Commercial Space And Launch Insurance: Current Market

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Fourth Quarter 2002 Quarterly Launch Report8Commercial Space and Launch Insurance:Current Market and Future OutlookINTRODUCTIONSince our last review of the space and launchinsurance industry (see "Update of the Spaceand Launch Insurance Industry," 4th quarter,1998 Quarterly Launch Report), many changeshave occurred in the market. This reportendeavors to examine the current market situation and to explore what causes insurance market changes. We also examine how and whythis market moves over time and discuss thefuture outlook for space insurance.OVERVIEW OF SPACE INSURANCEThe insurance market for the commercialspace transportation industry is a global one,with satellite owners, satellite manufacturers,launch services providers, insurance brokers,underwriters, financial institutions, reinsurers,and government agents worldwide cooperatingin order to coordinate an insurance package forany given commercial satellite launch.Space Insurance TypesWithin the space insurance market, many different types of coverage are available. Some ofthe key ones are noted here.Pre-launch insurance covers damage to a satellite or launch vehicle during the construction,transportation, and processing phases prior tolaunch.Launch insurance covers losses of a satelliteoccurring during the launch phase of a project.It insures against complete launch failures aswell as the failure of a launch vehicle to placea satellite in the proper orbit.In-orbit policies insure satellites for in-orbittechnical problems and damages once a satellite has been placed by a launch vehicle in itsproper orbit.Third-party liability and government propertyinsurances protect launch service providers andtheir customers in the event of public injury orgovernment property damage, respectively,caused by launch or mission failure. In theUnited States, Federal Aviation Administrationregulations require that commercial launchlicensees carry insurance to cover third-partyand government property damage claims thatmight result from launch activity. Becausethese insurances are obtained from a differentpool than the previous types of coverage, theseinsurances are beyond the scope of this report.For more information on licensee financialresponsibility requirements, liability, and U.S.liability risk-sharing regime, please see U.S.Department of Transportation/Federal AviationAdministration, Liability Risk-Sharing Regimefor U.S. Commercial Space Transportation:Study and Analysis, April 2002.Re-launch guarantees are a form of launchinsurance in which a launch company acts asan insurance provider to its customers. When alaunch fails and a customer has agreed toaccept a re-launch in lieu of a cash payment,the launch services provider re-launches a customer's replacement payload. The launch services provider often will protect itself by purchasing insurance for a series of launches, thusspreading risk over a number of events andreceiving better rates than could be obtainedfor a single launch event.Space Insurance FinanceSpace insurance is usually a small, specialty lineof business within a larger multinational insurance conglomerate. Several of these umbrellacompanies are headquartered in tax haven environments (like Bermuda and the CaymanIslands) and offer various specialty insurance,reinsurance, and financial services to a variety ofinternational clients.1 Most of these umbrellainsurance companies are publicly traded.Insurance conglomerates typically have largepremium bases to protect themselves in theextremely volatile insurance market. These

Fourth Quarter 2002 Quarterly Launch Reportconglomerates invest premium income and canreturn high profits on their investments, especially when located in favorable tax environments.After negotiating a space insurance policy,many underwriters also seek additional financial backing. Reinsurers and financial institutions can buy participation in any insurancepackage from an underwriter. Generally, reinsurers and financiers take on the same risks asunderwriters and are similarly affected by mission successes and losses. The participation ofthese additional financial backers allowsunderwriters to spread risk throughout manylayers of the insurance industry. Reinsurers donot analyze any technical information, butinstead depend on underwriters' evaluations ofrisk to determine their level of involvement.9CURRENT MARKET CONDITIONSIn our last look at insurance (see "Update of theSpace and Launch Insurance Industry," 4thquarter, 1998 Quarterly Launch Report), theinsurance market was a buyers', or "soft," market. The number of insured launches had beensteadily increasing. Capacity was growing, andthe amount of coverage available for a singlelaunch had been rising for 12 years. Premiumswere low, and contracts covering satellitelaunches plus five years on orbit were common.Over the last several years, the space insurancemarket has "hardened." The current situation isvery different from that described in the 1998report. The following discussion explains thecharacteristics of the current market.CapacityUnderwriting ProcessThe process of insuring a satellite is a complexone. Typically for a given launch project,either the satellite owner or manufacturerbegins by choosing an insurance broker. Thisbroker becomes the primary agent responsiblefor transmitting information between theinsured party and the underwriters.The underwriting process for a project beginswhen the broker presents technical reports andcontractual and financial information to anumber of international underwriters. In orderto decide what kind of coverage they can offer,the various underwriters conduct in-depthtechnical analyses of the satellite and thelaunch vehicle. The respective reliabilities ofthe launch vehicle variant, satellite model, andthe satellite's intended orbit are evaluated.Details such as launch site location, contractspecifics, and satellite finance and value arealso taken into account.When the various evaluations are complete,potential underwriters present the broker withbids containing information regarding capacity,premiums, and terms and conditions that theyfeel that they can offer the insurance client.Capacity for a single satellite launch is theentire amount of coverage that insurance companies are willing to underwrite for the project. Total yearly space market capacity is thetheoretical amount of coverage available forall commercial space activities in a given year.At the time of our 1998 special report on spaceinsurance, capacity available for a singlelaunch was increasing steadily. In the currentmarket, however, capacity is decreasing; thestated capacity for the entire space insuranceindustry has fallen from 1.3 billion in 1999 to 840 million in 2002, as shown in Figure 1.2The actual total capacity in 2002 is 500- 550million for launch-plus-one-year-in-orbit risksand 300- 350 million for in-orbit risks.3PremiumsPremiums are payments for an insurance policymade by the insured to the insurer. Premiumprices are usually determined as a rate, or percentage of the total value of the policy. Aninsurer's revenues for a given project are determined by premiums received for that project,minus claims paid out.Premiums for both launch and in-orbit coverage have been rising steadily since our 1998special report. Figure 2 shows that 2001launch-plus-one-year policy rates averaged

