Insurance pricing for air transport worldwide is subject to sudden and hardly predictable adjustments. The increase in premium costs after the Sept. 11, 2001, terrorist attacks and, more recently but less severely, after the June 2009 crash of Air France Flight 447 in the Atlantic Ocean illustrate how aviation insurance premiums can fluctuate because of unforeseeable events. Since the immediate aftermath of Sept. 11 — when insurance premiums reached levels eight to 10 times higher than today — premiums have considerably decreased, mostly because of the availability of huge financial capacity to absorb losses and strong competition.
Airlines voluntarily purchase insurance coverage or are required to by law because insurance is the most cost-effective financial risk protection against the consequences of major accidents. Airlines typically self-insure most of their non-catastrophic, attritional losses. Insurance contracts are generally written so that airlines pay any damage below agreed deductibles and insurers pay any damage above deductibles. To evaluate a risk and set a premium, insurers focus on various parameters of the airline such as number of aircraft, fleet value, age of aircraft, revenue passenger kilometers and area of operation.
Apart from collecting sufficient aggregate premiums to cover occasional major losses, insurers need to account for administrative costs and add a profit margin. Insurers tend to underwrite based on historical experience: If an insured party has had a major occurrence, premium charges tend to rise at policy-renewal time.
On the contrary, continuous improvement of an aircraft operator’s risk profile because of the absence of losses or improvement in the overall safety standard may lead to premium decreases over time and consequently lower airline operational costs.
Learning From Insurance
The International Civil Aviation Organization’s (ICAO) new Annex 19, Safety Management Systems (SMS) becomes applicable in mid-November, and regulators such as the European Aviation Safety Agency (EASA) already have clarified that SMS implementation will be required in Europe over the next few years. Risk-management policy and procedures of an SMS allow a structured way of identifying and handling all risks, particularly those that are unacceptable under all circumstances.
Risk management as a business practice distinguishes between all risks and those that can be kept under control by the organization, and only the mitigation of the latter is worth expending significant resources. Risk management, with cost-benefit analyses, allows for a measurement of the returns on investment from alternative control and mitigation options and so allows for efficient allocation of resources.1
Aligning the internal risk management approach with the external observations and experience of insurance providers can give airlines the benefit of an enhanced perspective for decision making.
Integrated Risk Management
As the International Air Transport Association (IATA) has noted, an airline is a “system of systems.” Management teams must continuously adjust to dynamic financial, competitive and operational pressures that characterize the complex aviation environment.2
Integrated risk management (IRM; Figure 1, p. 30) is a principle derived from recent developments in risk management theory in the insurance industry and the financial world. It is “a systematic assessment and analysis of all risks in an organization.” IRM analysis is conducted from the bottom up as well as the top down to provide all the information essential in determining a comprehensive view of risk. IRM provides significant input into the development of strategic plans, marketing initiatives, financial plans and resource investments, as well as airline safety.
Included is the assessment of risks that are common to most organizations — for example, strategic risk (market dynamics, resource allocation); financial risk (capital structure, liquidity, credit); operational risk (assets, people, technology); compliance risk (legal, regulatory, best practices); environmental risk (petroleum products, hazardous materials); corporate citizenship/image/reputation risk; and project risk.3
IRM is important in aviation because it provides the best framework for considering the connections among risks. As IATA has said, “In order to maximize the value of the organization, it is important to recognize that risks are interrelated and thus cannot be viewed and managed in isolation. As such, risk management is not a one-man show; it is a collaborative effort throughout the organization.”4
Risk management integration (Figure 2, p. 31) can be seen as a multidirectional process in which any component can influence others. The visualization shown is derived from the Committee of Sponsoring Organizations of the Treadway Commission, a joint initiative of five private-sector organizations “dedicated to providing thought leadership through the development of frameworks and guidance on enterprise risk management, internal control and fraud deterrence.”
The figure illustrates the value of strengthening the direct relationships between objectives — what an entity strives to achieve by strategy, operations, reporting and compliance and risk management, what is needed to achieve the objectives. These relationships can be visualized as a three-dimensional matrix. The risk-management components are represented by the horizontal rows, the organization’s units by the vertical rows and the categories of objectives by the third dimension.5
The insurance industry continually performs statistical analyses of data collected to assess the risks that insurers underwrite. In the airline business, there was not always this level of sophistication in managing risk — and although many airlines already have adopted comparable predictive capacity, others still rely exclusively on qualitative (that is, non-data-driven) observations and experience.
