If you think you can call your insurance broker and secure aircraft insurance just days before you close an aircraft purchase or renew liability coverage, think again. Insurance companies have changed the underwriting game after more than a decade of losing money.
In the last two years, many underwriters have exited aviation insurance while the remaining carriers have tightened up underwriting standards, reduced coverage limits, and increased premiums for liability coverage. These changes have impacted nearly all insureds in some fashion, including many receiving invoices with substantial premium increases. Worse still, owner-pilot and single-pilot aircraft have nearly run out of gas in finding adequate or any liability insurance coverage.
This tightening aircraft insurance market requires aircraft owners and operators to allow significant lead time to search for insurance when buying an aircraft or renewing existing policies. In addition, legal entity structuring and contractual agreements designed to mitigate the risk of personal liability have become more important as insurance underwriters clamp down.
Liability insurance typically applies to, and is often purchased by, an aircraft owner or operator as the “named insured.” The insurance indemnifies, or pays for, liability of the named insured and, when included in policies, other parties, identified as “additional insureds,” that have an interest in the aircraft or related liability risks. The obligation of the insurer to pay for potential losses is referred to generally as the “duty to indemnify” insureds. The insurance indemnifies for bodily injury, including death, incurred by someone other than the named or additional insured. Coverage should respond when claims arise out of the ownership, maintenance or use of the insured aircraft. For example, liability coverage should respond to a crash on takeoff or a collision of two aircraft on an airport ramp.
To help put market challenges in context, consider two hypothetical situations.
In the first case, a flight department operates for Big Co., a corporation with significant business operations that is owned privately by one family (Big Co.). The flight department employs professional pilots. Big Co. operates its aircraft under FAR Part 91. The fleet consists of three large cabin and three light jets. One pilot usually operates the light jets.
Big Co. carried $300 million per occurrence in liability coverage in 2018 but at renewal in 2019, Big Co. could only obtain $100 million per occurrence for the light jets. Big Co. kept the high limits on the large cabin aircraft but absorbed a 25 percent premium increase.
The carrier informed Big Co. that the light jets dragged down the original insurance limits and warned Big Co. that, in the next renewal into 2021, the underwriter may be able to insure the light jets only if Big Co. operates them with two pilots.
In the second case, a prospective aircraft owner, an ultra-high-net-worth individual (UHNWI), formed an LLC of which HW is the sole member/owner. The UHNWI client signed an aircraft purchase agreement to buy a $5 million preowned turboprop from the manufacturer but could only secure $1 million of liability coverage at a surprisingly high premium. When the client agreed with the underwriter that a professional pilot would fly the aircraft for a year while the client developed skills and knowledge on how to operate the aircraft, the insurer reluctantly increased coverage to $5 million. The client originally planned to buy 10 times that coverage.
As the aviation insurance market tightens, many, but not all, owners and operators seeking coverage will either pay higher premiums or be unable to purchase adequate or any coverage. In this new reality, potential owners or operators should engage, or continue to use, a specialized aviation insurance broker (not general lines brokers) to assist in purchasing, modifying or renewing coverage.
Waiting too long to transact with carriers is hazardous in today’s market as illustrated in the Big Co. and UHNWI situations, as underwriters seem to be circumspect about accepting or renewing certain underwriting risks, especially for single pilot aircraft. The broker should act as a trusted advisor, exhibit deep knowledge of underwriter capacity and focus quickly on policy provisions that exist or must be modified to optimize protection of the particular aircraft owner or operator.
In addition to an insurer’s “duty to indemnify” discussed above, insurers also have a “duty to defend” their insureds against liability claims for which potential coverage may arise under a liability insurance policy. The duty to defend is significant, financially and legally, for an insured. Even a small incident can run up significant legal fees regardless of the insurance coverage limits or disposition of the claim.
For this reason, even low limit liability policy coverage may have significant value to an insured when the insurer and not the insured foots the legal bill.
However, it’s critical to know when the insurance company can stop paying legal fees, which varies based on the circumstances, policy terms and state law. At that point, the insurance company may be out but the burden to pay legal bills may continue for an owner or operator such as Big Co. or the UHNWI client.
