Commercial Space and Launch Insurance: Current Market and Future Outlook

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Fourth Quarter 2002 Quarterly Launch Report 8

INTRODUCTION Third-party liability and government property insurances protect launch service providers and Since our last review of the space and launch their customers in the event of public injury or insurance industry (see "Update of the Space government property damage, respectively, and Launch Insurance Industry," 4th quarter, caused by launch or mission failure. In the 1998 Quarterly Launch Report), many changes United States, Federal Aviation Administration have occurred in the market. This report regulations require that commercial launch endeavors to examine the current market situa- licensees carry insurance to cover third-party tion and to explore what causes insurance mar- and government property damage claims that ket changes. We also examine how and why might result from launch activity. Because this market moves over time and discuss the these insurances are obtained from a different future outlook for space insurance. pool than the previous types of coverage, these insurances are beyond the scope of this report. For more information on licensee financial responsibility requirements, liability, and U.S. OVERVIEW OF SPACE INSURANCE liability risk-sharing regime, please see U.S. Department of Transportation/Federal Aviation The insurance market for the commercial Administration, Liability Risk-Sharing Regime space transportation industry is a global one, for U.S. Commercial Space Transportation: with satellite owners, satellite manufacturers, Study and Analysis, April 2002. launch services providers, insurance brokers, underwriters, financial institutions, reinsurers, Re-launch guarantees are a form of launch and government agents worldwide cooperating insurance in which a launch company acts as in order to coordinate an insurance package for an insurance provider to its customers. When a any given commercial satellite launch. launch fails and a customer has agreed to accept a re-launch in lieu of a cash payment, Space Insurance Types the launch services provider re-launches a customer's replacement payload. The launch serv- Within the space insurance market, many dif- ices provider often will protect itself by pur- ferent types of coverage are available. Some of chasing insurance for a series of launches, thus the key ones are noted here. spreading risk over a number of events and receiving better rates than could be obtained Pre-launch insurance covers damage to a satel- for a single launch event. lite or launch vehicle during the construction, transportation, and processing phases prior to Space Insurance Finance launch. Space insurance is usually a small, specialty line Launch insurance covers losses of a satellite of business within a larger multinational insur- occurring during the launch phase of a project. ance conglomerate. Several of these umbrella It insures against complete launch failures as companies are headquartered in tax haven envi- well as the failure of a launch vehicle to place ronments (like Bermuda and the Cayman a satellite in the proper orbit. Islands) and offer various specialty insurance, reinsurance, and financial services to a variety of In-orbit policies insure satellites for in-orbit international clients.1 Most of these umbrella technical problems and damages once a satel- insurance companies are publicly traded. lite has been placed by a launch vehicle in its proper orbit. Insurance conglomerates typically have large premium bases to protect themselves in the extremely volatile insurance market. These Fourth Quarter 2002 Quarterly Launch Report 9

conglomerates invest premium income and can CURRENT MARKET CONDITIONS return high profits on their investments, espe- cially when located in favorable tax environ- In our last look at insurance (see "Update of the ments. Space and Launch Insurance Industry," 4th quarter, 1998 Quarterly Launch Report), the After negotiating a space insurance policy, insurance market was a buyers', or "soft," mar- many underwriters also seek additional finan- ket. The number of insured launches had been cial backing. Reinsurers and financial institu- steadily increasing. Capacity was growing, and tions can buy participation in any insurance the amount of coverage available for a single package from an underwriter. Generally, rein- launch had been rising for 12 years. Premiums surers and financiers take on the same risks as were low, and contracts covering satellite underwriters and are similarly affected by mis- launches plus five years on orbit were common. sion successes and losses. The participation of these additional financial backers allows Over the last several years, the space insurance underwriters to spread risk throughout many market has "hardened." The current situation is layers of the insurance industry. Reinsurers do very different from that described in the 1998 not analyze any technical information, but report. The following discussion explains the instead depend on underwriters' evaluations of characteristics of the current market. risk to determine their level of involvement. Capacity Underwriting Process Capacity for a single satellite launch is the The process of insuring a satellite is a complex entire amount of coverage that insurance com- one. Typically for a given launch project, panies are willing to underwrite for the proj- either the satellite owner or manufacturer ect. Total yearly space market capacity is the begins by choosing an insurance broker. This theoretical amount of coverage available for broker becomes the primary agent responsible all commercial space activities in a given year. for transmitting information between the insured party and the underwriters. At the time of our 1998 special report on space insurance, capacity available for a single The underwriting process for a project begins launch was increasing steadily. In the current when the broker presents technical reports and market, however, capacity is decreasing; the contractual and financial information to a stated capacity for the entire space insurance number of international underwriters. In order industry has fallen from $1.3 billion in 1999 to to decide what kind of coverage they can offer, $840 million in 2002, as shown in Figure 1.2 the various underwriters conduct in-depth The actual total capacity in 2002 is $500-$550 technical analyses of the satellite and the million for launch-plus-one-year-in-orbit risks launch vehicle. The respective reliabilities of and $300-$350 million for in-orbit risks.3 the launch vehicle variant, satellite model, and the satellite's intended orbit are evaluated. Premiums Details such as launch site location, contract specifics, and satellite finance and value are Premiums are payments for an insurance policy also taken into account. made by the insured to the insurer. Premium prices are usually determined as a rate, or per- When the various evaluations are complete, centage of the total value of the policy. An potential underwriters present the broker with insurer's revenues for a given project are deter- bids containing information regarding capacity, mined by premiums received for that project, premiums, and terms and conditions that they minus claims paid out. feel that they can offer the insurance client. Premiums for both launch and in-orbit coverage have been rising steadily since our 1998 special report. Figure 2 shows that 2001 launch-plus-one-year policy rates averaged Fourth Quarter 2002 Quarterly Launch Report 10

