EN COMMISSION OF THE EUROPEAN COMMUNITIES Brussels, 2.7.2002 COM (2002) 320 final COMMUNICATION FROM THE COMMISSION on Insurance in the Air Transport sector following the terrorist attacks of 11 September 2001 in the United States COMMUNICATION FROM THE COMMISSION on Insurance in the Air Transport sector following the terrorist attacks of 11 September 2001 in the United States 1.Introduction 1.Following the terrorist attacks of 11 September 2001, the provision of third party liability insurance for war and terrorist risks to the air transport sector was thrown into doubt. Until that date, this type of insurance, which ensures that airlines and other service providers can meet the cost of compensation for persons and property affected by an attack involving an aircraft, was normally incorporated into the general policy of every company in the aviation sector. However, the extreme nature of the damage incurred in New York caused the insurance industry to reassess this situation and virtually all cover for third party war and terrorist risks was withdrawn. 2.In the immediate aftermath of the attacks, most companies operating in the air transport industry, including airlines, airports and other service providers, such as groundhandlers and air navigation providers, were left with either minimal insurance cover of US$50 million for these risks, or no cover at all. This compared with typical cover of well over $1 billion for most major airlines and airports before the attacks. Certain types of operations, notably security screening companies, found it virtually impossible to find any insurance given their pivotal role in controlling access to aircraft on the ground. 3.This situation left the industry in an unacceptable situation. Airlines, especially those with the financial obligation of paying aircraft leases, look for the financial security of insurance policies that are sufficient to cover the maximum of eventualities and, in particular, third party damages. If an incident were to occur causing extensive damage, an airline with insufficient insurance would have to meet the cost of any compensation from its own resources, leaving open the possibility of default on its financial obligations and eventual bankruptcy. Many airports and service providers similarly consider that it is essential to obtain a level of insurance cover high enough to meet the cost of the damages that might result from a substantial incident. 4.The objective of the present Communication is to present an update of developments in the market, to analyse the various initiatives undertaken at international level and by the insurance and air transport industry and to present a possible way forward. 5.In particular, this Communication takes account of the discussions of Ministers of Transport at the Council meeting on 17 June 2002, at which it was concluded that any solution to current problems "should be subject to conditions under which the commercial market is not unnecessarily restricted and that government exposure is limited as much as possible." And that "mutualisation schemes should be thoroughly assessed." 1.1.Restoring essential cover 6.Given the importance of restoring at least some insurance cover for third party war and terrorism risks, the Council of Ministers took the view on 22 September 2001 that Member States would exceptionally provide cover for risks of war and terrorist acts, on condition that such aid was temporary, strictly regulated and duly notified to the Commission. In its Communication on the repercussions of the attacks, dated 10 October 2001, the Commission presented the outlook for the aviation insurance market in the aftermath of these events and set out the criteria under which the Commission would consider Government insurance measures to be in line with Article 87 § 2 b) of the Treaty. This provision permits state aid "to make good the damage" caused by "exceptional occurrences". 7.In the event, all EU Member States introduced temporary insurance mechanisms for thirty days. Many countries around the world, including the United States, Australia and Canada, took similar action. The cover in Europe was provided initially for thirty days. The Commission stressed in its Communication that if the situation were to continue beyond the initial 30-day period, Member States might decide to continue providing a supplementary guarantee to the insurance companies, or to underwrite the risk directly themselves. The deadline was initially extended to 31 December 2001, although as it became clear that the insurance market would not recover rapidly, the option of government intervention was prolonged twice, eventually up to 30 June 2002. Only one Member State has since withdrawn its insurance scheme completely. 8.An "Ad-Hoc" Insurance group was established by the Council in order to ensure, as far as possible, that all insurance was provided on comparable terms and to monitor developments in the market. In this group, jointly chaired by the Presidency and the Commission, consensus was reached on a set of common principles for the provision of insurance, including the level of cover to be provided and the premiums to be paid. It was understood from early on that recipients of cover should pay the governments a market related charge for the insurance. The Ad-Hoc Group has met on a regular basis, reviewing the guidelines monthly.

