Airlines Look to Provide Their Own War and Terrorist Coverage

More than a year after Sept. 11, the U.S., the European Union (EU) and many other countries are still working on ways to provide adequate insurance coverage for their air carriers. While several plans have been suggested, none are actually functioning and carriers continue to rely on their governments to provide the coverage they need.

The situation became acute in the EU at the end of October. Just after Sept. 11, 2001, the European Commission (EC), suspended regulations that prohibit governments from subsidizing companies. This permitted countries like the U.K., France, Germany and others to offer their air carriers insurance coverage at an affordable cost, at a time when many policies were being cancelled outright, policy limits were reduced, rates were going through the roof, and aviation reinsurance was widely unavailable.

Originally scheduled to end in Dec. 2001, the EC extended the authorization several times, most recently in June, when it set Oct. 31 as the cut-off date. That was supposed to be absolutely, positively, the last extension, but Germany announced that it will insure its airlines until the end of the year, and asked that the deadline be extended. Others will probably do the same.

In June, the EC presented “an update of developments in the insurance market,” and undertook “a first assessment of the various initiatives undertaken by the insurance and air transport industry at European and international level.” It concluded that “the commercial insurance market should not be unnecessarily restricted; government exposure should be limited as much as possible and mutualization schemes should be thoroughly assessed.”

That last comment presents the classic response of many industries every time insurance becomes unavailable or too pricey—start your own insurance company for your industry. Whether they’re called risk retention groups (RRG’s), captives, or mutual insurance companies, their purpose is the same—spread the risk over the entire industry, charge adequate, but not excessive, premiums and lower the cost of insurance while increasing its availability.

The airlines’ situation is somewhat analogous to the “capacity crisis” in a number of industries that has led to the increasing formation of RRG’s and their cousins (See Insurance Journal Aug. 5, 2002.) Airlines, however, have problems beyond those of other industries.

To begin with most companies operate at a loss, especially after Sept. 11. Their equipment is dreadfully expensive to acquire and maintain, accidents, although they happen infrequently, do nonetheless occur, and are usually disasters of major proportion with losses running into the hundreds of millions of dollars.

In addition to the staggering claims liabilities, banks finance a large portion of aircraft purchases. Also a sizeable proportion of many fleets are leased. Ironically the two biggest lessors in the world are GE (its GECAS unit is the world’s largest) and AIG (its ILFC subsidiary is number two), who also happen to sell insurance. GE also makes a lot of the components, including the engines that go into the planes. These financing and leasing contracts require the carrier to maintain certain levels of insurance on the aircraft and the airline is in breach if it doesn’t, which effectively grounds the planes.

Following Sept. 11, what coverage was available carried a $50 million per occurrence policy limit on third party claims, and coverage could be cancelled on seven days notice. This was clearly insufficient. A single WTC claim – filed against American Airlines- asked for $50 million in damages. And aviation insurers are still reluctant to accept the $700 million or so per plane in third party liability coverage.

Enter the RRG’s. There are three proposals in the works. The most advanced is the U.S Equitime. The Air Transport Association (ATA) and Marsh Inc. have already formed a captive insurer in Vermont. Plans call for it to cover a first layer up to $300 million in third party and war risk liability with no requirement to obtain a policy in the commercial market. If government approval is obtained, the Federal Aviation Administration (FAA) will provide an additional layer of coverage up to $2 billion for the next 4 to 5 years, when, barring any huge losses, Equitime should be fully funded.

ATA members, who supply more than 95 percent of all air passenger and cargo transport in the U.S., and airport maintenance and service providers, would be the owners of the company. According to a comparative study by Marsh, the annual base premium rate per passenger would be 64 cents. This projects a “maximum total estimated annual premium of $435 million, assuming 100 percent participation.” $75 million would go to the government for its excess coverage leaving $360 million to fund Equitime, plus the $50 million to establish the company.

The study compared rates in the “usual aviation markets,” which are currently asking around $1.25 per passenger for coverage up to $50 million, and “new excess third party markets” that are seeking $1.85 per passenger for third-party excess and war liability coverage.

The Association of European Airlines and the European Regional Airline Association worked out the general formation of Eurotime in collaboration with Marsh, Aon and Willis. It’s roughly equivalent, if a bit less ambitious, than Equitime. It provides for $1 billion per occurrence, increasing to $1.5 billion if passenger war liability is included. According to Marsh’s comparisons, plans call for a 50-cent charge per passenger that would cover third-party liability and war risks. This would generate $325 million annually, assuming full participation, of which $65 million, roughly 20 percent of paid premiums, would go to governments for their excess coverage.

Airlines would be required, however, to obtain $50 million in first layer third party coverage through the private sector, unless they can show that such coverage has been cancelled. The scheme would also require the participation of the governments in countries where the carriers are located, and the approval of the EC.

Eurotime is projected as a medium term solution to the problem, which will eventually be superseded by a more inclusive global RRG proposed by the International Air Transport Association (IATA) through its operating arm the International Civil Aviation Organization (ICAO).

This plan would cover airlines globally on all the 1.7 billion passengers who fly each year for third party excess over $50 million and war risks. It provides $1.5 billion limits for each occurrence, rising to $2 billion if passenger war liability is included. The excess requirement would be waived if coverage is unobtainable by the airline in the commercial markets.

The total funding would be capped at $15 billion, and would require member countries to contribute 50 cents per passenger as a base premium rate, which would be capped in proportion to their funding of the ICAO. The U.S. is the largest contributor with 25 percent, followed by Japan, 14 percent, and the major European countries, who each contribute between six and nine percent.

As one might gather from the alphabet soup of agencies and countries involved, nothing moves very rapidly. The ICAO said it would launch its insurance plan when it receives the approval of 51 percent of its members, but that will require additional time. One thing appears clear—obtaining anything over $50 million in policy limits in the commercial markets is difficult and expensive. This classic crisis has led to a classic solution—establish a risk retention group, and insure yourself. The commercial insurers don’t like this, as they see business leaving the industry, but then they are at least partially responsible for the crisis to begin with.

Equitime, Eurotime and the ICAO’s plan offer the airlines the only really workable solution to their insurance coverage demands. They cannot rely forever on their country’s governments to insure them, even though they will need their backing for some time to come.

Topics Catastrophe Carriers Natural Disasters Europe Excess Surplus Aviation