Canadian Underwriter

The Risk of Terror: Attack on America: Impact on Aviation Covers

October 1, 2001   by Canadian Underwriter

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Whenever a commercial airliner goes down – whether due to weather, human error, mechanical malfunction, or by design – there are at least four main classes of insurance which can be impacted. First, is the hull – the physical aircraft, second is the accidental death of those on board, the third is cargo, and fourth is liability.

Though it is not clear what will happen to the cost of some of these covers, it became crystal clear very quickly what would happen to hull insurance. Along with providing for the reimbursement of the value of the physical aircraft, aircraft policies contain a component affording third-party liability in the case of an act of war or terrorism.

Within a week of the event, London aviation insurers invoked the standard seven-day cancellation clause on all war and terrorism cover from Monday, September 24 in order to raise premiums. The fallout was immediate. By September 20, just nine days after the devastating attacks in lower Manhattan and Washington D.C., Air France said it had been in touch with insurance companies about charges and that there was a risk that the costs could go up “by a factor of 10…”

Rupert Atkin, chairman of Lloyd’s of London’s “War Risk Committee”, told Reuters September 19 that airlines would face severe increases in war cover for hull insurance. “It’s fair to say that it’s hundreds of percent,” he said.

Passenger liability

Airlines buy separate insurance to cover both the aircraft and the passenger liability against war or terrorist attack. The second portion of the cover, that for passenger liability, “…will be done on a per-head basis and will go up from nothing to USD1.25 per [passenger],” said one leading Lloyd’s underwriter.

The contagion caused by policy cancellations spread to commercial air carriers throughout Europe, North America, Asia and other parts of the world, precipitating a very time-condensed crisis in air travel, an industry already shaken by a worldwide economic slowdown and skyrocketing fuel prices.

Commercial air carriers quickly found themselves faced with just three options: ground their aircraft, pass on any added expenses to consumers (a death-knell given current market conditions), or approach their home governments for aid. The list of airlines contemplating the first option grew rapidly, and governments worldwide soon realized that if the September 24 deadline for the cancellation of third-party war risk cover was allowed to come and go without action, the impact on business travel, cargo transfer and tourism would be devastating. Discussions were quickly opened between airlines and their respective home governments in order that a rapid solution could be found. Over the course of the weekend prior to the deadline, several governments hammered out short-term solutions to the growing crisis. With minor variations, each took similar approaches to the problem.

Insurer of last resort

European Union finance ministers agreed on Friday, September 21 to give war risk insurance to their airlines for at least the following month. The ministers agreed that EU member states could provide emergency insurance cover for airlines, but that they should be subject to common rules to prevent a distortion in competitive conditions. The ministers recognized that governments would have to be the insurers of last resort for companies with insurance problems, and that they would have to charge a “reasonable premium” to reflect, as far as possible, the risks involved. However, at the same time, the ministers’ statement said the premium could be waived in the short term.

In the U.S., president George Bush signed a bill on September 22 giving U.S. airlines US$15 billion in cash and loan guarantees. In addition, the federal government will for six months reimburse air carriers for the difference in their insurance costs before the attacks and after.

Kuwait Airways Corp. said on Sunday, September 23 that its government had granted it insurance coverage of US$2 billion. The New Zealand government said it had indemnified its debt-laden national carrier Air New Zealand against losses for acts of war or terrorism of up to US$808 million. The Australian government promised to underwrite damage claims from future acts of war, terrorism or hijacking against Quantus to a limit of US$5 billion and Jordan announced September 24 that it would stand in as a guarantor to face a sharp increase in insurance costs.

Asian governments also stepped up to bridge an insurance gap for airlines. South Korea said it had accepted requests from Korean Air Lines and Asiana Airlines for help and would allow carriers to pass on to passengers extra war risk insurance premiums of US$1.25 a passenger from October 1. Hong Kong also announced that it would offer insurance support, saying it would indemnify local carriers for up to US$1.95 billion in the event of hijackings, war and other disasters for six months. In South America, the government of Brazil announced September 24 that it, too, will back local airlines’ insurance claims resulting from acts of war.

The government of Canada also announced Saturday, September 22 that it would provide an indemnity for “third-party war and terrorism” liabilities for the country’s essential aviation service operators, including airports and airlines. From early media reports, Canada appears to be the only country which extended indemnification to “ground cover”, i.e. insurance for aviation-related ground facilities. The offer applies to Canadian air carriers, airports and NAV Canada, which provides air navigation services. Others such as the Air Transport Security Corp. and essential service providers at airports, including ground handlers and refuellers, are also available for the coverage, which will last up to 90 days. The indemnity will apply only to those operators that already carry such coverage, only to the limits of their existing terms and conditions and the portion of existing coverage that will not be offered in commercially available insurance policies.

The actions taken by these governments solved an immediate problem. But in each case, a sunset was placed on the insurer of last resort coverage – anywhere from one month to six months – with the hopes that airlines will be able to find economical solutions in the private market in that time.

Another challenge

Reacting to the potential for massive negative fallout affecting the country’s air carriers, on September 21 the U.S. House of Representatives followed the Senate in approving a US$15 billion, multi-faceted bailout package. Quickly signed by the president, the plan includes US$5 billion worth of direct grants and US$10 billion in federal loan guarantees.

