Special Report - Read the Small Print
Airlines are continuing to develop risk management strategies, but a better understanding of the financial implications of a crisis is necessary
It is said that a crisis is the normal state of affairs for an airline. But that refers more to business conditions than catastrophic accidents. In fact, most members of airline senior management have little experience of dealing with an accident.
Figures for 2011 prove the rarity of such an event. Last year was the safest year ever for air transport. The accident rate (measured in hull losses per million flights of Western-built jets) was 0.37. Airlines registered with the IATA Operational Safety Audit (IOSA) clearly benefited from global standards; their overall accident rate was 52% better than for non-IOSA operators.
Despite the constant improvements, accidents can occur. And if they do, airlines need to be prepared. Crisis management delves deeply into many areas, going as far as determining seating plans for press and family announcements. Carriers can be very good at much of this because, despite the rarity of an event, they plan or practice regularly using all available expertise.
Challenges remain, however. The financial implications of an accident are hard to judge, as each event is unique. Cost is not limited to hull loss and passenger compensation. Family care, reputation, criminalization, civil litigation, and even the ability to continue to operate can all come with a bill measured in millions—if not tens of millions—of dollars.
The financial management of a crisis is rarely practiced in advance. While accident scenarios may be practiced on a yearly basis to ensure the smooth running of communications and other operational aspects, many carriers don’t review their preparedness against the latest trends in financial consequences and insurance as frequently. But, it is a vital consideration.
The right relationships
The complexity of the insurance market itself is a contributing factor. Aviation insurance began in 1911 at Lloyd’s of London, with the first specialist aviation insurers emerging in 1924. But the sums of money now involved mean no airline has a single insurer. Most often, there is a lead underwriter and then several further underwriters.
Easing the aftermath of an event therefore depends on forming several relationships and coordinating one with the other. Sean Gates of Gates and Partners, an international law firm specializing in aviation, advises that the airline’s senior team should get to know their insurers and their insurer’s lawyers to ensure a unified front. “The worst handled accidents are those where the parties are not aligned or where the advisers are not the ones in whose appointment the airline has very actively participated,” he notes. “CEOs should consider carefully which partners are best for them and triangulate any advice they receive on a decision that could affect not only the company’s existence but their own liberty.”
In June 2012, a Dana Air plane crashed in Lagos, Nigeria. The resulting claims have been complicated by the number of insurers involved. Media reports have claimed Dana Air’s fleet insurance was agreed at a premium of $1,448,206. Lloyds of London took 70% of the risk with the remaining 30% retained by seven companies in the local market. Prestige Assurance had 8%, Leadway Assurance 7%, NEM Insurance 5%, Sterling Assurance 3%, Continental Reinsurance 3%, Aiico 2%, and Standard Alliance 2%.
Robert Jensen, CEO of Kenyon International, believes that the good judgement that was recognized in appointing CEOs is most critical in a crisis. “Yet many CEOs, because they find themselves in an area they are totally unfamiliar with, allow others to make decisions for them, at times to the detriment of the airline and families,” he says.
Of course, CEOs rarely have time to spend personally preparing for something they hope will never happen. But Jensen’s point is that they must work closely with brokers and insurers but the CEO must be prepared to make the final decision. Calling the various parties to a meeting and asking them to explain their roles, agendas, and the support that they would give in an accident is an efficient way for the CEO to get a feel for how the parties would work together. If discussions aren’t entirely satisfactory at that point, notes Jensen, it is highly unlikely they will be any better at 2am on a public holiday in the aftermath of an accident.
Understanding the complexity of how the insurance is structured is only half the battle. Just as important is knowing the details of the limits of the policy itself. Jensen believes most CEOs and CFOs are not always properly informed about policy limits, what’s covered and what’s not. “It’s not until an event occurs that they find out they don’t have the coverage they would have expected,” he says. “Many of them have never been through a loss. The people they often depend on for those answers—insurers—have an entirely different perspective.”
Policy limits could also be affected by trends in the insurance market. Gates says reports indicate there is abundant capacity in the market at the moment and rates are falling. According to Aon, a global provider of risk management, insurance and reinsurance brokerage, the aviation insurance market has consistently lost money in recent years.
Falling prices may seem like good news but the challenge is in ensuring that coverage and claims management do not drop along with the premiums.
Gates says, “In this environment insureds need to focus on the quality of security and its dependability and must verify for themselves the responsiveness of all of their insurers to claims rather than the cheapness of their offering,” he says. “A dollar for nothing is more expensive than two dollars for cover!”
Airlines need to be aware of any potential limitations. Crew may not be covered under the main policy, for example. If the extra cover needed for the crew is not of the same standard as that for passengers, airlines may support the crew above and beyond what they have done for families. Or the opposite may be also be true. This obviously has implications for employee relations, brand and reputation.
