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Cyclicality or volatility? The satellite insurance market
Space Policy 28 (2012) 192e198
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Space Policy journal homepage: www.elsevier.com/locate/spacepol
Cyclicality or volatility? The satellite insurance market Piotr Manikowski a, *, Mary A. Weiss b a b
University of Economics, Insurance Department, al. Niepodległosci 10, 61-875 Poznan , Poland Poznan Temple University, Risk, Ins.,& Healthcare Mgmt Dept, 1801 Liacouras Walk, Philadelphia, PA 19122, USA
a r t i c l e i n f o
a b s t r a c t
Article history: Received 31 October 2011 Received in revised form 4 January 2012 Accepted 10 January 2012 Available online 7 July 2012
The history of the satellite insurance market indicates that this market experiences crises and booms in profitability and prices that repeat in a manner suggestive of cycles. The purpose of this article is to rigorously investigate cyclicality of these and other features of the satellite insurance market and assess their volatility formally. Using data from 1968 to 2008, volatility and cyclicality are analyzed for satellite insurance market capacity, rates, and underwriting results, among other measures. The coefficient of variation for the various satellite insurance market metrics is used to assess volatility. Standard underwriting analysis is used to determine whether a cycle exists for various insurance metrics. The results indicate that some aspects of the satellite insurance market are volatile (e.g. claims) or cyclical (e.g. rates), while capacity is both volatile and cyclical. Ó 2012 Elsevier Ltd. All rights reserved.
Keywords: Satellite insurance Underwriting cycle Volatility
1. Introduction Satellites fulfill a variety of functions, ranging from providing voice/data/video communications globally to providing meteorological data for analysis and data for global positioning systems (GPS), as well as meeting military and scientific needs. In a report to the US president, the president’s National Security Telecommunications Advisory Committee (NSTAC) stated that the commercial satellite industry is critical to national and economic interests and homeland security. In addition, the structure of the space industry, its financial health and its workforce retention and development are dependent on the volume of satellites ordered and launched. However, without satellite insurance, it would be difficult to obtain financing for purchases and launches of satellites. There are two basic types of space insurance: property insurance (including pre-launch, launch and in-orbit insurance) and third-party liability insurance. Property insurance is available to cover particular phases of the satellite project: manufacturing and pre-launch activities, launch into space, and in-orbit life [1].1 Third-party liability * Corresponding author. Tel.: þ48 503719120; fax: þ48 61 8543101. E-mail address: [email protected] (P. Manikowski). 1 Pre-launch insurance covers transportation, temporary storage, integration with the launcher, as well as other preparations for launch, including the potentially dangerous loading of fuel. Launch insurance provides coverage from launch vehicle ignition to the confirmation of correct placement in orbit. In addition another 180 days from launch are covered to allow time for pre-operational tests and initialization of operations and to include at least one period of eclipse. In-orbit insurance covers the satellite during its operational lifetime, often in yearly renewable phases [2]. 0265-9646/$ e see front matter Ó 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.spacepol.2012.01.001
insurance covers the legal liability arising from damage to a thirdparty during the preparations for launch, the lift-off itself, in-orbit operations, and finally the re-entry.2 The availability and price of satellite insurance can fluctuate dramatically over time. For example, in the mid-1980s coverage was difficult to find and very expensive when it was available. Meanwhile, over the period 2005e2007, availability of coverage was plentiful with good premium terms. Like many types of insurance the insurance market for satellites may be cyclical in terms of profitability and pricing. More specifically, underwriting profit (i.e. the difference between premiums and losses expressed as a ratio to premiums) and price in many lines of insurance both follow a cycle. This cycle is commonly termed the “underwriting cycle”.3 The underwriting cycle does not necessarily synchronize with the general business cycle. In fact, it is much more regular than the general business cycle. In the operation of the underwriting cycle, the insurance market (either overall or by line) goes through alternating periods of “hard” and “soft” markets [4,5]. In a hard market, prices are high and coverage availability is low, while in a soft market premium prices are highly competitive (low) and coverage is more widely available. 2 This type of insurance will provide compensation in the event of personal injury and property damage to third parties, both on the ground and in space, caused by the launch vehicle sections or the satellite [3]. 3 The term “underwriting” refers to the process used by insurers to evaluate an insurance applicant, including whether the applicant is a desirable risk, and to determine the terms, conditions and pricing of any insurance that is offered.
P. Manikowski, M.A. Weiss / Space Policy 28 (2012) 192e198
Many studies have shown that an underwriting cycle in profitability and price exists in the overall US propertyeliability insurance market [6e10], in other developed countries [6,10,11] as well as in different lines of propertyeliability insurance [6,7,10,11]. The cyclical behavior may also extend to the total amount of coverage available to insure satellites (or capacity). In addition to cyclicality, the satellite insurance market may be more volatile than insurance markets for other types of coverage. This is because, when a loss occurs, the amount of loss is large. In fact, the first claim that insurers were responsible for in relation to a satellite consumed all premiums collected by the industry until that time [2]. Claims have outstripped premiums in several other years, especially in 1998 and 2000. Also contributing to volatility is the fact that there are few insurers who offer this specialized coverage. The purpose of this paper is to provide an analysis of the satellite insurance market to determine whether it is cyclical, volatile or both. As part of this research the stability of basic market indicators for the satellite insurance market is investigated. The analysis proceeds by analyzing data from 1968 to 2008. Volatility is assessed by examining the coefficient of variation for various metrics in this line of business compared to metrics for the broad insurance market (i.e. insurance in OECD countries). To determine whether an underwriting cycle exists, a second-order autoregressive model proposed by Venezian [6] is estimated, and the parameters from this model are used to test for the existence of an underwriting cycle. If a cycle is detected, the cycle period is estimated as well. The cycle period refers to the average time from one hard market to the next.4 By way of preview the results indicate that aspects of the satellite insurance market are volatile (e.g. claims) or cyclical (e.g. premium rates), while capacity is both volatile and cyclical. This research is important because the functioning of the satellite insurance market has a large impact on the satellite industry. Further, satellites are purchased and manufactured well in advance of their launch, and volatility or cyclicality in satellite insurance pricing could result in a satellite being ready for launch when satellite insurance premium prices are very high or availability of satellite insurance is scarce. Thus trends, volatility and cyclicality of the satellite insurance market can have a significant strategic impact on the space industry. The remainder of the paper is organized as follows. In the next section, the satellite insurance market and its operating results are described. In Section 3, the data and their sources are described. Section 4 presents the methodology for the volatility and cyclicality analysis. The results are presented next, and the last section concludes.
