January 1, 1999 by Sean van Zyl, Editor
Consolidation and cost cutting became the corporate buzzwords of the 1980s and 1990s, with operators from insurance to retail-chains through to the aviation industry embracing downsizing and cheaper marketing and delivery systems. The aviation business emerged from this process, particularly on the large commercial airline side, with a concentration of ownership at the manufacturing level and an increased number of airline operators working on code sharing agreements to maximize flight capacity and routes. The result of this has been an approximate 25% decline in the aviation premium base over recent years — insured losses, however, trended upward over the same period.Of particular concern to insurers is the market move from the limited liability exposure set out by the Warsaw Convention articles to unlimited liability agreements. Increased flight capacity, traffic, and exposures resulting from code share agreements, has boosted this anxiety. Furthermore, insurers report that there has been a surge in the value of single loss events, with the latest Swissair Flight 111 disaster presenting the first US$100 million-plus compensation lawsuits against the aircraft manufacturer and the airline. Insurers say it is time for the bleeding to stop.The tragic loss of Swissair Flight 111 off the coast of Peggy’s Cove, Nova Scotia last September — which claimed the lives of all 229 onboard — is ranked among the 20 worst aviation fatality disasters. The insured cost resulting from the disaster is expected to eventually be around US$700 million to US$800 million, with the hull insurance at US$126.5 million. The disaster is likely to be the single most costly aviation loss to hit insurers.
Although the cause of the Swissair crash has not been fully established, investigators are sure that an intense heat build-up near the cockpit led to the crash. Shortly before the crash, the aircraft’s pilots reported “smoke in the cockpit” and attempted to make an emergency landing at Halifax Airport on what initially had been a lower “pan, pan, pan” emergency call. The plane never made the landing.
The scare of “smoke in the cockpit” has since seen several aircraft around the world, including cases in Canada, commit emergency landings, none of which resulted in fatalities. Some argue that the “scare factor” with the fate of Swissair Flight 111 still fresh in memories led to an ultra cautious approach by pilots which increased the number of “smoke in the cockpit” emergency landings. In fact, 1997 and 1998 are regarded among the safest flying years since 1970, according to statistics compiled by the Aviation Safety Network.
Losses are rising
Insurers say, however, that the use of broad, short-term statistics can be misleading. Most believe that there has been an increase in airline accidents and damages over the past two years, even though they may not have resulted in high fatalities. And, insurers expect the loss numbers and incident of aircraft accidents will likely escalate with increased traffic volumes and carrier loads. Of particular alarm to insurers are the increased insured loss values arising from single events. Technology has dramatically boosted the value of aircraft while the industry move away from the Warsaw Convention compensation limits has opened the door to unlimited liability exposures. It is now not uncommon for a commercial airline jet’s hull to carry US$250 million insurance and up to US$2 billion in liability cover, notes Keith Selby at Swiss Re London, and the current chairman of the Aviation Insurance Offices Association (AIOA).
Two issues have focused the insurance industry’s attention on the recent Swissair crash. It is the first fatal accident where several families of passengers that died have initiated US$100 million-plus lawsuits against the airline and aircraft manufacturer. Shortly before going to press, a lawsuit amounting to $2 billion was filed by a Swiss family in New York against Swissair, McDonnell Douglas, Boeing Co. and the the carrier’s U.S. partner, Delta Air Lines Inc. The case of the lawsuit is that the airline is continuing to fly unsafe aircraft.
The second issue is the attention the crash has drawn to safety design of aircraft. Shortly after the Swissair crash, Jake LaMotta, former middleweight boxing champion, filed a combined compensation and punitive lawsuit totaling US$125 million for the loss of his son. LaMotta’s lawyers released a statement saying that the suit is designed to call attention to airworthiness concerns raised over recent years by the Federal Aviation Administration (FAA) concerning wiring problems in MD-11 aircraft, produced by McDonnell Douglas Corp which in turn is owned by Boeing Co.
Furthermore, a report was recently released by Edward Block, a U.S. safety consultant, saying that the crash of Swissair Flight 111 was an accident waiting to happen. He has compiled a list of electrical problems on MD-11 aircraft, Canadian Press reports.
