The aviation sector is in for another rough ride as insurers are forced to push for significant rate increases at the 1/1 renewals to mitigate against new risk exposures and COVID-19-adjusted reduction in premium base.
Global air traffic is unlikely to rebound fully until 2024, a year later than previously projected, due to slow virus containment in the US and developing economies, low passenger confidence and reduced corporate travel, according to the International Air Transport Association (IATA).
The Middle East aviation market may take longer to recover from the effects of the COVID-19 pandemic than those elsewhere in the world, said Sompo International SVP aerospace, London market & Europe insurance Andrew Metcalfe.
This is due to its hub and spoke business model, which relies on transiting a large number of planes and passengers through the region on long-haul flights. “As the airline market recovers, people will start to take shorter journeys first. There are signs that this is already happening – passenger traffic on UAE airlines was up 30%-40% in July and August, but it will take a while for confidence to return for longer journeys,” Mr Metcalfe said.
The Air Transport Action Group (ATAG) warned that the damage to the Middle East aviation industry and on economies caused by the shutdown of air traffic owing to the pandemic has deepened. It is now estimated that 1.7m jobs will be lost in aviation and industries supported by aviation in the Middle East in 2020. Meanwhile, GDP supported by aviation in the region will fall by $105bn, down 49% from pre-COVID-19 levels.
The aviation sector supported 3.3m jobs (4.5% of all employment) and contributed $213bn to the region’s GDP in 2018, according to ATAG.
“It’s important to remember that although the aviation market in the Middle East is subject to the same forces as those in the rest of the world, it is also characterised by its own unique dynamics,” said Mr Metcalfe. “The major Middle Eastern airlines typically operate modern fleets with very large and expensive aircraft that require a high level of insurance capacity. In addition, this is a market that even pre-COVID-19 was having to deal with operational challenges around safety and security with regional disputes – most recently in Syria – forcing aircraft to reroute.”
Impact on aviation insurance market
COVID-19 has occurred at a difficult time for the aviation insurance market, said Dubai-based Willis Towers Watson lead relationship manager for aviation Henry Adair.
“The past three years have been loss-making for many underwriters, and they continue to find themselves under scrutiny from capital providers to turn this around. Failure to do so will result in further capacity reduction and corresponding upward pressure on rates.”
Given the grounding of fleets globally one would expect a corresponding drop off in the level of attritional claims, lending itself to a profitable year, he said. However, a spate of catastrophic losses such as the Pakistan International Airlines and Air India Express incidents in May and August respectively, and the large-value aircraft fire at Ethiopian Airlines in July “remind us that despite the pandemic, we do not live in a risk-free world from an aviation perspective”, said Mr Adair.
Mr Metcalfe noted that the aviation insurance market has seen more than a decade of declining prices on the back of a surfeit of capacity and fierce competition. He said, “We have reached a point where rates became detached from the key exposures of airline risk and we are now seeing large adjustments of a scale never contemplated before.
“In a normal year, we would expect premium adjustments of around plus or minus 10%. Now the range is more like 40%-50% for passenger and departure exposures, in one direction only – downwards. This results in insurers having to introduce minimum premium levels to manage the risk to reward formula.”
Airline premium levels globally could drop from the 2019 estimate of $1.95bn to less than $1.4bn, while the value of new claims has held steady and is unlikely to be significantly less than the acknowledged average annual claims of $1.5bn, said Mr Metcalfe.
Support for airlines
Considering the severity of the crisis facing airlines and the impact on their liquidity, the insurance sector has shown “some sympathy”, particularly when it comes to premium instalment flexibility to help client cash flow, said Mr Adair.
“Many insurance policies are liability premium-rated on passengers and departures, so there has been a contractual obligation to return funds at the expiry of the policy and, on occasion, as part of adjusted instalments during the policy period. Some will look to trade at renewal to mitigate against future increases, depending on airline appetite,” he said.
AGCS head of aviation – regional unit London Jonathan Milford-Cottam said the insurer is working with its clients and their brokers to return premiums that are due to them following the reduction in key exposure metrics versus what they estimated pre-COVID-19. “This is a ‘bespoke’ approach and is undertaken on a case-by-case basis.”
He added, “Aerospace policies, incorporating manufacturers and airports, are primarily agreed on an in full non-adjustable basis and as such, requests for renegotiations have been minimal despite reduced turnover. We have observed a similar scenario with general aviation clients (including private single aircraft, business jets and large commercial fleets), where policy renegotiations have not been common due to the structure in which the policies are rated.”
