Several key issues in the current aviation products liability (APL) market have created pricing challenges for underwriters. How do we improve trading conditions so the market can continue to provide its clients with the capacity and coverages needed to protect their balance sheets?
Historical Background
The APL market has had only two substantive hard markets since 1972. In 1985 – 1986, APL premiums increased six-fold in a matter of 12 months. As an example, one major client’s premium went from $12 million per year to over $70 million. Product liability losses in the aviation market, and non-aviation losses as well, were off the charts.
Reinsurers had negative results because of these losses and withheld capacity as a result, causing premiums to increase dramatically. Three airframe manufacturers in the mid-1980s shut down, ostensibly because they could no longer afford APL insurance.
In 2001, the terrorist attacks on the United States on September 11 caused airline premiums to skyrocket and APL premiums followed suit, albeit to a lesser extent. Excess of Loss reinsurance is a key factor in writing cat risks and it became unavailable at attachment points generally below $300 million. Sophisticated reinsurers prior to 9/11 would not underwrite that low layer as pricing did not justify taking such risk. In fact, just one entity wrote a huge proportion of the Excess of Loss purchased at that level, and that organization is no longer operating. In the years following 2001, pure APL premiums declined from $800 million to approximately $450 million. Capacity grew rapidly after September 11, as insurers entered the market seeking to take advantage of higher premiums. Although some of these insurers have stopped writing the business and others have cut back line size, most are still in the market today with only 60% of the 2002 premium available.
Industry Factors that Reduce Premiums
Aerospace Industry Consolidation
When a large company purchases a substantial competitor, it is likely that underwriters will receive only a fraction of the premium attributable to the acquired company. The amount often bears no relationship to the acquired company’s loss and risk profile, especially if the acquiring company pays a large premium already. The clients, in general, correctly recognize that they have the leverage to put major pressure on their brokers to keep additional costs as low as possible when acquisitions take place to help meet the cost-cutting goals set by the acquiring company. The bottom line to insurers is less premium for the same exposure.
Excess Capacity
Most aviation capacity is composed of “following markets” (as opposed to lead markets) who are naturally interested in maintaining their market position. Many of these insurers write the aviation book to introduce uncorrelated risk to their entire book of business. Since their costs are lower than lead markets they can usually write business for lower premiums. In addition, the reinsurance market enables them to de-risk the exposure, enabling them to remain in the market at lower premium levels. As the increases following September 11 have subsided, reinsurance costs have fallen considerably and Excess of Loss attachment points are lower again which allows capacity to remain at higher levels.
Aerospace Technology
Technological strides in the aerospace sector over the past 20 years have contributed greatly to a reduction in accident rates and lower loss levels. Despite that, projected loss ratios for the last 4 or 5 years are marginal at best. When premium levels are this low, attritional loss levels may be closer to current premium levels than you think. A market trading close to attrition has inadequate funds to cover large and catastrophic losses or margin for profit. Such a market is unsustainable.
The Future
It is important to begin conversations with clients and brokers regarding the dangers of an ever-dwindling premium base coupled with growth in catastrophic exposures. In the current environment, insurers cannot continue to offer the products, services and limits that clients have come to expect.
You can choose the status quo, but be fearful of the repercussions in doing so. Supply and demand are economic forces that cannot be ignored. Some may have already recognized the dangers of an unhealthy market. The solution is to persuade all the stakeholders to be mindful of what is at risk.
Author Rod Mezzina, Former Aerospace Practice Chairman, Marsh New York. Rod has been involved in APL business since 1972 as broker and underwriter.