Shortly after the Swissair Flight 111 crash, another Swissair MD-11 jet leaving Japan had to turn back due to a “smoke in the cockpit” alarm — no casualties were suffered although a technical problem was uncovered. Furthermore, preliminary investigations into the Swissair Flight 111 crash suggest that a malfunction resulted from possible “arcing” of electricity between wire bundles located near the cockpit. Should it prove to be so, then the finger could well be pointed at “Kapton” a wire insulation product manufactured by DuPont and widely used in commercial airline jets. Boeing has indicated that Kapton is being replaced with the release of new aircraft, although no safety notice has as yet been issued to airliners to have it replaced in currently in service aircraft. Notably, The U.S. navy has banned the use of Kapton insulation in its carrier aircraft.
National safety plan
In April last year the U.S. government launched an air safety drive in response to predictions of increased traffic. The U.S. government, faced with 66% growth projection in passenger numbers over the next ten years, plans to cut airline deaths by 80% over the same period. Research indicates that air passenger numbers are likely to rise from the current 600 million a year to over a billion. The U.S. plan includes more stringent aircraft check procedures as well as compulsory fitting of safety equipment on aircraft.
Insurers say, however, that the safety spotlight also has to be directed at the airport and air traffic control authorities. Increased traffic is placing severe pressure on ground support services, which is not only presenting a safety threat but rising insured losses. At the time the U.S. air safety plan was unveiled, the U.K. Civil Aviation Authority issued a report stating that near misses between aircraft in-flight is currently double the rate of incidences five years ago — the U.K.’s air traffic control system is regarded as one of the safest in the world. Furthermore, from an insured cost perspective, the scraps and dings inflicted on landed aircraft, known among insurers as “parking lot losses”, have risen substantially with the cost of new aircraft. The number of parking lot mishaps is also said to have risen with the increased strain on the infrastructure of airports.
At this stage, according to Selby, the aviation insurance market is seriously under-priced and due for correction. The picture is particularly bad on the airline side, although the market’s excessive competition is feeding into general aviation business. Selby expects that recent aircraft design safety concerns will eventually shift up on the priority list of insurers. “However, subject to current market conditions, I don’t think there will be much sway by insurers on the market until we see signs of an underwriting correction.”
The bigger issue which insurers need to absorb is the unlimited liability practices being applied. The U.S. has always produced higher liability costs, however, that situation is likely to change with the new liability applications. “It is now not uncommon for
telephone-number long lawsuits to come up with some of the high-media profiled incidences. However, the amounts filed for shouldn’t be taken to indicate what the final settlements are likely to be, they eventually tend to fall back to economic reality.”
The risk on airline business is largely determined by the routes being flown and the passenger mix, says Selby. For instance, the high number of U.S. citizens who were aboard Swissair Flight 111 has boosted insured loss expectations. What has become an additional complication in rating the risk is the code share agreements between the different airlines. Basically, a third-party insurer could end up suffering losses due to their client’s exposure resulting from a code share arrangement.
With the clock ticking closer to the next millennium, potential Y2K related exposures have become the most pressing issue for insurers, says Selby. The aviation industry’s heavy reliance on computer-driven systems, from support infrastructure to the actual aircraft, increases the risk of failure. “We’re currently conducting research among clients to determine the extent that they are compliant.” However, Selby notes insurers reacted quickly in applying defined Y2K exclusions on aviation business. “Aviation is one of the first markets to come up with a structured approach to exclusions.”
Richard Etridge, the aviation manager for Employers Re, based in Munich, confirms that insurers are applying the agreed-to IATA (International Air Transportation Association) Y2K exclusions. “Every policy I have seen includes the IATA year 2000 clause, which we plan to stand by.” Furthermore, Etridge believes that both insurers and the airlines are effectively acting to prevent Y2K risks.
Harold Clark, president of U.S. Aviation Underwriters, the largest American aviation insurance pool, says Y2K is likely to produce some economic losses, “however, I don’t believe this a safety issue, there is nothing to suggest that aircraft safety could be affected by Y2K”.
Etridge supports the view that rates are unlikely to move upward in the near term. ‘We operate in a market, like most markets, which is being driven by an over supply of capacity. Losses, particularly on the liability side, have risen over the past two years with award values having doubled over the past ten years. We hope that the market will react.”
Clark points out that premium levels have fallen below what historic loss data suggests to be healthy — leaving no room for increased exposure costs (such as on the liability front). After a period of several years of price reductions, the market will eventually have to react and strengthen rates, he says.