IATA director, industry risk management and insurance Dr Dexter Morse sums up the conundrum insurers face. He said, “Insurers have been hit with COVID-19 claims and litigations – related to coverage issues such as business interruption losses – and are being much more cautious in the risks they are covering. The insurance market is also hardening and premiums have increased.
“Although insurers understand the situation is difficult for many airlines, they also have their own pressures and requirements. Aviation insurers have been unprofitable for almost a decade and even if some insurers are willing to support airlines, they are required to go back to a more sustainable market.”
Changing risk profile
While borders have started to open and travel bubbles offer a route to economic recovery, thousands of planes are still sitting idle in places vulnerable to natural perils, prompting concerns about aggregation risk.
Dr Morse said the only real way to mitigate a potential major ground loss event is for operators to look into this risk, provide different grounding zones and spread their ground risk at different locations.
“A large proportion of the world’s airline fleet remains in storage, with aircraft, including high-value wide-bodied jets, parked in airports, many of which might be exposed to hurricanes, hailstorms and tornadoes,” said Mr Milford-Cottam, adding that more than 2,000 planes are thought to be idle in the US alone as of September, with an estimated value of around $70bn.
“The risk of shunting or ground incidents also increases when large aircraft fleets are parked temporarily on a runway. Such incidents could result in costly claims,” he said.
Mr Metcalfe pointed out that the volume of aircraft parked is also having a dramatic effect on the second-hand market – it impacts insurers in several ways, particularly in the area of salvage following a hull loss.
He said, “Airlines’ risk profiles changed from dynamic to static risk at the height of the lockdown, while infrastructure risk for airports and air traffic control has obviously reduced during this period. This situation creates unique risks such as mental health, skill fade and potential mechanical issues for machines created to fly, not sit on the ground for extended periods. These are just some of the additional risks for insurers to consider.”
Apart from the logistical and operational challenges presented through lack of packing, ongoing maintenance, storage preparations, wildlife hazards and climate considerations, the threat of war/terrorism should not be underplayed, said Mr Adair.
“The aviation industry has always been a target for terrorists and has often been impacted by war, with the resultant loss of life and destruction of assets. Hull war policies, which provide the cover for asset exposure have aggregate limits in place which may not serve to protect the accumulated value in any one location, thereby returning that exposure to the airline.”
He added, “Remaining mindful of the evolving nature is incredibly important and brokers should be collaborating with risk managers to develop solutions to these changing needs.”
Mr Milford-Cottam said, “Airlines are likely to face changes in risk as they emerge from hibernation and ramp up operations. Airlines are operating under exceptionally difficult conditions and are now making deep cuts to their workforce, including the loss of experienced pilots, while many who remain will not have flown for months.”
Runway to 1/1 renewals
Tough conversations are expected leading up to the 2021 renewals.
“Insurers recognise that many airlines are struggling financially,” said Mr Metcalfe. “As insurance companies prepare to deploy their capacity at renewal, they will need to look forward at risks as they are presented. This is against a backdrop of emerging risk areas resulting from the prevailing health crisis and other recent claim events to achieve a sensible position for both the insured and their insurance partners.”
Mr Milford-Cottam said, “Driven by almost two decades of soft market conditions and years of deficit, we have seen rates continue to increase in the past months. Therefore on balance, although exposures across the industry are projected to be reduced, most aviation clients are unlikely to see a reduction in their premiums overall. As is to be expected, any adverse claims activity would affect rates on individual accounts.”
Painting the same picture, Mr Adair agreed that it is highly likely that insurers will be forced to push for more significant rate increases in the latter part of the year to mitigate against the COVID-19-adjusted reduction in premium base, and this will continue into 2021.
He said, “Despite achieving a trend of rate remediation over the past couple of years, any premium gains have now been neutralised by the pandemic. It is therefore possible that insurers conclude that aviation remains a market of unpredictability and poor returns and may decide to exit the class in part, or in entirety.
“The hardening airline insurance market of the past 18 months, even before COVID-19, had been catalysed by the capacity-awash soft trading environment that went before, coupled with a spate of loss-making years which required correction to ensure ongoing survival. Commercial instincts have become overridden by technically-driven pricing as a means of negotiation.”
He also pointed out the ill-discipline in the sector – to the benefit of the buyers – which has led to unrealistic pricing expectations despite the ongoing value of the product they buy. With pressure on revenue threatening airlines’ very existence without external support, the hard insurance market is another challenge that requires mitigation, he said.
However, on the bright side, certain new insurers have entered the sector in the past year or two, providing much needed new capacity, but “that is unlikely to stem the hardening rate environment that we anticipate will remain for some time”, he said. M