2. The satellite insurance market and its operating results Until the mid-1960s most satellites that were launched were related to the military aims of the USA and the USSR, and were not of interest to insurers. Space projects were uninsurable because launch vehicles were unreliable and most payloads were experimental. Therefore, the risk was retained by governments and the space agencies that financed the flights [12]. The situation changed with the arrival of commercial projects. On 6 April 1965 Comsat (Communication Satellite Corporation) obtained the first space insurance policy to protect the first commercial geostationary communication satellite, Early Bird (Intelsat I-F1) [13e15].5 In time,
4 The period can be estimated also as the period between one soft market to the next, with the same result. 5 The policy covered only material damages to the satellite prior to lift-off (prelaunch insurance for $3.5 million and third-party liability during launch for $5 million.
193
and with the increasing experience of all the parties involved, the satellite insurance market developed a wider scope of insurance cover [3].6 The satellite insurance industry is shaped by a number of forces: very limited number of new insurance contracts annually (no more than 20e30), large potential single losses (e.g. in excess of $250 million), and participation of several insurers for one launch because of the large loss potential and a limited number of insurers writing this coverage (about 30e40 companies worldwide). All this may have contributed to substantial volatility in the industry. Volatility in premiums and claims from 1968 to 2008 is demonstrated in Fig. 1. Premiums are the total amount paid for all insured satellites during the year (and include launch insurance and in-orbit insurance). Claims are defined as claims paid for losses that occurred during launch and in-orbit operations. Fig. 1 indicates that a period of premium growth occurred beginning with the 1980s through the first half of the 1990s, and in 1997 premiums exceeded $1 billion [19]. From market inception in 1965 until 1977 the satellite insurance industry remained free of claims. But this was not because there were no losses. Rather it was customary to insure several satellite launches under one policy and to consider one launch failure as the policy deductible. Fig. 2 contains the loss ratio for launch insurance and inorbit insurance. The loss ratio is defined as claims divided by premiums. Fig. 2 provides a clearer picture of the interrelationship between losses and premiums by collapsing information into one number. The loss ratio can be interpreted as a measure of underwriting profitability. Fig. 2 indicates that the loss ratio reached a minimum of about 7% (not including years free of any loss) in 1989, while a maximum of 570% was reached in 1979. Fig. 3 contains premium rates and capacity measures. Rates are stated as a percentage of the total amount insured.7 The rate indicates the cost of coverage (in terms of sum insured) for insuring an individual satellite for launch plus one year of in-orbit operations. Three different rates are depicted in Fig. 3. The minimum rate is the premium rate for the best (i.e. the most reliable) risk or technology in a given year; the maximum rate applies to the worst or most unreliable risk or technology. The average rate is the arithmetic mean of all individual rates.8 Historically rates were set too low in the early years of satellite insurance, which meant that total premium income was eroded by a few claims. Traditionally, rates have been set in reaction to claims experience rather than by statistical analysis of the launch and in-orbit record [20]. Each company has a maximum dollar amount of insurance (i.e. capacity) it can offer for an individual satellite or launch risk. Most insurers report a maximum theoretical capacity they can provide for an individual risk. However, many insurers only allocate part of their theoretical capacity to any specific launch or in-orbit risk and may not use their full theoretical capacity. Typically there is more capacity available for launch risks than in-orbit risks because some insurers find launch risks more attractive than in-orbit risks [21]. Fig. 3 indicates that capacity grew steadily in the industry initially.
6 For a description of different satellite insurance products, see for example [12,16e18]. 7 For example, if the rate is 20 percent and the amount of insurance desired is $250 million, then the premium paid by the insured would be 20 percent of $250 million (i.e. 0.2*$250 million). 8 Rates are calculated for each individual spacecraft during the underwriting process and depend on many factors, however the most important are: satellite platform and launch vehicle heritage as well as market conditions.
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P. Manikowski, M.A. Weiss / Space Policy 28 (2012) 192e198 1800
1600
Satellite Insurance Premiums Satellite Insurance Claims
1400
Million dollars
1200
1000
800
600
400
200
0
Year
Fig. 1. Satellite insurance premiums and claims: 1968e2008.
600% Loss ratios
500%
400%
300%
200%
100%
0%
Year
Fig. 2. Loss ratios: 1968e2008.
However, capacity declined in the mid-1980s thanks to a series of losses, including the loss of the Space Shuttle Challenger in 1986 [22]. But capacity began to grow again a few years later and reached its peak in 1999 at $1.3 billion [23]. From that peak, capacity steadily shrank to the end of 2004 [24]. However, since 2005 it has been growing again. Fig. 3 indicates that capacity and rates do not appear to vary directly together. For example, capacity appears to be at an all time high in 1999 when the average rate is relatively low. An inverse relationship appears to exist between capacity and rates in other years as well. This is confirmed by the correlation coefficient
between capacity and the average rate, which is 0.71 for the period 1984e2008.9 Table 1 provides a list and definitions of the insurance metrics mentioned above. Table 2 presents means and variances of the variables mentioned. It appears that the arithmetic means of all rates (minimum, maximum and average) are in the range of
9 The satellite insurance market from about the mid-1980s is considered to be more fully developed (matured). Moreover, we use that period for the volatility tests and for some cycles tests.