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1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Figure 1. Stated Insurance Capacity (Source: Willis Inspace)

around 15 percent, whereas rates in 1998 aver- Technical and Underwriting Requirements aged only seven percent. In addition to higher premiums and lower Figures 1 and 2 demonstrate the inverse rela- capacity, insurance customers in 2002 must tionship between capacity and premiums. deal with tighter underwriting and technical When economic conditions are generally favor- scrutiny. Technical examinations of vehicles able, insurance companies experience good and technology are more rigorous, and require- financial results and are able to offer high ments are stricter. Exclusions for losses result- capacity and low rates. Alternatively, when ing from terrorism and generic defects in a insurance companies experience poor financial particular model of satellite are now common results, capacity drops and premiums rise. in policies. New and higher deductibles are set to ensure that clients do everything possible to reduce risk.

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launch+1 rates annual in-orbit rates

Figure 2. Launch+1 and In-Orbit Premiums (Source: Willis Inspace) Fourth Quarter 2002 Quarterly Launch Report 11

Available Post-Launch Coverage Period (Years) 0 1995 1996 1997 1998 1999 2000 2001 2002 Figure 3: Post-Launch Coverage Period

Coverage Periods Insurance Cycles

In the last two years, the coverage periods Most insurance markets behave in a cyclical available to satellite insurance customers have nature over time. At the start of a typical insur- been decreasing. Starting in 1995, "launch- ance cycle, insurers lower premiums charged plus" contracts became available to insure a in order to compete for business. The insur- satellite against damage occurring during ance industry experiences a "soft," or buyers', launch plus a period of six months following market as customers are able to shop around launch. Over the next few years, launch-plus for the best premiums and coverage. The cycle contracts began to offer two, then three years turns when insurance profits begin to fall. The of coverage following launch. Starting in insurance market then enters a period of 1998, launch-plus-five policies became com- capacity shortage as firms retain earnings in mon throughout the industry. With the current order to cover current claims. Firms also begin hard market and the spate of launch and on- to raise prices in order to increase revenues. orbit losses between 1998 and 2001, the avail- The industry then enters a "hard" market, in able launch-plus coverage period has declined. which insurance buyers must accept limited In 2002, launch-plus contracts available at coverage and high premiums. competitive prices cover satellites for no more than one year after launch.4 Figure 3 illustrates It is generally believed that a number of fac- trends in post-launch coverage periods over tors influence the insurance cycle. Interest the last eight years. rates (which affect insurance company premium and investment income) and time lags in information used to set pricing both contribute to the cyclical nature of the industry.5 More CAUSES OF SPACE INSURANCE importantly, insurance markets are believed to MARKET DOWNTURN be “capacity-constrained.”6 In the capacity- constraint model of insurance cycles, changes Insurance cycles, general economic conditions, to supply and demand of capital cause changes launch and in-orbit losses, and commercial in capacity.7 Insurance companies report lower space industry changes have combined to capacity as the cost of raising external capital decrease profitability for insurers and thus to becomes higher than that of retaining earnings. harden the space insurance market. One factor that can trigger this capacity crunch is an exogenous shock due to an unexpected Fourth Quarter 2002 Quarterly Launch Report 12

