Aviation underwriters are desperate to turn a profit after yet another loss-making year. The total claims tally surpassed $2bn in 2010 according to Aon, with insurance losses from some unusual sources. This includes the $145mn Dubai crash of UPS cargo Flight 6 on 3 September, $360mn warehouse fire at King Abdulaziz International Airport in Jeddah in June and the $440mn collapse of a hanger at Washington Dulles International Airport in February.

Total claims came to $2.1bn compared to a premium base of just $1.9bn – the third time in the past four years that claims have exceeded $2bn. The record was in 2009 when the Air France 447 crash contributed to a high of $2.34bn for the year. The crash – which killed all 216 passengers and 12 crew members when it came down over the Atlantic on route to Paris from Rio de Janeiro – was the industry’s worst loss since 2001 costing insurers in excess of $600mn.

Yet despite mounting claims over the past four years, rates on line in the aviation insurance market seemed to defy logic by continuing to soften. “What happened at 9/11 changed the sector massively – prices shot right up reflecting the perception of risk and then declined very quickly towards the end of the last decade,” says Aon aviation risk analyst Magnus Allan. “They’ve now reached a sort of equilibrium where prices are responding to risk rather than overall changes in the sector.”

In part, the soft market can be attributed to the fact the underlying aviation market has been severely impacted by recession, with underwriters no doubt conscious of the decreasing passenger numbers and failing airlines. However, while some airlines are struggling – particularly in Western Europe and North America – others in emerging economies are just starting to take off.

The soft pricing is also a result of overcapacity, with specialist re/insurers unwilling to walk away and new capacity attracted despite the market’s inability to turn a profit. London-based Talbot, Hiscox and Argo International have introduced aviation to their portfolios in recent years among others. At a time when many international reinsurers were looking to build diversified books of business, aviation was viewed a non-correlating class to traditional property catastrophe books.

Rating adjustments

Underwriters are beginning to rethink their assumptions as a result of the heavy loss picture and unusual sources for claims in 2010. The sector is moving towards a trend of higher-value claims, although the total number of losses is decreasing. “What we seem to be seeing is there are fewer losses occurring but those that are occurring are more expensive and that seems to be reflective across all regions,” says Allan.

There are signs that underwriters are beginning to take a more selective approach to pricing as a result of the changing claims picture. While rates rose by 19% overall in November, this was strongly influenced by three loss-making airlines. Over the course of the year rates actually rose by a more modest four percent, according to Aon. Taking the three loss-hit accounts out of the equation, prices fell by an average of 12 percent in November.

“Ultimately the aviation industry does appear to becoming safer,” says Allan. “There are fewer losses occurring and that’s a reflection of the technology that’s being used and a reflection of the skills of the pilots. When you look at some of the losses that were very nearly exceptionally catastrophic, they have simply turned into being major losses from a hull point of view but with very few liabilities.”

This includes the memorable January 2009 Hudson River crash, when the pilot of US Airways Flight 1549 ditched into the river – adjacent to midtown Manhattan – after the flight’s engines were disabled due to bird airstrikes six minutes following takeoff from LaGuardia Airport. All passengers were safely evacuated thanks to the pilot’s quick reactions. This followed the crash landing of flight BA038 at Heathrow in January 2008 with the pilot gliding the Boeing 777 onto the runway despite suffering a total power failure.

Those with a good loss record, modern fleet and investments in new technology are the most likely beneficiaries of discounts, while airlines viewed as poorer risks will see their premiums climb. “The aviation sector is in a fascinating position at the moment,” says Allan. “The price of premium on individual insurance programmes is moving far more to the actual risk being presented than responding to market trends overall.”

Group programmes also continue to benefit from overall discounts – although there have been some interesting changes to the market with the Saudi warehouse fire prompting a break-up of the group placement for the Gulf Co-operation Council (GCC). This created 14 new programmes in November. “The Gulf consortium broke up because the one fallibility of these groupings is the moment there is a major loss event everyone turns around and says, ‘I’m not sure I’m my brother’s keeper anymore’,” says Nigel Weyman, Head of Global Aerospace at JLT Re.

