would be a "risk retention group" - more commonly called a captive insurance company - set up by some or all of the ATA members with the administrative assistance of Marsh, the risk and insurance services arm of Marsh & McLennan and the world's largest insurance broker. Marsh has formally applied for an operating licence for the proposed US airline war-risks insurance venture - known as Equitime - and a launch of commercial operations appears likely.
Its advantages to subscribers would be twofold, the ATA believes. One would be to reduce by more than half the premium levels US airlines are now paying for FAA war-risks coverage, from $1.33 per passenger to 62.5¢ (as calculated by the Salomon Smith Barney analysts), saving them $400-500 million a year in premium costs. Second would be to provide $1.5 billion of coverage per incident rather than limiting coverage to a total of $1.5 billion a year.
Non-profit Equitime would aim to provide this superior war-risks insurance product by pooling equity contributions from its founding shareholders (some or all of the ATA members), along with their premium payments, and making the total available for potential claims payments.
In its first year, Equitime would probably rely on the FAA for as much as $1.2 billion of war-risks cover, as the venture plans to start with only $300 million in reserves. But, barring a major claim and assuming it collects $300 million of premiums a year, over five years Equitime would build enough of a reserve to let the FAA to drop out.
Commercial opposition
AIG head Greenberg has complained about the proposal, citing the potential for the FAA to remain a provider of war-risks cover for up to five years. His argument is undermined by the fact that AIG's commercial-insurance scheme required the FAA to provide $500 million in coverage for an unspecified term.
In Equitime's favour is the interest shown in the project by the USA's regional airlines through their trade body, the Regional Airline Association. In addition, one or more large US industrial companies not traditionally active in the insurance market but attracted by Equitime's likely customer base are known to be interested in participating financially, perhaps allowing the FAA to withdraw more quickly than planned.
Europe's airlines are also keen to create their own captive insurance company through their trade association, the Association of European Airlines (AEA). The AEA has moved even faster than its US counterpart to set up its fund, which was unveiled in late May and aims to provide $1 billion of war-risks cover to participating carriers. Airline insurance executives point out that if both Equitime and its European parallel were launched they could reinsure the other, letting both spread their risks and reduce their costs.
The AEA fund will also rely on government aid. The proposal calls for two forms of government financial support. The first is three years of continued coverage by member airlines' respective national governments as the AEA fund builds its premium reserve; the second would be longer-term coverage for the airlines' war-risks liability risks above $1 billion.
Both of these forms of support will require approval by each AEA member's national government and overall approval by the European Commission (EC), which has its own plan for a government-funded war-risk insurance scheme for coverage of risks above the AEA's $1 billion threshold. Some European officials feel the approvals will not be automatic, given that the governments of Germany and the UK have indicated they are unwilling to keep providing the airlines with war-risk cover.
The transport ministers of the European Union nations were due to discuss on 17 and 18 June their governments' participation in both the AEA and the EC-sponsored war-risk coverage schemes. AEA officials expected a green light.
The second potential solution to the war-risk liability insurance problem would be a pan-governmental programme administered by the International Civil Aviation Organisation (ICAO), but relying on multilateral state guarantees to provide airlines with the requisite coverage. Australia's transport minister John Anderson says this non-profit programme would provide a firm foundation of war-risk coverage for the international airline industry until the commercial market is able again to offer suitable levels of competitive coverage.
Anderson also says the ICAO proposal could unify the patchwork of regional proposals that have sprung up round the world since 11 September. The global, multi-governmental nature of the programme could also give it a strong credit rating and help iron out local disputes.
Critics say the project has shortcomings. The reluctance of countries such as Germany, Sweden and the UK to keep providing war-risk liability coverage to the airline industry could hinder a project that will only make slow progress because of its multilateral nature. ICAO could set up a company quickly, but there is no telling how long it might take for all its member states to agree to provide guarantees.
Slow progress
Another apparent shortcoming is the size of the reserve the ICAO project is contemplating. Rather than the $1.5 billion most major international carriers believe is a realistic per-incident limit for war-risks coverage, the ICAO plan seeks to build a fund of just $850 million. The source of the other $650 million of coverage each major airline requires is unclear.
Delta Air Lines' chief risk officer Christopher Duncan believes, however, that the different ideas embodied by Equitime and the ICAO proposal could be complementary. Captive vehicles such as Equitime could provide a short-term solution, while the ICAO plan might be better long-term.
Source: Flight International
