The aviation reinsurance market has turned hard overnight, as an already extremely complicated landscape was shaken up by a shock surge in the Boeing loss which will reverberate through all tiers of the value chain.
Having passed through a phase in which insurers suffering from years of under-pricing continued to secure improved outcomes despite a highly distressed client base through better exposure-adjusted pricing, a new phase will now begin in which insurers face a major squeeze from reinsurers.
The radical shift reflects the latest development in the long-running and highly complex claim involving Boeing’s 737 Max planes, with the aircraft manufacturer indicating that its expected claim was set to rise to $2.1bn, after a ~$650mn increase in one component of the loss.
The claim on Boeing’s manufacturers’ policy, led by Global Aerospace and brokered by Marsh, is comprised of three components:
1) the cost of the grounding of the faulty planes
2) costs relating to the crash of Lion Air Flight 610 in October 2018
3) costs relating to the loss of Ethiopian Airlines Flight 302 in March 2019
Crucially, some of the liabilities attaching to the two lost planes are being paid out directly by Boeing rather than hitting the airline all-risks policies of Lion Air and Ethiopian Airlines, with Boeing essentially “stepping into the place” of the airlines to address the liabilities resulting from the crashes.
The component relating to Ethiopian Airlines Flight 302 has now grown by around $650mn to approximately $990mn, taking the combined loss above $2.1bn, and within sight of the policy limit of $2.25bn.
This is just the latest instance of loss creep, with early expectations of the insured losses relating to the Boeing 737 Max issues pointing to a figure closer to $1bn.
Sources have said that Boeing has been pushing hard to settle claims from passengers’ families to avoid court cases in the US, which would create scope for the kind of nuclear awards increasingly seen in that jurisdiction, underscoring the way social inflation is changing the risk profile of the aviation market.
Worst since 9/11
The degree of controversy around the surge in claims has been heightened by the timing, with the new loss notification dropping in the midst of the airline market’s crucial Q4 renewals.
This latest deterioration establishes the Boeing loss very firmly as the market’s biggest since World Trade Center in 2001. Sources have said estimated that reinsurers will pay at least $1.5bn-$1.75bn of the loss, and substantially all of the latest ~$650mn deterioration. A small amount of this will be ceded to the modestly sized aviation retro market.
The aviation reinsurers with the biggest market share are Swiss Re, Hannover Re and Munich Re. While other carriers that participate in the line of business include PartnerRe, Liberty Specialty Markets, Lancashire, Cathedral and the Atrium consortium.
Sources said that the deterioration was equivalent to between two and three years of the aviation excess-of-loss reinsurance premium pot globally (~$250mn), although typical quota share structures in aviation are uncapped, pointing to heavy losses here as well.
The degree of consternation caused by the loss is indicated by whispers from the market that some reinsurers pulled quotes for business (some aviation treaties are bought at 1 November or 1 December owing to the preponderance of Q4 renewals in the primary airlines book).
Having locked up the market is returning to quoting but, having shown meaningful hardening in 2019 and into 2020, it is now in hard market territory.
Sources said that even clean business – Boeing’s programme is widely spread but not written by all aviation markets – could attract 40%-50% increases, while those ceding heavy Boeing losses could expect to pay rate rises of 100% or above. Even ahead of the deterioration Willis Re’s 1 January renewals report said clean business was at +15%, with loss hit business – implicitly from Boeing – going at as much as +70%.
The excess-of-loss reinsurance market has had a very strong run of performance, with only bottom layer losses aside from Air France in 2009, but the premium pool has effectively been run down to a level where it cannot support the biggest losses.
However, this run-down of the premium base over 15 soft years following the 9/11 peak, likely means that early fears some aviation insurers will be unable to afford to buy their reinsurance will prove overdone.
Aviation treaties renewals are quite spread, with some in Q4, a further tranche at 1 January and others not until 1 April and 1 July. But whether it is almost immediate, or weighted to H2 next year, all aviation insurers are facing up to a substantial squeeze on margins.
Between a rock and hard place
In their attempts to offset the margin compression from increased reinsurance costs, aviation insurers will collide with a client base that is distressed to the point of near-bankruptcy as a result of disruption relating to Covid-19.
According to International Air Transport Association (IATA) airlines revenue in the second quarter of fell by 80% compared with the same period last year and burned around $51bn in cash reserves in the quarter. This cash burn is expected to continue in to 2021, with a second wave of Covid-19 impacting many countries and pushing out a normalisation of revenues.
Nevertheless, aviation insurers have had a good crisis, with a premium handback for calendar year 2020 expected to come to 25%-30% of the total against a rough halving of attritional claims activity – although a squeeze on premium levels creates pressure on expense ratios. Non-payment of premiums has also failed to emerge as an issue.
Rate rises in the market have also been running at around 20%-25% and this looked like the continued benchmark for Q4 renewals, with minimum premiums for airlines likely to run in the 75%-85% range – putting a floor on premiums regardless of how little flying is done.
Aviation is a relatively early market, with deals sometimes agreed months ahead of inception, so it remains to be seen what proportion of the upcoming renewals are still in play. What is left is likely to result in highly challenging discussions between insurers and clients.
And the key question there is whether insurers will be able to extract any further concessions from airlines to cover the reinsurance costs – something which will be a difficult ask as major airlines roll out mass redundancy programmes and plead for state bailouts.
As one source said: “Everyone will be looking for money that does not exist.”
One potential safety valve is for payback to be pushed into other areas of the aviation book besides manufacturers’ and airlines including general aviation and space, but these areas were already seeing major increases, particularly the latter where rates in some cases had been doubling.
In the next phase of the aviation market’s crisis, insurers may find themselves between the rock of their reinsurers and the hard place of their clients’ inability to pay more.