Recent Developments in the Aviation Insurance Industry

• Date: 01 September 2009
• Published date: 01 September 2009
• Author: Thomas Walker,Kuntara Pukthuanthong‐Le,Triant Flouris,Paul Hayes,Dolruedee Thiengtham
• DOI: http://doi.org/10.1111/j.1540-6296.2009.01165.x

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Risk Management and Insurance Review, 2009, Vol.12, No. 2, 227-249

PERSPECTIVES ARTICLES

RECENT DEVELOPMENTS IN THE AVIATION

INSURANCE INDUSTRY

Triant Flouris

Paul Hayes

Kuntara Pukthuanthong-Le

Dolruedee Thiengtham

Thomas Walker

ABSTRACT

The aviation industry has been hard hit in recent years. While there are numer-

ous factors that have contributed to the industry’s dilemma, rising and volatile

insurance premiums—particularly after the events of 9/11—have posed a par-

ticular problem for many airline managers. Despite a general trend for accident

rates involving commercial passenger airplanes to decrease as aviation technol-

ogy has advanced over the years and airplanes have become safer, the aviation

insurance market has been far from stable. This article provides an overview

of how the aviation insurance industry works and how it has changed in re-

cent years. We take a look at how the risk is spread between insurers, how

insurers treat deliberate acts of violence, and lastly, how insurers price the risk.

Our article shows that the aviation insurance market has undergone consider-

able changes in recent years and that it has adjusted to the post-9/11 aviation

insurance realities being reasonably ready to handle events of an even more

catastrophic magnitude.

INTRODUCTION

Aviation accidents, although infrequent, have the potential to result in large property

damages and a high number of fatalities. The extant academic literature includes several

Triant Flouris, AC117, School of Aviation Sciences, Daniel WebsterCollege, 20 University Drive,

Nashua, NH 03063-1300; phone: 603-577-6101; fax: 603-577-6177; e-mail: flouris@dwc.edu. Paul

Hayes, Ascend Worldwide,505 East 82nd Street, Suite 6D, New York, NY 10028; phone: 212-286-

1692; fax: 212-551-1001; e-mail: paul.hayes@ascendworldwide.com. Kuntara Pukthuanthong-

Le, SSE3400, Department of Finance College of Business Administration, San Diego State

University, 5500 Campanile Drive, San Diego, CA 92182-8230; phone: 619-594-5690; fax: 619-

594-3272; e-mail: kpukthua@mail.sdsu.edu. Dolruedee Thiengtham, GM300-84, Department of

Finance, John Molson School of Business, Concordia University, 1455 de Maisonneuve Boule-

vard West, Montreal, QC H3G 1M8, Canada; phone: 514-848-2424, ext. 2792; fax: 514-848-

4500; e-mail: dthiengt@jmsb.concordia.ca. Thomas Walker, MB 12-315, Department of Finance,

John Molson School of Business, Concordia University, 1455 de Maisonneuve Boulevard West,

Montreal, QC H3G 1M8, Canada; phone: 514-848-2424, ext. 2789; fax: 514-848-4500; e-mail:

twalker@jmsb.concordia.ca. This article was subject to double-blind peer review.

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228 RISK MANAGEMENT AND INSURANCE REVIEW

studies that examine the strategic and financial consequences of aviation accidents for

the affected airlines. Chance and Ferris (1987), Davidson et al. (1987), Walker et al.

(2005), and Pukthuanthong-Le et al. (2007), for example, study the stock price reaction

of airlines following an accident announcement.1In addition, Carter and Simkins (2004)

and Flouris and Walker(2005) take a detailed look at the airline industry’s reaction to the

events of September 11, 2001 (9/11).2Yet, despite a thorough examination of the airline

industry’s reaction to aviation accidents that is provided by these strands of literature,

there have been comparatively few studies that consider how insurance companies—

which ultimately pay the bills—are affected. Our study adds to the existing literature in

this area by exploring how the insurance industry has reacted to the events of 9/11.3

In the first part of our study we aim to provide insights into the inner workings of

the aviation insurance market. Specifically, we take a look at how the risk is spread

between insurers, how insurers treat deliberate acts of violence, and lastly, how insurers

price the risk. The statistics and related discussions presented have been developed

through cooperation with several industry insiders and should be of interest for both

practitioners and academics alike. In the second part of the article, we focus our attention

on the events of 9/11 and examine how they have affected both insurers and insureds.

Wedocument that the aviation insurance market has undergone considerable changes in

recent years that included, among other things, the withdrawal of numerous insurance

policies immediately following the events of 9/11, the departure of several insurers and

reinsurers from the aviation insurance market, the creation of a new drafting body for

insurance clauses, the redrafting of several old insurance clauses to better address war

and terrorism risks, the reformulation of previously designed disaster scenarios, and an

active discussion among airlines, insurers, and governments about governments’ role

in insuring certain war risks. We will review and discuss each of these developments in

detail in our article, and while many of them are still ongoing, it is fair to say that the

insurance market has already sufficiently adjusted to the post-9/11 aviation insurance

realities so that if worse comes to worst, it would be reasonably ready to handle events

of an even more catastrophic magnitude.

THE AVIATION INSURANCE MARKET4

The fundamental principle of all forms of insurance is that “the premiums of the many

will pay the losses of the few.”5As insurance businesses exist in the commercial realm,

1For related research on the reputational consequences and legal repercussions of aviation dis-

asters for airlines and airplane manufacturers, see also Chalk (1986, 1987), Borenstein and

Zimmerman (1988), Mitchell and Maloney (1989), Rose (1992), and Bosch, Eckard, and Singal

(1998).

2The hijacking of four aircraft and their subsequent deliberate crashing into the World Trade

Center and the Pentagon, as well as the crash in rural Pennsylvania on September 11, 2001, is

in short often referred to as “9/11.”

3For other studies that examine changes in the aviation insurance market after 9/11, see Margo

(2002, 2003), Abeyratne (2002, 2005), Kunreuther and Michel-Kerjan (2004), Caplan (2005a,b,

2006), and Hughes (2006).

4We use the term “aviation insurance market” loosely to refer to the group of insurers writing

risks in the commercial aviation sector.For a detailed overview of the different types of aviation

insurance available, see Margo (1996).

5Viccars (2001, p. xiii).