Market sources estimate that there are $12bn-$15bn of exposed limits on leased aircraft stranded in Russia, assuming that the annual aggregate caps on war policies apply. Total insured limits are believed to exceed $30bn, but accessing such limits would depend upon losses being recovered under all-risks policies that cover “each and every loss”.
Whether and how the loss crystallises will be determined by multiple interlocking dependencies around 1) the future behaviour of the Russian government and airlines, 2) the interpretation of the coverages in place, and 3) the way sanctions are interpreted.
The spread of possible ultimate outcomes is huge, with scope for scenarios where Russian behaviour and/or sanctions mean that no claims emerge, and others in which the London market would face its largest ever single loss event.
At the upper end, all the major players would blow through their reinsurance, and there would be scope for impairments, with some potential for losses to fall to the Central Fund.
Given the amount of money at stake, it seems highly likely that a final determination will only be reached after years of expensive litigation, with cases expected to be brought by the insureds, the airline leasing companies.
Key names in London’s aviation war market have moved rapidly to retain key law firms in an attempt to arm themselves for the inevitable fight to come, with sources suggesting some have sought two or three separate legal opinions already.
There is believed to be a spread of legal advice, particularly around the question of how the impact of sanctions should be interpreted.
If losses were to crystallise, they would likely hit a niche part of the aviation market called the contingent market, which provides all-risks (hull) and war protection to the aircraft leasing companies through separate policies.
The biggest names in the London-focused contingent war market are believed to be – in alphabetical order – Atrium, Axa XL, Beazley, Chubb, Fidelis, Liberty Specialty Markets and Tokio Marine Kiln. There is believed to be significant cross-over between the contingent all-risks and contingent war insurers, but not everyone writes across the two – with Global Aerospace cited as a contingent all-risks market and Fidelis as a contingent war writer only by broking sources.
Among the many moving pieces that make the potential loss difficult to decipher is provisions for the rescoping of war cover to exclude the effective territories. The clock on these seven-day “notices of cancellation” were set running at different points for different insurers, but most are believed to come into effect between Wednesday and Saturday.
London underwriters are waiting nervously and hoping that there is no clearer cause of loss in that period like the wholesale nationalisation of lessor-owned aircraft.
One additional doomsday scenario under watch is the scope for a misalignment in sanctions between the UK and the EU to permit London insurers to pay claims, which they would then be unable to recover from European reinsurers. This is perceived as a low likelihood, but high-severity outcome, given that the relevant reinsurances are heavily concentrated in the hands of European reinsurers like Hannover Re, Swiss Re and Munich Re.
Furthermore, some policies are believed to be written on Lloyd's Brussels paper, which would also circumvent the mismatch in sanctions.
The fear in the market around the potential outcomes is palpable, with scope for this to emerge as a multi-year overhang to the Lloyd’s market recovery and a running sore for lead markets that will likely reserve the event at zero.
The expected stressing of long-standing relationships with the leasing companies through litigation have the potential to destabilize the airline industry given that financing and leasing relationships depend upon the presence of insurance.
There are multiple layers of uncertainty which could influence the ultimate outcome and size of claims payments made by the market, which include:
How Russia behaves, including whether it makes a formal move to nationalise the planes, or individual airlines informally decline to return them
What action has been taken by the Russian government or airlines by the time notices of cancellation take effect
Whether the war itself or the subsequent announcement of EU sanctions could be established by insureds as the proximate cause and relevant date of loss
How sanctions will affect policy coverage, and how they will interact with the AVN 111 clause in aviation policies
How the loss will be treated from reinsurance purposes, and how aggregations will be considered
We explore the intricacies of the situation below.
Complex market structure
The aviation imbroglio results from a combination of the complex market structure around commercial airline ownership and the insurance protections purchased, and the speed and scale of the sanctions the West has imposed on Russia.
Most airlines do not own their planes, leasing them from specialist companies like Aercap and SMBC. The imposition of sanctions by the EU and the UK on the Russian aviation industry has prompted the leasing companies to terminate the leases and seek to recover their planes. Upwards of 500 aircraft are leased to Russian airlines, with over 400 believed to be in country.
Airlines purchase all-risks policies from the commercial market, protecting them from hull and liability losses. Hull losses triggered by war, terrorism or pilot suicide are excluded under all-risks policies, and are bought back by airlines through a separate hull war policy.
The airlines buy these covers, but if the plane is leased the beneficiary of the hull payout will be the leasing firm.
In addition, leasing companies themselves purchase two so-called contingent policies, both of which pay out in cases where the operator’s policy fails to respond, or where it is not fully insured for the perils required under the lease.
The first a contingent all-risks or hull policy sits behind the all-risks policy purchased by the airline, and the second – a contingent war policy – backstops the operator’s war policy.
These four interlocking policies are typically bought with different insurers, although there will be some overlap of carriers between the four.
Multiple layers of uncertainty
The first layer of uncertainty at this stage is that there are no claims, and it is also not clear that the necessary conditions are in place to trigger a claim.
