Prices ease a little

Risk & Insurance, Oct 1, 2004 by Bruce Shutan

Perhaps nowhere is the war on mitigating risk fought with such ferocity as in the transportation industry. From air transport to ocean shipping to land travel, risk management practices have been transformed since Sept. 11. Take U.S. domestic air travel, for instance. So safe has it become that many airlines are retaining more risk.

Major U.S. airlines like Delta Airlines, U.S. Airways and United may be flirting with bankruptcy, but insurance premiums are hardly to blame, according to a new report by the consulting firm Benfield Group Ltd.

"Aviation reinsurance and insurance pricing reflected another very benign year for aviation losses, which comprised about half the expected average loss of $2 billion in 2003," the authors of the report say.

With falling demand for reinsurance airlines have been taking on higher retentions as high as $400 million up from $50 million before Sept. 11, 2001 according to Benfield's estimates.

Stephen May, who heads Benfield's aerospace reinsurance team, explains that even as airlines retain more risk they spend, on average, less than 1 percent of their average total cost base.

"The insurance industry has historically been very generous in its pricing for airlines," says May. "Since rate increases following the losses from Sept. 11, reductions have returned." Many airlines still rely on state-backed emergency assistance for war risk third-party liability insurance in the post-Sept. 11 era, with coverage tightening to $50 million at a cost increase of $1.25 per passenger.

Ironically, since Sept. 11, it's been a safe time to fly. Air marshals, better baggage-screening technology and aircraft improvements such as reinforced cockpit doors have made flying safer.

The expensive and time-consuming but critical job of maintaining aircraft has also become a larger issue than it was several years ago, and regulators have stepped up efforts to ensure that flying remains safe.

Robert Hartwig, chief economist for the Insurance Information Institute, says that the number of people who die relative to the number of miles flown is still very small compared with other modes of transportation.

One aviation industry expert, Grant Whytock, an executive with the aviation practice of the Chicago-based insurance brokerage firm Aon, was quoted as saying that the fewer than 600 passenger deaths and total losses of less than $1 billion last year, come to about half the average annual liability posted in the entire decade preceding 2001.

While insurance premiums for airlines are easing, the cost of jet fuel is going in the opposite direction, leaving risk managers with a new set of challenges.

OIL PRICES: THE NEW CHALLENGE

Jet fuel, which accounts for roughly 10 percent to 15 percent of an airline's operating costs, reached a 13-year high over the summer. But the nation's big airlines, facing stiff competition from discount carriers, have had scant success in raising ticket prices to make up for the spike in jet fuel prices.

The Air Transport Association estimates that for every penny increase in the per-gallon price of fuel, U.S. airlines see annual expenses soar by $180 million. The industry's losses could surpass $5 billion this year if crude oil prices stay above $40 a barrel, UBS Warburg analyst Sam Buttrick recently told The Wall Street Journal. Airlines struggle to make a profit even when oil is as low as $25 a barrel.

Six airlines recently sought government assistance to absorb soaring fuel prices as well as higher costs associated with airport security and insurance for the war on terrorism, with United Airlines in pursuit of a federal loan guarantee that competitors have opposed behind the scenes.

With the exception of discount carriers such as Southwest Airlines, Delta Airlines' Chief Risk Officer Chris Duncan believes most airlines aren't in a position to invest much money in fuel hedges because of a combination of economic challenges affecting individual airline companies and the industry in general.

Higher fuel prices mean income statements and balance sheets are more sensitive to other risks. "When a balance sheet and income statement are weakened," Duncan says, "it's like the body's immune system being more susceptible to catching the flu. Other risks that might come out of the woodwork that in other times might have been absorbed by a stronger financial body are now a bigger deal." He predicts the industry will first need to show stronger cash flows before making bigger bets on jet fuel prices.

INLAND MARINE FACES A SQUEEZE

Trucking companies, which are required to carry a $1 million primary limit, four years ago routinely carried umbrella coverage of $2 million to $5 million in addition to their primary coverage.

That was when dozens of insurance companies competed in the market making umbrella coverage relatively affordable. But then jury awards started climbing.

"Claims we thought would be settled for half a million, the jury awarded $5 million," says Bill Prester, head of the trucking practice group at Aon. Before 2000, the number of claims exceeding $1 million was minimal. And after Sept. 11, the number of insurers willing to write the excess umbrella coverage dried up. Premiums tripled. In some cases premiums went up as much as 1,000 percent and scores of trucking companies stopped purchasing the coverage because it was no longer affordable, Prester says.