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By CYRIL TUOHY, managing editor of Risk & Insurance®.

If, by chance, you'd touched down at Los Angeles International Airport in mid-November, you would have seen a sight that the airline industry isn't likely to see again anytime soon.

But the story behind the open cowlings was decidedly more serious, and could have easily taken a turn for the worse. The Qantas A380s, the largest airplanes ever built, were grounded following a midair blowout of an engine over Singapore on Nov. 4.

The engine, a Rolls-Royce Trent 900, so large a man can stand upright in the intake, had sprung an oil leak. Parts of the malfunctioning No. 2 engine pierced through the engine housing and punctured the crippled plane's massive wing.

Images of the mishap shot by passengers inside the cabin and later posted on YouTube revealed shards of aluminum skin sticking up from the surface of the wing. The incident injured two people on the ground as pieces of the plane fell to earth. No one in the plane was hurt.

The resulting damage caused millions of dollars in property and business interruption losses for Australia's storied flag carrier. The accident, likely the largest ever single loss from an aircraft engine, one aviation insurance broker said, is expected to cost the insurance industry as much as $90 million, according to a report published by Marsh in January.

A $90 million loss sustained from one piece of airplane equipment is what you might call an expensive lesson in severity, and the incident signals a changing trend in the airline industry: a drop in claims frequency but an increase in severity.

Severity claims, as the name implies, never come cheap and 2010 claims are expected to come in at about $2.1 billion before reinsurance and fixed costs, Aon said, in a January report, while insurance carriers took in just above $1.9 billion in lead hull and liability premium last year.

As a result, the 2010 global aviation underwriting portfolios are likely to be in the red by at least $200 million.

In summary, 2010 was a year marked by "fewer small losses coupled with some very large ones," said Magnus Allan, a London-based aviation analyst with Aon's global aviation group.

No deaths were attributed to U.S. commercial aviation in 2010, but plane crashes abroad and an aviation-related loss in the U.S. made for a tragic, difficult and costly year.

A total of 601 people died in airplane-related crashes last year, and though the statistic remains below the long-term average of 621 fatalities a year, it is of little comfort to those who've lost loved ones.

Catastrophic airline losses in 2010, Lloyd's said, included the Jan. 25 crash of an Ethiopian Airlines jet, which killed all 89 people aboard; the February collapse of a business jet hangar at Dulles International Airport; the May 12 crash of an Afriqiyah Airways killing 103 passengers and crew; the May 22 crash of an Air India Express, which killed 158 people; the June 10 Saudi Arabian Airlines warehouse fire which damaged planes and equipment; the July 28 crash of an Air Blue aircraft in Pakistan killing 152 people; the Sept. 3 crash of a UPS 747 cargo jet in which two crew members were killed; the Nov. 4 oil leak to the No. 2 engine of the Qantas double-decker over Singapore; and the Nov. 4 crash of an Aerocaribbean propeller plane in which 68 people died.

The losses, many coming in the third and fourth quarters, added more than $1 billion to the annual total, according to Marsh's Europe, Middle East and Africa Insurance Market Report 2011.

In the end, the global aviation market last year had what is referred to a different aviation context as "a near miss." Had that A380 crashed and taken its passengers and crew with it, it "could have been a real market changer," said Jeff Moitozo, chief underwriter North America for Chartis Aerospace Insurance Services Inc. in New York.

"We're starting to see some hardening of rates and 'rate increase' is once again part of underwriting vocabulary," Moitozo said. Discount charter airlines operators are expected to feel the hardening first, he said.

"To say the market has hardened in 2010 is more applicable to the fourth quarter on the airline side," he said.

Taking into account premium trends for airports, air traffic control, ground service providers and the refuelers, there was simply too much capacity in global aviation portfolios, Marsh said, in its report.

Premium levels remain fairly high, but "capacity will continue to be attracted to this class of insurance and 'soft' market conditions will remain unless a major loss or two occurs in 2011," according to the Marsh report.

Allan, in a January interview with Risk & Insurance® said the aviation market in 2011, barring any catastrophic loss, is expected to "carry on hardening slightly but not significantly," from last year.

Fleet values were up 6 percent, passenger volume was up 10 percent, and renewal premium volume was up 4 percent last year compared to 2009, according to Aon data based on 203 renewal programs.

"The airline segment is recovering in terms of passenger movements and in terms of new aircraft purchases in the airline industry," Moitozo said. "But at the end of the day, the revenue to the underwriters is about the same."

Moitozo said airline capacity was "in excess of 200 percent of even 240 percent," and even higher on the general aviation side. The underwriters, Marsh said, are targeting airlines with losses for rate increases despite the excess of capacity.

For buyers with an average-to-good risk profile, lead hull and liability prices softened in the fourth quarter of last year compared with the year-ago period.

The Marsh report also pointed to the break-up of the Gulf Cooperation Council aviation insurance placement into 14 separate programs. Members of the group, Qatar and the United Arab Emirates, own some of the largest and most modern fleets.

Breaking up the pool for aviation insurance, therefore, resulted in a lot more competition between underwriters "looking to participate on the more 'desirable' risks," the Marsh report said.

Two contradictory trends--"nasty undercurrents" in the words of Aon--appear to be at work.

Lead hull underwriters coming into the fourth quarter were faced with soft pricing and many syndicates, or supporting markets, with which lead underwriters share the risk, seemed happy playing hardball.

By the time the fourth quarter rolled around, many supporting markets had already met their targets and could afford to decline business they believed to be underpriced, Allan said. The effect was to reduce competition and put upward pressure on the lead underwriters.

Still, capacity remains healthy, Aon said, because underwriters are willing to remain diversified across many insurance sectors. Hiscox's decision last year to enter the mainstream airline sector is a case in point.

"The consensus is that we don't need more capacity but it's great for buyers," Moitozo said.

For the moment, underwriters can have it both ways. They can maintain a presence in the airline sector without participating on every program, the Aon analysis also noted.

"It is this factor that means that while the market hardens considerably in the immediate aftermath of a loss, it tends to soften relatively quickly in the following months as underwriters that have been holding back from participating are attracted by the higher prices and become more active," the Aon report said.

Following the catastrophic loss of a Colgan Air regional propeller plane on approach to Buffalo, N.Y., Feb. 14, 2009, in which 50 people were killed, and the loss of an Air France Airbus jet over the South Atlantic June 1, 2009, in which 228 people lost their lives, rates spiked due to the liability losses. Rates have since been declining.

"It's really a Catch 22," Moitozo said. "The increase in capacity puts downward pressure on rates while still attracting new capacity with the anticipation of the inevitable hard market."

Predicting the future of the aviation market is never easy, but Allan summed up the state of the market best. "Ultimately the market will find its own equilibrium," he said.

March 1, 2011

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