The level of payment for humanitarian assistance varies too. Depending on the circumstances this could cost an airline more than $10 million. If the limit on the insurance policy is $5 million, the airline has a problem.
“The coverage provided by a policy is primarily for legal liability to passengers and third parties affected by an accident and for the aircraft hull, with some often poorly defined additional cover, the meaning of which needs clarification,” says Gates.
“However, the policy does not provide coverage for brand protection or assistance to recover from the many problems that follow a disaster and entitles insurers to control a response to what can easily be an existential threat to the insured’s existence,” he adds.
“A prudent insured needs to consider these matters carefully and take self-preservative steps. A responsible CEO would not outsource the company’s existence to an unknown third party and there is no doubt the quality of insurers’ claims teams varies significantly.”
Most airline CEOs will never have to deal with a major incident. But preparing for the worst is still the best solution. There can be no ballpark figure for the cost of an accident as each event will have its own characteristics. But understanding the variables at play is critical to good financial management.
Gates concludes that airlines should seek advice from those who can be genuinely independent. “Insist on full participation, plan and prepare,” he says. “Try to obtain an agreement with suppliers in advance of an accident that they will not try to send you to jail.”
Cooperating with business partners
It is not only the multitude of insurers that have to be coordinated by an airline. Partners such as airports and airframe and engine manufacturers have a key role too, and the relationships that exist can have a significant effect on the final outcome of any financial settlements.
The Qantas flight 32 incident that saw the aircraft returning to Singapore after an engine problem is a case in point. Many observed that the conflicting approaches to corporate communications by the various parties after the incident did little to ease the media frenzy that ensued.
An understanding among partners in advance of an accident is critical to a good outcome. Codeshare arrangements are the most obvious. But the need to coordinate extends well beyond to manufacturers, airports, and investigators. And social media is putting an added time pressure which needs careful consideration. IATA has put together best practices guidelines in social media to help the industry think through the implications.
Robert Jensen, CEO of Kenyon International agrees that everyone wants to take charge without taking responsibility. “This does not mean everyone has to agree or join hands,” he says. “But it also does not mean that you protect yourself by saying how bad the other guy is—from the families’ viewpoint or corporate communications viewpoint that is never helpful.”
The insurance market issues that came about as a result of 9.11 are still largely unresolved. The root of some coverage limitations stem from this tragedy.
Coverage for weapons of mass destruction (WMDs) was withdrawn after 9.11, which insurers were entitled to do under the cancellation provisions in their policies. “As a result, airlines were no longer complying with governments’ minimum insurance requirements,” says Carole Gates, IATA, Director Risk Management and Insurance. “It was a particular issue in Europe as carriers fell foul of EU regulation 785. To prevent a permanent grounding of fleets, governments stepped in—the United States, the United Kingdom, Australia, Canada, and Switzerland are examples—to fill the gap in coverage.”
The United States went on to form its own reinsurance program and has so far collected over $1 billion dollars from airlines. Other countries indicate that they will provide a backstop only if and when it is needed. Many non-US airlines now purchase additional coverage in the form of excess insurance, in an effort to shore up their total insurance package.
The International Civil Aviation Organization (ICAO) members, the insurance industry, IATA and other stakeholders made a serious effort to construct a formal global reinsurance program but the work failed to reach fruition. In 2010, ICAO proposed a modernization of the Rome Convention that would create a victim compensation fund fed by a surcharge on airline passengers and cargo shippers. IATA argued vehemently that governments should provide at least some of the funding for such a mechanism because governments are the target of terrorist attacks but this was not the end result of the ICAO initiative. To date, very few states have adopted the mechanism. To come into force, it needs to be ratified by 35 states with sufficient traffic volume to build up a fund.
IATA has also worked as a participant in the London Aviation Insurance Clauses Group (AICG) that was set up in 2005 by the Aviation Committee of the Lloyd’s Market Association (LMA) and the Aviation Technical Committee of the International Underwriting Association of London (IUA ATC).
The AICG has provided more transparency in the drafting and issuance of standard insurance wording used by the aviation insurance marketplace. “The AICG drafted standard wording for a product that could be offered by the insurance market participants as a replacement for a full withdrawal of WMD coverage,” says Gates. “What came out of the AICG’s work was coverage language to address accidents in flight that occur and cause damage on the ground, even if caused by WMDs.” So, if WMD coverage is withdrawn at some point, airlines still have a product at their disposal to deal with a crisis.
This new product has never been used, informs Gates, nor has any insurer emphatically stated that it will be used in the future. But at least a standard wording is now available that defines coverage for these limited circumstances.