P. Manikowski, M.A. Weiss / Space Policy 28 (2012) 192e198 35%
195 1400
Capacity - right scale
30%
Minimum Rate
1200
Average Rate Maximum Rate
1000
20%
800
15%
600
10%
400
5%
200
0%
0
million dollars
25%
year
Fig. 3. Capacity versus rates: 1968e2008.
their current levels. Moreover, standard deviations are quite moderate. This may suggest that they are not very volatile. This is in opposition to other variables (premiums, claims, loss ratio, underwriting result and capacity). For the latter indicators, the standard deviations are higher than their means. Thus, volatility is quite possible. The cursory overview of satellite insurance market statistics presented above provides some evidence that the satellite insurance market may be cyclical. Further explanation of the development of the satellite insurance market supports this contention. That is, in the early 1980s the market became very competitive. Then in the mid-1980s, the satellite insurance market experienced a crisis resulting from a series of losses (e.g. Intelsat IV, Palapa B2, Westar VI and the Space Shuttle Challenger). As a result, it was difficult to find coverage for the most valuable satellites [17]. In contrast, in the mid-1990s, the market was soft with low rates and capacity in excess of $1 billion [14]. But by the end of the 1990s, the market had again hardened after suffering several losses. Some insurers withdrew from the market e again capacity decreased,
Table 1 Variable definitions. Variable name Premiums
Definition
The total amount paid for all insured satellites during the year (includes launch insurance and in-orbit insurance) Claims Claims paid for losses that occurred during launch and in-orbit operations Loss ratio Claims divided by premiums Minimum The premium rate for the best (i.e. the most reliable) risk or rate technology in a given year Maximum The maximum rate applies to the worst or most unreliable risk rate or technology Average rate The arithmetic mean of all individual rates Capacity The market’s theoretical maximum capacity for launch risks, which is the sum of the maximum dollar amount of insurance that each underwriter is willing to provide for an individual risk Underwriting Premiums less claims result
and rates rose rapidly [25]. The last hard market lasted from 2000 to 2004. By the end of this period, the cost of insurance had increased by more than 100% and coverage terms became much more restrictive. Between 2003 and 2006 increased rates and improved satellite reliability returned the market to profitability which attracted more capacity and led to a softening from 2005 to 2007 (i.e. rates decreased and coverage terms improved). Losses in 2007 put the market in a negative position for the year, thereby prompting insurers to increase rates at the beginning of 2008. By the middle of 2008 launch rates had stabilized to an increase of 10%e15% over 2007, while in-orbit rates leveled out. The second half of 2008 saw rates stabilize further, starting to trend downwards [21]. Thus the satellite insurance market appears to go through repeating sequences of “hard” and “soft” markets, suggesting a cycle. In fact, Hiriart and Saleh [26] confirm the existence of broad cycles, where cycle refers to any cyclical fluctuation, for three types of satellite launch volumes: 1) defense and intelligence, 2) science, and 3) commercial satellites. Figs. 1e3 may also indicate that the satellite insurance market is characterized by extreme volatility in the market indicators depicted. This is different from the notion of cyclicality, which implies predictable changes over a long period.10 Volatility, in the context of the satellite insurance industry, concerns the relative rate at which market indicators (rates, profitability, capacity, etc.) move up and down. Thus volatility may be an alternative explanation for the crises and booms observed in the industry or it may exist in conjunction with cycles. In the remainder of this article indicators of cyclicality and volatility are investigated for this industry. 3. Data Annual data from 1968 to 2008 (41 observations) were used to conduct a time-series estimation for the satellite insurance
10 These predictable changes over time can be volatile, in that the insurance metric considered may move up or down quite a bit during the course of the cycle.
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Table 2 Summary statistics for variables in years 1968e2008.
Mean Standard deviation a
Minimum rate
Maximum rate
Average rate
Satellite premiuma
Claimsa
Capacitya
Loss ratio
Underwriting resulta
0.1082 0.0447
0.1727 0.0754
0.1307 0.0468
380.68 396.23
304.24 422.03
365.73 359.46
0.7884 1.1333
76.446 299.19
In millions USD.
market e this includes almost the entire history of satellite insurance. Data analyzed include: premiums, claims, underwriting results, loss ratios, minimum rates, maximum rates, average rates and capacity. These data were obtained primarily from market participants, mostly insurance brokers and underwriters, thus they are full and representative, since the main satellite insurance brokers e International Space Brokers (currently a part of Aon Risk Solutions), Marsh Space Projects and Willis Inspace e publish regular reports and booklets on the status of the satellite insurance market from a global perspective [27e32]. These publications include data on premiums, claims, rates and capacity starting from the early 1980s. Similar statistics are delivered at speeches at the biannual International Space Conferences [33e36]. Earlier data were taken from other available publications [13,37,38]. In addition, for purposes of comparison, written insurance premiums in OECD countries were analyzed as a control variable, with the expectation that these data should be relatively stable. (These data are available from 1984 to 2008 [39].)
4. Methodology To assess volatility the time-series behavior of basic market indicators was analyzed. One measure of volatility is the coefficient of variation (CV). The CV is a statistical measure of the dispersion of data points in a data series around the mean.11 It is calculated as follows:
CV ¼
Standard deviation Mean
(1)
The coefficient of variation is a useful statistic for comparing the degree of variation from one data series to another, even if the means of the series are dramatically different from each other. To determine whether an underwriting cycle exists, a secondorder autoregressive model proposed by Venezian [6] is estimated, and the parameters from this model are used to test for the existence of the underwriting cycle. Parameters needed to measure the cycle period are obtained by estimating the following autoregressive model with ordinary least squares:
Vt ¼ a0 þ a1 :Vt1 þ a2 :Vt2 þ ut
(2)
where Vt is a market indicator or performance measure such as the loss ratio in period t, and ut is a random error term. A cycle is present if a1 > 0, a2 < 0 and (a1)2 þ 4a2 < 0 [6]. This model is now well-established for conducting underwriting cycle tests. The cycle period, assuming a cycle is present, can be expressed as follows:
2p
T ¼ cos1
! a1 pffiffiffiffiffiffiffiffiffi 2 a2
(3)
Thus, the tests and analyses of cycles in satellite insurance are performed in two steps. First, tests are performed to determine whether underwriting cycles exist for different performance
11
An arithmetic mean is used here.
