The Aviation Working Party

1. The Aviation Working Party • Justyn Harding (chairman) • David Hart • Phillip Tippin • James Widdows The working party wish to acknowledge the valuable assistance provided by: • Richard Power • Cameron Johnston of BAIG

2. THE AVIATION AND SPACE INSURANCE MARKET

5. The Market The market can be split into the following areas: • Airlines • General Aviation • Space Risks

6. Airline Insurance is Big Business • Total premium is around US$1.4bn • Hull values up to US$225m • Liability payments can be over US$3m per passenger • The total cost of a single incident could exceed US$3bn • Over 500 airlines worldwide • War risks are covered separately

7. General Aviation • Aircraft with up to 40 passengers • Around 300,000 planes • Difficult to get an overall view of the performance of the market • More suited to a technical rating exercise

8. Product Liability • Annual premium around US$450m • Dominated by 4 programs • Claim sharing agreements are common • Hard to assess true profitability

9. Space Risks • Covers launch and in orbit risks • Annual premium around US$700m • Overall frequency of launch failure is around 4% • Loss severity is much more variable

10. Features of the Aviation Market • Rapidly increasing exposure • Rapid technological change • Dominance of small number of insureds, insurers & brokers • Vertical placement • Alliances and code sharing arrangements • Variability of claim sizes • Availability of reinsurance • Cyclical nature of business

11. Increasing Exposure • All sectors of the market are growing fast • Large numbers of increasingly expensive new airliners being ordered as fleets are modernised • Rising freight levels • Increasing number of passengers • More flights with smaller jets to provide better service • More frequent flights to wider range of destinations • More satellite launches

12. Technological Changes • Accident rate four times higher for non-industrialised nations compared to industrialised • Continuing process, always some accidents • Will reach safety plateau • Future Issues (a) Privatisation of ATC and possible conflict of interest (b) Need for secure communications (c) Regulation of crew drinking (d) Technological changes: cameras, radar to detect CAT • Better information is available to the public on which airlines and aircraft are safe

13. Airline Safety • New ranking system- Flightsafe • Non judgmental - allows for past accidents (number & nature), and ten factors including: average fleet age, type of planes, maturity of airline and the control environment • Air Canada renowned to be the safest airline, with British Airways ranked 9th and all five major US operators in the top 20 • Worst operators: (a) Small ex Soviet Union airlines (b) Nigeria Airways (c) Myanmar Airways (d) Merpati

14. Consolidation in Market • Only three brokers and four major manufacturers so have substantial power • Airlines and manufacturers becoming more global, so industry needs to respond • Merger of European and American insurance operations e.g. BAIG and AAU • This has caused the vertical placing strategy

15. Vertical Placing • Inefficient system that exploits poor market information • Risk placed with following market first who will not know lead terms • Different terms offered to leaders e.g. claims handling allowance or better rate • Many slips for one risk so terms not obvious • Difference between lead and follow terms can be up to 40% for airlines

16. Alliances & Code Sharing • Allow greater range of destinations to be offered • Invisible to public • Passengers on a flight may be travelling under different compensation regimes • Your paint, your claim adopted in practice

17. Claim Size Variation • To a large extent caused by differing liability payments • Hull values up to $225m • Liability payments up to $10m per passenger in US ($3m average) • Claims often split with products insurers • Highest overall claim $800m (Swiss Air) • Largest hull claim $150m • Will only rise in the future • Will rise as more operators move to unlimited liability working conventional defences

18. Reinsurance • Substantial amount needed to limit exposure • Reinsurance may end up with non aviation insurers - naive capacity • Naive capacity enters market on back of good years for the aviation market and falling returns in its own markets • Someone has to pay claims - this cycle the Australian reinsurers, REAC and GIO • Availability causes extreme cyclical swings

19. Cyclical Market • Rates are turning, particularly for airlines and these movements are dramatic • Thai Airlines recently suffered a 20% rise despite its size and having had few losses (none in the last year). • Indian Airlines facing 65% rise after two losses last year (A320 at Yangon and 737-200 at Patna) • This comprises an increase of 14% in liability costs and 90% in hull costs

20. Airline Trends • Bigger aircraft • Unlimited liability • US Courts & Inflation • More traffic • Approaching safety plateau • Code sharing and the “deep pockets syndrome” • Overall => losses to increase

21. General Aviation Trends • More private wealth • Implies more traffic • Growth rate => airline growth 10%pa • Overall => losses to increase

22. War Trends • Middle East? • Air rage and pilot suicide • Hijackings • Overall => losses not set to improve

23. Satellite Trends • Cheaper launches • Lower orbit launches • Implies more failures? • US manufacturers losing market share to Chinese • Ageing satellite population increasing in-orbit risk • Overall => losses likely to increase

24. In General • Increasing costs • Market WILL turn • But retro market will turn first • Could see a vicious 2000 year for arbitrageurs

25. Vertical Placing • Smoke and mirrors placing • Maximises opportunity for imperfect information • Leading to inefficient market results • Result of too few brokers, too many underwriters

26. Lemmings • Players in the market doing better than average by making money from their reinsurers. • Somebody selling reinsurance too cheaply. • Ultimately someone will end up sitting on a very poorly priced liability as losses work through retro layers. This cycle much of losses have ended up with REAC and GIO • Late 1980s saw marine underwriters caught the same way. • There is a macho image associated with aviation XL

27. Lemmings • And still companies start up new aviation wings - DP Mann only a month ago. • Situation is theoretically unsustainable, but will last as long as there are lemming insurers prepared to throw capital off a cliff. • The ultimate question is a simple one. Are our lemmings dying off too quickly to survive, or is this ritual suicide a symptom of a constant level of overpopulation? • For non-US risks last year, available capacity equalled 170% of the size of the aviation insurance market. • Who are our next lemmings?

28. THE END