Imagine yourself here: you’ve finally saved enough to buy that beauty of a Cessna 172. You have got your pre-buy done, the loan paperwork finished and the delivery to your home airport all arranged. You suddenly remember that you need insurance, but realize you have no clue if aircraft insurance works the same as car insurance. Today’s post is designed to give readers an idea of how aviation insurance works – you’ll see that aviation insurance is similar to your car, but also very different. Before I give you the low-down on aircraft insurance works, it’s important to get a little history.
A Brief History
After World War I, we begin to see the emergence of the civil aviation industry which goes hand in hand with the aviation insurance industry. Post-war brought a surplus of war aircraft which were then either dumped into the market for pennies on the dollar. An aircraft which had previously cost the government, such as $17,000 for a Curtiss Jenny, was being sold in the open market for as little as $50 – I don’t know about you but I’d buy an airplane right now if a Cessna was that cheap!
Former military pilots all over the country were buying these cheap planes up using them for a variety of civil aviation activities such as barnstorming (trick flying), crop dusting, mail delivery, passenger transport, and more. As one can imagine, these new civil aviation activities added a whole new risk for insurance companies and often resulted in crashes for a variety of reasons. Companies were ill-equipped to handle this new risk and many saw a significant loss as a result.
However, one company rose to the occasion, despite an almost certain loss, and Travelers Insurance Company became the first to announce a comprehensive program specifically for air risks in 1919. Travelers wrote lines of insurance primarily for maintenance, operation, and the use of an aircraft for private and commercial operations. Several lines were included in the program including: life insurance, accident insurance for owners and pilots, trip accident ticket insurance, Workers’ Compensation insurance, and public liability and property damage insurance. While Travelers was the first to offer these lines of insurance, it’s important to note that they did not include lines for damage to the actual aircraft (this is referred to as hull coverage).
Over the next few years, which Travelers anticipated to be a period of profit, the company ceased to exist in 1931 after being in business for 12 years. Several other companies sprung up during those first years after Travelers made their foray into aviation insurance. As the aviation insurance industry stabilized, companies that exist still today started to appear such as United Sates Aircraft Insurance Group (USAIG), the Associated Aviation underwriters (AAU), and the Aero Insurance Underwriters (AIU). With several new companies in the U.S. market and an abundance of accidents during the early years, companies began to look for ways to spread the risk so that losses were not so significant.
Group Approach, the Law of Large Numbers, & Reinsurance
As many new companies were entering the aviation insurance industry, it was discovered there was a more economical way to do business in addition to spreading the risk. Individual companies were taking huge losses when a claim was filed because of the damage to aircraft and property as well as the deaths of those involved.
The “Group Approach” was created with the intent not only to spread the risk between many companies but also to spread the profit between those same companies. The founders of the group approach did considerable research in Europe (a country with a more developed aviation insurance industry) and found that indemnification (making a party whole after a loss) could be handled safely only by employing the group approach. This new method of the group approach also brought about the synonymous concept of the “Law of Large Numbers” – the risk and profit are spread over a large number of companies which allows for a much more stable aviation insurance industry.
Another approach used to stabilize the insurance industry was the approach of “reinsurance”. In the early days of insurance, a devastating fire threatened to bankrupt several of the local insurers and it was quickly discovered that insurance companies themselves needed to be insured against such catastrophic losses. What began as a way to protect insurance companies became the essential element of aviation market supporting major airlines, airports, and even space risks. Aviation insurance can be similar to auto insurance (premiums, liability, etc.), however there are some key differences that are important to know about.
Direct Writers, Brokers, Underwriters & Policy Term Length
Recently I bought a new car. To add it to my insurance, all I did was call up my insurance agent at State Farm® and give the Vehicle Identification Number (VIN), make, model, year, and the accident history. I opted for full coverage since it was a much newer car than I had owned previously and in a matter of minutes I had a binder (temporary insurance policy) ready for me at the office to pick up so that I could use my new car.
State Farm® is a great example of what is known as a Direct Writer. A direct writer gives a you an aircraft policy option through their company, just like an auto insurance agent. There is actually only one company that currently issues policies this way – the Avemco Insurance Company. This company is actually very popular with private owners of aircraft in general aviation, airports and Fixed-Base Operators (FBOs). It can be argued that Avemco gives the best deal as they directly write their own polices, which brings me to the concept of insurance brokers.
Insurance brokers (as well as agents) are the middle men between insurance companies and people looking for insurance. Brokers work for a commission (percentage) of the premium and work with certain companies to find the best policy for their client much like aircraft brokers look for the best buyer for their clients’ aircraft. When they gather a list of different policies, they take them back to their client for comparison and selection. Agents are a representative of an insurer and have delegated authority to act on behalf of their company. Insurance agents, however, are often certified as both an agent and a broker.
An important item for novice plane owners to know is that the policy term is much different than that of auto insurance. For instance, if you have auto insurance, you are probably set up for auto-renewal. You pay your bill every month, every 6 months, etc., and your coverage continues along. However, when it comes to aircraft insurance, a policy must be reviewed every year – this means that Avemco, your agent, or broker will be giving you a call to re-write your policy contract. While this may be slightly annoying to you, it is actually in your best interest as it allows the company to revisit you and the aircraft and see what has changed in the last year. The assumption is that risk has changed at some point whether that relate to you as the pilot or the aircraft itself.
Prior to a few months ago, I actually could not have told you the differences between auto and aviation insurance. Since then I have been taking a class about aviation insurance and learning that it is a lot more complex that I originally thought. I’m not sure when I’ll be able to insure an aircraft at this point, but just learning about it will only help me to become a more informed consumer. Hopefully that is the case for my readers as well!
Brandon Wild, Assistant Professor, University of North Dakota, Aviation Insurance, Lecture, Fall 2016.
Wells, A., & Chadbourne, B. (2007). Introduction to aviation insurance and risk management. Malabar, Fla: Krieger.
Images courtesy of Google Images.