Aircraft non-payment insurance (NPI) significantly reduces credit risk for investors by lowering expected loss in aviation-finance transactions, says Scope Ratings.

“NPIs are effective risk mitigants under an expected loss perspective,” says Scope analyst Helene Spro.

“The bottom line for any creditor is working out how much of their investment they can expect to get back,” says Spro. “That’s another way of saying that the potential scale of any loss for the investor is more important than the likelihood of there being a loss in the first place.”

The expected loss approach considers the severity of all default scenarios together with the probabilities of these scenarios occurring.

One irony of focusing only on probability of default in NPI lending – rather than expected loss – is that the risk of one insurer defaulting is higher as the number of insurers involved in the NPI transaction increases. This is countered by a lower default severity when more insurers are involved because the exposures are diluted. The risk level in an NPI transaction gets distorted when only probability of default is considered.

The origins of NPIs go back to Boeing’s search for an alternative to export-credit guarantees. Created by the plane maker in conjunction with Marsh LLC, the Aircraft Finance Insurance Consortium (AFIC) programme was designed to offer insurance coverage for Boeing aircraft. Since then, Marsh S.A.S, a separate Marsh entity, has worked together with a pool of highly rated insurance companies to launch Balthazar to offer a similar product for Airbus aircraft.

“We are likely to see more of these financing options arise as this product can be replicated for other aircraft manufacturers and other aviation assets,” says Spro.

Central to the appeal of NPIs is the high credit quality of the insurers involved, which decreases the contract’s default probability. The probability of a joint default between an airline and insurer is substantially lower than the airline’s standalone default probability. The severity of an event of default is also reduced when more than one insurer participates in an NPI transaction. Consequently, the expected loss decreases in line with the number of insurance companies – assuming there is a certain level of independence between the insurers – and also as a result of the contract’s lower probability of default.

“Being exposed to multiple insurers is a material net credit-positive. The more insurers are involved, the lower the severity in case of default, despite the higher probability of an insurer defaulting,” says Spro.