The airlines themselves – which would be sanctioned anyway – have not suffered a loss because they still have the planes (despite the termination of the leases). For a war claim, typically there would need to be a cancellation of the leasing contract, the non-payment of the lease and then the loss of the plane.
Specifically, hull war policies cover “confiscation, nationalization, seizure, restraint, detention, appropriation, requisition for title or use by or under the order of any government … or public or local authority" subject to exclusions, as per a briefing note from law firm Holland & Knight.
To date, despite challenges recovering planes and some threatening noises from the Russian government, this loss trigger has not been satisfied with all stakeholders currently in a period of uneasy limbo.
There is other language in the war policies which could be triggered if planes are withheld by the airlines, and government influence around the decision is suspected.
But it is also possible that claims could be filed here under the all-risks policy based on theft language.
Decisions around the way claims are filed will likely reflect attempts from insureds to maximize recoveries. They may feel that war language would fit better, but if they have low annual aggregate caps (as some leasing companies do), then they could choose to go after the all-risks insurers as they offer unlimited sideways protection – presenting at least the possibility of total recoveries.
This is just one of the areas where it is difficult to determine which set of insurers would be expected to absorb a loss – and, of course, different insureds may choose to play the litigation differently.
Notices of cancellation
Additional uncertainty is created by the scope for war hull and contingent war insurers to issue notices of cancellation to insureds. Under these provisions, insureds are told that they have a period – typically seven days – to agree that a certain area (in this case Russia, Ukraine and Belarus) are excluded from the policy, and that if they do not agree at the end of the period the policy will be cancelled.
Insurers have to give individual clients notice of cancellation, although in this case some are understood to have issued blanket cancellation notices which are believed to be ineffective.
Some notices were issued the day Russia invaded Ukraine on 24 February, but many are believed to have been issued during the middle of last week and through to the weekend. It is understood that only some of the contingent war policies can be cancelled, while contingent all risks cover would likely require a 30-day wait on a cancellation.
Insurers are currently waiting for cover to lapse on the above territories, and hoping that no clearer loss triggers emerge while the clock ticks down to zero.
Sources do not believe that insurers will escape the need to defend their position in court even if no clear loss trigger emerges over the next week.
Leasing firms and brokers are believed to be arguing that the war itself or the subsequent announcement of EU sanctions constitute the proximate cause and relevant date of loss, something which would date claims to a point where cover was still in place.
The differences between the dates when insurers issued notices of cancellation also creates scope for differential outcomes between carriers writing the same accounts.
How will the sanctions be interpreted?
The last layer of uncertainty around the primary loss reflects the way in which EU and UK sanctions are interpreted, and the implications of specific sanctions language included in all aviation war policies.
Both EU and UK sanctions look to suspend cover for the Russian aviation industry, something which should spare the normal all-risks and war markets from claims.
The impact of the sanctions language on the contingent market, where the policyholders are primarily Irish-based leasing companies and banks, is much more heavily disputed.
The EU sanctions note that it is “prohibited to provide” insurance or reinsurance “directly or indirectly” for use in the aviation industry to “any person, entity or body in Russia or for use in Russia”.
Insurers are expected to rely on this as suspending coverage to the leasing companies, and it is understood that some legal opinions suggest that this effectively denies coverage.
EU sanctions, Article 3c, paragraph 2
All aviation policies include a clause – AVN 111 - which states that “if, by virtue of any law or regulation …applicable to an Insurer… providing coverage to the Insured is or would be unlawful because it breaches an embargo or sanction, that Insurer shall provide no coverage”.
But this then ties back to the grounding question of whether the leasing companies are sanctioned when it relates to their Russian aircraft.
Broking sources in particular have tended to stress that sanctions are not a get-out for the contingent war insurers, noting that it was clearly not the intention of the sanctions to prevent claims payments to EU firms.
Some underwriting sources have also acknowledged that the cover was sold to protect leasing companies in instances like this where they are unable to recover their planes, or make recoveries via the all-risks or war hull covers bought by the operators.
How will reinsurance respond?
The final layer of uncertainty around the loss is provided by the way in which it will be treated for reinsurance purposes.
Even assuming that there is no ultimate issue with European reinsurers paying claims – which would be a catastrophic unintended consequence of the sanctions regime – it is not clear the basis on which claims will be presented to reinsurers.
Cedants typically consider a PML event to be something involving two planes, or a handful of planes at the outside, pointing to a total mismatch around an event which could see hundreds of planes lost.
Disputes again seem likely in this situation, with cedants likely to push for any losses to be defined as two events to allow them to reinstate cover.
Another eventuality that could be challenging is if theft claims are made under contingent all-risks policies. Under this circumstance, it is not clear that reinsurers would allow cedants to aggregate these losses, potentially inflicting multiple sideways retention losses on insurers and leaving them recovering under proportional treaties only.
Sources suggested that these exposures in Lloyd’s are often reinsured into composite or marine whole account covers, pointing to the likelihood of contagion into other specialty lines markets.
Marine and aviation are relatively concentrated reinsurance markets, with big writers including Hannover Re, Swiss Re, Munich Re and Validus Re.
Losses on this scale would also trigger recoveries from the marine retro market.
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