Making plain sense out of aviation insurance
There was no such thing as aviation insurance when Shakespeare penned, in Henry VI, “The first thing we do, let’s kill all the lawyers.” If there had been, the quote might have been a bit longer, according to many in the industry. Next to lawyers, everyone loves to hate insurance agents and underwriters.
Recently, it has become a common belief that although insurance companies have traditionally made unholy profits, they’ve gotten even greedier since 9/11. But Robert Beyers, senior v-p of aviation and aerospace practices for insurance broker Marsh, sees it somewhat differently.
“To make money an insurer needs a loss ratio no greater than 60 percent,” he explained. “What that means is that for every $100,000 worth of premiums an insurer takes in, it can’t pay out claims in excess of about $60,000. On top of the losses you have to pay overhead, reinsurance costs and the cost of the capital you provide. If everything works out just right, the profit margin should be around 10 percent. What people rarely understand is that very high premiums do not reflect a high profit margin.”
Headquartered in New York City, Marsh is one of the world’s leading insurance brokers, listing such clients as Signature, Piedmont Hawthorne, Mercury Air Group, Atlantic Aviation, Jet Aviation and other larger FBOs throughout the U.S. A broker works on behalf of the insured client, while an agent works on behalf of one or more specific insurance companies.
Beyers said that after 9/11 there was serious concern there may not even be an aviation insurance market. “Before 9/11 there was relatively inexpensive reinsurance, allowing insurers to write more risk at lower premiums. Equally important, because the stock market was constantly rising, investments would offset any losses, but 9/11 changed that drastically.”
It is worth noting that in the U.S., federal regulators severely limit insurance company investments in equities to reduce the risk that an insurer might lose the funds necessary to pay claims. Insurance premiums continue to be invested to increase their worth, but government regulators strictly control the type of investments, typically government and treasury bonds. Outside the U.S., insurers are often permitted to invest a higher percentage of premiums in equities, increasing the potential for significant losses when the market goes sour.
David Kennedy, manager of government industry affairs for the
Washington-based National Air Transportation Association, told AIN, “Insurance continues to be an issue in a couple of areas. Flight schools are enormously affected by it, especially since 9/11. As you move up the scale to the FBO world there’s more ability to handle the costs, but it’s still a very hard market.
“NATA has put a lot of emphasis on its Safety First program to reduce those $50,000 fender benders,” he said. “If we can reduce those by any significant percentage it will have a real effect on the industry. We’ve seen a substantial increase in the use of that program.”
Amy Koranda, manager of education and training for NATA, reviewed one aspect of Safety First– the professional line-service training program. According to Koranda, it is the only aircraft-specific training program in the industry. The five-hour video program is divided into nine modules, giving clear, close-up video of step-by-step refueling, towing and safety procedures for piston, turboprop and jet airplanes and helicopters. There are other modules for fire safety and customer service.
What makes them particularly attractive is that they are economical. NATA member companies can provide a program for $100 per line-service technician, including detailed reference materials, testing materials, textbooks and training manuals covering instructions, unique safety procedures and illustrations.
Despite the positive effect of Safety First on reducing insurance claims, the industry continues to look for additional ways to reduce premiums. One of the more controversial and increasingly used methods is the waiver.
More Expensive Aircraft–and Insurance
According to Bill Welbourn, executive v-p of United States Aviation Underwriters, in addition to all the hangar- and facility-related issues that drive the cost of premiums, there’s the simple fact that aircraft are getting more expensive. “Very expensive airplanes are being significantly damaged on the ground,” he said. “Let’s face it, insurers don’t print money, and I doubt FBOs do either. It is in all our best interest to try to solve the problem. In the face of such high claims there are only two choices: either insurers charge higher premiums or the insured accept a higher deductible for ground-handling risks. That leaves the insured with either passing along the cost to the operator or having them sign contractual agreements that throw some of the risk, such as consequential losses, back to the owner/operator.”
Welbourn noted that during calendar years 1996 through 2000, the most recent years for which hard figures are available, the earned premium/loss ratio for general aviation premises liability, including hangarkeepers liability, was 62.3 percent. Yet during that same period the earned/incurred ratio for property damage losses to aircraft skyrocketed to 150 percent. Although it is still too early to get the results for 2001 and 2002, he said, the ratio appears to be increasing.