Legal Steps To Mitigate Liability Risk
For insureds facing payment demands for successful claims in excess of policy limits, claimants may, and will almost certainly attempt to, overcome legal barriers so they can tap into an owner’s or operator’s personal assets. However, certain structures or contractual strategies may mitigate risk for owners and operators.
Choice of the Right Owner/Operator Entity. Deeply rooted in state law, various types of entities, if properly structured and managed, can mitigate personal liability of aircraft owners and operators, including certain LLCs, corporations and trusts.
- LLCs. Private aircraft owners widely believe that LLCs that have no function other than to own their aircraft will shield them from personal liability. In the UHNWI client’s case, they are the sole LLC member. Claimants will almost certainly sue the UHNWI and the LLC and, with a money judgment in hand, seek to pierce the LLC veil and force the UHNWI personally to pay for damages in excess of insurance coverage. This risk is particularly acute if the UHNWI exercises operational control of the aircraft or if liability arises concurrently with a violation of the FARs (see “AINsight: Piercing the Aircraft LLC Veil”). Variations on LLC structures and proper legal management of the LLC company might reinforce its shield against a claimant.
- Corporations. In the Big Co. example, Big Co. is a corporation, which like other corporations, is designed under state law to shield its shareholders from third party claims against Big Co. However, Big Co., as the aircraft owner, might still be liable for claims in excess of insurance. And the payment by Big Co. itself could, of course, reduce the value of Big Co. to the family that owns it. Placing aircraft in an affiliated company with a lower shareholder value might provide more protection for Big Co. itself and preserve more of the net worth of the family owners.
- Trusts. Three types of trusts deserve mention, two of which might provide some protection against liability claims. A “statutory trust,” which is a creature of state statutes, protects beneficial owners from liability like shareholders of a corporation. An “irrevocable trust,” often created for estate planning and tax purposes, might protect its beneficiaries from claims because the beneficiary does not own, and claimants should not therefore be able to access, the trust assets as a result of the beneficiary’s liability. A “grantor trust,” often used for compliance with the FARs or asset management, is a pure “pass-through entity” for a beneficiary and is very unlikely to afford any protection to the beneficiary from third-party claims.
Operate under Part 135. In both examples of Big Co. and the UHNWI client, the owners operate under Part 91 where each of them maintains “operational control” under the FARs. As such, they have direct responsibility for the flights and potential liability for their actions as operators. By contrast, if Big Co. or the UHNWI hires a Part 135 on demand air carrier, the air carrier exercises operational control and thereby takes responsibility for liability arising from the flight’s initiation, conduct, and termination under its air operator certificate.
Although Big Co. might mitigate its risk of liability by hiring a Part 135 operator, the UHNWI intends to fly his or her own aircraft under Part 91 only. The UHNWI, therefore, needs to look even more closely at other structures to protect themselves against liability in excess of insurance limits, assuming insurance is even available.
By hiring a Part 135 operator, Big Co. can also access the fleet insurance policy of the operator with more comprehensive coverage including acceptable liability limits. Before signing on to the fleet coverage, Big Co. should investigate whether Big Co. can separately procure superior insurance.
Contractual Indemnification and Waivers. If an owner or operator does not hire a Part 135 operator or cannot purchase adequate liability insurance, the owner or operator can try to spread risk to other potential claimants by obtaining contractual indemnities from them that connects to that party’s insurance.
To make this work, the party that indemnifies the owner or operator, such as the UHNWI or Big Co., must modify that party’s insurance policy to obtain a blanket contractual liability coverage through and with the approval of the underwriter—not an easy task.
Even if the insurance company rejects contractual liability inclusion, an insured can still reduce exposure by asking third parties to waive their rights and claims against the insured in selected circumstances. For example, the UHNWI might try to obtain a liability waiver from their passengers or fuel suppliers (assuming the UHNWI’s compliance with the FARs).
In today’s aviation insurance market, underwriters have hit the brakes on issuing cheap and unprofitable aircraft insurance policies. No longer can owners and operators wait until the last moment before aircraft delivery or a renewal date to place, renew or modify aircraft insurance. Quite to the contrary, owners and operators should continuously monitor insurance placement, legal structuring and contractual negotiations to mitigate risk or allocate liability among appropriate parties.
Many aspects of private aviation transactions benefit from using industry experts to guide owners and operators. It is clear that insurance, regulatory, and transaction expertise in the current insurance market is not optional.