“The differentials that emerged following the break up were quite interesting,” he continues. “There were very big changes in premium for a number of the members because their growth, which for some of them is phenomenal, hasn’t been reflected in rates because they’ve been carrying their smaller partners.”

Unusual claims

He thinks the Saudi claim and A380 loss among others in 2010 will also prompt underwriters to rethink how they approach insuring spares. The warehouse fire – which was a significant and largely unreinsured risk – came as a surprise to many in the industry. “Insurers were really quite shocked because traditionally they’ve included spares coverage – first of all for a nominal premium and secondly without a great deal of underwriting information being required, because they’ve had a pretty good run,” says Mr Weyman.

“There are occasional spares losses but I’ve never seen one that in my memory was as severe as the Saudi loss,” he continues. “So that was a very rude awakening and now you’ve got underwriters asking for a great deal more detail on the nature of that exposure, quantum and the specification of the warehousing. Although they haven’t reacted too quickly by charging ridiculous premiums you can tell they’re going into deep analysis of the data and eventually they’re going to come back at us with a more significant and perhaps appropriate premium allocation for that.”

The A380 loss was also a sign of changing claims trends. The Qantas aircraft was forced to make an emergency landing in Changi International in Singapore after one of its engines failed. It grounded its six-strong fleet as safety checks were carried out on the Trent 900 Rolls Royce engines. The cost of repairs to the new generation aircraft – coming in at a heady $70mn – has taken many by surprise.

On the liability side, while overall fatalities was below average in 2010 – at 601 compared to a long-term average of 621 – the cost of individual passenger awards is climbing as the rest of the world catches up with the US. “Whereas insurers had tended to feel that certain parts of the world still offered relatively low liability awards and exposure, the market is now recognising that the differences aren’t quite so marked,” says Mr Weyman.

The February 2009 Colgan Air crash brought some of the highest liability losses to date, fetching around $5mn per victim with a total passenger liability reserve of $250mn. There were no survivors from the Continental Flight 3407, which was carrying 44 passengers and four crew members when it crashed into a house in Buffalo, New York, killing the occupant inside. Individual claims have since gone over $10mn in a couple of recent cases.

Bottoming out?

Such mounting claims and the growing realisation that aviation underwriters would fail to make a return for the fourth year running spelt an end to falling rates in the fourth quarter of 2010. The firming trend looks set to continue into 2011, says Mr Weyman. “I don’t think you can call it a soft market anymore and probably the $2bn in losses have underlined to insurers the need to firm up the rates in order to bring the thing back into some semblance of a profit,” he says. “But firming up the rates is not easily done. There is still overcapacity and you need some insurers willing to walk away.”

While no one has withdrawn from the sector, a number have cut back on their capacity for 2011. “You’ve got a relatively small number of players doing it and they’re absolutely committed so there’s a tendency to stick with it and hope that the thing will correct itself,” explains Mr Weyman. “Occasionally they have a bumper two or three years which justifies their patience.”

But it is tough to say if the airline market is indeed at the bottom of the cycle. With capacity in excess of 200 percent, it is conceivable that prices could continue to fall in 2011 in the absence of significant claims. But in such a volatile sector, it would not take much to change things, particularly not after another $2bn-plus loss year. A big crash would test the resolve of newcomers to the market and perhaps see a more decisive contraction in capacity.

“If the Qantas aircraft had crashed – and thank god and amazing airmanship that it didn’t – that would have potentially transformed the market because it would have been above a $1bn loss,” says Mr Weyman. “If we get a normal $2bn loss year I think you’re going to get a gradual increase in premium due to growth. I don’t think you’re going to see any rate reductions as a norm, but you will see individual cases get changes in their rates because they warrant it.”