One area where technology has helped reduce rates is through the use of closed-circuit TV monitoring to view ramp and hangar areas. When a pilot suggests an aircraft was damaged after being left with the FBO, the tapes can be reviewed to determine if the event occurred on location. In light of the extremely high cost of aircraft damage claims, FBOs are forced to take substantial measures to reduce their exposure to liability.
A chain such as Signature or Mercury typically buys one group policy for its entire operation, possibly carrying the premium into many millions of dollars. Premiums are determined primarily on loss history and the deductible the insured is willing to shoulder.
“If we damage an airplane through our own negligence we are responsible about rectifying our own errors and omissions,” David Vaughan, v-p of sales and marketing for Signature Flight Support told AIN. “We want to be fair with our customers, but in return we ask our customers to be fair with us, too. We are proactive about minimizing our risks, with comprehensive employee-training programs and by creating a culture of safety, but accidents do happen. We have our customers sign a waiver for INC [incidental consequential damages].” (See box.)
Vaughan explained that insurance premiums nationwide are built around actual losses. The greater the losses, the greater the premiums and the more the insured has to charge its customers. “By asking customers to sign an INC we’re trying to help control the costs of this industry. Over the years insurance claims have gotten so inflated it’s ridiculous. Putting the aircraft back into its original condition somehow became insufficient. Claimants want hotel rooms, meals, incidental expenses and even replacement aircraft. We simply don’t want to accept responsibility for losses outside the value of the airplane.”
But David Moll raises questions about the practice. Chief pilot for Hotel Aviation, Moll pointed out, “The problem is the diminution of value. If they damage your airplane in such a way that you now have to declare the airplane has a damage history, you have a lower-value airplane. That can be a large-dollar item. And Signature isn’t the only one. Aspen Base Operations charges extra for services if you don’t sign a similar INC. Fortunately, the customer service reps are used to people not signing the release forms and don’t make a big deal out of it.”
Beyond potentially reducing the value of the aircraft, Moll raises a thornier question. “The really big issue here is whether or not a company pilot is authorized to sign such a major release of liability. Our attorney doesn’t think so, but it may take a costly court case to decide. We’ve been advised not to sign it.”
So just how much does insurance actually affect the operating cost of a corporate flight department? Far more than anyone can actually calculate. When a dozen randomly selected corporate pilots were asked what percentage of their flight department’s operating costs could be attributed to insurance premiums, each did a quick math problem and came up with a percentage. Each calculated their annual insurance premium and divided it by their annual flying time. Quick, easy and completely wrong. Your annual aircraft insurance premium is merely the tip of an iceberg, and like all icebergs the vast majority of it is invisible.
The Real Cost of Insurance
Take a look around you right now. Just look up at the first object you see. Part of the cost of that object includes an insurance premium. Everything you see–the airplane, your Jepp bag, the computer, your other crewmembers, everyone and everything–represents an insurance premium of some sort and you’re footing the bill one way or another.
Think about it–a couple of decades ago small airplane manufacturers stopped building two-seat trainers because their average per-aircraft insurance premium across the product line was greater than the selling price of the smallest aircraft. Everything you see has the cost of an insurance premium built into it, whether it be workman’s comp or liability insurance. The cost in real dollars is staggering, and probably inestimable. It is, in a very real sense, the good fortune of many helping provide for the bad fortune of a few. The problem is that, today, all too often the few are getting way more than fair compensation.
Contemporary society has become “not my fault” oriented, and it is driving up insurance costs across the board. It can cost millions of dollars to defend a lawsuit even if you’re not guilty of anything. In a speech at the 27th Annual Educational Conference of the Aviation Insurance Association, Dave Baker, senior v-p of AIG Aviation of Atlanta, said, “The cost of the U.S. tort system grew by 14.3 percent in 2001. It accounted for $205 billion of the U.S. economy. It was the equivalent of a 5-percent tax on the wages of every worker in the country.”