loss. Payment of claims resulting from such a After a slight decline mid-decade, the space loss reduces capital available to insurance com- insurance market again softened in the late- panies. Revenues for that financial period fall, 1990s with launch-plus-one premiums as low and internally generated capital becomes more as seven percent and total market capacity attractive to insurance companies than capital soaring to levels well above $1 billion. Since from external sources. The pool of capital avail- this time, the market has turned yet again. In able to insurance companies shrinks, and these response to a variety of causes, cyclical market insurers are able to offer less capacity to insur- forces have contributed to the market downturn ance clients in the following financial period. observable in 2002. As a result of the decreased amount of capacity, the need to raise internally generated revenue, General Market Conditions and the falling revenues in the previous period, insurers must increase the prices on their poli- In the months prior to September 11, all com- cies. After a period of high prices and retained mercial insurance markets were hardening as earnings, insurance profits begin to rise, and insurance companies experienced poor finan- insurers are able to offer higher capacity. With cial results following the low pricing of the more capacity available on the market for past years. By mid-August 2001, insurance launches, insurance companies begin to lower companies, began to raise prices. The devasta- their rates in order to compete for business. tion resulting from the events of September 11 These trends continue until another shock to cost an already hardening market $40-$70 bil- capital supply or demand occurs. lion.8 Available funds were tapped to pay these claims and perceptions of risk changed. The The insurance cycle is easily visible in the ensuing capacity crunch particularly hurt space space insurance market. A variety of factors insurance, which shares a common capital pool make the market very volatile. The space mar- with aviation.9 ket is a unique insurance market; it involves a relatively small number of underwriters and In addition to the strain resulting from insur- expensive catastrophic coverage. Technical ance cycle and general market conditions and requirements are necessarily very strict. September 11 repercussions, the space insur- Reliability is a crucial underwriting determinant ance market has felt pressure from many com- but is also difficult to gauge accurately with mercial launch industry-related changes. such a small number of annual commercial launches. Since a majority of the premiums paid Number of Launches on a policy applies to the launch portion of the coverage period, and since an accident at launch The annual number of insured commercial can result in instantaneous total mission failure, launches has decreased in recent years, large amounts of money are either made or lost although 2002 already has seen an increased in the first half hour of any mission. volume of commercial launch activity com- pared to 2001. This general decline in launch Figures 1 and 2 trace capacity and premiums, activity drastically reduces the amount of pre- respectively, in the space insurance market mium income available to insurers and causes over the last fifteen years; the cyclical behav- capacity offered to insurance customers to fall ior of these variables is easily observable. In and premium rates paid by policyholders to the mid-1980s, a string of launch failures dra- rise. Figure 4 on the next page illustrates recent matically reduced industry capacity. As a worldwide commercial launch activity. result, premiums rose, and technical requirements became stricter. The 1990s saw an Claims/Losses and Reliability expansion in number of launches and available capacity. With the increasing profitability of As previously mentioned, launch vehicle and the insurance industry and the entry of new satellite reliability are important rate determi- capital, soft market conditions returned. nants for underwriters. Establishing reliability, with so few annual launches and so many variables affecting a mission, is a long and difficult process. Fourth Quarter 2002 Quarterly Launch Report 13

25 International FAA-Licensed 20

15 Number of Launches

0 1997 1998 1999 2000 2001 2002

Figure 4. Annual World Commercial Launches A launch vehicle or satellite failure is costly to space insurance claims resolved to date over all involved parties. For example, the manu- the last 15 years. facturer of a failed vehicle and its current and future contracted clients face additional insur- ITAR ance difficulties as a result of the associated decline in reliability of the failed launch vehi- In evaluating risks, many non-U.S. space cle. As perceived reliability decreases, avail- insurance underwriters face obstacles in the able coverage drops and premiums rise. The form of International Traffic in Arms effect of a failure can dramatically affect Regulations (ITAR). When a client or broker is capacity and premiums for all those seeking unable to obtain a license from the United space insurance. States State Department to share a launch vehicle or satellite's technical details with non-U.S. The last several years have also seen many sig- underwriters, international insurers are forced nificant losses. In 2001, an Ariane 5G upper to either decline the risk or else to offer poli- stage failure led to the loss of the Artemis and cies based on insubstantial technical informa- BSAT-2B satellites, resulting in $150 million in tion. In the instance that international insurers claims. In September 2001, an Orbital Sciences are unable to participate in underwriting a par- Taurus 2110 failure led to the loss of Orbview ticular risk, capacity available for the vehicle 4 and an additional $75 million in claims.10 in question is reduced.

