By Owen D. Kurtin

According to several published reports, satellite insurance premiums are approaching 25 percent of satellite procurement costs. As is widely known in the industry, launch/post-separation and in-orbit insurance have become one of the most volatile indicia of satellite project cost and viability, and play a dominant role in the development, launch and operation of satellite projects. Are these costs inevitable, given the risky nature of the business, or have they become a separate basis for design, production and financing decisions and strategies? This article, a companion to a panel to be held at the upcoming Satellite 2005 conference in Washington D.C., puts in play the role of insurance as facilitator or impediment in the space business.

Most of us recognize that insurance is an actuarial business, but most people do not think clearly about the inverse relationship of odds and stakes. When we do, we know that the expectation cost of a future, but uncertain, event is its cost, should the event happen, multiplied by the probability that the event will in fact occur. It is the sort of calculation that risk arbitrageurs make every day. Thus, if the replacement cost of a satellite in the event of total loss at the beginning of its mission (when it has not yet generated any off-setting revenues) would be $250 million and the probability of that loss is 10 percent (0.1), then the expectation cost is $25 million and that is the basis of the cost of insurance (the premium), as adjusted for a premium-reducing deductible, should be.

A premium of 25 percent of satellite procurement cost presupposes a loss rate far in excess of current anomalies. Satellite operators and manufacturers clearly feel that the insurance industry is overestimating the probability of catastrophic failure; the insurance industry responds that it is in fact responding to chronic underestimations of the past.

Leaving aside the actuarial exercise that might determine which side was right, a more comprehensive question is: what are such risk premiums doing to the industry? The well- known military-industrial complex phenomenon referred to as "gold-plating" becomes more dominant as costs of a procured system increase. More redundancies and more features are built in, partly to get more bang for the buck in an already and increasingly expensive system, in part because cost overruns are assumed as how "the game is played," but each new system and subsystem means there is more to go wrong, increasing the risk of total loss. A more efficient insurance market would look at which satellite subsystems are the most prone to anomaly and when, and create a niche market for carving out, separately insuring and re-insuring the riskiest parts of the space system, just as a company’s different securities, and even some of the same security, may be carved up and separately priced.

The same would be the case for carving up the insurance components of a satellite system, as opposed to current general practice of insuring the whole system, dividing up merely the launch/post-separation and in-orbit phases, without fully amortizing the value for that part of a satellite’s mission and cost recovery already achieved at the time of loss. A beneficial side result would be the inhibition of gold-plating and suppression of unnecessary and unreliable subsystems. While lack of volume for given satellite systems imposes some constraints on the reliability of such an analytic approach, statistical tools are available to perform extrapolation analysis without being much fuzzier than current whole-system practice.

In his new book, "Catastrophe," (Oxford University Press, 2004) Judge Richard Posner of the U.S. Court of Appeals suggests that an economic value based on expected cost, and therefore an economically rational investment in prevention, can be put on any catastrophe, including those potentially involving human extinction, such as a major asteroid impact on Earth or the development by high-energy particle accelerators of unanticipated "strange matter" that created a miniature dwarf star or black hole on Earth. Judge Posner’s analysis falls down when he assigns a lower value for human life to extremely unlikely events (under a rigorous application of the theory, the stakes should remain the same, with that variable fully accounted for in the "odds" multiple). His analysis also assumes that the value of the human race’s life now is no greater than it may be in the future, when advances may banish disease, privation, war, ignorance and other ills, increasing our net happiness, longevity and well-being. However, he does raise a valuable point. While satellite insurance calculations are banal by comparison with considerations of human extinction, valuation of a space system by nothing more finely tuned than its total procurement of replacement value at a few broad stages of its mission ignores many more finely-honed criteria for which statistics and analytical tools are available, and, in so doing, artificially inflates mission cost, inhibiting new projects, new technology and techniques and new mission objectives.

Owen Kurtin is a partner in the New York office of law firm Brown Raysman Millstein Felder & Steiner LLP and a member of the firm’s Technology, Media and Communications and Corporate Departments. He may be reached at +1.212.895.2000 or by e-mail at [email protected].