04 April 2025
Frequency and Severity An Insurer's Nightmare
In the Q4 2024 edition of Plane Talking, Gallagher provided an update on the state of the market as we entered 2025 and referenced the impact that further losses could potentially have, following the tragic incidents involving Jeju Air and Azerbaijan Airlines in late 2024. That series of air disasters has continued into 2025, and we now face a period of uncertainty as the market seeks to adjust in order to maintain sustainability.
According to industry media reports, the Jeju Air loss has now been reserved for a sum in the region of USD300 million. In isolation, this loss may not have typically had a meaningful impact on hull and liability pricing. However, the fact that it occurred after the busy fourth quarter renewal season makes it more significant, as it did not allow insurers to factor the impact into their underwriting strategy for this year.
Early in 2025, the mid-air collision in Washington DC, involving American Airlines and a US military helicopter in which 67 people were killed was followed by the landing accident at Toronto Pearson Airport, involving a Delta Air Lines feeder operation called Endeavor Air which resulted in the aircraft coming to a halt upside down with a wing missing. Thankfully, all the passengers and crew survived in this event, which is a credit to the integrity of the airframe. In addition, there were a handful of other significant but relatively unpublicised losses during January and February.
The potential impact of these and the other losses this year cannot be overlooked as the accumulation of attritional losses (losses less than USD10mn) and these larger events are likely to be the tipping point at which aviation underwriters become unprofitable for the 2024 underwriting year and/or the 2025 calendar year. Calendar year economics becomes very relevant as senior management not only analyses underwriting results but also cash flow as this is the fundamental to a successful business.
What does this mean for the airline insurance sector?
Availability of capacity is generally the driver of pricing in the market, but for capital providers to maintain their commitment to the class of business, they expect a return on their investment over time.
Basically, underwriting profitability (or loss) is looked at using three basic metrics:
1) Premium coming in against claims (Paid and Reserved) going out
2) Expenses also going out
3) Combined Ratio, which is essentially produced by adding 1) and 2) above.
Crudely, a ratio below 100% indicates that the company is making an underwriting profit, while a ratio above 100% means that it is making an underwriting loss. However, this number cannot be looked at in isolation as insurers will also need to see a profit margin from the underwriting, therefore, the Combined Ratio must be nearer 90% in order to provide enough margin to make the business profitable and sustainable. Return on Equity, will also be factored into an investor’s assessment of the business, this is a more complex calculation that is relevant to capital providers as it will enable a more long term view of the business.
Premium and claims are relatively straightforward to understand, but expenses and the impact to underwriters' performance are not.
Expenses will include operational costs (staff, office space, support functions, third-party providers, Travel & Entertainment) and the cost of reinsurance. These are usually fairly fixed in terms of money spent, as such, if top-line premium income reduces, the expense ratio will increase, in addition, with less premium to pay for claims the claims ratio will also climb unless the underwriting risk selection process improves or an underwriter gets lucky and misses some losses. (Who would want to write a business plan based on getting lucky?) The overall outcome from this simple equation is that it is very difficult for an underwriter to shrink profit as both expense and claims ratios work against you. This invariably means that underwriters pay more attention to premium income in order to reduce the impact of a rising expense ratio. In a soft market with rates reducing the net logical result is that loss ratios increase. The trick is therefore to balance these metrics. This puts any underwriting business under immense pressure.
The other important feature to be considered is reinsurance. Underwriters who participate in the Airline or Aerospace lines of business (and some top-end General Aviation) will generally need to buy Excess of Loss reinsurance treaties (XOL) to protect their financial position as these segments have a volatility impact on the result. XOL will limit the net loss incurred when a loss event exceeds a predetermined threshold. There isn’t a standard trigger point for XOL to attach, and each insurer can buy at different levels, albeit this would influence the reinsurance premium charged.
The cost of XOL is fixed, based largely on income and exposure, with a minimum premium often applying. This again, encourages underwriters to write for premium income to cover this cost. This is effectively another risky strategy as underwriters once again write for income in a market where rates are decreasing. This produces the same metrics as mentioned earlier. Writing business that is underpriced to pay for expenses and reinsurance has a short shelf life.
What does this mean in the context of the current market?