Fourth Quarter 2002 Quarterly Launch Report101400Capacity (Millions 961995199419931992199119901989198819870Figure 1. Stated Insurance Capacity (Source: Willis Inspace)around 15 percent, whereas rates in 1998 averaged only seven percent.Technical and Underwriting RequirementsIn addition to higher premiums and lowercapacity, insurance customers in 2002 mustdeal with tighter underwriting and technicalscrutiny. Technical examinations of vehiclesand technology are more rigorous, and requirements are stricter. Exclusions for losses resulting from terrorism and generic defects in aparticular model of satellite are now commonin policies. New and higher deductibles are setto ensure that clients do everything possible toreduce risk.Figures 1 and 2 demonstrate the inverse relationship between capacity and premiums.When economic conditions are generally favorable, insurance companies experience goodfinancial results and are able to offer highcapacity and low rates. Alternatively, wheninsurance companies experience poor financialresults, capacity drops and premiums rise.2515105launch 1 99119901989198801987Rates (%)20annual in-orbit ratesFigure 2. Launch 1 and In-Orbit Premiums (Source: Willis Inspace)

Available Post-Launch Coverage Period (Years)Fourth Quarter 2002 Quarterly Launch ure 3: Post-Launch Coverage PeriodCoverage PeriodsInsurance CyclesIn the last two years, the coverage periodsavailable to satellite insurance customers havebeen decreasing. Starting in 1995, "launchplus" contracts became available to insure asatellite against damage occurring duringlaunch plus a period of six months followinglaunch. Over the next few years, launch-pluscontracts began to offer two, then three yearsof coverage following launch. Starting in1998, launch-plus-five policies became common throughout the industry. With the currenthard market and the spate of launch and onorbit losses between 1998 and 2001, the available launch-plus coverage period has declined.In 2002, launch-plus contracts available atcompetitive prices cover satellites for no morethan one year after launch.4 Figure 3 illustratestrends in post-launch coverage periods overthe last eight years.Most insurance markets behave in a cyclicalnature over time. At the start of a typical insurance cycle, insurers lower premiums chargedin order to compete for business. The insurance industry experiences a "soft," or buyers',market as customers are able to shop aroundfor the best premiums and coverage. The cycleturns when insurance profits begin to fall. Theinsurance market then enters a period ofcapacity shortage as firms retain earnings inorder to cover current claims. Firms also beginto raise prices in order to increase revenues.The industry then enters a "hard" market, inwhich insurance buyers must accept limitedcoverage and high premiums.CAUSES OF SPACE INSURANCEMARKET DOWNTURNInsurance cycles, general economic conditions,launch and in-orbit losses, and commercialspace industry changes have combined todecrease profitability for insurers and thus toharden the space insurance market.It is generally believed that a number of factors influence the insurance cycle. Interestrates (which affect insurance company premium and investment income) and time lags ininformation used to set pricing both contributeto the cyclical nature of the industry.5 Moreimportantly, insurance markets are believed tobe “capacity-constrained.”6 In the capacityconstraint model of insurance cycles, changesto supply and demand of capital cause changesin capacity.7 Insurance companies report lowercapacity as the cost of raising external capitalbecomes higher than that of retaining earnings.One factor that can trigger this capacity crunchis an exogenous shock due to an unexpected