measures. Next, cycle period lengths are estimated if a cycle is detected. The performance measures used as dependent variables to estimate the equation (2) are: the underwriting result (premiumseclaims), loss ratio (claimsepremiums), minimum rate, maximum rate, average rate and capacity. Equation (2) is estimated using two different time-series: 1968e2008 (all data) and 1984e2008. The shorter period is used for two reasons: 1) this is the same period used for the volatility tests; and 2) the satellite insurance market is considered to be more fully developed during this time period. Finally, equation (2) is also estimated after adding a linear time trend to each equation [7]. Thus, 24 sets of results are obtained. All equations are estimated using ordinary least squares (OLS). 5. Results The results of the volatility tests are found in Table 3. The coefficient of variation for rates appears to be quite stable. That is, the CV is less than 0.5 (the CV of the OECD premium) for the minimum, maximum and average rate, while it is moderately close to the OECD premium for satellite premiums (0.55) and capacity (0.62). However, the CV of claims is almost twice the CV for the OECD premium (0.92 versus 0.5). Thus claims are subject to large fluctuations. Table 4 reports the results of the underwriting cycle analysis. Two underwriting related variables are analyzed, the loss ratio and the underwriting result. In all models in Table 4 no cycle is observed with respect to these variables. Additional variables, rates and market capacity are analyzed for cycles. When minimum, maximum or average rates are used as performance measures, in eight cases out of 12 a cycle exists. A cycle always exists for the minimum rate; but cycles appear to exist only over the 1984e2008 time period with respect to the average and maximum rates. Finally, capacity is cyclical in three of the four models in Table 4. The cycle periods estimated from the rates range from about six years for the maximum rate to over 13 years for the minimum rate with a trend. Observed lengths of the cycles with respect to rates are comparable or a little bit longer than those estimated in other lines of insurance in prior research. For example, in earlier research based on underwriting profit and loss ratios [6,7,10,11], cycle periods very rarely exceeded 10 years e the average was about six to seven years. Underwriting cycle lengths in different lines of insurance and in different countries are usually in the range of about 5e10 years [6,7,10,11], with only very few instances exceeding that range.12 However, a large difference exists in cycle length with respect to capacity when the 1984e2008 sample period is used (nearly 13 years when the model is estimated with a trend compared to nearly 25 years when the model is estimated without a trend variable).
12 For example cycle length in motor insurance varies from four to five years in Australia, Canada, Denmark, Germany, France, Switzerland, the USA, and Taiwan; it ranges from six to seven years in Italy, Japan, Singapore, and almost 10 years in Spain. For fire insurance the results are not very different: four to five years in Australia, the Netherlands, the USA and South Korea, six to seven in Canada, Denmark, Germany and Japan, as well as about 10 years in Malaysia.
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197
Table 3 Volatility of basic market indicators in years 1984e2008 (statistics summary).
Coefficient of variation
Minimum rate
Maximum rate
Average rate
Satellite premium
Claims
Capacity
OECD premium
0.36
0.22
0.23
0.55
0.92
0.62
0.50
Table 4 Results of tests for cycle existence for satellite insurance. Sample period
Variable
Without trenda
With trendb
Cycle
Cycle
1968e2008
Underwriting result Loss ratio Minimum rate Maximum rate Average rate Capacity Underwriting result Loss ratio Minimum rate Maximum rate Average rate Capacity
No No Yes No No No No No Yes Yes Yes Yes
Period
N/A No N/A No 13.44 Yes N/A No N/A No N/A Yes 1984e2008 N/A No N/A No 10.07 Yes 5.99 Yes 10.78 Yes 24.98 Yes pffiffiffiffiffiffiffiffiffi The cycle period is estimated as T ¼ 2p=cos1 ða1 =2 a2 Þ. a The OLS equation estimated is Vt ¼ a þ a1Vt1 þ a2Vt2 þ et. b The OLS equation estimated is Vt ¼ a þ a1Vt1 þ a2Vt2 þ a3Trend þ
Period N/A N/A 11.71 N/A N/A 13.63 N/A N/A 9.96 6.09 11.93 12.85
et.
Thus inclusion of the trend variable in the model appears to be an important factor when estimating cycles; the large cycle length estimated in capacity in the model without a trend appears to be unreasonable given the length of the sample period used to estimate the model (1984e2008). Hence, the empirical evidence only partially confirms cyclicality. The results demonstrate the presence of underwriting cycles in satellite insurance in about half the cases (11 out of 24). Existence of a cycle was confirmed only for rates and capacity for the shorter time-series. Surprisingly there was no cycle observed for underwriting profit or the loss ratio e variables which are usually used to assess cyclicality. It is not clear why cycles are not observed in loss ratios or underwriting profitability. One explanation is that claims in this industry are just too irregular. Underlying events leading to an accident are unpredictable, and claims associated with accidents contain an element of unpredictability as well. That is, because the satellite insurance market is very small, one major accident can skew the claim results. Also, satellite launch technology and the value of satellites in space have changed dramatically over the period since 1984. This would make the loss ratio and underwriting data very noisy. Premium rates, on the other hand, may be more cyclical because pricing may be based on the expected number of accidents and loss rates and premium rates are likely to be correlated over time as Cummins and Outreville explain [7]. 6. Conclusion Satellites fulfill many important functions globally. But the satellite industry can be affected by the availability and price of satellite insurance. History shows that availability, coverage terms and pricing can fluctuate dramatically for satellite insurance, with crises and boom conditions common. The most basic satellite insurance provides coverage for launch losses as well losses that occur while the satellite is in orbit. The crises and booms within the satellite insurance industry raise questions about whether this line of insurance is more volatile than other lines. In addition, the repeating sequences of hard markets (crises) and booms (soft markets) are suggestive of the operation of a cycle. Underwriting cycles are common in many lines
of insurance and have been found to exist in many countries. Thus the purpose of this research has been to investigate whether satellite market indicators are volatile and/or cyclical over the period 1968e2008. The results indicate that aspects of the satellite insurance market appear to be both volatile and/or cyclical. More specifically, claims appear to be volatile, while rates are subject to fluctuation and are cyclical in nature. Capacity in the satellite insurance industry is both volatile and cyclical.
