A question of perspective?
With the frenetic final quarter of the year approaching, opinions on the benefits of the airline insurance market’s current position are divided: Things are favourable for airline insurance buyers, but significantly more challenging for the insurers that are taking the risk.
But what are the key challenges that aviation insurers are facing as Q4 looms? Primarily insurers are having to contend with rising costs on one hand and increased competition on the other.
Rising costs are being driven mostly by claims inflation, but reinsurance and operational expenditure are also factors.
Claims inflation is complex and difficult to quantify. The legal processes that tend to be involved in an aviation claim make pay awards a sensitive subject, and the long-tail nature of the claims process complicates the overall picture.[1]
Any case that goes to court is rightly scrutinized in minute detail. This takes both time and money, and any insurer involved in a case, whether lead or following, needs to make sure that they are in a position to support a payout at the very top end of the scale.[2]
Social inflation also means that liability claims are becoming more expensive.[3] While efficient risk management and understanding of aviation as a whole means that there has arguably been a reduction in the size and frequency of major claims, when they happen, they are more costly, and insurers are having to take the worst-case scenario into account.
Most insurers purchase reinsurance to protect their portfolio from catastrophe loss, and many reinsurers purchase retro cover (reinsurance of reinsurers) to do the same for their own portfolios. There have been some large losses in recent years (some are being contested and others going through the process of settlement) and most of the costs of a catastrophe loss are passed on to the two reinsurance markets.
As a result, reinsurance policy conditions have tightened and pricing for these types of insurance has increased. The cost of these increases tends to be passed on to direct insurers, and when the insurance cycle is functioning normally, these costs are passed on via increased direct insurance pricing. At this point though, the price increases are not tending to be passed on.
This is a consequence, in part, of the larger losses still making their way through the legal process, but it is also a result of several unprofitable underwriting years prior to COVID-19. These encouraged insurers to raise prices over the last couple of years as the industry recovered.
Beyond claims inflation and reinsurance costs, several other factors are at play.
In the direct airline insurance market, airline operators have been reporting increases in both fleet and traffic, so exposure is rising.[4] This is compounded by the application of modern materials, which reduce running and operational costs but cost more to replace in the event of an incident. This makes claims more likely and more costly.
The baleful influence of global inflation is also a factor here, with the price of replacement parts rising since the Russia/Ukraine crisis, adding an extra layer of costs to repairs or maintenance across the aviation industry. This, in turn, raises the cost of claims.
Finally, while we all like to think that it is over as a major economic factor, the ramifications of COVID-19 continue to make their presence felt in the background. Some aviation organisations, including maintenance, repair and overhaul (MRO) operations, deskilled during the lockdowns. Now that aviation activity is back to normal, some MROs are struggling to hire the expertise that can reduce a damaged aircraft’s time out of service. This is creating competition for repair slots and the increasing the cost of hiring repair teams, which in turn is driving up the overall cost of repairs and the time it takes to complete them. Which again increases any associated insurance claim.
Meanwhile, new capacity has entered the market, attracted by the rising premium in aviation insurance over the last couple of years. The result is fierce competition for participation on clean, well-managed programmes, and insurers are having to work very hard to either maintain their positions on their existing programmes, or secure participation on new placements.
Total gross written premium (GWP) in the aviation insurance market is estimated to be at a two-decade high.[5] This in part reflects the aviation industry’s growth, which has been exacerbated by the post-COVID-19 bounce-back, but recent years have also seen rates increase significantly.
This means that, for the time being at least, the market is delivering generally profitable results to capital providers. While we are still awaiting the conclusion of the leased aircraft legal proceedings following the eruption of the crisis between Russia and Ukraine,[6] the amount of competition in the airline insurance market puts it in the unusual position of having rising costs and softening rates.
The bottom line though is that in the absence of catastrophe losses, appetite among insurers is healthy, which is tending to push rates down. This is good news for insurance buyers who may see insurance costs fall, but it’s more challenging from the insurers’ perspective because they must balance the need for premium income with risk selection and increasing costs.
It has created a situation where the losses loom large and the reinsurance cost increases are biting, but prices are perceived to be adequate because of the previous rate increases. As a result, no direct insurer wants to miss their opportunity of gaining profitable income while the market is high.
This puts the aviation insurance market in an unusual position. Costs are rising for insurers, but the availability of capacity means that they are likely to struggle to raise the price of insurance.
To understand the airline insurance market, it’s important to view it through the lens of everyone involved to gain a balanced understanding of market dynamics and offer a fair outlook of what lies ahead. If costs continue to increase, at a certain point, participation in the airline insurance market could become unprofitable, at which point capacity will contract, competition fall away, and prices start to rise.
Meanwhile, after around two years of rate increases, the hull war market has become more resilient and should be in a position able to absorb losses while still delivering profitability to most insurers.
A reflection of this is the increase of hull war premium relative to the total aviation market, with WTW estimates suggesting that hull war premium as a proportion of total aviation premium has tripled between 2021 and 2024, from a low of below 5% to the current levels of just below 15%. While we are seeing tighter underwriting of conditions, rates are under pressure and reductions are available, especially for buyers bringing fleet growth to the market. Hull war insurers are battling to secure market share and prevailing conditions are favourable for buyers.
So, as we proceed through the third quarter and into the busy final quarter, how is the airline insurance market expected to perform? Insurers are likely to be feeling the pinch from the combination of increased costs and reducing premiums, but while there remains surplus capacity required to complete insurance placements, we feel this will remain a market that will perform to the benefit of insurance buyers at least through to the end of 2024.
From a buying perspective in the short term, it doesn’t really matter if airline insurers are struggling with rising costs, so long as competition keeps driving rates down. The trouble with this is that the airline insurance cycle keeps turning and sooner or later, competition is likely to start to tail off, at which point prices will stabilise or even start to move upwards. The best negotiations happen when you can see both points of view.
