Market hedging, non-aviation risks driving captive conversations among airlines

While it is not uncommon for aviation companies to have captives, a large proportion have utilised them to write non-aviation risks.

All-risk aviation insurance has historically been cheap to purchase in the commercial market, but large reductions in retro capacity following carrier withdrawals and the war in Ukraine are expected to create a more challenging environment.

“Rates spiked just after 9/11 and then they’ve been in a downward spiral ever since. The events in Ukraine and Russia where Putin obviously confiscated $16 billion worth of aircraft has focused everyone’s mind,” one anonymous source said.

Some aviation companies have been known to use their captive to take a gross line of the liability and hull cover to get direct access to the reinsurance markets, with the captive then reinsuring 100% of the risk back to the market.

The hull war market has also traditionally been underpriced and has often been written as part of a composite treaty with other lines such as political violence and marine war.

Russia’s invasion of Ukraine has led to triple-digit rate increases in the hull war market and has resulted in greater interest in captive use.

Martin Rossiter, partner in Gallagher’s aerospace practice, revealed that the broker is having conversations with many clients about the viability of engaging a captive in their programme “and not just around the aviation insurance elements”.

“Last year, we set up a captive for a major aviation client and we are currently having discussions with another major client who is exploring the merits of setting up a captive vehicle,” Rossiter told Captive Intelligence.

Adrien Collovray, head of captive advisory, GB, Europe and international at WTW, has also held conversations with the aviation industry about the use of captives, but he noted that most are struggling to find the buy-in from senior leadership and finance to support greater involvement in the captive.

“There are frankly other financial priorities within their organisations at the moment,” he said.

Captive Intelligence has spoken to one airline which recently went through an 18-month feasibility and internal stakeholder process, and chose its captive domicile, only to be scuppered at the final hurdle by a major shareholder.

Despite the challenges outlined below, Captive Intelligence is also aware of three airlines actively considering a captive formation in the near future.

John Wadhams, managing director in WTW’s aviation division, said one of the challenges for airline captive owners is that the majority are not investment grade and 50% of the flying fleet is leased.

“The majority of lessors won’t allow airlines to have retained amounts that are greater than the standard deductible or excess points that exist for the aircraft types,” he explained.

One of the largest aviation captives is Lufthansa’s Delvag, domiciled in Germany, which employs around 140 people and writes a number of traditional and third-party risks.

Speaking on GCP #58 in 2021, Tobias Winkler, now an executive board member at Delvag, said: “Our main focus is aviation and marine, and on a reinsurance basis, we also write employee benefits, travel insurance, credit card programmes and property – so almost everything that would be considered a traditional captive line.”

In the United States, Delta and United own captives in Vermont, while Alaska Airlines owns a Hawaii-domiciled captive, and Southwest’s captive is domiciled in Bermuda.

In Europe, Are Lingus, part of International Airlines Group (IAG), owns a Bermuda captive, while Ryanair owns a captive domiciled in Malta.

All risks

Rates in the all-risks market have been viewed as underpriced for a long time, resulting in a lack of appetite to write the risk in captives

“It is so cheap in its scale and efficiency, you’re literally paying less than $100 a flight for a wide body to take off and be insured for the billion and a half limit, and all the passengers, and third party,” Wadhams said.

“It’s hugely efficient, and some of the captives can’t match that, and don’t want to take that on.”

James Straker-Nesbit, senior manager of insurance at Virgin Atlantic, highlighted that back in the 1970s, a A747 aircraft with four engines was worth about $40 million and the deductible was around $1 million.

“Now if we take a similar modern aircraft, such as an A350, it can worth be $250 million and the deductible is still $1 million,” he told Captive Intelligence.

“There are pros and cons to this for both parties, but it does lead to attritional hull damage losses falling into the aviation insurance market because, in the 1970s, $1 million of damage was a lot but now it’s not much at all.

“For aviation hull all risks, I do see the potential that a captive could remove most of the attritional losses in the primary working layers, but from a catastrophic perspective, you’d have to be quite brave.”

Despite stagnant rates and deductibles, Rossiter highlighted that a select few companies have historically taken a share of aviation risk within their captive.

“There are a number of airlines that have taken a share of their aviation risk over the years and this is not something new, it goes back to the early 1970s, so it has a market profile of 50 years,” he added.

“Any airline that has done this on a legacy basis is likely to have built up a positive fighting fund and within certain tolerances this has proved sustainable for them when they carry on with a captive.

“Currently, the use of a captive for airlines is still very much the exception rather than the rule.”

However, the significant challenges within the retro market and issues surrounding the war in Ukraine could see pricing increase and capacity shrink, causing more companies to assess utilising a captive.

