19 September 2014News

An era of turbulence

In order to comprehend the true insurance repercussions of such tragic, extraordinary events as the losses of Malaysian Airlines flights MH370 and MH17, one first needs to understand their context in terms of how the resulting insured losses are being settled.

As Ian Wrigglesworth, global practice leader of Guy Carpenter’s aviation and aerospace business explained: “The complexity with the losses is really which particular coverage is picked up, in which markets and which sectors.”

The first loss—the disappearance of MH370—is being shared between hull war underwriters and hull risk underwriters in a 50:50 advance settlement. This is the current situation, according to Wrigglesworth, who said that “the claim has been paid and shared, but the merits of each of them paying an equal share or otherwise will be discussed at a later time”.

The liability loss, on the other hand, remains a subject of uncertainty until the policy leader posts an official reserve figure, as is usually the case. In this instance, Allianz will use gathered data on the passenger mix and loss expectations to calculate this figure, eventually releasing it into the market. This access to data means that Allianz is therefore the most accurate judge when it comes to this kind of information.

One might think there would be extensive implications when it comes to designating the cause of the MH370 loss, considering the plane ‘disappeared’ under mysterious circumstances. The loss designation will impact the hull portion of the loss only however, and as it stands the all risks market and hull war market will split the $108 million hull loss down the middle.

This all hangs in the balance however, as Doug Morrison, Arch Re’s managing director of treaty casualty and aviation explained: “If the cause is determined to be a deliberate act by the pilot, the hull war market will then be liable for the full hull loss amount.”

The shooting down of MH17 over a combat zone presents a more complex situation. As described by Wrigglesworth, a three-way payout split means that the war market would pay for the physical damage to the hull, the passengers would be covered by the all risks market under Malaysian Airlines’ normal passenger liability policy, and a separate panel of insurers would be presented with a further claim if there was any third party involvement from air traffic control or others.

Additionally, according to an AM Best briefing on the insurance implications of MH17, The Montreal Convention provides a payout of approximately $175,000 to each family, and permits them to sue the airline and the airplane’s manufacturer for additional damages. However, the airline’s liability exposure per passenger will be capped unless it is deemed to have been negligent.

Looking ahead, Wrigglesworth believes that pricing will be the only major factor facing Malaysian Airlines when it comes to obtaining future coverage. He says that regardless of the high profile losses suffered by the airline, brokers will assist Malaysia Airlines if they actively search the market. “They’ll be able to fill out the slip depending on the price that is charged—so it is dependent on price rather than struggling to obtain coverage in the first place,” he said.

Lloyd’s is still the preeminent quoting market for aviation hull war business, so Wrigglesworth said that he would expect it to be very involved with the original placement and its rating, as well as providing existing and future capacity. AM Best’s report states that as an industry leader in the global aviation sector, the Lloyd’s market will undoubtedly be affected by recent passenger liability claims, as will a number of global reinsurers. Due to Lloyd’s players’ level of exposure and the general nature of the losses, a complex and lengthy settlement period is anticipated.

According to recent reports, MH17 is valued at approximately $97 million, so there is more certainty in terms of the overall cost of physical damage. AM Best’s MH17 briefing confirmed that Lloyd’s Syndicate 609 and its co-insurers, managed by Atrium Underwriters, are responsible for settling the hull war policy for Malaysia Airlines MH17 and instigating the collection of funds.

AM Best’s briefing states however that given the diversified nature of business underwritten by those involved in providing coverage, “AM Best does not expect to take any rating actions in response to this single large loss.”

Yet, some ambiguity remains as to whether the agreement is to be settled on the basis that the early key facts are correct; that the hull war insurers, not the all risks policy, are held liable; and that the plane was indeed shot down. This uncertainty means reaching finality regarding payout will prove difficult.

What does this all mean?

These aviation disasters provide some indication of the challenges facing those entering specialty markets, as many are looking to do as they diversify their portfolios. Wrigglesworth said he has seen a few new entrants already this year, driven by an appetite to develop by line. “There is a desire to diversify, and it’s one of the main drivers of the constant supply of new capacity.”

Currently, around 50 separate insurers are able to take a share of major international airline placements, which are written predominantly through just three brokers: Marsh, Willis and JLT. These firms have a commanding market share, while the competition between them is intense and prices tend to favour the insured. Wrigglesworth added that while there are some very knowledgeable, experienced leaders in the marketplace, “the abundance of available capacity and fierce competition means the voice of reason is sometimes drowned out by price”.

Aviation remains a favoured line among insurers as it is an uncorrelated line of business, but there are potential pitfalls in the pursuit of diversification in both insurance and reinsurance. As Wrigglesworth questioned: “Are rating agencies inquisitive about profitability by diversified line or is credit just given for the diversification in its own right?”

A final issue to tackle is the ramifications of these losses when it comes to future rate heading. In recent times, an abundance of capacity has placed considerable pressure on pricing and terms and conditions across all aviation lines. AM Best says that international airline rates were significantly below peak levels at the beginning of 2014, and Wrigglesworth believes that this is due to consistent discounting that has taken place over the years.

It comes as no surprise that a number of significant sources in the marketplace are keen to eliminate the rate reductions of the last two or three years and get them back on track. Yet, in spite of a number of large losses in recent years, “the market has remained profitable, largely due to the positive development of prior year claims reserves, and fierce competition”, says AM Best.

AM Best says that for the niche aviation war risk market, losses this year will considerably outweigh premiums written and insurers are expected to react with substantial rate increases. “The market is able to respond quickly to large losses and escalation of political violence by imposing additional premium for airlines flying over areas deemed high risk,” said AM Best.

The three high-profile losses this year—the disappearance of Malaysia Airlines flight MH370, the downing of Malaysia Airlines flight MH17, and the hull loss of Air Algérie flight AH5017—should serve to halt the decline in aviation rates. However, increases will evidently be constrained by the wealth of capacity serving the market, so some uncertainty remains as to whether the aviation industry will regain its foothold as a high-flying specialty market of choice among diversified, global players.