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Space Policy journal homepage: www.elsevier.com/locate/spacepol
Cyclicality or volatility? The satellite insurance market Piotr Manikowski a, *, Mary A. Weiss b a b
University of Economics, Insurance Department, al. Niepodległosci 10, 61-875 Poznan , Poland Poznan Temple University, Risk, Ins.,& Healthcare Mgmt Dept, 1801 Liacouras Walk, Philadelphia, PA 19122, USA
a r t i c l e i n f o
a b s t r a c t
Article history: Received 31 October 2011 Received in revised form 4 January 2012 Accepted 10 January 2012 Available online 7 July 2012
The history of the satellite insurance market indicates that this market experiences crises and booms in profitability and prices that repeat in a manner suggestive of cycles. The purpose of this article is to rigorously investigate cyclicality of these and other features of the satellite insurance market and assess their volatility formally. Using data from 1968 to 2008, volatility and cyclicality are analyzed for satellite insurance market capacity, rates, and underwriting results, among other measures. The coefficient of variation for the various satellite insurance market metrics is used to assess volatility. Standard underwriting analysis is used to determine whether a cycle exists for various insurance metrics. The results indicate that some aspects of the satellite insurance market are volatile (e.g. claims) or cyclical (e.g. rates), while capacity is both volatile and cyclical. Ó 2012 Elsevier Ltd. All rights reserved.
Keywords: Satellite insurance Underwriting cycle Volatility
1. Introduction Satellites fulfill a variety of functions, ranging from providing voice/data/video communications globally to providing meteorological data for analysis and data for global positioning systems (GPS), as well as meeting military and scientific needs. In a report to the US president, the president’s National Security Telecommunications Advisory Committee (NSTAC) stated that the commercial satellite industry is critical to national and economic interests and homeland security. In addition, the structure of the space industry, its financial health and its workforce retention and development are dependent on the volume of satellites ordered and launched. However, without satellite insurance, it would be difficult to obtain financing for purchases and launches of satellites. There are two basic types of space insurance: property insurance (including pre-launch, launch and in-orbit insurance) and third-party liability insurance. Property insurance is available to cover particular phases of the satellite project: manufacturing and pre-launch activities, launch into space, and in-orbit life [1].1 Third-party liability * Corresponding author. Tel.: þ48 503719120; fax: þ48 61 8543101. E-mail address: [email protected] (P. Manikowski). 1 Pre-launch insurance covers transportation, temporary storage, integration with the launcher, as well as other preparations for launch, including the potentially dangerous loading of fuel. Launch insurance provides coverage from launch vehicle ignition to the confirmation of correct placement in orbit. In addition another 180 days from launch are covered to allow time for pre-operational tests and initialization of operations and to include at least one period of eclipse. In-orbit insurance covers the satellite during its operational lifetime, often in yearly renewable phases [2]. 0265-9646/$ e see front matter Ó 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.spacepol.2012.01.001
insurance covers the legal liability arising from damage to a thirdparty during the preparations for launch, the lift-off itself, in-orbit operations, and finally the re-entry.2 The availability and price of satellite insurance can fluctuate dramatically over time. For example, in the mid-1980s coverage was difficult to find and very expensive when it was available. Meanwhile, over the period 2005e2007, availability of coverage was plentiful with good premium terms. Like many types of insurance the insurance market for satellites may be cyclical in terms of profitability and pricing. More specifically, underwriting profit (i.e. the difference between premiums and losses expressed as a ratio to premiums) and price in many lines of insurance both follow a cycle. This cycle is commonly termed the “underwriting cycle”.3 The underwriting cycle does not necessarily synchronize with the general business cycle. In fact, it is much more regular than the general business cycle. In the operation of the underwriting cycle, the insurance market (either overall or by line) goes through alternating periods of “hard” and “soft” markets [4,5]. In a hard market, prices are high and coverage availability is low, while in a soft market premium prices are highly competitive (low) and coverage is more widely available. 2 This type of insurance will provide compensation in the event of personal injury and property damage to third parties, both on the ground and in space, caused by the launch vehicle sections or the satellite [3]. 3 The term “underwriting” refers to the process used by insurers to evaluate an insurance applicant, including whether the applicant is a desirable risk, and to determine the terms, conditions and pricing of any insurance that is offered.
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Many studies have shown that an underwriting cycle in profitability and price exists in the overall US propertyeliability insurance market [6e10], in other developed countries [6,10,11] as well as in different lines of propertyeliability insurance [6,7,10,11]. The cyclical behavior may also extend to the total amount of coverage available to insure satellites (or capacity). In addition to cyclicality, the satellite insurance market may be more volatile than insurance markets for other types of coverage. This is because, when a loss occurs, the amount of loss is large. In fact, the first claim that insurers were responsible for in relation to a satellite consumed all premiums collected by the industry until that time [2]. Claims have outstripped premiums in several other years, especially in 1998 and 2000. Also contributing to volatility is the fact that there are few insurers who offer this specialized coverage. The purpose of this paper is to provide an analysis of the satellite insurance market to determine whether it is cyclical, volatile or both. As part of this research the stability of basic market indicators for the satellite insurance market is investigated. The analysis proceeds by analyzing data from 1968 to 2008. Volatility is assessed by examining the coefficient of variation for various metrics in this line of business compared to metrics for the broad insurance market (i.e. insurance in OECD countries). To determine whether an underwriting cycle exists, a second-order autoregressive model proposed by Venezian [6] is estimated, and the parameters from this model are used to test for the existence of an underwriting cycle. If a cycle is detected, the cycle period is estimated as well. The cycle period refers to the average time from one hard market to the next.4 By way of preview the results indicate that aspects of the satellite insurance market are volatile (e.g. claims) or cyclical (e.g. premium rates), while capacity is both volatile and cyclical. This research is important because the functioning of the satellite insurance market has a large impact on the satellite industry. Further, satellites are purchased and manufactured well in advance of their launch, and volatility or cyclicality in satellite insurance pricing could result in a satellite being ready for launch when satellite insurance premium prices are very high or availability of satellite insurance is scarce. Thus trends, volatility and cyclicality of the satellite insurance market can have a significant strategic impact on the space industry. The remainder of the paper is organized as follows. In the next section, the satellite insurance market and its operating results are described. In Section 3, the data and their sources are described. Section 4 presents the methodology for the volatility and cyclicality analysis. The results are presented next, and the last section concludes.
