Aviation insurance rates have been on the ascent for more than a year. However, their rate of climb started to increase more dramatically in the 3rd quarter of 2019. Underwriting has become more restrictive. Pilot and training requirements are much more stringent. Some insurance companies have decided to exit the aviation insurance marketplace. But what is causing this hardening in the market?
The aviation insurance market has some parallels to the tides of the ocean. High tides and low tides are cycles of water movement caused by the moon. The moon’s gravitational pull generates something called the tidal force. The tidal force causes Earth—and its water—to bulge out on the side closest to the moon and the side farthest from the moon. These bulges of water are high tides.
In the aviation insurance marketplace, high availability of capital, cheap reinsurance, strong investment returns, and good loss records bring additional insurance companies (capacity) to the market. Competition for the available business ensues. This leads to lower rates, less restrictive underwriting, and relaxed pilot and training requirements. This is a high tide for the aviation insurance marketplace. When losses rise, reinsurance costs increase, and investment income wanes, insurance companies pull out of the aviation insurance market. This leads to increased premiums, and more restrictive underwriting as the tide changes the other direction. For more than 100 years the aviation insurance market has gone through these hardening and softening tides we call cycles.
In the days following September 11, 2001, the industry saw an immediate hardening of the market. Increasing attritional losses in the aviation insurance market, combined with the catastrophic shock losses of September 11, 2001, left the insurance market depleted. From 2001-2003 the aviation insurance market felt the hardening cycle of significantly increased rates, restrictive underwriting and fewer insurance companies in the aviation insurance marketplace. These two years served as a recapitalization of the market.
Between 2004-2005 the aviation insurance market experienced some stabilization. In 2006, two new (to the market) insurance companies entered into the United States general aviation insurance marketplace and began competing for business by lowering rates. For the next 12 years, aviation insurance buyers enjoyed a long season of declining rates, relaxed underwriting and an abundance of capacity in the market. The United States aviation insurance marketplace grew in capacity from approximately 8 insurance companies in 2005 to 20 competing in the space at one time just a few years later. This led to a number of issues that have depleted the aviation insurance market again. Let’s examine some of these key issues that are affecting the market today.
After 12 years of declining rates, the premiums collected are not enough to pay for the losses. There are very few expenses in business that decrease over time. Labor, maintenance, parts, and supplies all increase. Decreasing prices in any sector will eventually lead to increased pricing.
Fewer premium dollars received compounded with a larger frequency and severity of high liability awards have been a threat to the aviation insurance market. The U.S. airline sector’s decade long streak with no fatalities ended with the 2018 engine issue on Southwest that punctured the fuselage and led to the death of one passenger. Two 737 Max-8 losses with 346 dead have amounted to catastrophic losses to the industry. The grounding liability for Boeing with an estimated 500 aircraft grounded has been devastating to insurers. There has been an uptick in attritional and catastrophic general aviation losses in recent years. All this to say it has been a financially trying time in the aviation industry.
In addition to the increasing frequency and severity of liability awards, there has been an increased cost to write business and adjust the claims. The cost of repairs, and loss adjustment costs have been on the rise over the past decade. Despite efforts to streamline and remain lean by aviation insurers, there has been an increased cost of writing business. Higher labor costs and business operating expenses have continued to rise. It is a challenge for a business to remain healthy with increased costs of conducting business coupled with declining revenues.
The large awards paid combined with the declining premiums have led to claims reserves dipping below desired levels. In a healthy market, reserves for large claims are built up to strong levels. This helps ensure an insurance carrier’s health in a year of high losses. It is critical that the insurance carriers restore their larger loss reserves to maintain a healthy aviation insurance market.