However, the rescue package has also managed to help American Airlines and United Airlines put another looming problem temporarily behind them – that of heavy jury awards and court costs that could be triggered as a result of individual and class action lawsuits filed against them. The new law limits carriers from liability for claims as a result of property damage from the hijackings and crashes and limits airlines’ liability for loss of life. The package includes a cap on insurance claims for injury or loss of life at US$100 million per airline. For those who were injured and the families of the passengers who were killed, the legislation provides two ways to seek compensation. Victims could go to federal court in New York, where claims will be consolidated. Or, they could apply for payment through an administrative process to be run by the U.S. attorney general. Relatives of victims may still choose to sue the airlines but those who do will not be eligible for the federal deal.

Taken to court

Not too long ago, such a plan would be unnecessary because such court awards were clearly and solidly capped by the Warsaw Convention, which had placed a monetary ceiling on such liability payouts. But in recent years, the cap has been voluntary removed by many airlines worldwide.

The Warsaw Convention is a group of articles brought about in 1929 which governs international transportation of people an
d goods performed by aircraft for hire. A number of countries still implement the bulk of the agreements reached in Warsaw, including The Carriage by Air Act, signed in Guadalajara, Mexico on September 18, 1961. This agreement encompasses the provisions of the Warsaw Convention as amended at the Hague in 1955. The Carriage by Air Act, 1961 not only covers an airline’s liability in respect of cargo/baggage but also passenger liability and applies not only to in-flight disasters, but also to slips, falls and other accidents in the jetway.

The convention assesses compensatory liability for all accidents without proof of fault for damages up to US$75,000. Only proof of willful misconduct will result in greater recovery. There is nothing in the convention that prohibits punitive damages in cases involving willful misconduct.

In November 1996, European airlines KLM, SAS, Swissair, Austrian Airlines and Finnair said they would accept unlimited liability for accidents in which passengers are injured or killed, doing away with the 1929 Warsaw Convention principle of limiting liability. Japanese airlines cancelled liability limits in 1992. The move was designed to pre-empt implementation in 1997 of a deal negotiated by the International Air Transportation Association, dubbed the IATA Intercarrier Agreements (IAA).

Long term impacts

The events of September 11 will no doubt remove a large amount of capital from the world’s aviation insurance market, will possibly spur a significant drop in capacity going forward, and will likely drive changes in the way the product is written.

The attack will also trigger a dramatic rise in aviation insurance premiums. William Yankus, an equity analyst with Fox-Pitt, Kelton – commenting on potential p&c rate increases triggered by the terrorist attacks – told A.M. Best on September 24 that, “with aviation in particular, the numbers get crazy, I can’t be certain, but I think we’re talking premium increases of 100% to even 300%”.

The attack on the World Trade Center (WTC) has managed to underscore two main attributes of the aviation insurance product. Firstly, like marine, aviation has proved to be a market which is truly global – loss events in one part of the world can quickly impact rates charged in another part. Though the events of September 11 directly impacted only two U.S.-based airlines, and the havoc was wreaked only in America, the fallout for commercial airlines worldwide was immediate and far reaching.

Secondly, the attacks highlighted the fact that the aviation insurance market is one that can harden virtually overnight. Though there is much speculation as to what may happen to property, liability and workers’ compensation pricing going forward, there is little doubt what will happen to aviation rates.

For the insurance industry, a hardening market is good. U.S. industry results have been lackluster of late, with first-half 2001 numbers showing net income after taxes down by 75.6% from the year-earlier period. The figure was driven largely by first-half catastrophe losses, which came in at US$6.6 billion – the second highest for any first-half since 1949. What’s more, the industry’s consolidated surplus declined US$19.1 billion over this period, and will surely get hit harder once WTC claims start to be paid. But, all insurers will surely agree, they did not want the market to harden this way.

Sequence of events, September 11

American Airlines Flight 11, a Boeing 767 aircraft, departed Boston at 7:59 a.m. EST, bound for Los Angeles with 81 passengers, nine flight attendants and two pilots. It crashed into the World Trade Center North Tower at 8:45 a.m.

United Flight 175, a Boeing 767 aircraft, departed from Boston at 7:58 a.m. local time, bound for Los Angeles, with 56 passengers onboard, 2 pilots and 7 flight attendants. It crashed into World Trade Center South Tower at 9:05 a.m.

American Airlines Flight 77, a Boeing 767 aircraft, departed from Dulles at 8:10 a.m. EST, bound for Los Angeles with 58 passengers, four flight attendants and two pilots. It crashed into the Pentagon at 9:40 a.m.

United Flight 93, a Boeing 757 aircraft, departed from Newark, N.J. at 8:01 a.m. EST, bound for San Francisco with 38 passengers onboard, 2 pilots and 5 flight attendants. It crashed at 10:10 a.m., 80 miles southeast of Pittsburg as passengers fought with hijackers.

Aircraft insurance – Top 10 writers by GPW (1999)

Company Market share
New Hampshire Insurance Company (UK Branch) 46.93%
Royal & SunAlliance 20.25%
CGU International Insurance Plc 12.12%
British Aviation Insurance Company Limited 8.17%
Tryg-Baltica International (UK) Ltd 5.04%
AXA Global Risks UK 2.7%
QBE International 1.39%
China Insurance Company (UK) Limited 1.15%
Heddington Insurance (U.K.) Limited 0.83%
SR International 0.77%
Total 99.4%

Source: Reinsurance Online

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