In addition, on-orbit defects are affecting the capacity available for satellite purchasers. In 2001, PanAmSat and Arabsat solar array fail- TRENDS AND OUTLOOK ures cost the insurance industry $253 million and $173 million, respectively.11 Anomalies The current and future insurance markets must like those on Boeing's 702 satellite model, deal with new technologies entering the mar- announced in September 2001, are expected to ketplace. Arianespace's Ariane 5-ECA, affect premiums for all current and future Boeing's Delta 4 and Lockheed Martin's Atlas operators of these satellite models. None of the 5 are all relatively new vehicles that face 702 claims have been resolved. unique challenges in the 2002 space insurance market. These new launchers have been Figure 5 on the following page illustrates designed to deliver larger satellites into space. Fourth Quarter 2002 Quarterly Launch Report 14

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1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Figure 5. Annual Space Insurance Claims Resolved to Date In the past, new technologies have been subject insurance. After a series of disputes with under- to intense scrutiny from underwriters. writers, EchoStar is considering providing in- Establishing reliability is an uphill battle that all orbit backup rather than securing insurance. An launch vehicles must initially face, and usually executive from EchoStar estimated that the cur- three to four successful launches are required in rent cost of all insurance expenses for one satel- order for a vehicle to be considered commercial- lite launch could just as easily pay for a second ly insurable at reasonable terms.12 Until reliabili- launch of an equivalent backup vehicle.15 ty is ascertained, the Lockheed Martin Atlas 5 and Boeing Delta 4 Evolved Expendable Launch Vehicles' launch insurance premiums are expected to comprise 12 to 15 percent of the launch CONCLUDING REMARKS vehicles' prices.13 In addition to large coverage costs arising from their relatively unproven tech- Although space insurance is currently experienc- nologies, these vehicles will also need more ing a hard market, if space insurance continues high-priced insurance because they will be car- to behave cyclically, conditions will eventually rying larger, more valuable payloads. This next return to their previous soft market state. With a generation of heavy-lift launch vehicles is capa- greater number of launches to prove reliability, ble of carrying more than one payload, making rates for new launch vehicles may improve over the potential cost to insurers of a launch failure time. Resolving technical problems on satellites even greater. will help to reduce in-orbit rates. Current high premiums and improving economics conditions Launch vehicle manufacturers are taking differ- will help insurers to rebuild capacity. As capaci- ent approaches to deal with the current market ty improves, underwriters will lower premiums conditions. Re-launch guarantees remain a com- to compete for insurance clients. mon way for launch services providers with vehicles that are expensive to insure to reduce insurance costs. Arianespace is operating a divi- sion to self-insure its Ariane launches when insurance market offerings are insufficient.14 Satellite operators are also considering self- Fourth Quarter 2002 Quarterly Launch Report 15

1 Communication with Devin Fairbanks, Brockbank Insurance Services, Inc., 9 July 2002.

2 Communication with Willis Inspace, 1 July 2002.

3 Communication with Willis Inspace, 12 October 2002.

4 Communication with Willis Inspace, 1 July 2002.

5 Neil A. Doherty and James R. Garven, “Insurance Cycles: Interest Rates and the Capacity Constraint Model” (working paper), November 1994.

6 Anne Gron, “Capacity Constraints and Cycles in Property-Casualty Insurance Markets,” Rand Journal of Economics 25 (Spring 1994): 110-127.

7 Communication with Dr. Anne Gron, Kellogg Graduate School of Management, Northwestern University, 28 June 2002.

8 Communication with Willis Inspace, 1 July 2002.

9 International Space Brokers, “An Update on the Space Insurance Market,” presentation to the Commercial Space Transportation Advisory Committee (COMSTAC), 23 May 2002.

10 International Space Brokers, “An Update on the Space Insurance Market,” presentation to COMSTAC, 23 May 2002.

11 International Space Brokers, “An Update on the Space Insurance Market,” presentation to COMSTAC, 23 May 2002.

12 Communication with Willis Inspace, 1 July 2002.

13 Communication with John Vinter, International Space Brokers, 15 October 2002.

14 Communication with Suzy Chambers, Arianespace, 18 July 2002.

15 Peter B. de Selding, “Insurance Underwriters Using Rate Hikes to Recover Losses,” Space News (13 May 2002): 19.