Recent Developments in the Aviation Insurance Industry

Article excerpt

ABSTRACT

The aviation industry has been hard hit in recent years. While there are numerous factors that have contributed to the industry's dilemma, rising and volatile insurance premiums-particularly after the events of 9/11-have posed a particular problem for many airline managers. Despite a general trend for accident rates involving commercial passenger airplanes to decrease as aviation technology has advanced over the years and airplanes have become safer, the aviation insurance market has been far from stable. This article provides an overview of how the aviation insurance industry works and how it has changed in recent years. We take a look at how the risk is spread between insurers, how insurers treat deliberate acts of violence, and lastly, how insurers price the risk. Our article shows that the aviation insurance market has undergone considerable changes in recent years and that it has adjusted to the post-9/11 aviation insurance realities being reasonably ready to handle events of an even more catastrophic magnitude.

INTRODUCTION

Aviation accidents, although infrequent, have the potential to result in large property damages and a high number of fatalities. The extant academic literature includes several studies that examine the strategic and financial consequences of aviation accidents for the affected airlines. Chance and Ferris (1987), Davidson et al. (1987), Walker et al. (2005), and Pukthuanthong-Le et al. (2007), for example, study the stock price reaction of airlines following an accident announcement.1 In addition, Carter and Simkins (2004) and Flouris and Walker (2005) take a detailed look at the airline industry's reaction to the events of September 11, 2001 (9/11).2 Yet, despite a thorough examination of the airline industry's reaction to aviation accidents that is provided by these strands of literature, there have been comparatively few studies that consider how insurance companies which ultimately pay the bills - are affected. Our study adds to the existing literature in this area by exploring how the insurance industry has reacted to the events of 9/11.3

In the first part of our study we aim to provide insights into the inner workings of the aviation insurance market. Specifically, we take a look at how the risk is spread between insurers, how insurers treat deliberate acts of violence, and lastly, how insurers price the risk. The statistics and related discussions presented have been developed through cooperation with several industry insiders and should be of interest for both practitioners and academics alike. In the second part of the article, we focus our attention on the events of 9/11 and examine how they have affected both insurers and insureds.

We document that the aviation insurance market has undergone considerable changes in recent years that included, among other things, the withdrawal of numerous insurance policies immediately following the events of 9/11, the departure of several insurers and reinsurers from the aviation insurance market, the creation of a new drafting body for insurance clauses, the redrafting of several old insurance clauses to better address war and terrorism risks, the reformulation of previously designed disaster scenarios, and an active discussion among airlines, insurers, and governments about governments' role in insuring certain war risks. We will review and discuss each of these developments in detail in our article, and while many of them are still ongoing, it is fair to say that the insurance market has already sufficiently adjusted to the post-9/11 aviation insurance realities so that if worse comes to worst, it would be reasonably ready to handle events of an even more catastrophic magnitude.

THE AVIATION INSURANCE MARKET4

The fundamental principle of all forms of insurance is that "the premiums of the many will pay the losses of the few."5 As insurance businesses exist in the commercial realm, they use conventional business management principles applied in the way they operate. …