Based on our own data, we believe the total Airline hull and liability market generated approximately USD1.65 billion net (Leaders’ terms) in 2024. The chart included shows the recent claims performance of the airline portfolio, using the aggregated data from all submissions received by Starr. What this identifies is slightly lower claims in 2019 and 2020 as these years were severely impacted by COVID, but 2021 returned to what we would see as a ‘normal’ year with regard to attritional losses.
The 2022 underwriting year (which covers the majority of the 2023 calendar year) was the safest in history, with no fatalities resulting from accidents involving commercial jet aircraft. This masked the worrying upward trend in attritional losses. As you can see, there was a significant increase of more than USD200 million, and unless more is done to mitigate these incidents, we believe these costs will continue to rise.
The 2023 underwriting year is still relatively under-developed; hence, we account for IBNR (incurred but not reported lossesThis figure is derived from actuarial analysis of the book of business by looking at claim deterioration over time and also known events which have not yet been reserved and accounted for. Taking this into account, will bring the total attritional losses for the year to just below USD1 billion.
Based on the assumption that attritional losses will remain at a similar level for the 2024 underwriting year and comparing this to the premium generated in 2024 (USD1.65 billion) only leaves approximately USD650 million to pay for any large losses. This is before expenses are allocated and any profit margin. When factoring in known losses to date, we can already assume that 2025 will be a challenge, particularly if your business is largely airline or major risk business.
Attritional losses continue to erode the premium base
Something that we have been concerned about over the past few years is the alarming rate at which claims costs have been increasing. With the introduction to the service of new aircraft types over the past 10-15 years, we saw an advancement in technology and the materials being used to drive improved efficiency to meet the airlines’ needs. This has brought a new challenge when it comes to claims, specifically concerning:
1. Who can carry out the repair? Often requires OEM repair scheme.
2. How much will it cost to carry out the repair? Engine claims can exceed ten times the cost of repairing more traditional models.
3. How long will it take to source the parts and obtain a slot for the work to be completed? Delayed repairs generally increase the cost, as the aircraft will incur costs for parking or hangarage, as well as increased cost of working.
Andy Pickford from Gallagher provided some great insight on this topic in the last edition of this publication, but I wanted to put this into perspective when looking at it from the context of the airline insurance market.
Mitigating the impact of attritional losses
Over the past six years, Starr have been working with our clients to address some of the most challenging drivers of attritional losses. Starr Consulting Services (SCS) has highly experienced aviation industry experts offering a variety of solutions, from wildlife management, Upset Prevention Recovery Training (UPRT), human factors, emergency response planning and impairment management, to name but a few.
Risk management is a key factor for clients to demonstrate to underwriters that they want to differentiate themselves from the competitors. Starr’s advice to clients would be to communicate and showcase their efforts to improve safety and mitigate against incidents that frequently cause attritional losses.
Prediction for 2025
Every underwriting office will have its own view on what global premium they need to derive from airline sector to make them sustainable; however, it is clear that current rating levels are not adequate across this part of the business. This fact becomes more pronounced when we consider the impact of social inflation on claims, both Hull and Liability and ‘nuclear awards’ for liability claims, arising from injury and death to passengers, crew and third parties on the ground. This is genuinely a cause for concern amongst insurers as pricing models haven’t kept pace with social inflation.
We’ve already seen a major insurer withdraw from the aviation sector in 2025, and it wouldn’t be surprising to see more companies make the tough decision to pull back capacity as the year progresses.
There is little doubt that statistically, when isolating just the airline segment, the market needs to see positive rate change and premium growth to preserve current capacity levels. If more capacity starts to disappear, then dependent upon how much goes will determine the volatility of the rate movement upwards. Controlled premium growth over time that recognises the rising cost of claims, will make the business more sustainable without adversely impacting clients’ (airlines) balance sheets; however, as mentioned earlier, capacity drives price, so this needs to be factored in by clients, brokers and underwriters when negotiating renewal terms for the business. Sustainability for our business needs to be all-encompassing if what we want is a market that does not have volatile changes.
From a Starr perspective, we see ourselves as a long-term partner for clients and can provide support across the entire suite of aviation products, including Deductible, Hull War and Third-Party War Liability. Due to this, we always look to bring stability and certainty when it comes to pricing. We prefer to see gradual and manageable movement within the market rather than dramatic peaks and troughs in the cycles, which make it hard for clients to budget. Fundamentally, partnership and mutual understanding of the needs of our respective businesses is the way forward.
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