Learning from the insurance industry’s example, an airline willing to manage risks with state-of-the-art methods needs to start by developing (or refining) a system that includes routine flight data monitoring and a database of past safety occurrences (including near-misses and employee concerns) by which to assess the risks it faces. It must also develop systems to identify and implement risk-control measures.
The development or refining of the reporting system and of the database needs to account for data quality, and this is ensured only by a taxonomy.
If the aim is to generate consistent and repeatable results, the taxonomy used in the observational programs must be well defined, easily understood and applied by those responsible for recording the observations. The taxonomy’s framework has to be in active use by personnel in terms derived from their operational language. It needs to support the human factors model of human error and to provide data that can support the SMS risk management components.6
Such database development and ongoing analysis by the airline is normally highly regarded by insurers, which especially are interested in data collection related to safety occurrences, monitoring mitigation outcomes and systematically addressing concerns of personnel. In fact, if the insurer considers the availability and quality of the airline’s internal data sufficient, its normal scope of on-site investigation of claims in the case of minor occurrences or near-misses may be reduced, although results still could influence the insurer’s risk profile of the operator.
Data collection is, however, a very sensitive area, said Reto Inderbitzin, CEO of Inderbitzin Comprehensive Solutions, a consultancy. “Everybody would agree on collecting data, but would be less enthusiastic if it comes to disclosure,” he said. “Some other open questions with regard to data collection are what happens to the data collected, who benefits from the collection, if results are shared or kept under tight wraps and what the consequences for the discloser are.
“Nobody likes to admit inadequacies or issues within their area of accountability if they do not receive support in exchange for shared data regarding such issues. Establishing a data collection and sharing mechanism in an organisation with a ‘just culture’ might not be a big challenge. Other organizations are more reluctant to share such data. Data sharing is just the top of a sound and established safety culture within an organisation.
“In addition, performance analysis is an important management task of a properly working quality assurance process. Incidents and accidents are performance indicators. Some of them may even be safety performance indicators and therefore part of an overall safety performance assurance program. A company with a transparent and tangible safety culture would not hesitate to share the required information with its insurance partner and would most likely create increased appreciation and understanding.”
It is critically important in SMS that a reporting system and a safety database be suitable for the interpretation of collected data. One of the biggest challenges in this regard is “to acquire or train personnel who possess the skills and knowledge in these disciplines, and an understanding of the tools and analysis methods used in them,” said SMS specialists Alan Stolzer, Carl Halford and John Goglia. “Unfortunately, these are not skills that the typical aviation manager currently has.”7
To acquire and develop the analytical expertise needed, look at the measures used by the U.S. National Aeronautics and Space Administration (NASA) to enhance the agency’s probabilistic risk assessment (PRA) expertise. PRA is one of the most sophisticated risk management analytical techniques in aerospace, established by NASA as a decision-making support tool following the 1986 Space Shuttle Challenger disaster.
“Real PRA expertise cannot be developed overnight,” a NASA document said. “If in-house experts do not exist initially they must be hired or groomed through training and transfer of technology. They have to be able to build PRA knowledge and experience and stimulate cultural changes so that the progressive organization can use these resources to make sound and cost-effective safety improvement decisions.”8
The following steps have guided NASA in PRA development:
- “Transfer PRA technology to managers and practitioners as soon as possible;
- “Develop or acquire PRA expertise and state-of-the-art PRA software and techniques;
- “Gain ownership of the PRA methods, studies and results in order to use them effectively in the management decision process;
- “Develop a corporate memory of the PRA project results and data on which to build future capabilities and experience; [and,]
- “Create risk awareness in programs and projects that will eventually help to develop a risk-informed culture for all programs and activities.”9
Negotiating With External Suppliers
One area of great concern for airline risk managers is that in practice, third parties under contract are almost never liable for consequential damages to an airline’s aircraft during the rendering of services such as ground handling. This status of things dates back several decades to when such services were usually provided by in-house companies under the same ownership and with the rigid bilateral agreements then in place, it meant that an airline was as likely to have an aircraft damaged overseas as it was to damage another airline’s aircraft at its home base, said Ivar Busk, manager of insurance at SAS Scandinavian Airlines.
Very much as insurance contracts — covering only major losses and catastrophes — stimulate an airline to generate operating efficiencies to reduce more frequent minor losses, making service providers more accountable for the damages they cause can improve the quality and safety of contracted services.
