By DJA – Graham Speller

Aviation insurance has become a very different commodity to the one we have been used to over the past 15 years or more.

When effecting insurance, you are buying a promise – that’s all. A promise of some future conduct, based on a pre-agreed set of terms and conditions.

You hope (because you cannot guarantee it) that the insurer(s) you have contracted with will fulfil their obligations under the contract. They, in turn, assume that you will do likewise.

And provide both parties follow the rules, keep to their promises and respect each other’s rights under the contract, all is well.

The disastrous losses sustained by Property & Casualty (P&C) losses in 2017 and, to a lesser extent, in 2018, led to a global shift in the manner in which short-term insurance coverage is assessed, priced and offered. Multiple natural disasters – hurricanes, earthquakes, fires, etc. – resulted in massive insured losses, easily exceeding 200% of the global premium income.

Coupled with a collapse of international insurance rates, the direct underwriting losses (the extent by which claims exceeded premium income) placed many/most Insurers and Lloyd’s Syndicates in a life-threatening position, from which they needed to extricate themselves in a very short period of time.

In essence, the 2017-18 P&C losses severely depleted the reserve account of many Insurers and their respective Reinsurers. Without reflating the market, future catastrophic losses may have led to widespread failures, leading to financial ruin for many policyholders.

The aviation market, meanwhile, had been losing money for several years – at least since 2015.

Following a spike in airline insurance rates in 2002, as a consequence of the 9/11 losses, the airline industry entered a golden age of safety, with a continually-falling loss rate and big profits for those Insurers who had not exited the aviation market in the aftermath of the attacks.

Of course, there is nothing quite like seeing your competitors raking it in to encourage you to enter the game, whether for the first time or as a returning player!

This sudden expansion of capacity (more Insurers offering coverage), coupled with benign loss experience, started the “soft market” cycle which, with only momentary pauses, saw airline insurance rates dropping steadily over the next 15 years.

At the same time, many airline Insurers who saw their income being eroded due to the falling rates, turned elsewhere for income – General Aviation became an obvious choice, leading to accelerated softening of GA insurance rates as a result.

If we were to go back 20 years or so, to the late 90s, we would see that aviation rates were probably running at about the same as they are today, in 2020.

In the interim, however, they hit an all-time low.

As part of the efforts to reflate the market in 2018, Insurers were forced to carry out a complete review of all parts of their portfolios (i.e. all classes of insurance), including niche areas like Aviation which, at best, accounts for around 2% of the world’s total short term insurance premium income.

What those Insurers found was that Aviation (and other niche classes) had been “sheltered” by the P&C account for years. Bear in mind that, by comparison, the P&C market accounts for about 60% of the total global premium income.

The consequences were as dramatic as they were rapid.

Many Insurers completely withdrew from underwriting Aviation. Understandably, perhaps, these tended to be those that had been the ones offering the cheapest rates.

Others, who decided to stay in the game, needed to take action on three fronts: increasing rates, restricting coverage and reducing exposure (the shares they write), in order to get their portfolios back into a profitable position.

For an Insurer, a “profitable position” probably means a return of no more than 5% across the portfolio.

In other words, provided they paid out no more than $95 for every $100 of nett income, they are profitable.

Nett income would be calculated, very simply, as gross premium, less expenses, plus investment income.

Given that global interest rates have dropped to virtually 0% in most developed countries, there is no investment income to be made and Insurers are faced with a very simple equation.

Expenses include the overall cost of running the place plus the cost of acquiring business and runs at around 40% of gross premium for most Insurers.

So if an Insurer pays more than $55 in claims, for every $100 of gross premium, they are running at a loss.

Against this background, Insurers have to take great care in how they price their exposure, in order to give themselves a reasonable chance of turning a profit. Losing money is no longer an option and will result in job losses and the potential withdrawal of the Insurer from Aviation, with all that infers.

What Insurers are doing is to take a completely fresh look at the exposure and repricing the risk from the perspective of their own position alone. They call it “modeling the exposure”, which is usually carried out by actuaries.

In “hard” markets like the current one – where rates are being driven up by Insurers, the cost of insurance becomes a key factor for most policyholders.

A true broker will spend his/her working life trying to secure the best possible terms for their client. To some, this means the cheapest rates, but that is a dangerous fallacy.

The terms of insurance are a combination of a number of things. At DJA we refer to The Right Approach. This encapsulates our entire business philosophy, and enables us to fulfil our responsibilities to our clients and provide our clients with the financial peace of mind they need in order to operate.

There are four principle aspects which we say MUST be kept in balance with each other – like the blades of an aircraft propeller.

Coverage

Naturally, the coverage must be appropriate for the risk and the policyholder’s requirements – no point in cutting out required coverage and hoping things will be OK

Service

The service provided by the Insurer and the Broker, on a day-to-day basis, and especially when claims arise, is important – the insurance will be worthless if you cannot get anything done, or get advice when you need it

Security

This is a big one. Why bother to insure if the Insurer you choose is not going to be able to provide the service or, far more importantly, is not going to respond to claims – either because they don’t want to or because they cannot?

Cost

The premium must be competitive, having regard to all the other factors. Again, there is no point in cutting down on required coverage, giving up service or selecting a sub-standard Insurer all for the sake of a cheaper premium. That is the height of idiocy and DJA does not see that as a means of fulfilling its duties towards its clients.

A fifth aspect, that is particularly relevant in a hard market, is Relationships. That is, the relationship between the Insured and his Insurers. When things are tough, as they are right now, and claims arise which could go either way (as many can), it can be the strength of the relationship with the Insurer that makes the difference. So we try to promote the maintenance and growth of Insurer-Client relationships wherever we can.

It makes sense to follow an Insurer’s financial strength rating, as applied by ratings agencies who specialize in analyzing insurance companies. Standard & Poor’s and AM Best are the principal ratings agencies for the insurance industry and apply financial strength ratings (FSRs) to hundreds of Insurers all over the world, using a consistent rating methodology that enables and Insurer in one country to be reasonably compared with one in a different part of the world.

Both S&P and AM Best use an alphabet scale, ranging from A as the highest.

The insurer may need to be around to defend you, and settle claims, for many years following a loss – particularly in relation to Passenger Liability claims. The last thing an Insured needs is to find that, at the crucial moment, the Insurer has disappeared. There is no such thing as joint liability under an insurance policy – each Insurer is only responsible for its own share.

Anyone considering whether to accept an insurer it is being offered to underwrite the insurance of substantial assets and potentially-huge legal liability exposures should wish to get a high level of comfort based on the financial strength rating of the Insurer(s) concerned.

Particularly an Insurer located in a foreign country that does not have a subsidiary in the policyholder’s country of domicile and no assets which can be applied to cover its liabilities.

Based on the above scale, an Insurer rated below A- by S&P, or B+ by AM Best – or not rated at all by either – should be carefully considered and further investigations carried out in conjunction with a knowledgeable insurance broker.

The more care and attention that is applied to the selection of the Insurer(s) to be relied upon to fulfil their promises under the insurance contract, the less likely it is that claims will result in tears.