Aviation insurance markets continue to recover from the crisis that followed 11 September, but questions linger over the level of premiums and the future of war risk cover
For a market that was in outright crisis only two years ago, the aviation insurance sector is now a good deal calmer than in the dramatic weeks that followed 11 September 2001. While more fundamental issues still remain over the provision of war risk cover, in the main the market appears to have settled back to more familiar tussles over the level of premiums: ever too high for airlines and too low for insurers.
If the market is calmer, then it is largely thanks to the fact that the past two years have been exceptionally uneventful in terms of airliner losses. That may be just as well, given that further catastrophes could easily have pushed aviation insurance back into crisis. The year just past featured fewer than 600 passenger fatalities and total losses of less than $1 billion, points out Grant Whytock, an officer with the aviation practice of brokerage firm Aon. He says that this represents about half the average annual liability posted over the 10 years leading up to 2001.
There are also welcome signs that money is flowing back into aviation underwriting. The prospect of higher premiums and lower pay-outs are attracting back capacity providers who left the sector in the wake of the terrorist attacks and had stayed away since. "Capacity is considerably higher than it was two years ago, when it was getting seriously short," says Nick Brown, chair of the aviation executive committee with the International Underwriting Association (IUA), which represents insurers in the lead London market. "The good experience of the last two years has gone some way to repairing the premium deficit of the last eight years and has done a lot to repair confidence in the sector."
Balance sheets too are looking stronger. Andreas Peter, managing director of aviation with reinsurance giant Swiss Re, estimates that 2002 insurance activity led to net premium income of around $3.3 billion.
The influx of new capacity has already helped lower rates. Whytock at Aon says that the prices airlines paid for their risk in 2003 was down 16-17%, even as the average value of the fleet increased 2%. Brown at IUA explains that hull and liability costs for European carriers have fallen to about 0.75% of their total operating revenues, down from 1.1% in the aftermath of the US terror attacks.
While all agree that rates have come down, there is less agreement on whether the current price levels are reasonable. The airlines, unsurprisingly, feel that the rates being commanded are too high. Sami Sarelius, who is in charge of risk coverage procurement for Finnair, argues that insurers have been too slow to pass on the benefit from two light years of airline losses. "True, prices are coming down, but not fast enough, especially given how light the liabilities were in the last two years," he says.
Eugene Hoeven, director for risk management and insurance with IATA agrees. He points out that, with only small losses in the past two years, premiums still stand well above their pre-11 September levels, even if renewal premiums in 2003 did come down by 19%. He complains that rates remain high, even though the trade group estimates that "the market has recovered most, if not all, of the reserves" that were established to cover the attacks on the World Trade Center.
Whytock adds that this remains the case, even though in some ways risks are now lower. He explains that airlines have withdrawn much of their old equipment, which is more susceptible to claims, and their reduced schedules means fewer flights, and therefore less likelihood for mishap. On the war side, he points out that, while the threat of terrorism is higher, there is in fact lessened risk, thanks to the steps taken to prevent further attacks, such as sky marshals and tighter security checks.
Predictably, the insurance community sees it differently. Brown says that the recent security scares "remind us that there is a risk we will see further incidents and that aviation remains the terrorist's favourite target". He adds that the costs involved with non-war related risk have actually continued to rise, pointing out that the costs of repairing modern technology aircraft have pushed the insurance value of some aircraft up to the $250 million mark. As an example, he cites a recent engine failure incident that ran up a bill of $80 million.
But it is the cost of liability risk - both passenger and third-party - that remains the big-ticket item and that continues to cause the most friction. Peter at Swiss Re says this is unlikely to change. "There will never be a full consensus on the issue of pricing," he says.
Rick Price, general manager for risk management at Delta Air Lines, exhorts the insurance industry to find an equilibrium price at which it can continue to provide capacity for the next 15-20 years. "It doesn't do anyone any good to have rates too low, as this causes the market to lose all stability," says Price. That said, he adds that at today's loss profile, he still sees room for downward movement on prices.
This assessment is met with disapproval if not surprise by Steven Riley, underwriting executive with Global Aerospace Underwriting Managers, the world's largest aviation underwriter. "Airlines will say we're making an indecent amount of money, but with the prices currently commanded, we're at just over break-even levels," he says adding that if premiums continue to fall, the financial health of the airline insurance community will be jeopardised.
Catastrophic exposure
Brown agrees, saying: "Insurance is about catastrophic exposure. High sums insured and high liability mean a single loss can wipe out a year's - or even two years' - premiums. The industry needs to ensure that there's enough premium in the market to make insuring that volatility worthwhile."
If liability is a divisive issue, then the issue of third-party liability war risk is a giant wedge, splitting opinion across the industry. The extent to which government's should be involved in underwriting such risks is a case in point. In the USA, the FAA has made provision for war risk coverage for third-party, passenger and hull liabilities at greatly discounted rates.
This programme is renewable every 60 days and is likely to last at least until the end of the year, at which point the US government will determine whether to extend it. No-one is predicting what the FAA will do in December.
While non-US carriers agree that it is morally right for government to assume the risk of terrorism, they also argue that by doing so unilaterally the USA has distorted the market. "Terrorism should be viewed as a state risk, not a commercial risk," says Sarelius from Finnair. "But this view was unfortunately not taken by the European Union." In consequence, he claims, it distorts competition for US carriers to receive such assistance from their government.
Quite naturally, carrier perception on the other side of the Atlantic is slightly different. Delta's Price says: "We don't feel that we are being subsidised. We feel that the appropriate place to address terrorism risk is at the government level." Although most sector participants agree to some extent with this view, the fact is that the USA is alone in offering war risk cover to its airlines, with carriers elsewhere forced to fend for themselves in a market unanimously regarded as expensive.
The market for third-party liability war risk is expensive for a variety of reasons. Key among them is that the unknown liability ceilings and the danger of the current period have combined to scare the entire reinsurance market away from backing policies over $50 million. Swiss Re's Peter speaks for his industry when he says that "the risk there is simply not quantifiable".
The absence of reinsurance cover means that only companies with enormous balance sheets can offer such policies. At this point, only four have taken up the challenge: AIG, Berkshire Hathaway, Francona and AXIS. Of those, the giant US insurer AIG has far and away the most risk in the market. Because there is a functioning market for this type of cover, all momentum seems to have evaporated from prior initiatives to formulate a multilateral or pool alternative to the private sector, putting Equitime, Globaltime and their like firmly on ice.
However, because there are so few players in the market, the price for such cover is high, even if it is slowly coming down. The chief risk officer at one airline complains: "The aggregate premium is four to five times higher than the levels paid before the attacks, and it's all down to war risk, which is being exclusively offered by a cartel. It looks like there are four players, but there's just one: the cartel."
Small insurer pool
Beyond the pricing, there are also worries about what such a small pool of insurers means to the future of the market. Delta's Price, remembering the immediate post-11 September market collapse, when governments around the world were forced to step in, believes that "having only a few providers of coverage does not make for a sustainable market". He adds:"If there is another event, what will happen to these providers? What will happen to pricing? Having 20 providers is one thing, but as it is now, we would be right back where we were two years ago."
Although hardly in such dire shape as that, airline insurance remains nowhere near providing the comfort for which it was designed.
REPORT BY RICHARD PINKHAM IN LONDON
Source: Airline Business
