The soaring cost of space insurance has convinced EchoStar Communications [SPOT] that buying coverage for its eight in-orbit satellites is not worth the price.

According to documents filed with the Securities and Exchange Commission (SEC), EchoStar has decided to “self-insure” by setting aside reserves of $151 million in the event of a major anomaly. It is a risky strategy, but other companies have taken similar action when insurance rates have soared in the past. The downside is that if an in-orbit satellite suffers a catastrophic failure that requires the launch of a replacement spacecraft, the reserve fund would be wiped out.

A number of insurers are embroiled in a dispute with EchoStar that has gone to arbitration in an attempt to determine how much the company should be paid for the impairment of the EchoStar IV satellite. EchoStar filed a $219.3 million insurance claim in September 1998 after concluding that the satellite was a “total loss” under terms of its policies. The insurers, however, only offered to pay approximately $88 million, or 40 percent of the total amount claimed by EchoStar.

With EchoStar declaring one of its eight in-orbit satellites a total loss and reporting that an additional four satellites have a technical problem of one kind or another, insurers are wary about writing new policies for the company. EchoStar’s history of legal disputes with business partners also may be a factor in the reluctance of insurers to offer coverage without insisting upon sizable premiums to avoid an underwriting loss.

The fallout is that EchoStar no longer has “traditional commercial insurance” to cover the failure of launches or satellites, according to its 10-K document filed with the SEC earlier this month. In addition, EchoStar warned in the same document that it might not be able to “settle” outstanding claims with insurers.

EchoStar’s plan to drop both launch and in-orbit satellite insurance rather than pay the rising rates now commanded by underwriters posed an additional challenge for the Littleton, Colo.-based satellite TV services provider since the company’s debt covenants require it to maintain coverage. The $151 million reserve fund set up by EchoStar for self-insurance is a way to meet that obligation.

“The launch and/or in-orbit insurance policies for EchoStar I through EchoStar VIII have expired,” EchoStar confirmed in its latest 10-K. “We have been unable to obtain insurance on any of these satellites on terms acceptable to us. As a result, we are currently self-insuring these satellites.”

Rates for the insured value of a satellite generally now range between a low of 15 percent and high of 35 percent of the spacecraft’s value, insurance industry sources said. Space insurers lost $525 million between 1998 and 2001, without including an estimated $1.7 billion in claims that remain unsettled due to in-orbit problems involving six Boeing Co.-built [BA] BSS 702 satellites (SN, March 10, pp. 1, 8-9).

“Clients are offered a price that reflects the risk,” said one insurance industry source. With high-stakes litigation pending, none of the insurance industry sources contacted for this story wanted to be identified.

To satisfy insurance covenants for EchoStar’s senior notes, the company reclassified $151 million — the amount of the depreciated cost of four of its satellites — from cash and cash equivalents to cash reserves for satellite insurance on its balance sheet.

“The reclassifications will continue until such time, if ever, as we can again insure our satellites on acceptable terms and for acceptable amounts, or until the covenants requiring the insurance are no longer applicable,” EchoStar said in its 10-K.

The company has sufficient in-orbit satellite capacity to recover transmission of most programming “expeditiously” in the event one of its in-orbit satellites fails, its officials said.

“However, the cash reserved for satellite insurance is not adequate to fund the construction, launch and insurance for a replacement satellite in the event of a complete loss of a satellite,” according to EchoStar’s 10-K. “Programming continuity cannot be assured in the event of multiple satellite losses.”

Self-insurance Risky, But Viable

D.K. Sachdev, an engineer who heads Vienna, Va.-based SpaceTel Consultancy, said that “self-insurance does become a viable option, particularly when the insurance rates are high, provided the number of total interchangeable spacecraft procured exceeds the number of operational roles needed to conduct the business. However, dropping in-orbit insurance after a successful launch saves only a fraction of the total insurance premium. If there is a total failure in orbit, and there is no in-orbit healthy spare satellite, the total cost for a new spacecraft and its launch has to be incurred in the short term.”

Ellen Hoff, president of the Bethesda, Md.-based satellite consultancy W.L. Pritchard & Co., said that “in prudent cash management, a company may decide the best use of its cash is not to pay additional premiums on satellites for which insurance claims are already pending. Such an assessment would depend on factors such as the status of an in-orbit fleet and the company’s plan for meeting current and future customer requirements. If the fleet is big enough, there may be operational changes that could be implemented to work around a problem.”

Wall Street analysts have continued to recommend EchoStar’s stock, despite the company’s decision to drop insurance.

“If EchoStar had a failure on a number of its satellites at the same time, the company would face a material financial impact,” said Bob Peck, a satellite analyst at Bear Stearns. “Generally speaking, we think EchoStar’s decision to set aside reserves as self-insurance is prudent and allows the company to meet its debt covenant requirements.”

EchoStar’s debt covenants require it to self-insure at least half of the net book value of its satellite fleet and $151 million in reserves allocated by the company for that purpose meets the obligation, Peck said. Key reasons why EchoStar opted to self-insure are the “very expensive” rates now offered by underwriters for coverage, along with “conflicts” that the company has had with insurers due to past claims, Peck explained.

