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Aviation Innovation

In a soft market, how can brokers grow in the aviation space? Above all, experts say it takes creativity to succeed

On March 8th, Malaysian Airlines Flight 370 departed from Kuala Lumpur en route to Beijing, just before 1 a.m. local time. There were 227 passengers and 12 crew members on board. One hour into the flight, ground control lost contact. In the following three weeks, investigations into the commercial jetliner’s mysterious disappearance came up empty. On March 24th, mistakenly citing evidence of satellite images of debris, Malaysia’s prime minister controversially notified the families of passengers, most of whom were Chinese nationals, that the flight was thought to have gone down in the Indian Ocean and that all on board were presumed dead.

What does an incident like this mean for the global aviation insurance market? At first glance, a tragedy of this scale in most markets would trigger a surge in pricing. But in aviation, many are unsure that even a catastrophic event of this size—with insurance claims expected to eat up all projected profits for the aviation insurance market this year—will have significant impact.

“The aviation market is softer than any other insurance market we deal with right now,” says Belinda Bryce, executive vice-president at The Magnes Group Inc., which specializes in the general aviation market. “It’s decreased by double digits year after year.”

Premiums, both in general aviation insurance and commercial airlines insurance, have been on a downward trend since 2005. Increased security and technology in the wake of 9/11 have contributed to a trend of low losses. At the same time, new underwriters are emerging in this space all the time, creating a flood of capacity.

The premium base for insurers is expected to be about $1.4 billion globally in 2014, compared to an all-time high just after 9/11 of $5 billion to $6 billion. “Because of the amount of capacity that’s available, it’s unlikely one significant event, even the worst scenario you could think of, will have a sustainable long-term impact on the aviation insurance market,” says John Rooley, CEO of Willis Aerospace Americas. “We saw this after the Air France incident in 2009. Insurers tried to increase pricing and rates went up for approximately two months before the excess supply piled in and the rates went back down again.”

As a result, brokers that specialize in aviation insurance are finding themselves in a fiercely competitive space. To retain clients and recruit new business—including poaching from competitors—requires brokers to create innovative packages in-house, act as risk management partners to their clients and to be at the cutting edge of analytics.

Taking Flight

The softness in the market comes at a time when the aviation industry itself is growing exponentially, creating a rapidly changing risk environment. The International Air Transport Association (IATA) predicts passenger numbers will increase by 31%, from 2.98 billion passengers in 2012 to 3.91 billion passengers in 2017. The IATA attributes a good chunk of this growth to increased demand in the emerging markets, particularly in China. Canada, is also expected to see growth, however.

“In the Canadian marketplace, there’s talk of a number of airline start-ups,” says Rooley. “Various companies are looking to get into that space, which was originally dominated by Air Canada.”

Both property and liability costs in the event of a loss have increased as well. In commercial airlines, rapid technological advances have contributed to highly sophisticated and valuable hulls, along with expensive security equipment. On the general aviation side, development in charter services, helicopter surveillance, drone monitoring and satellites is seeing a boom in value and growth.

“There is a natural growth in the aviation industry,” says Nigel Weyman, chairman of the aerospace division for JLT Specialty Limited. “Manufacturers are producing new products every day; the world needs aviation. In emerging [markets], people are suddenly realizing that traveling by air is a very economic and time-saving way to move. As manufacturers sell more aircraft, there’s peripheral aviation business attached to that, and new customers have been brought into their scope as well.”

But the growth in the aviation industry has not translated into growth for the insurance market.

Primarily this is because losses have been trending downward. Increased surveillance of everything from pilot activity to mechanics has made aircraft the safest means of travel in the world. Incidents like Malaysian Airlines Flight 370 and the Air France crash in 2009 are the exception rather than the rule, says Weyman. “There’s been a huge amount of investment in safety technology in the last five or ten years,” says Weyman.

“Everything that goes on in-flight is scrutinized by computers. Even the slightest anomaly will be identified. That same oversight by technology is occurring on the maintenance side; every maintenance requirement is being driven by IT monitoring systems. Engines are transmitting information to the engine manufacturer constantly. That sort of Big Brother, real-time view of what goes on in an aircraft is something we’ve never had access to before.”

For brokers, however, the low-loss environment means differentiation has become key to survival.

“It’s a moment when there’s a lot of competition between brokers to win business or retain business,” says Weyman. “This is very healthy for the clients, but tough on brokers because the margin has become pretty narrow, and very tough for the insurers because they’re on the receiving end.”

Current Conditions

Insurance requirements for commercial airlines and others are relatively formulaic. The most basic coverage involves damage to the aircraft itself, as well as costs for replacement parts. Over and above that, there are requirements for war or terrorism, and of course, passenger and third-party liability.

“When considering pricing and exposure, most insurers will analyze the entire airline portfolio, which includes approximately 450 risks,” explains Mike Hansen, global product leader, aerospace, at Catlin Insurance. “Information is very transparent and both insurers and brokers have pretty accurate records of the overall portfolio, which we use to build our underwriting models and tools.

“A major airline, for example, will carry at least $2 billion of liability coverage,” he adds. “That’s exposed every time an aircraft takes off, essentially.”