2. The satellite insurance market and its operating results Until the mid-1960s most satellites that were launched were related to the military aims of the USA and the USSR, and were not of interest to insurers. Space projects were uninsurable because launch vehicles were unreliable and most payloads were experimental. Therefore, the risk was retained by governments and the space agencies that financed the flights [12]. The situation changed with the arrival of commercial projects. On 6 April 1965 Comsat (Communication Satellite Corporation) obtained the first space insurance policy to protect the first commercial geostationary communication satellite, Early Bird (Intelsat I-F1) [13e15].5 In time,
4 The period can be estimated also as the period between one soft market to the next, with the same result. 5 The policy covered only material damages to the satellite prior to lift-off (prelaunch insurance for $3.5 million and third-party liability during launch for $5 million.
193
and with the increasing experience of all the parties involved, the satellite insurance market developed a wider scope of insurance cover [3].6 The satellite insurance industry is shaped by a number of forces: very limited number of new insurance contracts annually (no more than 20e30), large potential single losses (e.g. in excess of $250 million), and participation of several insurers for one launch because of the large loss potential and a limited number of insurers writing this coverage (about 30e40 companies worldwide). All this may have contributed to substantial volatility in the industry. Volatility in premiums and claims from 1968 to 2008 is demonstrated in Fig. 1. Premiums are the total amount paid for all insured satellites during the year (and include launch insurance and in-orbit insurance). Claims are defined as claims paid for losses that occurred during launch and in-orbit operations. Fig. 1 indicates that a period of premium growth occurred beginning with the 1980s through the first half of the 1990s, and in 1997 premiums exceeded $1 billion [19]. From market inception in 1965 until 1977 the satellite insurance industry remained free of claims. But this was not because there were no losses. Rather it was customary to insure several satellite launches under one policy and to consider one launch failure as the policy deductible. Fig. 2 contains the loss ratio for launch insurance and inorbit insurance. The loss ratio is defined as claims divided by premiums. Fig. 2 provides a clearer picture of the interrelationship between losses and premiums by collapsing information into one number. The loss ratio can be interpreted as a measure of underwriting profitability. Fig. 2 indicates that the loss ratio reached a minimum of about 7% (not including years free of any loss) in 1989, while a maximum of 570% was reached in 1979. Fig. 3 contains premium rates and capacity measures. Rates are stated as a percentage of the total amount insured.7 The rate indicates the cost of coverage (in terms of sum insured) for insuring an individual satellite for launch plus one year of in-orbit operations. Three different rates are depicted in Fig. 3. The minimum rate is the premium rate for the best (i.e. the most reliable) risk or technology in a given year; the maximum rate applies to the worst or most unreliable risk or technology. The average rate is the arithmetic mean of all individual rates.8 Historically rates were set too low in the early years of satellite insurance, which meant that total premium income was eroded by a few claims. Traditionally, rates have been set in reaction to claims experience rather than by statistical analysis of the launch and in-orbit record [20]. Each company has a maximum dollar amount of insurance (i.e. capacity) it can offer for an individual satellite or launch risk. Most insurers report a maximum theoretical capacity they can provide for an individual risk. However, many insurers only allocate part of their theoretical capacity to any specific launch or in-orbit risk and may not use their full theoretical capacity. Typically there is more capacity available for launch risks than in-orbit risks because some insurers find launch risks more attractive than in-orbit risks [21]. Fig. 3 indicates that capacity grew steadily in the industry initially.
6 For a description of different satellite insurance products, see for example [12,16e18]. 7 For example, if the rate is 20 percent and the amount of insurance desired is $250 million, then the premium paid by the insured would be 20 percent of $250 million (i.e. 0.2*$250 million). 8 Rates are calculated for each individual spacecraft during the underwriting process and depend on many factors, however the most important are: satellite platform and launch vehicle heritage as well as market conditions.
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P. Manikowski, M.A. Weiss / Space Policy 28 (2012) 192e198 1800
1600
Satellite Insurance Premiums Satellite Insurance Claims
1400
Million dollars
1200
1000
800
600
400
200
0
Year
Fig. 1. Satellite insurance premiums and claims: 1968e2008.
600% Loss ratios
500%
400%
300%
200%
100%
0%
Year
Fig. 2. Loss ratios: 1968e2008.
However, capacity declined in the mid-1980s thanks to a series of losses, including the loss of the Space Shuttle Challenger in 1986 [22]. But capacity began to grow again a few years later and reached its peak in 1999 at $1.3 billion [23]. From that peak, capacity steadily shrank to the end of 2004 [24]. However, since 2005 it has been growing again. Fig. 3 indicates that capacity and rates do not appear to vary directly together. For example, capacity appears to be at an all time high in 1999 when the average rate is relatively low. An inverse relationship appears to exist between capacity and rates in other years as well. This is confirmed by the correlation coefficient
between capacity and the average rate, which is 0.71 for the period 1984e2008.9 Table 1 provides a list and definitions of the insurance metrics mentioned above. Table 2 presents means and variances of the variables mentioned. It appears that the arithmetic means of all rates (minimum, maximum and average) are in the range of
9 The satellite insurance market from about the mid-1980s is considered to be more fully developed (matured). Moreover, we use that period for the volatility tests and for some cycles tests.
