Insurance Post 9/11

While most aviation insurers will survive the largest claims in history, expect rising premiums to cover the losses.

The events of September 11 have already drastically changed the face of general aviation. While most of us are back to flying, there are lots of places we cant go and that might never change.

Even bigger changes are afoot in the aviation insurance industry in the wake of what will certainly be the largest insurance claims in history. Although most of us dont think about it much, aviation insurance markets are definitely affected by what goes on in other segments of the industry. The brunt of earlier catastrophes such as Northridge earthquake ($10 billion) and hurricane Andrew ($18 billion) was borne primarily by one segment of the industry: property insurers.

Aviation disasters are generally borne by hull and liability insurers and no one else. The September 11 attacks arent the most expensive by multiples, but they involve the entire industry including property, life, liability, workers compensation and aviation insurance. And they are the biggest event by multiples for each of these insurance lines. Ever. This type of event, known as a clash, is difficult for insurers and reinsurers because it overwhelms the traditional risk management tactic of diversification. Insurers who cover large or catastrophic exposures pass on large amounts of risk to reinsurers in return for a portion of the premium.

Most reinsurers participate in a range of activities so that they wont be wiped out by a single event, be it hurricane, earthquake, oil rig loss or airline accident. On September 11, reinsurers were hit with huge losses from many sides.

A complicating factor is the habit-especially widespread in the London and European markets-of reinsurers reinsuring one another, something known as the reinsurance spiral. After a series of transactions, you may no longer know whos securing you and, in ultimate absurdity, you might find that youre reinsuring yourself. In essence, some reinsurers are simply passing the grenade around.

Early estimates of the September attacks by the major insurers added up to about $13.6 billion. These estimates are the net of sums that these companies expect to be paid by reinsurers. Many analysts feel that there will be failures among the weaker reinsurers, leading to uncollectable reinsurance.

When reinsurers fail to pay, the primary insurers are forced to pay their policy holders out of their own pockets. This will probably lead to some failures among weaker insurers, as well. Weve heard estimates of the total damage from $40 billion to $70 billion. The loss is so large and complex that itll take years to know its true cost.

Not Normal
In most normal situations where airliners kill people or damage property on the ground, the claimants, both inside and outside the airplane, will turn to the airlines liability carrier. Insurers forced to pay for property damage and injury would normally take their claims to the airlines carrier to be reimbursed.

In theory, the WTC and Pentagon attacks should be no different. After all, who allowed these people aboard? But theres a twist here. With limits of about $1.5 billion per airplane, which has to pay for passengers, the airlines dont even have 20 percent of what will be needed to pay for the damage. And thats before theyre asked to pay property damage.

Will the government step in and limit the airlines liability? Given its resolve to preserve the national airline system with bailout funding, we think liability limit legislation is inevitable. Were also sure other aviation entities-manufacturers, security services, ground handlers-will get dragged in.

What the long-term effects will be are unclear. But heres what we do know: The entire U.S. insurance industrys capital base is about $300 billion. While the events of September 11 will make a dent and there will be company failures, the losses wont threaten the system.

But that doesnt mean things are rosy for the aviation industry. Worldwide, the total aviation and aerospace gross insurance premiums were estimated at around $2.2 billion last year and theyll be substantially higher this year due to ongoing premium increases.

This number includes general aviation, airlines, manufacturers and satellites. The lot of it. Losses for the past few years have run about $1 billion ahead of premiums, so the aviation carriers were in the red before September 11.

In the Red
If we assume that the liability claims paid out for the four airplanes involved come to about $5 billion, were looking at two years of worldwide premium. If claimants drag in others, such as Boeing, the number will likely be higher still. Insurers of large airlines are the same companies that cover aircraft manufacturers, corporate and light aircraft. So, even though GA was not present on September 11, it will be deeply involved.

Morgan Stanleys Alice Schroeder, in an industry report issued on September 17, predicts a shrinkage in worldwide reinsurance capacity, and increased concentration of this capacity among a smaller number of well-capitalized reinsurers. For a while, at least, insurers will be more careful about the reinsurers that they use, and favor paying higher prices to blue chip firms in order to avoid the risk of default. Reinsurance will become less available and will cost more.

While there are many unknowns, well make some predictions. We think that the rate increases that most GA owners have seen for the past two to three years will continue for several more years before leveling off. Aviation underwriters will pay at least $5 billion and possibly much more.

Compared to the size of the annual premium taken in, this number is enormous. The bulk of the worlds war risk coverage was cancelled early in October and where buy-backs are available, the cost has increased eight-fold.

We dont think hull and liability premiums will go up this much, but theres an enormous sum of money to replace. We believe that the increases will be lowest in areas where carriers require very little or no reinsurance. This includes less expensive light airplanes that carry low limits of liability.

Increases will vary, but will tend to be greatest in areas where companies have consistently lost money or where the need for reinsurance is high. These include fixed-base operators, flight schools, commercial helicopters, owner-flown turbines and piston air-taxi operators.

For corporate operators that require large liability limits, hull rates will probably increase slightly and liability premiums will increase more substantially. With the huge increase in war premium, overall increases of 60 percent and more wont be unusual.

Is there an upside to this? Perhaps only that most of the aviation insurers will remain standing. For individual aircraft owners without need for high-limit liability, there will still be companies vying for your business; premium increases are inevitable but will be manageable. And given the enormity of changes ahead, thats not as bad as it could be.

-by Jon Doolittle

Jon Doolittle operates Sutton James Insurance in Hartford. Hes an Aviation Consumer contributing editor.