The IATA and its national counterparts, such as Canada’s Transportation Safety Board, are transparent with monitoring and recording data on losses in the industry, says Hansen. To remain competitive, brokers have to be up-to-date on the stats and able to provide appropriate peer group comparisons to get their clients the best pricing. They also have to be prepared to come up with creative solutions to their client’s needs.

“Our role is changing; we have to be aware of that,” says Bryce at Magnes Group. “We could lose a customer purely on price. We have to be educating our customers more on what’s happening, we have to make sure we’re not making any mistakes on our servicing and we’re constantly trying to find ways to provide new products and new coverages.”

Magnes has a number of niche offerings, including those with betterment coverage for lifetime components of an aircraft. An engine, for example, may need to be overhauled after 2,000 hours of service. Under most policies, if the aircraft has an accident halfway through the engine life and the engine requires an overhaul, the owner would only be reimbursed for half the cost. The betterment coverage would pay the other half.

“A lot of the larger brokers have their own manuscripting policy they use that can be more comprehensive than the standard available,” says Bryce. “This is stuff [brokers] can’t normally get in the mainstream. They have to come to an aviation specialist to get the best product.”

JLT’s Weyman says that the an advantage of a soft market is that it forces innovation. “The opportunities for innovation and price competition are probably more relevant and more prevalent than they are in a hard market,” he says. “If you can be innovative, you can deliver a competitive product, you’re going to have opportunities available to you.”

JLT has developed a product in-house called the Continuous Period Policy, which allows buyers to set premiums at current rates with no expiry date. If either party wants to change the terms of the policy, they are required to give 12 months notice.

“Airlines already hedge their fuel; they hedge their foreign currency, now they can also hedge their insurance,” says Weyman. “Insurers like it because they don’t have to negotiate with a gun to their heads with a client saying, ‘if we don’t like your price, we’ll go elsewhere.’”

Navigating Relationships

It may sound cliché to suggest brokers have to focus on relationships. But, both clients and insurers say that, in the aviation market, they are counting on brokers to be in continuous contact and focused on brokering the best partnerships.

“The broker’s main role is still to advocate for the client,” says Hansen at Catlin. “But they are clearly our sole distribution, and, therefore, it’s important we have positive relations with brokers who are distributing our products. With more than 100% capacity available for every aviation risk, we want them presenting a positive image of us. Brokers are a critical part of our sales.”

Clients are also counting on brokers to understand their businesses inside and out, says Laval St. Germain, director of flight operations for airline Canadian North.

“Yes, it’s a buyers’ market,” says Germain.

“That still doesn’t change the fact that, even in good times, our brokers have to be there to tactically position us in the market, no matter how soft or how hard. They have to make sure the conversations are going on about our company and our coverage.”

Canadian North, headquartered in Calgary, has a fleet of 19 jets that specialize in Arctic and remote operations. They’re somewhat unique in the global aviation market because of their need to land on gravel and to conduct highly sophisticated landings on frozen lakes.

Germain, who travels annually to Europe and the United Kingdom with his broker, says he wants insurers there to be able to put a “name to the face” when they arrive, and to understand the reality of the risk, rather than making misguided assumptions about Canadian North’s operations. He needs the broker to facilitate understanding, for example, that landing on a frozen lake isn’t a spontaneous thing, but that it requires laser analysis of the ice surface weeks in advance.

“It’s only a couple of days every year that we get to do our presentation,” says Germain. “We have to trust that our broker is doing the other 99% of our conversations with these people 12 months per year.”

Future Uncertainties

Brokers, underwriters and clients have been waiting with bated breath for a reversal in premium pricing. Some, like Bryce, say a market correction is imminent because, however safe the aviation market, losses are still occurring. According to the Transportation Safety Board of Canada, there were 290 aviation incidents involving Canadian aircraft in 2012, an increase of 13% over the previous year.

“The reductions we’re seeing in Canada are even greater than elsewhere; it’s a bit of an anomaly worldwide,” says Bryce.

“There’s no particular reason to justify that from an underwriting point of view. Canada is going to have to put the pricing up first.”

At Catlin, Hansen tentatively agrees that a market correction may be on the horizon. If it doesn’t come, he says, underwriters that don’t have sufficient scale to cover their costs and expenses may move out of the space altogether.

“Most insurers are dependent on the reinsurance market to be able to offer the very large limits,” says Hansen. “But the reinsurance costs that we have to pay to buy that coverage have not been reducing as fast as our original pricing. If the costs continue to be disproportionate to the revenue, there may be a correction.”

Finally, for many, the impact of the Malaysian Airlines catastrophe earlier this year puts a big question mark on the future of aviation insurance premiums.

“Is this Malaysian plane going to trigger a change in insurance?” says Weyman at JLT. “It hasn’t pulled the trigger on the hard market, but it has at least cocked the gun. If you had another major event, you may have to talk about underwriters raising premiums…There’s a lot of the year left.

“But I’ve been predicting a market correction for four years,” he adds. “It’s amazing the tolerance for pain that insurers have.”

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Copyright 2014 Rogers Publishing Ltd. This article first appeared in the April 2014 edition of Canadian Insurance Top Broker magazine

Transcontinental Media G.P.