P. Manikowski, M.A. Weiss / Space Policy 28 (2012) 192e198 35%
195 1400
Capacity - right scale
30%
Minimum Rate
1200
Average Rate Maximum Rate
1000
20%
800
15%
600
10%
400
5%
200
0%
0
million dollars
25%
year
Fig. 3. Capacity versus rates: 1968e2008.
their current levels. Moreover, standard deviations are quite moderate. This may suggest that they are not very volatile. This is in opposition to other variables (premiums, claims, loss ratio, underwriting result and capacity). For the latter indicators, the standard deviations are higher than their means. Thus, volatility is quite possible. The cursory overview of satellite insurance market statistics presented above provides some evidence that the satellite insurance market may be cyclical. Further explanation of the development of the satellite insurance market supports this contention. That is, in the early 1980s the market became very competitive. Then in the mid-1980s, the satellite insurance market experienced a crisis resulting from a series of losses (e.g. Intelsat IV, Palapa B2, Westar VI and the Space Shuttle Challenger). As a result, it was difficult to find coverage for the most valuable satellites [17]. In contrast, in the mid-1990s, the market was soft with low rates and capacity in excess of $1 billion [14]. But by the end of the 1990s, the market had again hardened after suffering several losses. Some insurers withdrew from the market e again capacity decreased,
Table 1 Variable definitions. Variable name Premiums
Definition
The total amount paid for all insured satellites during the year (includes launch insurance and in-orbit insurance) Claims Claims paid for losses that occurred during launch and in-orbit operations Loss ratio Claims divided by premiums Minimum The premium rate for the best (i.e. the most reliable) risk or rate technology in a given year Maximum The maximum rate applies to the worst or most unreliable risk rate or technology Average rate The arithmetic mean of all individual rates Capacity The market’s theoretical maximum capacity for launch risks, which is the sum of the maximum dollar amount of insurance that each underwriter is willing to provide for an individual risk Underwriting Premiums less claims result
and rates rose rapidly [25]. The last hard market lasted from 2000 to 2004. By the end of this period, the cost of insurance had increased by more than 100% and coverage terms became much more restrictive. Between 2003 and 2006 increased rates and improved satellite reliability returned the market to profitability which attracted more capacity and led to a softening from 2005 to 2007 (i.e. rates decreased and coverage terms improved). Losses in 2007 put the market in a negative position for the year, thereby prompting insurers to increase rates at the beginning of 2008. By the middle of 2008 launch rates had stabilized to an increase of 10%e15% over 2007, while in-orbit rates leveled out. The second half of 2008 saw rates stabilize further, starting to trend downwards [21]. Thus the satellite insurance market appears to go through repeating sequences of “hard” and “soft” markets, suggesting a cycle. In fact, Hiriart and Saleh [26] confirm the existence of broad cycles, where cycle refers to any cyclical fluctuation, for three types of satellite launch volumes: 1) defense and intelligence, 2) science, and 3) commercial satellites. Figs. 1e3 may also indicate that the satellite insurance market is characterized by extreme volatility in the market indicators depicted. This is different from the notion of cyclicality, which implies predictable changes over a long period.10 Volatility, in the context of the satellite insurance industry, concerns the relative rate at which market indicators (rates, profitability, capacity, etc.) move up and down. Thus volatility may be an alternative explanation for the crises and booms observed in the industry or it may exist in conjunction with cycles. In the remainder of this article indicators of cyclicality and volatility are investigated for this industry. 3. Data Annual data from 1968 to 2008 (41 observations) were used to conduct a time-series estimation for the satellite insurance
10 These predictable changes over time can be volatile, in that the insurance metric considered may move up or down quite a bit during the course of the cycle.
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Table 2 Summary statistics for variables in years 1968e2008.
Mean Standard deviation a
Minimum rate
Maximum rate
Average rate
Satellite premiuma
Claimsa
Capacitya
Loss ratio
Underwriting resulta
0.1082 0.0447
0.1727 0.0754
0.1307 0.0468
380.68 396.23
304.24 422.03
365.73 359.46
0.7884 1.1333
76.446 299.19
In millions USD.
market e this includes almost the entire history of satellite insurance. Data analyzed include: premiums, claims, underwriting results, loss ratios, minimum rates, maximum rates, average rates and capacity. These data were obtained primarily from market participants, mostly insurance brokers and underwriters, thus they are full and representative, since the main satellite insurance brokers e International Space Brokers (currently a part of Aon Risk Solutions), Marsh Space Projects and Willis Inspace e publish regular reports and booklets on the status of the satellite insurance market from a global perspective [27e32]. These publications include data on premiums, claims, rates and capacity starting from the early 1980s. Similar statistics are delivered at speeches at the biannual International Space Conferences [33e36]. Earlier data were taken from other available publications [13,37,38]. In addition, for purposes of comparison, written insurance premiums in OECD countries were analyzed as a control variable, with the expectation that these data should be relatively stable. (These data are available from 1984 to 2008 [39].)
4. Methodology To assess volatility the time-series behavior of basic market indicators was analyzed. One measure of volatility is the coefficient of variation (CV). The CV is a statistical measure of the dispersion of data points in a data series around the mean.11 It is calculated as follows:
CV ¼
Standard deviation Mean
(1)
The coefficient of variation is a useful statistic for comparing the degree of variation from one data series to another, even if the means of the series are dramatically different from each other. To determine whether an underwriting cycle exists, a secondorder autoregressive model proposed by Venezian [6] is estimated, and the parameters from this model are used to test for the existence of the underwriting cycle. Parameters needed to measure the cycle period are obtained by estimating the following autoregressive model with ordinary least squares:
Vt ¼ a0 þ a1 :Vt1 þ a2 :Vt2 þ ut
(2)
where Vt is a market indicator or performance measure such as the loss ratio in period t, and ut is a random error term. A cycle is present if a1 > 0, a2 < 0 and (a1)2 þ 4a2 < 0 [6]. This model is now well-established for conducting underwriting cycle tests. The cycle period, assuming a cycle is present, can be expressed as follows:
2p
T ¼ cos1
! a1 pffiffiffiffiffiffiffiffiffi 2 a2
(3)
Thus, the tests and analyses of cycles in satellite insurance are performed in two steps. First, tests are performed to determine whether underwriting cycles exist for different performance
11
An arithmetic mean is used here.
