Unfriendly Skies?

Earlier this summer, it seemed that every week there was a significant, if not catastrophic, aviation incident reported in the media. What made this even more alarming was that these events were in the wake of Malaysian Airlines Flight 370, which disappeared while travelling from Kuala Lumpur to Beijing on March 8. The shooting down of Malaysian Airlines Flight 17 in July over Ukraine only exasperated the situation and left many stakeholders scratching their heads as to how the past seven months will affect the aviation insurance industry and what conditions can be expected leading into the 2014 airline renewal season.

While the two Malaysian Airlines losses were, by far, the most publicly visible losses in mainstream North American media, there were other losses of note, including the following:

• Transasia, GE222, which crashed July 23 during approach to the airport in Magong, Taiwan;

• Air Algerie/SwiftAir, DAH5017, which crashed July 24 in Mali, on its way to Algiers from Ouagadougou, Burkina Faso; and

• Hull war losses in Libya and Pakistan.

Currently, markets are still awaiting the outcome and quantum of this year’s major losses but some insurers have indicated that profitability will be hit and the rating levels will need to be reviewed to ensure longevity of insurers for the global airline industry. The final quantum is yet to be determined, but loss estimates for hull and liability insurance market for the year so far range between US$1.5 billion and US$1.8 billion. This includes an estimate for minor losses based on historic data and does not allow for any further claims that may be incurred during the remainder of the year; this already exceeds the estimated annual market earned premium figure for all of 2013.

If the frequency and severity were not enough, the shooting down of MAS17 over the Ukraine is a potential game changer within the aviation war market. Historically, geographic areas that were known conflict zones were excluded or carved out of the worldwide policy territory by a clause known to the industry as LSW 617G. This is a geographic exclusion clause frequently attached to aircraft hull & liability policy wordings as a way to limit worldwide territory coverage, excluding coverage for operations into known conflict zones. However, this clause allowed “for the overflight of any excluded country where the flight is within an internationally recognized air corridor and is performed in accordance with” International Civil Aviation Organization (ICAO) recommendations. The assumptions that allowed for overflights of these conflict areas are now being reconsidered.

Unfortunately, a period of uncertainty will prevail as insurers review their portfolios, consider their loss positions and respond to their senior management accordingly. Until a sustained period of renewal activity begins in the final quarter of this year, a trend is unlikely to become evident. Insurers will have to balance their desire to increase rates and premiums against over-capacity (i.e. the excess of markets able to participate on any single renewal) that still exists.

Another question on the minds of many industry participants is just how far within the aviation insurance industry a reaction to the recent disasters will reach. There is little doubt that commercial operators will be put under the microscope when purchasing hull and liability coverage (including war), but what will the impact be on other lines of aviation insurance? Will product manufacturers be impacted? Will

industrial aid operators be impacted? Will service providers be impacted? These are all very valid concerns.

It is safe to say that industry participants can expect a greater focus on quality exposure information. Those participants providing detailed renewal submissions for insurers to review are likely to benefit. At the time of writing, there are no signs of insurers withdrawing from the market and an excess of capacity still exists. This over-capacity should prevent any potential overreaction on rating and premium. It may well be that the market realigns itself to previous rating and premium levels. However, until the period of uncertainty passes, the exact quantum of losses are understood and the reinsurers have had a chance to review their portfolios, there will be a period of pricing uncertainty for buyers of aviation insurance.

Information that will be important to underwriters of this class of business moving forward will include the following:

• current scheduled destinations;

• anticipated charter destinations;

• whether the insured currently, or intends to, operate in any of the countries stated in LSW617G and/or Lebanon or Ukraine. Policyholders would be asked to advise on the frequency and/or any overnight stops;

• whether the insured has conflict area destinations, and if so, details of the security assessment plans prior to departure;

• if the insured has overnight stops in conflict areas, what are security arrangements for the safety of the aircraft?

• details of any aircraft on wet lease and dry lease to other operators and areas of operation;

• details of the insured’s main hub airport and estimated highest potential aggregation of aircraft at such locations;

• whether the insured plans overflights of the countries listed in LSW617G or other conflict zones;

• what security is in place for current operations;

• what proactive aircraft safety awareness the policyholder has put in place (i.e. withdrawing routes/destinations because of safety concerns before a conflict escalates); and

• details of proactive safety initiatives procedures undertaken prior to the operation of new routes or destinations.

With four months of 2014 left for underwriters to both earn premium and pay claims, the year may indeed leave many underwriters facing red ink come December 31. As indicated, a period of uncertainty will prevail over the next few months until trends emerge from the airline renewal season in the fourth quarter. It is only when the airline renewal trends are identified and combined with the reaction of reinsurers for 2015 aviation treaties, will the industry have a true understanding of what the industry reaction will be to the events of 2014. Until that time, understanding an insured’s exposure to geographic areas with changing conflict environments will be key to ensuring appropriate coverage is in place.