9.As presented in the previous Communication of 10 October 2001, the Commission considered that the government insurance schemes introduced by Member States qualified as a state aid and had therefore to be duly notified to the Commission. In line with its responsibility under the Treaty, the Commission has examined the notified measures each time they have been renewed, on the basis of Article 87(2)(b) as indicated above. 2.The response of the insurance industry 2.1.Market developments 10.In parallel with the introduction of the government schemes, certain insurance companies entered the market to provide essential cover over and above the basic $50 million cover offered by all insurers for passenger and third party liability. A small number of insurance companies have gradually developed their offer until they can provide $1 billion of third party cover for war and terrorist risks. 11.The total cover now available commercially is less than that purchased by most major carriers before 11 September 2001, but the premiums demanded are several times greater than the total premium previously paid by most airlines for their entire insurance policy. Since September, rates in the commercial market have ranged from around US $1.85 down to around US $ 1.30 per passenger per flight. 12.In addition to costs higher than prior to 11 September, the policies offered continued initially to be subject to the standard cancellation period of 7 days, which had been included in all policies before 11 September and had permitted the crisis situation to develop in the insurance market in the first place. There are some signs that competition is opening up on this aspect of the policies and it is possible now to buy a policy that includes a cancellation clause that only comes into effect once a series of four large scale incidents has taken place. 2.2.The international context 13.As stated above many countries took similar action to that of the EU Member States. The United States, Australia, and Canada are among the major aviation nations that provided some or all of the cover required. Some have charged premiums, although these are often far lower than those required in Europe, while others have simply provided a government guarantee at no cost to their airlines at all. 14.However, many countries, in particular developing countries, found it hard to provide adequate insurance to their airlines through government action given the very high liability burden that they would need to assume. Since many of these airlines fly to international destinations, it was essential that they have such insurance, so they faced no option but to purchase whatever commercial cover was available at the premiums demanded. 15.This has left disparities in the position of airlines and service providers from different countries in the international air transport market and an unacceptably low level of cover for some airlines. 3.Options for Future Action 16.In the longer term, the Commission considers that it is unsustainable for governments to continue to provide third party cover for war and terrorist risks in this ad-hoc manner that was designed to address exceptional circumstances. The current system has prevented a breakdown of both the air transport system and the insurance market for these types of aviation risk, but it is not stable enough to give companies or governments the level of certainty they need. 17.The Commission is of the opinion that, at this stage, there are two basic options for future action - a return to the commercial market or the establishment of some sort of mutual insurance fund. The creation of such a fund has been proposed at global level in the International Civil Aviation Organisation, in the United States under the auspices of the Air Transport Association, which brings together the top American airlines, and in Europe under the auspices of the Association of European Airlines. The latter has the support of all major air transport stakeholders in Europe: IACA (International Air Carriers' Association), ERA (European Regions Airline Association), ACI (Airports Council International) and AECMA (European Association of Aerospace Industries). 18.These proposals are described below, although it should be said that other proposals could be envisaged, differing in the level of cover; the mechanism for government involvement or the level of government involvement, which possibly might be reduced by using commercial reinsurance or guarantees. Other options outside a fund, such as the possibility of addressing concerns about cancellation through a commitment from governments to intervene if the market withdraws, can also be considered. 19.In considering the future, it will be important to avoid any undue distortions of competition between airlines and between service providers within the Community. Even with agreed guidelines for the provision of this insurance, there are currently some differences in approach between different Member States, which, among many other factors, clearly affect competition between companies in the air transport sector and insurers. As mentioned above, one Member State has already withdrawn its government scheme. Others have either limited the cover available and or raised the cost of their schemes. 3.1.A return to the commercial market 20.A simple option for resolving differences between government regimes and restoring some normality to the situation would be to agree on a date for the complete cessation of the government schemes in the EU, after which all airlines, airports and service providers such as groundhandlers and air navigation providers, would have to buy commercial cover once again. This would restore a market solution and remove any distortion based on differing government regimes affecting the functioning of both the air transport and the insurance sector. 3.2.A "mutual fund" solution 21.However, as mentioned above, a number of mutual fund solutions are under consideration in the United States, in Europe and at a global level. The three schemes proposed are summarised in an annexed table. 3.2.1."equitime" - the US industry initiative

