A View from Me on ’23 – Mounting risks in the world of aviation ahead… or a mountain of risks?

Oli Dlugosch, head of aerospace at Swiss Re Corporate Solutions and president of the International Union of Aerospace Insurers (IUAI) explains in an incaresing volatile landscape for the aviation sector insurance still offers value for money.

Thinking about the current and emerging risks landscape, be it in aviation or elsewhere, many considerations come to mind, so that you can hardly see the “wood for all the trees”. When trying to zoom in from a macro level to something as specific as aviation insurance or reinsurance you can observe striking similarities and dependencies between various risks which affect many industries and companies. I will focus on a couple of main areas of concern.

Geopolitical risk landscape

One of most pressing risks these days is geopolitical. The Russian invasion of Ukraine and its repercussions led to significantly rising energy prices for oil and gas, an emerging food crisis, on top of supply chain issues which are additionally driven by the zero COVID-19 policy in China. This resulted in a rising inflation of sometimes 10% or higher according to monthly inflation reports and is prompting central banks to tighten financial conditions through higher interest rates or reduced asset purchases.

Now, what does this mean for aviation overall? Aviation traffic is dependent on many factors, geopolitics being one of them, to allow for a free flow of goods and passengers globally. If there is a war more people are more concerned to fly abroad. The aviation industry is just recovering from the COVID-19 crisis with many travel restrictions, entire countries were closed. Many airlines and aviation companies only survived because of restructuring measures and had to cut costs after a revenue “shock”, with government bailouts and capital raises. Although air traffic has recovered in some regions, it will take years to restore balance sheets and financial health of the companies.

What does that mean for aviation insurance and reinsurance?

Having insurance cover in place is mandatory, so without liability insurance no aircraft will take off or land at an airport, and no goods will be transported. During the peak of the COVID-19 crisis from early 2020 to mid 2022, there has been very low flight activity. This had several consequences: At first it led to lower insurance premiums as airlines typically adjust the insurance premium based on exposure e.g. size of fleet, number of passengers or departures or a combination of them. Insurance losses were “artificially” low due to less congestion at airports, less flights in the air, less bags being transported etc. As the air traffic increases, we will see more congestion, and more total losses for insurers. Traffic is one topic, geopolitics is another one. If the world is in a situation of a conflict or geopolitical tensions, there is a risk of an accidental shoot down, a terrorism event, the risk of an aircraft being destroyed etc…. in insurance terms the frequency risk of loss increases. Airlines will monitor the situation closely, change the routes or simply stop flying, applying sound risk management. The risk for insurers or reinsurers still rises, resulting in more premium charged for the same risk or insurers might offer less coverage.

Shortage of skilled workers

During the peak of the COVID-19 crisis many airlines, airports, manufacturer or other companies had to lay off employees to survive financially. Now, as the aviation traffic is recovering quickly, we face the issue of long queues at airports in security screening or else, flights being cancelled due to a shortage of pilots leading to hours and hours of delays. Flying has become less “glamorous” than it used to be. People who were dismissed during the COVID-19 crisis simply found other jobs and could not be rehired at the same speed. The shortage of pilots with the long-term traffic forecasts is a big issue for the industry which could lead to less trained pilots flying, pilots flying much longer and an increased loss frequency. A recent study by Geoff Murray from Oliver Wyman predicts a gap of 25’000 pilots by 2025 and 60’000 by 2030 Pilot Shortage Predicted to Reemerge in 2022: What to Do Now (avsoft.com). Recently we heard about discussions to switch to a system with only a single pilot flying a plane, which could lead to reduced safety.

Inflation or social inflation

Social inflation is a phenomenon which we have observed over many years. There is a significant amount of data on that related to the number of “outsized” insurance losses well beyond general levels of economic inflation, the so called “nuclear verdicts”. We have seen many headlines on this across multiple industries, not only aviation. Social inflation simply exists, especially in the United States, but it also affects other insurance lines like casualty. Insurers need to factor this volatility into the severity calculations by adjusting the loss costing and factoring in more extreme scenarios.

The “normal” inflation we talk about is different. With goods and services becoming more expensive the simple cost of material or cost of labor to repair something increases. From an insurers’ perspective this erodes premium with small or mid-sized losses, which are called attritional losses in form of basic losses or major partial losses, mostly without the headline of a total loss event. In simple terms, if from a premium of USD 100 roughly more than 50% is taken by normal base loss levels, there is simply not enough premium left to pay for the low frequency and high severity catastrophic loss scenario during more challenging times. This is the basic concept of insurance, with a mutualization and the losses of the few paid by the many. For both insurers and reinsurers there needs to be a profit left after losses, commissions, taxes and other costs etc. The margin for the volatility that (re)-insurers take on the balance sheet with the capital in the form of equity comes at a price.

In many cases the very large catastrophic events are covered by the reinsurance markets which typically are the “shock absorbers” backing insurance companies.

In summary, many risks, increased volatility and higher demand for (Re-)Insurance

There are many risks correlating with each other, be it geopolitical risks, inflation, social inflation, staff shortages or climate change all with varying degrees of severity. But all of these are increasing the volatility and demand for both insurance and reinsurance solutions. Increased volatility comes with a “price tag” in a form of premium or margin to cover “normal losses”. The aviation insurers and reinsurer offer a great product at a certain cost, which is typically cheaper than using your own equity to cover the risk.

The IUAI  represents aviation and space insurance and reinsurance companies worldwide and has acted as the representative voice of the aerospace insurance industry to Governemnts, Regulators and industry stakeholders since 1934. Its members provide about 90% of global aviation and space insurance. . The IUAI is working with its members, clients and other stakeholders to address emerging industry issues, providing education on aviation insurance or reinsurance, collecting industry data and identifying new risks.