Aviation market braces for ‘potentially huge losses’ as Russian aircraft seizures bite

Shortly after the Russian Federation’s president – Vladimir Putin – ordered his troops into Ukraine on 24 February 2022, the Western world responded by imposing sanctions on Russian economic assets.

As part of his riposte to these sanctions, Putin signed a law on 14 March 2022 that allowed Russian airlines to retain and operate over 500 leased airliner jets that had become stranded in Russia following the commencement of hostilities.

Nearly six months after this action, the aviation sector is no closer to a solution which would allow it to recover these aircraft – this raises questions for the insurance industry about whether it may need to eventually pay out up to £8bn to compensate airline carriers for their losses, according to the Express.

This situation – while currently the largest aviation-related financial risk emanating from the conflict – is far from the only problem the aviation sector is facing.

Bob Sawers, crisis advisory lead at Marsh McLennan, explained: “From a Ukraine war perspective, the immediate, direct impacts are things like territorial and airspace exclusions, aircraft unable to leave home bases, sanctions on Russian individuals and organisations and the effective self-sanctioning of companies [that] are concerned over their reputations should they continue to operate or trade with various entities.”

Sawers’ role with Marsh leads him to examine strategic threats and help clients prepare for and respond to associated risks and challenges.

He noted that the Russian seizure of airline firms’ assets had a dual purpose: “One – on the economic end – is that there was a lot of money there that could be repurposed to serve the Russian interest as a revenue generator.

“The other is more political – putting pressure on Western organisations so that they will, in turn, pressurise Western governments. It’s a neat way of getting your message out there.”

Sawers added that while this aircraft seizure was “undeniably a challenge” for the insurance sector, resolving the situation would take time.

“How this is unpicked remains to be seen because it’s already in the political realm - there’s no pure economic motivation,” he said. “It’s probably going to be one of those enduring aspects of the conflict which, of course, isn’t going away.”

War market liability?

Wrangling over the liability for covering the loss of the confiscated airliners has already begun, said Wayne Murphy, aviation portfolio manager at Rokstone Underwriting.

Most insurance policies exclude, by default, damages caused by acts of war. However, coverage of war risks is not automatically excluded in lines of business that feature international transport and travel - including marine and aviation, which both have defined war risk markets.

The war market has traditionally stepped up to cover incidents such as 1988’s Pan Am Flight 103 – when an explosive planted on the aircraft exploded over the Scottish town of Lockerbie and caused 270 deaths.

Murphy explained that airline leasing companies that have lost their assets to Russian confiscation had approached the war market to say they couldn’t recover their aircraft because of a situation resulting from war.

“There’s been an element of pushback there,” he said. “The war market is saying ‘well, have they actually been confiscated? There’s been no order by the [Russian] government to confiscate the aircraft.’

“The whole war market wants to say ‘no it’s not a war loss’ and the all-risk market wants to say ‘it’s a war loss’”.

This dispute over responsibility for covering the aircraft losses has “exposed a lot of holes in the marketplace”, added Murphy.

Further complications

Sanctions imposed on Russia have contributed further complexity for those with aviation insurance. Once sanctions were imposed, sanction clauses in aviation insurance contracts were activated.

Murphy explained: “The sanction clauses say that cover ends when sanctions are applied, but it doesn’t say the policy is cancelled [at that point]. So, there is speculation that the policies still need to be cancelled.”

However, a lack of clarity among brokers on whether they are allowed to correspond with sanctioned entities and companies has led to hold-ups in the policy cancellation process.

“When letters of cancellation were issued, we encountered a situation where brokers refused to pass these letter on to clients,” said Murphy. “We’re in a situation where we don’t know whether cancellation letters were actually passed on to clients.

“We’re looking at potentially huge losses and it’s almost like the market is burying its head in the sand at the moment.”

Gleaning clarity

Clarity over whether the war market or the all-risk market is liable for the Russian seizure of the stranded jets is likely to arise from legal decisions.

Murphy said: “Often with these things, it’s when they get tested that we really understand where we are – where the coverage is and where the issues are.

“It’s going to come back down to the lawyers as a lot of this will end up in court.”

The war market has reacted to the situation in Ukraine by substantially adjusting its rates upwards to begin covering the losses that it expects from the conflict. This has always been the case in such a “volatile” market, explained Murphy.

Murphy added that the all-risk aviation market was currently not responding in the same way as the war market.

He said: “It feels like the all-risk market currently has its head in the sand. It doesn’t seem like people are really prepared to understand the implications of these losses.

“There are going to be potentially huge losses from a very, very small part of the all-risk market’s portfolio. At some point, the market will realise that it needs to apply increases across its whole portfolio to recover those losses.”

The lesson that can be learned from this wrangling over responsibility is that the aviation market needs to “question its assumptions around the marketplace from time to time”, continued Murphy.

He said: “The expectation from this situation was that the war market would cover these losses – if it’s not going to, then we all need to go back to our wordings. We need to think about these unknown exposures because it seems to be that it’s these unexpected events that are coming up and biting underwriters.”