Are rising fuel costs hurting the aviation insurance market?

With rising fuel costs forcing many airlines to cut back on services and ground aircraft, industry experts have predicted that the aviation insurance industry could be set for a difficult year ahead.

Despite some recent variations, the cost of crude oil is still over US$100 (£50) a barrel, hitting airline operating costs hard. Many airlines are starting to rethink their business and make cutbacks to their operations.

The American carrier Continental Airlines has just posted a loss of $3 billion (£1.5 billion) for the second quarter of 2008, with the loss standing at $25 million (£12.5 million) when special items are excluded from the calculations. The company has blamed a combination of record-high fuel prices, sluggish economic conditions and a weak dollar for the dismal results.  And it's not just American airlines who have been suffering - Australian carrier Qantas has recently announced that it will be cutting 1,500 jobs worldwide, also putting the blame on rising fuel costs and wider economic downturn.

In fact, the situation is so serious that the International Air Transport Association (IATA) has recently revised its industry financial forecast for 2008, with far gloomier projections. The trade body predicts that the loss will amount to $2.3 billion (£1.15 billion), a swing of $6.8 billion (£3.4 billion) away from the previously forecast profit of $4.5 billion (£2.25 billion). IATA’s director general, Giovanni Bisignani, predicts a tough year ahead for the industry.  He commented at the association’s 64th Annual General Meeting and World Air Transport Summit (WATS/AGM) that “oil is changing everything. There are no easy answers." He continued by warning: "There is no fat left. To survive this crisis, even more massive changes will be needed quickly.” 

The IATA is not the only industry body to predict a difficult year for aviation. According to Fitch Ratings, record jet fuel prices and falling demand for air travel, particularly in North America and Western European markets, have placed increased pressure on many airlines. It believes this elevates the risk of default on leases and places significant strain on the value of certain aircraft types.  As a result, Fitch has revised its asset performance outlook for aircraft securitisations to declining and its rating outlook for the sector to negative, with downgrades expected to outpace upgrades over the next 12 months.

Director of aviation strategy at Mott Macdonald, Laurie Price, agrees that things are tough for airlines at the moment. He said that the airline industry has been hit by a double whammy of rising fuel costs and limited consumer spending as the credit crunch continues to bite.  Price adds that "every dollar increase in the price of a barrel of oil literally knocks the bottom line of the industry off in many billions of dollars".

As airlines begin to try to reduce operating costs by grounding aircraft the aviation insurance industry is also likely to be hit. The problem for brokers is that grounded planes only require ground risk cover rather than the more expansive hull, war risk and passenger liability cover. More grounded planes leads to a reduction in the cost of premiums.

As more airlines begin to cut back, insurers themselves are starting to feel the pinch.  Magnus Allan, aviation analyst at AON insurance, shares the gloomy outlook of Mott Macdonald's Laurie Price.  He believes that there will be some difficult decisions going ahead as the industry tries to adjust to the current economic climate. He also commented that: “the airline insurance market has got to operate in such a way that there is a safety net in place in case there are significant or extreme losses." 
 
According to Aon's Airline Insurance Market Review 2007, the airline insurance market was broadly unprofitable in 2007 due to the high level of hull and liability claims, at $1.7 billion (£851 million), coupled with the lowest amount of lead hull and liability premiums since 2000. Allan predicts that in 2008 insurance prices for these other liability products are likely to be fairly static which is still significantly below where they were in 2003/2004.

However, Allan provides one glimmer of hope. He states that the insurance industry is far more flexible than it was 20 years ago, so as a result it should be able to respond fairly effectively to any changes in the makeup of the aviation industry. He points to Hurricane Katrina as an example of the industry coping in difficult times, commenting that the companies who had diversified across sectors coped the best. He adds that "most global underwriters don’t keep their eggs in one basket; they are all very well diversified."