Fourth Quarter 2002 Quarterly Launch Reportloss. Payment of claims resulting from such aloss reduces capital available to insurance companies. Revenues for that financial period fall,and internally generated capital becomes moreattractive to insurance companies than capitalfrom external sources. The pool of capital available to insurance companies shrinks, and theseinsurers are able to offer less capacity to insurance clients in the following financial period.As a result of the decreased amount of capacity,the need to raise internally generated revenue,and the falling revenues in the previous period,insurers must increase the prices on their policies. After a period of high prices and retainedearnings, insurance profits begin to rise, andinsurers are able to offer higher capacity. Withmore capacity available on the market forlaunches, insurance companies begin to lowertheir rates in order to compete for business.These trends continue until another shock tocapital supply or demand occurs.The insurance cycle is easily visible in thespace insurance market. A variety of factorsmake the market very volatile. The space market is a unique insurance market; it involves arelatively small number of underwriters andexpensive catastrophic coverage. Technicalrequirements are necessarily very strict.Reliability is a crucial underwriting determinantbut is also difficult to gauge accurately withsuch a small number of annual commerciallaunches. Since a majority of the premiums paidon a policy applies to the launch portion of thecoverage period, and since an accident at launchcan result in instantaneous total mission failure,large amounts of money are either made or lostin the first half hour of any mission.Figures 1 and 2 trace capacity and premiums,respectively, in the space insurance marketover the last fifteen years; the cyclical behavior of these variables is easily observable. Inthe mid-1980s, a string of launch failures dramatically reduced industry capacity. As aresult, premiums rose, and technical requirements became stricter. The 1990s saw anexpansion in number of launches and availablecapacity. With the increasing profitability ofthe insurance industry and the entry of newcapital, soft market conditions returned.12After a slight decline mid-decade, the spaceinsurance market again softened in the late1990s with launch-plus-one premiums as lowas seven percent and total market capacitysoaring to levels well above 1 billion. Sincethis time, the market has turned yet again. Inresponse to a variety of causes, cyclical marketforces have contributed to the market downturnobservable in 2002.General Market ConditionsIn the months prior to September 11, all commercial insurance markets were hardening asinsurance companies experienced poor financial results following the low pricing of thepast years. By mid-August 2001, insurancecompanies, began to raise prices. The devastation resulting from the events of September 11cost an already hardening market 40- 70 billion.8 Available funds were tapped to pay theseclaims and perceptions of risk changed. Theensuing capacity crunch particularly hurt spaceinsurance, which shares a common capital poolwith aviation.9In addition to the strain resulting from insurance cycle and general market conditions andSeptember 11 repercussions, the space insurance market has felt pressure from many commercial launch industry-related changes.Number of LaunchesThe annual number of insured commerciallaunches has decreased in recent years,although 2002 already has seen an increasedvolume of commercial launch activity compared to 2001. This general decline in launchactivity drastically reduces the amount of premium income available to insurers and causescapacity offered to insurance customers to falland premium rates paid by policyholders torise. Figure 4 on the next page illustrates recentworldwide commercial launch activity.Claims/Losses and ReliabilityAs previously mentioned, launch vehicle andsatellite reliability are important rate determinants for underwriters. Establishing reliability,with so few annual launches and so many variables affecting a mission, is a long and difficultprocess.

Fourth Quarter 2002 Quarterly Launch Report134540Number of 719981999200020012002Figure 4. Annual World Commercial LaunchesA launch vehicle or satellite failure is costly toall involved parties. For example, the manufacturer of a failed vehicle and its current andfuture contracted clients face additional insurance difficulties as a result of the associateddecline in reliability of the failed launch vehicle. As perceived reliability decreases, available coverage drops and premiums rise. Theeffect of a failure can dramatically affectcapacity and premiums for all those seekingspace insurance.The last several years have also seen many significant losses. In 2001, an Ariane 5G upperstage failure led to the loss of the Artemis andBSAT-2B satellites, resulting in 150 million inclaims. In September 2001, an Orbital SciencesTaurus 2110 failure led to the loss of Orbview4 and an additional 75 million in claims.10In addition, on-orbit defects are affecting thecapacity available for satellite purchasers. In2001, PanAmSat and Arabsat solar array failures cost the insurance industry 253 millionand 173 million, respectively.11 Anomalieslike those on Boeing's 702 satellite model,announced in September 2001, are expected toaffect premiums for all current and futureoperators of these satellite models. None of the702 claims have been resolved.Figure 5 on the following page illustratesspace insurance claims resolved to date overthe last 15 years.ITARIn evaluating risks, many non-U.S. spaceinsurance underwriters face obstacles in theform of International Traffic in ArmsRegulations (ITAR). When a client or broker isunable to obtain a license from the UnitedStates State Department to share a launch vehicle or satellite's technical details with non-U.S.underwriters, international insurers are forcedto either decline the risk or else to offer policies based on insubstantial technical information. In the instance that international insurersare unable to participate in underwriting a particular risk, capacity available for the vehiclein question is reduced.TRENDS AND OUTLOOKThe current and future insurance markets mustdeal with new technologies entering the marketplace. Arianespace's Ariane 5-ECA,Boeing's Delta 4 and Lockheed Martin's Atlas5 are all relatively new vehicles that faceunique challenges in the 2002 space insurancemarket. These new launchers have beendesigned to deliver larger satellites into space.