The list of satellite anomalies that EchoStar has accumulated since it began operating in the mid-1990s already is fairly lengthy. Known flaws with the company’s in-orbit satellites include:

• EchoStar III – affected by the temporary failure of 12 of the 44 transponders on the spacecraft. The significance of that problem is limited since only 32 transponders can be operated at any one time. However, service provided by the satellite was interrupted during January 2002 before it quickly was restored.
• EchoStar IV – impaired by the failure of solar arrays to deploy fully and the failure of 38 of the 44 transponders onboard. Only six of the transponders on the satellite are available for use at this time. In addition to transponder and solar array failures, the satellite also has incurred anomalies of its thermal systems and propulsion system. Those limitations give the satellite only two or three more years of useful life and caused EchoStar to operate it as an in-orbit spare that currently provides no programming services.
• EchoStar V – faced with anomalies that included the loss of two solar array strings during 2000 and 2001, the loss of an additional solar array string in August 2002 and a faulty spacecraft electronic component that affects the ability to receive telemetry from certain onboard equipment. Other methods of communication have been established to alleviate the effects of the failed component. Since only 92 of EchoStar V’s 96 solar array strings are required to ensure full power availability over the spacecraft’s 12-year life, none of the problems has impaired the satellite’s performance. However, company officials have yet to determine the root cause of the problems. Nor can the officials be sure that commercial operation of EchoStar V may not be affected.
• EchoStar VI – operating with the loss of two solar array strings during 2001 and an additional solar array string during July 2002. For this satellite, 106 of the 112 solar array strings are required to assure full power availability for the estimated 12-year life of the spacecraft. The commercial operation of the satellite has not been impaired but the root cause of the anomalies has yet to be determined.
• EchoStar VIII – lost the use of two thrusters during September and October 2002. The satellite has 12 thrusters and currently is using the other 10 to help perform the roles of controlling spacecraft location, attitude and pointing. The use of only 10 thrusters requires more frequent maneuvers to maintain the satellite at its specified orbital location and is exhausting onboard fuel faster than planned. In addition, the satellite’s gyroscopes are used more than their originally qualified limits. None of these problems has cut the expected 12-year life of the satellite but the root cause has yet to be found.

“This fleet, despite all of its problems, certainly has considerable value, when considering all pertinent factors including its subscriber base,” said Elie J. Boubli, managing director and CEO of Fofiel International, a Melville, N.Y.-based consultancy.

Among the flawed satellites, the problems on the EchoStar V and VI do not seem to be very significant, said Charles Sampson, president of the Vienna, Va.-based satellite engineering consultancy CS Communications.

EchoStar III appears to have lost a group of transponders, Sampson said. However, only 32 transponders need to be operational to maintain full performance and the satellite still has that level of functionality, he said, adding, “I don’t think that is a dramatic loss.”

“Thrusters usually are highly reliable,” so the loss of two of the 12 on the EchoStar VIII satellite is atypical and does not indicate that the other ones will go bad, Sampson said.

However, the problem-plagued EchoStar IV is another matter.

“I don’t see how the satellite could be useful,” Sampson said. “If another satellite loses a little capacity, it possibly could provide a bit of backup service.”

In Sampson’s view, “very few satellites go up that don’t have any problems. It seems to me that recently the major problems aboard satellites have been with power control units and digital processors. With the exception of the EchoStar IV, I wouldn’t characterize these as major problems.”

Dispute In Two Venues

The insurance claim for the troubled EchoStar IV is moving ahead in two different arbitration venues, one in New York and the other in London. Separate policies with various insurers cover the loss, EchoStar reported. The comparatively small $88 million offered by insurers to settle the claim spurred EchoStar to request arbitration and allege breach of contract, failure to pay a valid insurance claim and bad faith denial of a valid claim, according to the company’s 10-K.

“The insurers assert, among other things, that EchoStar IV was not a total loss, as that term is defined in the policy, and that we did not abide by the exact terms of the insurance policies,” according to EchoStar’s 10-K filing. EchoStar strongly disagreed with that position.

EchoStar is pursuing the arbitration claims against Ace Bermuda Insurance in London, England, while the arbitration claims against all of the other insurance carriers will be heard in New York. The New York arbitration action is scheduled to begin in late April, but the insurers recently requested a delay of that hearing date. A hearing for the London arbitration matter is expected to occur later this year, according to the 10-K.

“There can be no assurance that we will receive the amount claimed in either the New York or the London arbitrations or, if we do, that we will retain title to EchoStar IV with its reduced capacity,” according to the 10-K.

–Paul Dykewicz

(D.K. Sachdev, SpaceTel Consultancy, 703/757-5880; Ellen Hoff, W.L. Pritchard & Co., 301/654-1144; Bob Peck, Bear Stearns, 212/272-6665; Elie Boubli, Fofiel International, 631/491-3904; Charles Sampson, CS Communications Inc., 703/938-5365)