22.In the United States, the Air Transport Association (ATA) has developed a plan called "Equitime". It would entail the establishment of a fund paid from premiums levied on airlines and major service providers, but would require a guarantee from the government in order to be established. It would provide cover for a maximum of US$ 2 billion for passenger and third party primary and excess liability, without any scheme cap, cancellable after a 7-days notice for non-payment of the premium or otherwise after a 90-days notice. The annual retention amount, i.e. the amount paid once-off to the insured following any one occurrence, would be set at US$ 300 million for the 1st year of the functioning of the scheme. The US government would have to provide an underlying guarantee to cover liabilities in excess of the fund that had been built-up. 23.The ATA has submitted proposals to the US government for consideration, but, at this stage, no further information is available about the progress of discussions. The US is set to extend its government insurance system until mid-August while further analysis is undertaken. 3.2.2.The ICAO Scheme 24.At global level, the International Civil Aviation Organisation (ICAO) has overseen the development of a proposal for a mutual fund that would provide third party liability cover for war and terrorist risks to the air transport industry as a whole. As with Equitime, the scheme would see the creation of a fund from the premiums collected from participating companies. The scheme would provide cover between US$ 50 million and US$ 1.5 billion. It would be non-cancellable, with total liability capped at US$ 15 billion. It would be able to "drop down" in order to cover the primary third party and passenger liability should the commercial market issue a seven-day cancellation notice. All ICAO member states would have the option of joining and they would share the cost of providing an underlying government guarantee in proportion to their budget contributions to the Organisation. 25.The ICAO proposal has been developed to a high level of detail. Following a discussion of the proposal in the ICAO Council, ICAO Members are now being consulted about the scheme and asked whether they are prepared, in principle, to sign-up. If 51% of the Members, by budget contribution, agree, the scheme will be established. 3.2.3."Eurotime" - the European initiative proposed by the AEA 26.The Association of European Airlines (AEA) with the support of the biggest air transport industry stakeholders in Europe, has reacted to developments in the United States and ICAO by devising its own proposal for a regional mutual fund, called "Eurotime". 27.The proposal is closely based on the work carried out in ICAO and the scheme can be considered largely compatible with the broader global system proposed in that organisation. Similarly, it would provide insurance not only to airlines, but also to the industry (the service providers) as a whole. 28.The proposal would entail the gradual building of a mutual fund from which the cost of damages would be met. The fund would be built up from premiums charged to companies. According to the scheme's promoters, the system would require an underlying guarantee from the governments of participating countries to cover the cost of claims while the fund was being amassed and to ensure that the company remained properly financed in all eventualities. 29.For example, there are strict requirements concerning the amount of capital an insurance company is required to have and the way in which it makes provision for possible claims. Clearly, the large commercial insurers currently offering products in this market are already well established, with all the financial requirements in place. Eurotime will need to find the funding to satisfy these requirements. Under the current proposal, the promoters propose that governments should fund the capitalisation using the premiums they have collected from airlines for the insurance cover they have supplied since September 2001. Moreover, governments would initially be asked for their guarantee to be extended for at least three years, i. e. until the initiators expect Eurotime to be superseded/absorbed by the global ICAO scheme. As of that date, government guarantees would have to be provided according to the conditions of the ICAO scheme. However, if the Eurotime scheme were to continue after that time, an extension of the guarantee would be needed. 