Given the large values involved with aircraft and aviation businesses and the potential severity of aviation liability awards, the only way that an insurance company is able to survive a catastrophic loss to their business is by sharing risk. Insurance companies purchase reinsurance to help accomplish this. Reinsurance is insurance for insurance companies. Reinsurance can be purchased on a portfolio of risks (treaty reinsurance) or on an individual account (facultative insurance). The insurance company will retain a certain percentage or fixed amount of the risk, and then cede the remaining risk to a reinsurer. The insurance company will pay a premium for this reinsurance coverage. In the soft market of 2006-2017 reinsurance was readily available at very cheap premiums. Over the past couple of years, the premium for reinsurance has significantly increased. At the same time, the number of reinsurance companies in the aviation sector has decreased. The increase in the cost to purchase reinsurance gets passed on to the insurance buyer.
Through reinsurance, the insurance risk is spread. This prevents a business-ending loss to an insurance carrier. It expands the risk appetite of the carrier. Reinsurance increases the amount and type of business an insurance carrier can write. Given the high loss potential in aviation, reinsurance is critical to aviation’s success. Because reinsurance diversifies risks, which means that losses in sectors outside of aviation will affect aviation rates. Recent years have brought devastating hurricanes, wildfires, and other major losses that have contributed to the increasing reinsurance premiums.
One other issue affecting rates is that investment income returns are diminishing. Underwriting losses can often be offset by investment income. Given low-interest rates and flattening growth in the market, the investment income is offsetting fewer losses. This creates a need for more premium revenue in the insurance carrier’s coffers.
Due to there being countless variables that affect rates, we can’t cover all of the issues that determine rates. However, a few of the key factors that affect rate increases include loss record, experience, and current rates in correlation to today’s market rates. If an operation with a good loss record has been paying rates well below the market, they could still see a relatively large increase. On the opposite side, if someone has been paying rates at or above market, they might not see as substantial an increase. Accounts with losses will most likely see larger increases than those with a good loss record. Commercial or corporate aviation operations currently priced below market rates could see 30-40% increases at renewal in today’s market even for those operators who are claims-free. Aviation Commercial General Liability/Products Liability could see 20-30% average increases in their premiums as well. However, that could change overnight. Keep in mind that insurance only works by the fact that the losses of a few are paid for by the premiums of many. This means that operators without losses will still experience increases to keep the market healthy.
What can an insurance buyer do to mitigate the increases in premiums? First, understand that aviation operations of all size and claims experiences are receiving increases and tightening underwriting guidelines. Work to instill a culture of safety. Implement (or Improve) a Safety Management System to improve your loss record. Increase training opportunities and provide human factors training in an effort to reduce losses. Avoid any action that would cut corners on safety and training. Work with your aviation insurance broker to provide them with as much information as possible about your safety and training initiatives. Provide them with all of your updated risk information as quickly as possible prior to your renewal date so they have plenty of time to shop the market and negotiate terms for your insurance renewal.
Avoid taking unhealthy actions to control your insurance costs during the hardening market. Decreasing the insured amount of your assets could result in them being totaled on a partial loss. This would cause a loss of equity and leave you without enough claims funds to replace the asset. Decreasing liability limits to unhealthy levels could also put your business or estate at risk. In some situations, higher limits of liability are no longer available. However, purchasing as much liability coverage as practical for the individual situation is advisable.
Insurance is a key component to a successful economy. It is critical to an industry. Without insurance, banks wouldn’t lend money to purchase aircraft and grow businesses. Aircraft owners and aviation companies wouldn’t be able to maintain financial surety. The industry would collapse. Insurance allows businesses to take risks, and purchase assets. It is important that aviation insurance carriers maintain a healthy profit margin, otherwise, they will pull out of the aviation sector and diminish the capacity available to aircraft owners and aviation businesses. This would mean extremely high rates, very tight underwriting, low liability limits, and a lack of availability of coverage for some higher-risk operations.
The earth would be in big trouble if there was only high tide. This is just as true for the aviation insurance market. The next few years could be painful. However, it would be much more painful if the premium is not recapitalized and the aviation insurance markets aren’t restored to health.
By Timothy K. Bonnell Jr., CIC, CAIP
