Will Airline Stocks Ride Out a Rise in Insurance Premium?
Per a recent report by Reuters, insurers serving the aviation industry are set to hike premiums by double digits, for the first time in almost 15 years, as they grapple with rising cost. With airlines serving as the lifeline of the aviation industry, surely carriers will bear the brunt of this hike directly.
This raises concerns for investors putting their money into U.S. airline companies. It is imperative to mention in this context that consecutive air crashes in recent times are the primary reason behind premium hikes by insurers.
Is Boeing 737 Grounding the Major Culprit?
Aviation industry premiums have been rising since 2017, with companies renewing their contracts in the aftermath of costly plane and helicopter groundings. In the past 4-5 years, there have been multiple cases of airline accidents including the disappearance of the Malaysian Airlines flight 370 (227 fatalities), Cubana Flight 972 crash (112 deaths), Malaysian Airlines Flight 17 crash (298 deaths), Lion Air crash (189 deaths) among others.
The grounding of Boeing’s BA 737 MAX this March, following the two fatal crashes involving this jet model, further pushed up the need for premium hikes by aviation insurers. According to a July report in Insurance Insider, Global Aerospace, a joint venture of reinsurers — Munich Re and Berkshire Hathaway BRK.B — was able to secure a 59% rate hike from Indonesian carrier Lion Air, which operated one of the two MAX jets that crashed.
Moreover, globally, in regions where the crashes happened, premiums have gone up by 20-30% in 2019, per a report by MoneyControl. This report also predicted that airlines might face a 10-15% increase in insurance premiums, following the Ethiopian Airlines crash on Mar 10 that resulted in the loss of 157 lives.
Apart from claims stemming from crashes, insurers are also facing claims due to losses incurred by airlines during the grounding period. Insured airlines are trying to make up for the losses by submitting claims with their insurers. This must have also been another reason for insurers to consider premium rate hikes to survive in the market.
Airlines’ Loss Estimates
U.K.-based flight data information firm OAG projects 737 Max’s grounding to hurt global airline industry revenues by $4.1 billion in 2019, including $600 million for three U.S. airlines that fly the aircraft. These three airlines are Southwest Airlines LUV, American Airlines AAL and United Airlines Holdings UAL.
Per the Reuters report, insured losses following the MAX grounding would be the highest for aviation insurers since the Sep 11, 2001, attacks in the United States. Notably, global insurers incurred $5.2 billion in aviation liability losses due to the Sep 11 attacks, according to the industry-funded Insurance Information Institute. A hike in premiums had followed the Sep 11 attacks and the Boeing 737 Max grounding is likely to have resulted in another.
While 737 grounding remains a key hindrance to aviation industry growth, other factors like rising costs across the board — including labor, fuel, and infrastructure — along with substantial weakening of world trade with U.S.-China at loggerheads have also been weighing on airlines. These factors forced the IATA to downgrade its 2019 outlook in June for the global air transport industry to profits of $28 billion from $35.5 billion forecast in December 2018.
Will U.S. Airlines Survive?
Considering the aforementioned estimates, an investor might be skeptical about the growth prospects of the U.S. airline industry.
Nevertheless, IATA’s latest projection, involving a reduction in profitability for all regions except North America and Latin America, comes as a relief. Notably, North American carriers are projected to deliver the strongest financial performance with a $15 billion post tax profit (up from $14.5 billion in 2018). This represents net profit of $14.77 per passenger, which indicates a marked improvement from $2.3 in 2012.
It is reasonable to expect that airlines might transfer the hike in premium cost to customers in the form of raised air fares. In fact, according to data released by the Bureau of Transportation Statistics, August ticket prices increased 1.7% on a month-on-month basis. As the industry braces up for a double-digit premium hike, the ultimate fate of U.S. airlines hangs in balance right now.
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