Beyers of Marsh explained that it was the General Aviation Revitalization Act’s statute of repose of 18 years that allowed OEMs to get back to manufacturing aircraft. “The act relieved the OEM’s liability for a crash for any aircraft in the field more than 18 years. That basically allowed manufacturers to get back into the market.
“People blame [rising premiums] on insurance companies, but the insurer had nothing to do with it,” Beyers said. “Insurers don’t determine how much to pay for injured victims and hull losses. Insurance is a business, and insurers react to costs appropriately. All we do is react to the market. Remember that an aviation loss isn’t like a car loss. You put a couple of executives into a $25 million aircraft and you’re looking at hundreds of millions of dollars in a single loss.
“Corporate flight departments focus on their individual insurance premiums as their only insurance costs and don’t take into account the increased costs associated with all aspects of aviation,” Beyers continued. “When they taxi up to an FBO, they want to know why they’re asked to help tow the airplane or why they can’t drive their limo up to the airplane. It relates directly to the insurance costs of the service provider. FBOs, maintenance providers, fuel providers and airports have had bigger premium increases than anyone since 9/11–on average about 100 percent. Insurers had fewer reinsurance options, so they’ve had to assume more of the liability and hence charge greater premiums.”
Aircraft insurance premiums had increased about 30 percent immediately before 9/11 due to the increasing costs of aircraft, which drove up reinsurance costs and payouts. For example, according to Beyers, before 9/11 an insurer offering a $50 million policy would probably keep the first $10 million of liability itself and reinsure the remaining $40 million. After 9/11 there was little or no reinsurance available, so the insurer would be stuck with responsibility for the entire $50 million. The premiums for what limited reinsurance that did exist were at least doubled after 9/11.
Harold Clark, chairman and CEO of United States Aviation Underwriters, explained reinsurance: “Reinsurance is insurance for insurance companies. When we take on a risk, we manage the net exposure to our company by buying various forms of reinsurance. Reinsurers specialize in writing reinsurance contracts with insurers to cover a single aircraft or a full year’s worth of homogenous business.”
If an insurance company is insuring a specific hull–say a $26 million aircraft–it might want to retain an amount of risk of only $10 million and would look to reinsure the remainder. Alternatively, it might buy reinsurance on a specific event such as catastrophe insurance to cover a tornado. In the case of a fleet, it might assume the full risk on the first aircraft in case of a tornado but wish to reinsure a portion of the second and perhaps all of the third, but only in the event of a tornado.
Clark noted that the insurance and reinsurance marketplaces for aviation are comparatively small, meaning there are few players in each area that provide coverage in substantial amounts. “Losses very much affect the cost of reinsurance to primary insurers,” he said. “If reinsurance is costly, the increased prices must be passed along. If reinsurance is unavailable, there are typically fewer players willing to take on the potential of losses. In short, any losses of significance will affect the cost of insurance. The same is true of non-aviation losses arising from natural disasters.”
He reaffirmed what many have suspected: the fear of future terrorist events has already affected today’s insurance rates. “Certainly it affects insurance rates,” Clark said. “Especially war-risk coverage and higher levels of liability limits. Before 9/11 terrorist coverage was relatively inexpensive. Today, hull war-risk rates are up 500 percent or more, reflecting the higher cost of reinsurance, as well as the perceived higher exposure to loss. Under TRIA [Terrorism Risk Insurance Act], insurers are required to offer coverage, even though insurers may prefer not to do so. Without the protection that the aviation interests were granted by Congress following 9/11, it would be unlikely that the airlines and security companies [and perhaps their respective insurers] would have been able to pay all claims in the event liability were to be ultimately proven. Most insurers believe that the risk of terrorism should be borne solely by the U.S. government.”
Clark said that the 500-percent increase has declined somewhat more recently, though it is still more than double what it was before 9/11. “You know, you read about shoulder-fired missiles and everything,” he said. “Also, many companies are buying less terrorism insurance because of the cost.”
Insurance Premium Financing
With insurance premiums at an all-time high, a once small niche market has begun to flourish–insurance premium financing. With insurance premiums ranging from below $100,000 annually to upwards of a million dollars for corporations operating several aircraft under Part 91, it’s no wonder CFOs are looking for a helping hand.
