Aviation Insurance

 - June 2, 2008, 7:17 AM

Despite the economic uncertainty in the U.S. and abroad, the mood was decidedly upbeat at the Aviation Insurance Association (AIA) convention April 26 to 29 at
the Gaylord Opryland resort in Nashville. In fact, due in part to the downturn in financial circles, aviation insurance–a truly worldwide industry–has been experiencing a mini-boom that is benefiting the insured, large and small.

The reason? A credit crunch throughout much of the economy, triggered by the U.S. sub-prime loan debacle, has been driving capital, especially private-equity funds, toward less risky investments, including aviation insurance. With a favorable loss history and an upscale, worldwide clientele, the field presents an attractive vehicle in an otherwise uncertain time. Those two factors, even before the current economic slow-down, had begun drawing money into an aviation insurance industry that had been posting pleasing profits.

This has created an increase in underwriting capacity and an influx of new entrants to the market. As a result, competition has stiffened, premium rates have dipped significantly and insurers have been offering higher coverage limits. This is not unusual for a cyclical market like aviation insurance, AIA treasurer Mary D’Alauro told AIN. She pointed out that when participants in the market are few, competition does not outstrip demand and all of them profit. Fund managers and corporate CFOs take note and, D’Alauro said, “They say, ‘Hey, we need to get into this market.’ So capital comes in, underwriting capacity increases and the competition forces premiums down. This goes on until people stop making money and the market contracts.”

Watch Your Step

Stephen Catlin, founder and CEO of London-based Catlin Group, told the AIA assembly that insurers will be walking a tightrope to avoid taking a tumble in the current economic climate. “The sub-prime crisis is going to run and run and run. It will impact us personally and in our corporate lives.” Underwriters should be concerned, he said, about the possibility that financially squeezed policy holders might skimp on risk management, thus increasing loss frequency and severity. Catlin noted that a softening investment market “is already affecting the balance sheets” of several major U.S.-based and international underwriting firms.

Capital is less easily available, he continued, as fixed-income investments become no longer liquid, while hedge funds and banks move to de-leverage. “We’re all going to have to pay more to borrow money, there will be more prudent collateral requirements and bank fees will increase,” he warned. “Nobody can say at this moment how much [the sub-prime crisis is] going to cost.” He predicted, however, that bank de-leveraging will take longer than commonly anticipated, resulting in a prolonged credit crunch. When insurer access to debt and equity markets becomes narrowed, “then cash is truly king.”

Catlin said prudent insurers can tread safely over such precarious ground with careful financial planning, including provisions for a major natural catastrophe, which he warned is “not unlikely” in the next five years. To survive such a disaster, insurers must, he said, know their true capital positions, actual reconstruction costs and model exposure to perfect their catastrophe loss scenarios. This will require accurate estimates of potential cash flow available from investment portfolios, taking into account that the discount on liquidated fixed-income instruments could be as high as 40 percent.

Meanwhile, Catlin continued, in the current buyer’s market premium rates will fall steadily, and insurers’ bottom lines will shrink accordingly. He asked, “Will this soft market be different?” from those in past cycles. Perhaps, he answered, the correction at the end of this cycle will be less severe due to several factors, including increased transparency in the industry and more proactive insurance regulation. The influence of rating agencies and a better-informed investor base should also dampen market fluctuations.

Catlin summed up his presentation by saying, “Insurance is the DNA of capitalism.” He said it is quite possible that the insurance industry understands correlated risk better than the banks do. To maintain sufficient capacity it must manage business cycles to give capital investors a sufficient long-term return. Insurers have a vital role in local and global economies, he concluded, pointing out that they paid almost all the cost of losses and rebuilding after 9/11 and Hurricane Katrina.

In the Safety Loop

Leading off the lineup of AIA convention keynote speakers was Doug Carr, an NBAA vice president, rulemaking specialist and AIA certified aviation insurance professional. He asked, “How can you be part of the safety solution? What can you offer in the way of safety guidance?” He suggested visiting policy holders and observing the physical environment. “Is the hangar and shop sparkling… or is it dirty and cluttered?” The answer, he suggested, can be a tell-tale sign of the customer’s commitment (or lack thereof) to a culture of safety.

He likened a corporate safety culture to a three-legged stool, with insurance the third leg. “The other two are the regulations, the FARs, which represent minimum standards, and the company’s own corporate culture. What do they do beyond the minimum?” he asked. Despite technological advances such as the transition from propeller to jet engines and the arrival of TCAS and TAWS, the policies that companies put in place could be even more significant, Carr said. He urged underwriters to gauge the CEO’s commitment to flight department safety policies and toward implementing a safety management system (SMS).

SMS, which seeks to integrate all aspects of an operation and its people into a safety-oriented matrix, “is the next thing coming to business aviation and will play a significant role in safety,” he continued. Training is an essential component of an SMS, and is especially relevant to the advent of very light jets (VLJs), Carr noted.

