06 April 2023
Aviation reinsurance challenges
After a turbulent few years with the impact of the COVID-19 pandemic, geopolitical shocks and macroeconomic challenges affecting the insurance and reinsurance industry as a whole, rates for aviation reinsurance increased at the most recent renewal.
Recent history
The insurance and reinsurance market will always be cyclical, and the aviation segment is no exception to this. In recent years we have seen turbulent cycles that have led to some carriers restricting the amount of aviation business they underwrite, or in some cases withdrawing altogether.
The aviation insurance and reinsurance market underwent a severe correction in the early 2000s, following the tragic events of September 11, 2001 and several other large aviation losses. As well as introducing exclusions and tightening terms and conditions, many aviation underwriters also began to introduce pricing tools and use more actuarial resources. There then followed a prolonged period of low claims activity — about a decade — for both the aviation all-risks and aviation war reinsurance market, which resulted in a widespread market softening.
The soft market of the 2010s, however, where a series of large losses occurred at a time when rates were low and terms and conditions broad, left many aviation insurance and reinsurance underwriters suffering from deteriorating profit margins and lacklustre combined ratios. When the series of catastrophic windstorms Harvey, Irma and Maria hit in 2017, the reinsurance market sustained large losses. The management of many companies took a hard look at which lines of business were not returning sufficient profits, and many withdrew from aviation entirely at that time.
The industry is also faced with the challenge, and opportunity, of a transition to lower carbon, more sustainable fuel sources and the drive towards net-zero.
Where are we today?
Fast forward to today, and the aviation insurance and reinsurance market is facing another set of challenges. Global inflation, and social inflation, coupled with the volatile geopolitical environment is affecting companies of all types around the world, but is perhaps particularly acute for the aviation insurance and reinsurance segment.
In recent months and years there has been a series of very large aviation losses which has had repercussions throughout the whole of the aviation insurance and reinsurance market. Against this backdrop, however, the aviation industry itself is beginning to show green shoots after the difficult years during the height of the COVID-19 pandemic.
The industry is predicted to return to almost pre-pandemic levels this year as the demand for air travel continues to pick up after the lifting of travel restrictions.
There is still a number of challenges for the airline industry, however, including inflation, rising fuel costs, labour shortages and supply-chain crunches to name a few. The industry is also faced with the challenge, and opportunity, of a transition to lower carbon, more sustainable fuel sources and the drive towards net-zero.
The expected return to profitability for airlines should spell good news for both insurance and reinsurance underwriters. We hope that the support that the insurance and reinsurance market showed through the past few difficult years for the aviation industry will not be forgotten. And the large claims paid out by our market should, we believe, serve to underline the value of the product we provide to our clients.
Surprise market reaction
The series of unprecedented losses from 2019 to 2021 prompted very different reactions from different areas of the market.
To put those loss years into perspective, it not only impacted previous market profits for a number of years, it was greater than the total worldwide insurance premium, and many times larger than the aviation reinsurance and retrocession premium income.
In response, the aviation reinsurance market introduced large rate increases. Retentions were reviewed, minimum-rates- on-line re-examined, and coverage restrictions introduced. This move was already underway before the largest renewals took place, and clients and brokers were given the warning by reinsurers that this is not likely to be just a short-term reaction.
It’s likely that for the medium-term at least, a hard market for aviation reinsurance will persist. In the insurance segment, however, the reaction was somewhat mixed. While some insurance underwriters clearly agree with their reinsurance counterparts that a correction is needed, others have pointed to their ‘risks-attaching’ reinsurance programmes and decided that there is no immediate need for change as they still benefit from historic terms and conditions.
The aviation insurance market currently has ample capacity, with some established players seeking to grow their market share, in anticipation perhaps of increasing rates in the near future, and some newer capacity with fresh appetite also looking to build market share.
Most cedents did seem to indicate that a primary rate increase will happen over the course of 2023, but this is of course more difficult to achieve when capacity is plentiful.
As a multiline reinsurer, AXA XL Reinsurance has experience of what can happen when portfolio re-evaluation results in more targeted use of capacity and other reinsurers have also experienced the necessity of withdrawing from a line of business. We do not want to see this happen in the aviation reinsurance space.
While we appreciate that it is more difficult to increase rates when there is ample capacity, some of the market reactions in the insurance market did surprise us.
For example, it is not clear how newly introduced multi-year deals help to secure future rate increases when no or very little automatic increases are built in? The other question is why securing a large or new share in a year with rate reductions is beneficial, when in a market with differential terms a share can be secured almost at every renewal. One could argue that the position on the slip is better for the renewal, but maybe it’s at a lower level with a smaller share from everyone.
The most convincing rationale appears to be that most of the reserve increase from the recent losses only really hit the profit and loss accounts of reinsurers, as the loss was already within excess-of-loss programmes and the reinstatement premiums on the primary side were purely attritional.
Outlook
Market players must do their own analysis as to whether they believe the rates they can achieve are adequate and check the health of the market for major risks. They need to try to assess whether the market premium income for 2023 will return to somewhere near pre-coronavirus levels, and whether exposures are at a similar level too.
General costs are on the increase as inflation bites, and reinsurance rates are likely to continue to increase or remain at today’s levels for some time to come. Buyers of aviation reinsurance should consider the reinsurer position when it comes to adjustable rates even if direct market premium is not growing at the same pace as the rates-on-line. Nor should a tougher stance on minimum premiums come as a surprise.
One potential reaction of the excess-of-loss market to current conditions could be to change the basis of coverage to losses-occurring; this would then negate some of the argument for delaying rate increases.
We are already seeing a clear reduction in appetite for proportional business. This typically is a sign of scepticism about future profitability and might be driven by rate adequacy or structural issues like unlimited event definitions.
Reinsurers should not have to act as the market police and do not want to be seen as the voice of doom. But it is necessary for a sustainable product to be able to demonstrate that there’s a chance of a healthy return on the capital investors have loaned us, and aviation requires rather a lot of said capital given the large exposures and limits in our market.
Risk managers do understand that position and will no doubt agree that the product this market offers is still of very high value, even when they have to pay slightly more than they perhaps did in the past.
There were not many other things outside the insurance and reinsurance market which got cheaper in 2022: other than primary airline insurance.
We believe that a sustainable market with stable capacity is a healthy market and we hope that the technical analysis of the professional market players will continue and underwriting discipline will return, even if there is more than enough capacity.
Over history the reinsurance market has not always been the most disciplined and time will tell whether the current market cycle will result in a return to healthy growth. But we believe that learning from the lessons of the past and thinking about the changing risk outlook of the future will mean that the aviation (re)insurance market remains in good health for the medium term.
The Walbrook Building 25 Walbrook London, EC4N 8AW
Author
André Liebkopf
Head of Property & Aviation, International Reinsurance
AXA XL
Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.