Jotte Haile, an underwriter for Universal Premium Acceptance Corp. of Lenexa, Kan., described how it works. “What we do is very similar to what you would do if you purchase a car,” he said. “You’re leveraging the funds we give you to pay for the premium as opposed to using your own money to pay for it. We typically require the insured to put down 20 percent of the premium and we finance the rest of it. There are tax implications because the interest is tax deductible, and you don’t tie up your funds with the premium.”
According to Haile, “The policy itself is our collateral. The insured signs a finance agreement stipulating that if he defaults on the payment we have the right to cancel the policy. The downpayment and payment schedule keeps the coverage payback in step with the time frame covered, so essentially we can’t lose.” Haile said premium finance companies are third-party operations. You don’t go to them direct; you go through your insurance agent. He also explained they would finance any type of insurance coverage, from aircraft to worker’s compensation, personal auto, equipment and professional liability, to name a few.
Is the Tail Wagging the Dog?
Beyers ticked off a list of the types of insurance coverage the typical flight department would need: “Hull and liability insurance are not optional. You can’t finance an aircraft without them. Hull rates are based on the value of the aircraft, and liability premiums are based on the limits of liability you buy. The more financial risk you’re willing to assume, the lower your premium will be.
A flight department will also need all-risk property insurance on its hangar, workman’s compensation insurance, employee benefit insurance and even auto insurance if you have company vehicles. If you have tenants in your hangar, you need hangar keepers insurance, even though you’re not an FBO. In fact, you need hangar keepers insurance even if you shelter a prospective customer’s airplane in your hangar overnight while he’s visiting you.
“Corporate operators should invite and welcome their broker to visit their flight department,” Beyers said. “Have him meet the chief pilot, get an understanding of how the operation runs and how go/no-go decisions are made. He should interact with the company’s chief execs, too. Whatever you do, don’t just fill out an application for insurance and see what happens. Be involved. Your broker should become your friend and advisor.”
Beyers listed factors considered by insurers when evaluating a prospective client: “We look at such things as how you store your aircraft and where you operate. Do you operate out of nonstandard airports, for example? We’ll also want to look at the experience levels of the pilots and whether or not you have a formal, structured flight department run by experienced people. Another big issue is whether or not you have an emergency plan.” According to Beyers, an emergency plan would include such things as a worst-case scenario plan, procedures for identification of victims and notification of key individuals, a plan for securing the accident area and a procedure for interacting with the press.
More than one flight department executive has wondered if the tail has begun wagging the dog. “Our insurance company dictates the flight hours and training required for a right-seat pilot in a Citation I/SP even though these are not required by the FAA. In short, he’s only a set of extra eyes,” he groused. “If he’s legal as far as the FAA goes, then that should be it; but these insurers want us to put him through a formal initial aircraft course at FlightSafety or SimuFlite. That’s nuts.”
But Beyers disagreed: “That particular type of case may look unduly restrictive, but in a very real sense if someone sits in the right seat that person could essentially take control of the aircraft, and that becomes a concern of the insurance provider.”
Ronald Davis, president of the National Hangar Insurance Program, a division of Arthur J. Gallagher Co. of Oklahoma, discussed hangar insurance: “We do the ground side of aviation–anything on the airport that doesn’t fly. T-hangars all the way up to municipal airport authority facilities. We cover the buildings, tools and equipment. Quite simply, our business is to pay claims. If people didn’t make claims we wouldn’t exist.
“When you hear of a large premium increase, it is generally the result of continuing claims of a similar nature,” Davis said. “One wing-damage claim may not have much effect on your premium, but if you start having them over and over, we have to take a look at the operation, the building and your location. We understand the reason you buy insurance is to cover your losses, but at some point repetitive losses make it unfeasible to insure the insured at the same premium. They also indicate some sort of problem that needs to be better understood. It isn’t a matter of punishing the insured; it’s a matter of having to charge an appropriate premium to stay in business. For instance, during El Niño we took major losses in Minnesota, where we had been charging lower premiums due to the lack of such claims historically.”
According to Davis, hangar premium determination takes many issues into account.
