Watch the horizon
From a pricing point of view, the airline hull and liability market hit a low point in 2017. The amount of available capacity meant that from the perspective of an insurer, rates fell to an unsustainable level. Capacity tightened, the market corrected itself by raising rates and the airline insurance market is thought to have been broadly balanced between 2020 and 2022.
In the normal course of events, capacity would have been attracted to the markets, which in turn would have put downward pressure on rates. The pandemic disrupted normal market functions however, and the atypical industry and insurance market experience complicated trends and made projections a major challenge for insurers.
As the situation started to return to something akin to normal,[1] the data has matured, and it is becoming clear that the combination of rate and exposure increases have made conditions in the airline hull and liability market relatively positive for insurers up until 2023.
There has been a relatively high level of capacity for each risk which curtailed insurers’ ambitions for rate increases in 2022 overall and by Q4 2022, we were starting to see some softening in rates.
As well as assessing future risk, insurers need to reconcile the cost of past claims. At the end of 2022, there was substantial movement in the Boeing 737-MAX claims which date back to two fatal incidents in 2018 and 2019[2] and developed into what is thought to be the biggest claim in the history of the aviation industry.[3]
Almost every direct insurer purchases reinsurance to offset the risk of catastrophic claims. It enables an insurance company to smooth their experience over time and makes their loss profile more predictable, because they only retain the first proportion of any claim, which is known as the priority or retention. For the B737-MAX claim, this retention had been fully eroded by the initial reserve, so the most recent development was almost entirely passed on to reinsurers.
Because the impact of the claims was mostly felt in the reinsurance market, there wasn’t an immediate pricing reaction at the end of 2022. It is however one of the reasons why reinsurance is currently being so widely discussed in the aviation insurance markets (the other being the evolution of the claims relating to the Russia and Ukraine crisis[4]).
The reality is that reinsurers have been stung by the massive deterioration in the loss and are now looking to balance their books. The reinsurance market is significantly smaller than the direct market, and reinsurers only receive a proportion of the premium paid to direct markets. As a result, the B737-MAX claim is likely to have had an exceptionally detrimental influence on reinsurance premium and the reinsurance renewals at the start of January and April 2023 were very challenging for insurers who were met with a significant increase in reinsurance costs.
What this means is that while the top line is healthy and the rates appear to be in the right place to make it worthwhile for insurers to support the airline sector, there are now significant increases to their bottom-line costs. The question going into 2024 will be how much of these increased costs can be passed on to direct customers.
Despite the likelihood of a contraction in reinsurance capacity in the medium term, there has not yet been a noticeable reduction in insurance capacity since the start of the year. Will insurers be able to dig their heels in and try to demand higher rating if there is a queue of new markets waiting to replace them? History suggests otherwise.
In the short term, insurers have been looking for modest rate increases for clients whose exposures are growing, for those who have good loss records, and for those who buy lower limits and therefore need less capacity. They have justified this by pointing to increased reinsurance costs, inflation across the business and claims attrition. Those clients who do not meet these criteria have had a challenge renewing their insurance programmes.
The amount of capacity that’s available means that we do not think it is likely that airline hull and liability insurers will be successful in their ambitions for modest rate increases in the short term for most programmes, but we do not expect the rate reductions to continue unless there are exceptional circumstances on specific insurance programmes.
The reason for this is that there are darker clouds on the horizon as the year draws to a close. Reinsurance coverage changes have the potential to lead to a reduction in capacity for direct clients as 2023 progresses.
Then there is also the question of where, when and how the potential claims from Russia materialise.[5] The legal process continues, and we are starting to have more clarity on the size of the loss and where this will be paid. A multi-billion-dollar loss hitting both insurers and reinsurers simultaneously at this sensitive moment could be catastrophic for both and could see a sharp reaction.
To sum up, the first half of 2023 witnessed robust discussions with insurers, but clients that took a proactive approach to risk and were willing to shop around enjoyed a relatively simple passage through the insurance markets. It is likely to be a different story in the second half, and clients renewing later in the year are advised to keep a close eye on the horizon. We recommend being proactive, starting conversations with insurers early and being ready to clearly explain risk reduction strategies.
