Paris Air Show

Several Factors Causing Softness in Aviation Insurance Market

 - June 16, 2013, 3:30 AM
David McKay, CEO of insurer USAIG, said that further airline and industry consolidation could push rates back up as there are fewer premium-payers to cover the risk.

There has hardly been a better time to be a buyer of aviation insurance, as all signs point to a buyer’s market. Several factors are driving lower rates in this insurance segment, including fewer airline accidents, lower overall insurance claims, the economy, more underwriters entering the market, increased adoption of safety management systems and more sophisticated aircraft. AIN talked to David McKay, president and CEO of insurer USAIG, to get a better sense of this market. USAIG and McKay are here at the Paris Air Show supporting long-time customer Bombardier.

There has been overcapacity in the aviation insurance market for the past few years. Where it is today and where is it likely headed?

The bigger story than the supply side of aviation insurance is what that supply has to actually do to make money to be sustainable. For the market to be sustainable in this low-interest-rate environment, the quality of its underwriting has to get better, not worse. Insurers have greater and greater pressure to target increasingly better gross underwriting results to meet their cost of capital. With few recent aviation catastrophes, it is easy for insurers to say that their underwriting is brilliant. The challenge is to be in a position to produce those kinds of required results when the catastrophes occur.

What’s creating these market conditions?

Certainly a driver for change in the capacity committed to aviation underwriting will be when there is an opportunity for a better return elsewhere. Given the current interest rate environment and yield on long-term bonds there is a lot of pressure to find return, and several have turned to insurance investments to find a higher return. When higher yields are available at the same or lower perceived risk than aviation insurance, the shorter-term, more opportunistic players in the business will be better identified and maybe even gone. For a point of comparison, though trading at near 2 percent, a 10-year U.S. treasury is considered to be essentially risk-free. How much more then should those who commit capital to aviation insurance expect as a return for the risk they assume? History doesn’t always provide perfect clarity, but those who have been in the business for decades with consistently positive “underwriting” results are likely those who will be committed to the business in the future.

Another dynamic has been, following Hurricanes Katrina, Rita and Wilma, the property and casualty market has moved to become more diversified. Aviation is considered a “non-correlated” risk to the standard property and casualty lines and represents one such source of diversification. Finally, a stalled global economy has put tremendous growth pressure on the insurance market as a whole. Consolidations have taken units and values out of the business and manufacturing output has significantly slowed. As the global economy recovers, pressures for external growth in non-core lines should ease.

How big is the aviation insurance market?

The aviation and aerospace market–all segments combined–represents approximately 0.4 percent of the world property casualty market. It’s quite tiny. In fact, the entire aviation and aerospace marketplace represents less to the global airline industry than a $3.50 increase in the price of a barrel of oil at anticipated 2013 prices, or less than one percent of their total operating expense. Despite its size, it is amazingly efficient and produces products and services the major risk business simply could not reasonably access any other way.

Conventional wisdom is that the aviation insurance market will not firm until there are catastrophic airline losses. What’s your view?

Remember that the insurance business is in the financial business. A series of catastrophic accidents certainly will have a major affect on the business and billons are at risk, but it doesn’t have to be an airplane accident that creates the financial event. The U.S. property and casualty business, for example, lost more than $100 billion in policyholder surplus (capacity) from mid-2007 until late 2008 during the U.S. financial crisis. Thankfully, the business had several years to recover before near record non-aviation catastrophe losses in 2011 and beyond.

So if there are not any major airline losses or other catastrophic financial events, will rates just continue to fall?

No, there is a point at which the market will have to rationalize its diminished return on committed capital and where uncertainty becomes a known. The major aviation risk business, including airlines and major aircraft manufacturers, has two components of loss: catastrophe and attrition. Attritional losses represent the everyday “expected” losses and are largely predictable. The catastrophic component is not that predictable and represents huge uncertainty. Should dollars continue to come out of the market through things such as continued airline or manufacturer consolidations, continued rate reductions or through some other dynamic, the business will get squeezed by the expected loss costs and transaction costs alone with little to no funding for the inevitable catastrophic event. That would likely spur market reaction and thus cause rates to rise.