Fourth Quarter 2002 Quarterly Launch Report1418001600Claims (Millions 961995199419931992199119901989198819870Figure 5. Annual Space Insurance Claims Resolved to DateIn the past, new technologies have been subjectto intense scrutiny from underwriters.Establishing reliability is an uphill battle that alllaunch vehicles must initially face, and usuallythree to four successful launches are required inorder for a vehicle to be considered commercially insurable at reasonable terms.12 Until reliability is ascertained, the Lockheed Martin Atlas 5and Boeing Delta 4 Evolved Expendable LaunchVehicles' launch insurance premiums are expected to comprise 12 to 15 percent of the launchvehicles' prices.13 In addition to large coveragecosts arising from their relatively unproven technologies, these vehicles will also need morehigh-priced insurance because they will be carrying larger, more valuable payloads. This nextgeneration of heavy-lift launch vehicles is capable of carrying more than one payload, makingthe potential cost to insurers of a launch failureeven greater.Launch vehicle manufacturers are taking different approaches to deal with the current marketconditions. Re-launch guarantees remain a common way for launch services providers withvehicles that are expensive to insure to reduceinsurance costs. Arianespace is operating a division to self-insure its Ariane launches wheninsurance market offerings are insufficient.14Satellite operators are also considering self-insurance. After a series of disputes with underwriters, EchoStar is considering providing inorbit backup rather than securing insurance. Anexecutive from EchoStar estimated that the current cost of all insurance expenses for one satellite launch could just as easily pay for a secondlaunch of an equivalent backup vehicle.15CONCLUDING REMARKSAlthough space insurance is currently experiencing a hard market, if space insurance continuesto behave cyclically, conditions will eventuallyreturn to their previous soft market state. With agreater number of launches to prove reliability,rates for new launch vehicles may improve overtime. Resolving technical problems on satelliteswill help to reduce in-orbit rates. Current highpremiums and improving economics conditionswill help insurers to rebuild capacity. As capacity improves, underwriters will lower premiumsto compete for insurance clients.

Fourth Quarter 2002 Quarterly Launch ReportCommunication with Devin Fairbanks,Brockbank Insurance Services, Inc., 9 July 2002.1Communication with Willis Inspace, 1 July2002.2Communication with Willis Inspace, 12October 2002.3Communication with Willis Inspace, 1 July2002.4Neil A. Doherty and James R. Garven,“Insurance Cycles: Interest Rates and theCapacity Constraint Model” (working paper),November 1994.5Anne Gron, “Capacity Constraints and Cycles inProperty-Casualty Insurance Markets,” RandJournal of Economics 25 (Spring 1994): 110-127.6Communication with Dr. Anne Gron, KelloggGraduate School of Management, NorthwesternUniversity, 28 June 2002.7Communication with Willis Inspace, 1 July2002.8International Space Brokers, “An Update onthe Space Insurance Market,” presentation to theCommercial Space Transportation AdvisoryCommittee (COMSTAC), 23 May 2002.9International Space Brokers, “An Update onthe Space Insurance Market,” presentation toCOMSTAC, 23 May 2002.10International Space Brokers, “An Update onthe Space Insurance Market,” presentation toCOMSTAC, 23 May 2002.11Communication with Willis Inspace, 1 July2002.12Communication with John Vinter,International Space Brokers, 15 October 2002.13Communication with Suzy Chambers,Arianespace, 18 July 2002.14Peter B. de Selding, “Insurance UnderwritersUsing Rate Hikes to Recover Losses,” SpaceNews (13 May 2002): 19.1515

OVERVIEW OF SPACE INSURANCE The insurance market for the commercial space transportation industry is a global one, with satellite owners, satellite manufacturers, launch services providers, insurance brokers, underwriters, financial institutions, reinsurers, and government agents worldwide cooperating in orde

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