“In my experience over the years, I have become convinced that if a ground service provider pays more of the damage, including consequential losses up to a certain limit, then we will see a more proactive engagement from the service provider. The difficulty is to value the consequential loss without going too far. It is therefore necessary to determine the quantum beforehand, such as a lost bulkhead per aircraft type. This will in the end lead to safer ground handling,” said Busk.
In order to update the limits to the liability of ground handling companies to reflect current industry needs, the Association of European Airlines (AEA) has proposed to amend the IATA Standard Ground Handling Agreement. “The proposals from AEA have been presented to the IATA AGSA (ground handling contract group) but, not surprisingly, the requests were not accepted with immediate effect,” said Busk. “Ground handling companies want to discuss the matter without any time constraint, but at least they recognize that some changes need to be done.” The European Commission in its latest update of Regulation 261/2004 has expressed “that national law and contractual provisions may not restrict the air carriers’ right to seek compensation from a third party responsible for delays or cancellations. This provision aims to create an economic incentive for third parties to find ways to reduce traffic disruption.” This is in line with what airlines want to see implemented, said Busk.
Airline safety directors and their risk managers can benefit from knowledge that today’s considerable competitiveness in the aviation insurance market, characterized by a strong availability of capital as noted, has motivated several aviation insurance providers to launch collaborative services to enhance risk management. This is an attempt to develop a more stable and longer-term partnership with client airlines, instead of these airlines shopping for the lowest premium deal every 12 months.
“Global Aerospace Underwriting Managers, for example, runs a program called SM4 which allows its customers to attend safety assurance and risk prevention seminars,” said Inderbitzin. “The benefit is not specifically that of a reduced insurance premium, but of obtaining up-to-date know-how from high-level speakers and recognized industry experts, and also nurturing a network of personal contacts which would otherwise be hard to develop. Putting this learning opportunity into the context of a long-term business relationship, the program provides the customer with a more solid outcome than selecting insurance coverage upon premium level only.”
But long-term partnership with an insurance provider typically does eventually offer benefits in terms of premium costs. “If an insurer knows how the client is organized and that it is operating to recognized standards, it would then be more flexible with regard to individual premiums,” said Inderbitzin. “It is all about the relationship. Professional insurance brokers who are acting on behalf of airlines develop and maintain an interrelationship to achieve a trustworthy and efficient day-to-day contact, which will eventually also assist in [case of] a claim.”
International Safety Standard
Achieving a recognized registration such as under IOSA (IATA Operational Safety Audit) or IS-BAO (International Standard for Business Aircraft Operations) is generally positively regarded by underwriters. The International Business Aviation Council (IBAC) reports that “approximately one-third of IS-BAO registered operators report significant insurance savings as a result of registration, and the number is growing.”10
Inderbitzin has a similar perspective when airlines and business aviation operators come to negotiate insurance contracts. “Although I cannot speak for all the insurers, as each one has its own individual perception, it is certainly a positive element to recognize an organization which has demonstrated its compliance to standards like IS-BAO or IOSA,” he said.
Carl Norgren, formerly an airline training captain and currently an aviation safety consultant, added, “Especially in comparison to other operators in the non-commercial or corporate aviation sector, where the regulator relies on individual accountability rather than a stringent set of regulations or standards, an accreditation is a visible and comprehensible commitment to safety and risk management standards recognized and accepted worldwide.”
More than 20 years ago, to implement quality management systems, expertise was brought into the airline sector from the manufacturing industry. Today, risk management expertise is required for the full functionality of an SMS, an area in which insurance companies as well as risk management consultants should be invited to contribute.
Senior airline managers and risk managers have a unique opportunity to exploit today’s strong competition in the aviation insurance market, which already is making a wealth of risk management expertise, tools and methods more accessible to airline partners.
Mario Pierobon works in business development and project support at Great Circle Services in Lucerne, Switzerland.
- ICAO.Safety Management Manual. 2009.
- IATA. Integrated Airline Management System for Air Transport — Operators. 2007.
- IATA. Integrated Risk Management Guidance Manual. 2010.
- Committee of Sponsoring Organizations of the Treadway Commission. Enterprise Risk Management/Integrated Framework (Executive Summary). September 2004.
- Stolzer, A.; Halford, C.; Goglia, J. Safety Management Systems in Aviation. Farnham, Surrey, England, and Burlington, Vermont, U.S.: Ashgate. 2008.
- NASA. Partial excerpt from Probabilistic Risk Assessment Procedures Guide for NASA Managers and Practitioners. Washington, D.C.: NASA. 2002.
- IBAC. Building an Aviation Safety and Security Culture. Pamphlet, no date.