“We look for the type of construction to assess fire exposure, as well as how the facility will be used. Are you doing spray painting? How close is the fuel farm, how old are the tanks and are they above or below ground? What fire- and theft-protection systems do you have? If there’s a maintenance shop, it will have more exposure to flammables than a plain aircraft storage hangar. Does it have a fire-protection system and, if so, what type? A sprinkler system and a foam system will affect your premium differently. In a hangar, a wet sprinkler system isn’t a good choice because fuel floats on water; you need a foam system. Unfortunately, the large majority of hangars have neither. Only hangars built in the past 10 to 12 years have been required by code to do so.”
Davis also said the “wind uplift rating” on the hangar was a significant premium driver. “A hangar will fly,” he said. “It is a large, flat surface and a downburst, tornado or hurricane will blow it away. They look heavy but they’re actually very light. If the wind gets in a door or through the seams, it’ll literally pull the roof off or blow it away.”
Davis said most hangars are prefabricated. As such, they come with test results for wind uplift ratings. “There are different building code requirements in different parts of the country. For instance, you can’t build a hangar with a 70 to 80 mph wind uplift rating in Florida because of hurricanes. They must have a rating of at least 120 mph. On the other hand, in Michigan the rating might be as low as 70 mph. It is statistically a fact that the largest cause of loss to airport property is wind and hail, so the likelihood of either will have a significant effect on premiums.”
Teri Pray, underwriter manager for St. Louis, Mo.-based The ABC Program, said her company writes only property insurance. “We don’t write any general liability. We deal with aviation insurance brokers and provide property and auto coverage related to aviation.” Pray said a lot of airport properties are finding it difficult to get insurance from standard sources because of the terrorism/ airport stigma. “A lot of general insurance companies have decided aviation is not a niche they wish to write,” she said. “They probably weren’t doing much to begin with, so it wasn’t worth their while to continue it after 9/11, but rates today do take the threat of terrorism into account, and where you’re located affects that rate.”
Pray said in November the federal government dictated that, in general, the insurance industry must provide some form of terrorism coverage. The rates are divided into three different tiers across the country. For example, Tier 1 territories include such places as New York City, Los Angeles and Chicago. Tier 1 territories are perceived to have the highest terrorism threat level. Tier 2 has a somewhat lower perceived threat level, and Tier 3 is lower still. Premiums are adjusted based on the tier level where an operator is located.
Making a Claim
When an accident occurs or disaster strikes, the process that occurs when a claim is made is straightforward. When a client has a claim, it calls its broker, who tells it to take steps to minimize further damage. The broker sends a written notification to the insurance provider, which in turn sends out an adjuster to meet with the insured and assess the damage. When the assessment is complete, the insured can either accept or challenge it. If it’s challenged, more often than not it is renegotiated, but with increasing frequency it goes to court. That’s when the expert witnesses get involved.
The array of expert witnesses is astounding. Some of the more common fields are wreckage reconstruction, documentation and evidence preservation, fire and explosion investigations, product design engineers, material failure analysis, human factors, meteorology and even more esoteric subjects.
Dr. Lee Branscome, president and certified consulting meteorologist of Palm Beach Gardens, Fla.-based Climatological Consulting, said he is frequently hired by attorneys involved in aviation litigation. “We testify in turbulence incidents and damage to aircraft on the ground due to bad weather,” he said. “I probably work on about a dozen aviation cases a year, and there are probably half a dozen of us around the country who are fairly active in this area.” He estimates that about a third of all accidents are related to the weather one way or another.
“I’m not a pilot. I merely provide an objective opinion about what the weather conditions were at a given time and location,” he explained. “There are occasions I will go to the scene of the accident, but only to see the surroundings first-hand. To get an idea about the topography, buildings and other factors that might influence the wind.” Branscome charges $185 per hour for research and testimony, in addition to incurred expenses–and that’s not unusual for expert witnesses in all areas.
When you add up the costs of damage repair, alternative support costs associated with the loss of use of an aircraft or facility, expert witnesses, attorneys, court costs and time lost, it is clearly to the benefit of both the insurer and the insured to be proactive in avoiding claims.