30.The promoters of Eurotime hope for the support of all the EU Member States plus the other European members of the European Civil Aviation Conference (ECAC), which would bring in all the Community's partners in Central and Eastern Europe. They propose that governments would receive payment (set by the promoters at 20% of premiums collected) in return for providing their guarantee. 4.Evaluation 4.1.The commercial market 31.A return to the market would present many advantages, allowing a natural equilibrium to re-emerge and leaving flexibility for premiums to adjust as insurers assess their liabilities and potential future risks over the coming years. 32.However, three difficulties with this solution have been put forward by the air transport industry: –They argue that the level of competition in the market is as yet unproven and the cost of the insurance policies on offer remains historically high compared to prices before 11 September 2001. –They argue that, unless commercial premiums fall further, European airlines and service providers could be left at a cost disadvantage if other countries maintain their government schemes or decide to set up a mutual fund of their own. They argue this could be exacerbated if EU companies were forced to return to the market ahead of their competitors and before the market develops further. –Finally, they argue that the conditions attached to the commercial insurance policies now available, while varying from offer to offer, still involve cancellation clauses similar to those that existed before 11 September and which permitted insurers to withdraw at seven days notice. This would mean that in the event of another serious incident or, a series of incidents, industry and governments could be back to where they started immediately post 11 September, with no cover even having paid very high premiums to insurers in the meantime. 33.It is certainly true that the cost of the third party war risks insurance is at a historically high level, although, to some extent, it must be considered a normal process for insurance costs to rise when insurers face an increased level of claims and as risks are reassessed. 34.As regards distortion of competition between airlines, while insurance might have become a more substantial element in airline costs than previously, the scope for raised insurance costs to create distortion of competition, particularly on intercontinental routes where ticket prices are higher, is admittedly limited.

35.The most serious of these problems appears to be the threat of instability and cancellation. While the risk of seven-day cancellation is not a new one, it would be preferable to avoid a repetition of the situation in September 2001, when a sudden cancellation of cover forced a period of uncertainty and a hasty intervention by governments. An attempt has been made by the commercial insurers in this part of the market to overcome the problem of short term cancellation, however, in the event that the primary policy is cancelled, it would still be necessary to renegotiate the third party war risks policy to allow it to take-over some of the cover previously supplied under the primary policy. 36.In the light of experience over the last eight months, in which insurance has only been provided in an ad-hoc manner with government support, the important issue is how to find a solution that offers more stability than the current one. The tense international situation and the reaction of the reinsurance industry as it assesses its exposure to air transport may mean that it is difficult for the commercial market to provide this stability. While it is unclear to what extent it is the current government insurance schemes that have distorted this market and discouraged companies from providing this type of insurance, it is clear that a return to the situation pre-11 September is highly unlikely. 37.Three companies are currently offering products in this part of the insurance market. However, having been able to restrict their exposure for third party war and terrorist risks to $50 million under the primary policy, many of the traditional insurers are still choosing to remain on the sidelines as far as providing excess cover up to $1 billion is concerned. Indeed, further repercussions on the market are possible as the reinsurance industry reassesses its exposure to the air transport sector. It may become more difficult to find reinsurance cover for air transport policies. 38.In conclusion, while price competition is increasing and while the improved cancellation clauses in the commercial offers represent some movement towards greater stability, last year's events demonstrate that a market solution may yet oblige governments to intervene once again in an ad-hoc and temporary manner. A more durable and stable solution is desirable. 4.2.The "Eurotime" scheme 39.As presented by the AEA Eurotime seeks to offer the benefit of stable insurance cover by anchoring the scheme initially with government guarantees and at a later stage with a large fund accrued from premiums. This removes much of the risk of cancellation and breaks the dependency of the sector on the commercial insurance and reinsurance market. However, under this scheme, government intervention would be needed once a serious incident happened and the resources accumulated under this mutual fund had been exhausted. 