measures. Next, cycle period lengths are estimated if a cycle is detected. The performance measures used as dependent variables to estimate the equation (2) are: the underwriting result (premiumseclaims), loss ratio (claimsepremiums), minimum rate, maximum rate, average rate and capacity. Equation (2) is estimated using two different time-series: 1968e2008 (all data) and 1984e2008. The shorter period is used for two reasons: 1) this is the same period used for the volatility tests; and 2) the satellite insurance market is considered to be more fully developed during this time period. Finally, equation (2) is also estimated after adding a linear time trend to each equation [7]. Thus, 24 sets of results are obtained. All equations are estimated using ordinary least squares (OLS). 5. Results The results of the volatility tests are found in Table 3. The coefficient of variation for rates appears to be quite stable. That is, the CV is less than 0.5 (the CV of the OECD premium) for the minimum, maximum and average rate, while it is moderately close to the OECD premium for satellite premiums (0.55) and capacity (0.62). However, the CV of claims is almost twice the CV for the OECD premium (0.92 versus 0.5). Thus claims are subject to large fluctuations. Table 4 reports the results of the underwriting cycle analysis. Two underwriting related variables are analyzed, the loss ratio and the underwriting result. In all models in Table 4 no cycle is observed with respect to these variables. Additional variables, rates and market capacity are analyzed for cycles. When minimum, maximum or average rates are used as performance measures, in eight cases out of 12 a cycle exists. A cycle always exists for the minimum rate; but cycles appear to exist only over the 1984e2008 time period with respect to the average and maximum rates. Finally, capacity is cyclical in three of the four models in Table 4. The cycle periods estimated from the rates range from about six years for the maximum rate to over 13 years for the minimum rate with a trend. Observed lengths of the cycles with respect to rates are comparable or a little bit longer than those estimated in other lines of insurance in prior research. For example, in earlier research based on underwriting profit and loss ratios [6,7,10,11], cycle periods very rarely exceeded 10 years e the average was about six to seven years. Underwriting cycle lengths in different lines of insurance and in different countries are usually in the range of about 5e10 years [6,7,10,11], with only very few instances exceeding that range.12 However, a large difference exists in cycle length with respect to capacity when the 1984e2008 sample period is used (nearly 13 years when the model is estimated with a trend compared to nearly 25 years when the model is estimated without a trend variable).
12 For example cycle length in motor insurance varies from four to five years in Australia, Canada, Denmark, Germany, France, Switzerland, the USA, and Taiwan; it ranges from six to seven years in Italy, Japan, Singapore, and almost 10 years in Spain. For fire insurance the results are not very different: four to five years in Australia, the Netherlands, the USA and South Korea, six to seven in Canada, Denmark, Germany and Japan, as well as about 10 years in Malaysia.
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197
Table 3 Volatility of basic market indicators in years 1984e2008 (statistics summary).
Coefficient of variation
Minimum rate
Maximum rate
Average rate
Satellite premium
Claims
Capacity
OECD premium
0.36
0.22
0.23
0.55
0.92
0.62
0.50
Table 4 Results of tests for cycle existence for satellite insurance. Sample period
Variable
Without trenda
With trendb
Cycle
Cycle
1968e2008
Underwriting result Loss ratio Minimum rate Maximum rate Average rate Capacity Underwriting result Loss ratio Minimum rate Maximum rate Average rate Capacity
No No Yes No No No No No Yes Yes Yes Yes
Period
N/A No N/A No 13.44 Yes N/A No N/A No N/A Yes 1984e2008 N/A No N/A No 10.07 Yes 5.99 Yes 10.78 Yes 24.98 Yes pffiffiffiffiffiffiffiffiffi The cycle period is estimated as T ¼ 2p=cos1 ða1 =2 a2 Þ. a The OLS equation estimated is Vt ¼ a þ a1Vt1 þ a2Vt2 þ et. b The OLS equation estimated is Vt ¼ a þ a1Vt1 þ a2Vt2 þ a3Trend þ
Period N/A N/A 11.71 N/A N/A 13.63 N/A N/A 9.96 6.09 11.93 12.85
et.
Thus inclusion of the trend variable in the model appears to be an important factor when estimating cycles; the large cycle length estimated in capacity in the model without a trend appears to be unreasonable given the length of the sample period used to estimate the model (1984e2008). Hence, the empirical evidence only partially confirms cyclicality. The results demonstrate the presence of underwriting cycles in satellite insurance in about half the cases (11 out of 24). Existence of a cycle was confirmed only for rates and capacity for the shorter time-series. Surprisingly there was no cycle observed for underwriting profit or the loss ratio e variables which are usually used to assess cyclicality. It is not clear why cycles are not observed in loss ratios or underwriting profitability. One explanation is that claims in this industry are just too irregular. Underlying events leading to an accident are unpredictable, and claims associated with accidents contain an element of unpredictability as well. That is, because the satellite insurance market is very small, one major accident can skew the claim results. Also, satellite launch technology and the value of satellites in space have changed dramatically over the period since 1984. This would make the loss ratio and underwriting data very noisy. Premium rates, on the other hand, may be more cyclical because pricing may be based on the expected number of accidents and loss rates and premium rates are likely to be correlated over time as Cummins and Outreville explain [7]. 6. Conclusion Satellites fulfill many important functions globally. But the satellite industry can be affected by the availability and price of satellite insurance. History shows that availability, coverage terms and pricing can fluctuate dramatically for satellite insurance, with crises and boom conditions common. The most basic satellite insurance provides coverage for launch losses as well losses that occur while the satellite is in orbit. The crises and booms within the satellite insurance industry raise questions about whether this line of insurance is more volatile than other lines. In addition, the repeating sequences of hard markets (crises) and booms (soft markets) are suggestive of the operation of a cycle. Underwriting cycles are common in many lines
of insurance and have been found to exist in many countries. Thus the purpose of this research has been to investigate whether satellite market indicators are volatile and/or cyclical over the period 1968e2008. The results indicate that aspects of the satellite insurance market appear to be both volatile and/or cyclical. More specifically, claims appear to be volatile, while rates are subject to fluctuation and are cyclical in nature. Capacity in the satellite insurance industry is both volatile and cyclical.
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