Aviation Insurers Ride A Finely Balanced Market

The opposing market directions are the result of differing loss experience that translates into diversified carrier underwriting appetites affecting risk capacity.

Airline losses have been comparatively low, while the longer-tail, aerospace manufacturing market has experienced significant deterioration with the final settlement of some claims being far larger than originally anticipated, affecting reserves.

Aerospace sector deteriorates.

The aerospace sector is going through a period of intense scrutiny by underwriters. The product manufacturers class is under particular review. Over the past six years, the manufacturers reserved claims position is believed to have deteriorated by nearly $1 billion.

The nature of this business has always meant that adequate and accurate reserving is often difficult. It is not surprising, therefore, that capital providers have reason to review their positions. As a result, the level of market capacity is restricted and generating premium increases across all sectors of the aerospace book.

o Risk reduced for airlines.

The airline sector, by contrast, has enjoyed a period of fortunate loss experience in recent years. Incidents are down, and 2003 was widely declared as the safest year ever for commercial aviation. The lower levels of departures and passengers after the events of Sept. 11 may have been a contributing factor. But, as travel levels increase to above those of 2001, it is now felt that air travel is simply safer.

The airlines improved their risk profile by making a significant investment in technology in the late 1990s, combined with a notable reduction in the average age of the global commercial fleet. In the last five years, the number of commercial airliners has grown by approximately 1,600 aircraft to nearly 18,900, despite the fact that nearly 2,000 aircraft have been retired. This has resulted in the average age of the operational fleet being reduced from nearly 21 years old to 15 years old.

Less than 10 percent of the global fleet is now older than 35 years. Perhaps more importantly, nearly a quarter are less than five years old.

From an insurance standpoint, however, the reduction in frequency does not always translate into a severity reduction, as one incident provides the potential for a financial catastrophe.

While insurance rates have fallen, premium reductions have been lessened by increased exposures of fleet values, as well as traffic growth, as the industry has recovered from the Sept. 11 terrorist attack, the war in Iraq, and the SARS epidemic.

With the industry still facing considerable challenges, it will be interesting to see if this level of exposure growth continues until year end as the largest airline programs renew.

A changing industry.

The boom in low-cost airline carriers, while changing the face of the industry, has yet to generate a significant impact in terms of premiums and exposures in the insurance market. It is industry consolidation that is still having a larger impact on insurance. The coming together of some of the worlds largest airlines, such as Air France and KLM, will impact the airline insurance market as some of the business alliances do not match the current group purchasing arrangements of the airlines involved.

Geographically, the industry is displaying sharp contrasts. While the majority of the world is showing signs of recovery, there continues to be a negative outlook from the U.S. airlines, which still face financial challenges and are calling for more aid from Congress.

The U.S. airlines do, however, currently enjoy a financial advantage in relation to war and terrorism coverage as this is provided to them under the U.S. Homelands Security Bill. This could be an increasing advantage as commercial market insurers are looking to exclude the use of various "dirty" bombs in terrorist attacks.

The industry is unable to stand still, as highlighted by the recent announcement that the Airbus A380 program is progressing as planned. Singapore Airlines anticipates receiving the first production aircraft during 2006. The A380 will represent peak exposures in both hull value and seating capacity in a single aircraftat approximately 30 percent above current large exposures.

However, on the whole, it is felt that the plane is not so significantly bigger than current wide-bodied jets that it should create a huge problem for the insurance industry. (It is interesting to note that, historically, the larger wide-bodied jets, such as the DC10 and 747-400, all suffered accidents in their first five years.)

The remainder of 2004 finds underwriters facing a contrast between their two traditional market segments. Aerospace premiums will undoubtedly continue to climb, while the airline book keeps performing well, despite the reduction in premiums and profit margins.

With 80 percent of the airline premium volume entering the market in the last three months of the year, today's market is finely balanced. However, a major loss or the withdrawal of a major underwriting unit, in either the airline or aerospace sector, could have a significant impact at this critical time.

As buyers look for consistent pricing and differentiation of their risk, aviation underwriters must deploy capacity wisely to retain confidence of secure capital sources and ensure risk is balanced by reward.

Like any other market, aviation is influenced by the forces of supply and demand, which when combined with differing loss experience can cause variations in the treatment afforded the variety of risks.

More technical, model-based underwriting and detailed actuarial analysis have been introduced to the market by capital providers. These capital providers seek to reap a reasonable return from this catastrophe business. In turn, these practices could likely bring more long-term pricing stability.

Steven Doyle is global manager, aviation and aerospace, Global Practice Group, for Aon Corp. in the United Kingdom.

Reproduced from National Underwriter Edition, August 12, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.