40.It should be noted that the extent of the state guarantees for Eurotime would be substantial, in particular in the first few years of operation. The limit of the scheme for third party liability would be $1 billion per incident, yet its retention would only be US $150 million in the first year if the currently proposed premium level of $0.50 is retained. Therefore, in the case of a single serious incident in the first year of operation, Member States would have to close any gap between that retained capital and the upper limit of the policy. This exposure would be higher if the primary insurance market collapsed and the "drop-down" facility within the scheme was invoked to provide airlines with passenger liability in addition to the basic third party liability. 41.The scheme's promoters also see cost saving as a major benefit of Eurotime. A premium of $0.50 as proposed could value the underlying state guarantees and savings to EU carriers, based on estimated traffic of 420 million passengers per annum, at around $300 million. For the broader membership of ECAC, with traffic of approximately 650 million, the value of state guarantees and the savings to carriers could be around $500 million. The precise cost to governments of supporting this scheme will need to be examined further. 42.This cost advantage appears substantial, although it might decrease in later years, since in the absence of a claim, the commercial insurers could reduce premiums through a "no claims bonus", bringing their prices closer to the projected Eurotime premium. In the case of an incident, Eurotime would need to increase its premiums in order to cover potential damages and to reimburse its government backers, again eroding its cost advantage. 43.The Eurotime system might be able to offer a level of stability to the European aviation industry that makes it attractive, since it would quasi automatically trigger government guarantees in case of a major incident, while a return to the commercial market would potentially oblige governments to intervene once again in an ad-hoc and temporary manner, 4.3.The ICAO Scheme 44.The ICAO scheme could go ahead if a broad global consensus can be reached on its establishment. As noted above, it is similar to the Eurotime proposal, but would offer all air carriers and service providers from ICAO countries the possibility of benefiting from adequate insurance cover for both third party as well as passenger liability, if necessary. That, in turn, would facilitate the introduction by the Community of a harmonised approach to insurance minimum coverage, as all third country carriers flying into and within the Community would be able to obtain the necessary cover at reasonable cost. 45.However, European countries should not shoulder the burden alone, which suggests that at least one other major aviation members, notably either the US or Japan, would need to participate in that scheme for it to gain full European support. Since the support of 51% of the ICAO membership by budget share is required before the scheme can proceed, however, it seems unlikely that the scheme could get off the ground without the US (around 30% of the budget) and Japan (around 15% of the budget). The Member States of the European Union together account for some 32% of ICAO contributions. 46.Furthermore, it should be borne in mind that establishment of the ICAO scheme is likely to be a complex process, given the large membership of that organisation. The promoters of Eurotime estimate that it could take three years. This might mean that European governments might wish to intervene to provide insurance for a substantial period to bridge the gap until the ICAO scheme comes on stream. 47.A global scheme would have significant advantages. Most importantly, it would be open for accession to all ICAO members, thereby bringing the scheme within the reach of developing countries. This could help ensure that all airlines are appropriately insured - an important objective given that many developing country carriers fly into the Community. It would also make it easier to subject all air services both into and within the Community to common rules on adequate insurance, applied in a harmonised way. Finally, by spreading risk widely between many ICAO Members, the scheme places a lower individual liability on each state. 5.Conclusion With regard to the establishment of a mutual scheme: 48.In the light of the conclusions reached at the Transport Council meeting on 17 June 2002, and on the basis of the analysis presented herein and given the current market conditions, the Commission considers that the air transport sector should, in the short term, work further on a mutual fund solution, whether Eurotime or the ICAO scheme, variations on either, or a combination of the two, so as to offer air transport undertakings a stable operational environment, preserving third party war and terrorist cover without any risk of future disruption. It was estimated by representatives of the European air transport sector that they might need another three months to agree on the details of the Eurotime proposal. 49.However, the creation of such schemes must at all times be fully compatible with the Treaty rules, in particular those on competition and State aid. The Commission reminds Member States of the obligation to notify in advance to the Commission any project to grant aids (Article 88.3 EC). The present communication in no way prejudges the position that the Commission may take following such a notification.