One aviation insurance buyer, speaking to Captive Intelligence on condition of anonymity, said that although there has been noise from insurers about changing appetites, reduced capacity and pricing changes, when they have gone to market to purchase cover, they have not found that to be the case.

“When some of our peers have gone to market, they haven’t found that either,” they said.

“We’ve actually had more capacity offered to us this year for our renewal than the previous decade in terms of percentage and we increased our limit.”

Stewart McLaughlin, business development director in Europe at Artex, said the captive manager had been working with one client who was interested in launching a captive to leverage more control over the market.

“They saw the value in taking more control over the insurance narrative and established a captive to write the hull all-risk deductible and a modest primary layer above the deductible,” he told Captive Intelligence.

McLaughlin said one of the main challenges with writing hull and liability risk in a captive is the considerable risk gap – the difference between premiums and the sums insured.

“Given the drivers for captive solutions are now present, it’s becoming a more realistic proposition,” he said.

Wadhams said the challenge you have is the liability limits are vast in aviation and it’s written in a vertical.

“So you write your 10% line of a $1.5 billion, and you’re not writing 10% through the card with 15 layers with $100 million each,” Wadhams said.

Collovray added there are very few aviation companies that can put out a few hundred million dollars of capacity into their captive, “and when we’re talking about towers, it doesn’t move the dial from the aviation perspective if they just put out a bit more”.

“Then we’ve got the connection with the lease companies, etc. The combination of the two means that the aviation captives are generally playing as a more reactive position within the overall risk financing strategy,” he said.

“They’re reacting to what they’re required to take in terms of retentions, rather than proactively seeking risk.”

A large Aircraft leasing company is currently embroiled in a multi-billion pound claim against insurers refusing to pay claims over aircraft stranded in Russia.

Hull war

The hull war market is a relatively small part of the aviation insurance market, but it has grown in significance since Russia invaded Ukraine.

A recent Gallagher Plane Talking report noted that in respect of war capacity, overall levels have reduced during the past 12 months.

“There is a general heightened focus around geographic exposure, routes and accumulation, and coverage restrictions and limitations continue to be applied with overall aggregates and sub-limits under pressure,” the report states.

One of the main difficulties with writing hull war in a captive is its profile as a low frequency, high severity risk.

“Aircraft hull war is a catastrophic risk and the only way I can see it working in a captive is if you have a way of feeding that captive with a significant amount of premium every year and you’re making a profit from it, and your company is willing to keep investing in that captive and not taking that money out,” Straker-Nesbit said.

“If you’ve got that kind of arrangement, that’s fine, but is that actually going to provide best value to your company? From our perspective, I can’t see how that would work, we’d need a much larger fleet before that’s something we could even possibly consider and even then I would think it unlikely to be feasible.”

Rossiter said that some clients are looking at aviation war and thinking about what they can do to give themselves a degree of hedging against recent market increases.

“That can drive the conversation around where the airline might want to look in terms of a captive’s involvement in aviation insurance,” he added.

“We have a client who has taken an appreciable share of their aviation war risks and placed that in a captive.”

Non-aviation risks

Where there are captive utilisations by airlines, and there are many, they are predominantly used to incubate non-aviation risks.

“The big entities have captives, but they don’t transfer aviation risk into the captive. A lot of the airlines run their travel insurance programmes and stuff like that through their captives,” said Mark Costin, commercial director at Insurwave.

These tend to be high frequency, low severity lines and can often be profitable for the captive.

“Some of the North American airlines I used to be involved in had captives, but it was all for the non-aviation side to their business,” Oliver Schofield, CEO at RISCS CWC, told Captive Intelligence.

“The airline is not necessarily saying we are an airline with aviation risks, but rather a business with business risks like any other business and how do we use a captive to provide us with that support for our general business?”

Schofield noted that the captive could be particularly useful if a client has a frequent flyer programme “because if you’ve got a frequent flyer programme and all the associated data, you essentially have a captive audience to whom you can sell”.

“In other words, you could consider offering an insurance programme as part of a frequent flyer programme, such as hire car excess buy-down, theft or damage or loss to private possessions whilst on a trip, perhaps even hotel cancellation; of course, the use of this data will be subject to different data rules around the world.”

Straker-Nesbit said the customer ancillaries are a really good example of something that can help feed a captive to potentially help subsidise some of the other areas “and it’s just a question of how those are structured and offered to customers”.

Schofield also revealed that a couple of airlines have contacted him previously asking to look at how they could use their captive to write D&O.

“And we advised them that it was a valid thing to do for certain aspects of the D&O cover because they were seeing such a rapid increase in the premiums that they were asked to pay.”

This long-read article was originally published on Captive Intelligence, by Luke Harrison.