He urged underwriters and agents alike to look for hints about whether a client treats training “like a necessary, required nuisance or part of a sincere commitment to safety.” He said that VLJs and their pilots present “an entirely new pilot-versus-risk scenario,” with training issues such as glass panels dissimilar from aircraft previously flown, and varying levels of instrument proficiency. He suggested encouraging if not actually requiring unusual-attitudes training to mitigate risk, especially in the newest aircraft.

“The simulator can’t train for it. It has to be in the airplane, but the right training can be a life-saving investment.” Carr explained that a correct reaction to an upset is more likely if the pilot has actually experienced one before. He listed other operational risks and challenges, including runway overruns, recognizing and dealing with contaminated surfaces and poor landing technique. “How to train for maximum braking operations is lacking in off-the-shelf programs” but should be incorporated in a flight department’s syllabus in accordance with its corporate safety culture, Carr stated.

He further noted that operational control is an important issue for insurers. “There have been a lot of recent changes by the FAA that you should become familiar with, and spend some time with your clients to explain them.”

Secrets of Success

The final presenter, Roger Woolsey, CEO of the Million Air FBO chain, shared with insurance professionals his strategies for building and sustaining a competitive advantage. He told his audience that the same principles he used to define and implement a successful strategic plan for Million Air could also prove effective for an aviation insurance business to acquire, serve and retain its clients.

Woolsey, who had earned both his commercial pilot certificate and A&P licenses at age 18, first discussed employee motivation, starting with orientation of new hires. He explained the importance of the first day on the job to determine an employee’s commitment level, then described techniques Million Air uses to create pride in the company identity.

Of particular interest to the insurance industry, Woolsey told how an integrated strategy for customer satisfaction works to promote safety at Million Air, and how by using some of the same approaches “You can evaluate a risk” embodied by a particular client.

He stated that success for any entrepreneurial enterprise “is about being unique, and selecting and acting upon an integrated set of choices that it can sustain over time.” Successful strategies have clear trade-offs, he went on, describing how Million Air–starting with the Houston Hobby franchise–moved away from the normal FBO “gas and grass” business model to discover “how can we redefine ourselves?” Woolsey said he decided to adopt what he called the Rolex model: “We don’t sell watches; we sell luxury.”

Insuring the VLJ

Gordon Murray, president of Travelers Aviation, outlined his company’s policy about insuring the emerging very light jet (VLJ) class. “From Travelers’ perspective, we would consider quota-share basis but not 100-percent coverage by a single insurer. Quota share is when different insurers share coverage of a single aircraft. That’s how the airline market is placed. I feel there is some marvelous technology involved, but from a long-term viability standpoint a number of [builders] have not been able to bring products to market. On those who have, we’re going to stand back and see how these aircraft perform, how the training that has been developed works out.” He explained that Travelers and others will wait for an operational history database to develop before jumping into the VLJ market with both feet.

What is the underwriter’s view of the risk posed by relatively low-time owner-pilots, many transitioning from piston singles to turbine-powered aircraft? “It’s a bit reminiscent of when the Malibu and Mirage came out,” Murray said. “There were a number of unseasoned pilots jumping into these airplanes, and there was certainly some loss history associated with that. I would hope that it is less [in the VLJ case] than previous. Since then there have been tremendous advances in avionics and the willingness on the part of manufacturers to provide high-caliber training for these guys.”

Commenting on mentor programs for such pilots, as instituted by Eclipse Aviation for its Eclipse 500 VLJ, Murray said, “Frankly that is the preferred approach for an underwriter. When [an underwriter looks] at a Mustang versus an Eclipse, the Eclipse is certainly a lot of new technology and a new aircraft company, whereas Cessna has been building single-pilot jets for a number of years, lending an advantage to Cessna. When we look at a risk and a Mustang comes across the table we treat it just like any other Cessna single-pilot Citation such as the 525, CJ1 or CJ2. Those aircraft have so much history that they represent a simpler situation to underwrite. However, to my knowledge there have been no losses associated with the Eclipse to date.”

Limiting Liability

Regarding tort reform to address the problem of product liability and operator negligence lawsuits that have driven up costs in every segment of aviation, AIN asked if there has been any legislation introduced in Congress that Travelers believes could, if enacted, improve the aviation insurance climate. Murray is not aware of any such legislation.

Jim Cooling, a principal in the Kansas City aviation law firm of Cooling and Herbers, said the 1994 General Aviation Revitalization Act, which limited OEM product liability, was “probably the high-water mark” in tort reform for the industry. Given the current political climate, that legislation is about as much as the industry can realistically expect in the near term, he explained.

Patrick Bailey, the principal of Bailey and Partners, a Santa Monica, Calif. aviation law firm, said an increase in aviation-related litigation can be expected in times of dynamic economic change, either up or down. Bailey gave as an example VLJs and new glass cockpits with which many new turbine pilots are unfamiliar. This change in risk brings a potential increase in the loss rate, and consequently “litigation is bound to increase.”

The association will hold its 2008 international conference and reception October 23 in the UK, as guest of Lloyd’s of London. San Francisco will host the 2009 annual meeting and convention in the new downtown Intercontinental Hotel, April 25 to 28.