Tuesday 5 April 2016

Why Airlines Cannot Recover Disruption Losses Caused By Handlers Who Damaged Their Aircraft, And What Needs To Be Done To Make Their Claims Successful

Interview with Ivar Busk

Airlines pay a high price for their ignorance about origins and true value of disruption costs. This increases their business vulnerability including unexpected events caused by external service providers. Among the most costly ones are ground handling incidents resulting in aircraft damage which cost major airlines over $10 billion annually. The majority of these costs are disruption related and impossible to recover using the existing, oversimplified methodologies. 

Instead of introducing the effective disruption cost/cause tracking methodologies as an integral part of airline decision making and applying them when needed, like in the case of recovering costs of aircraft damage, airlines either do nothing (and pay a high price when incidents happen), or opt for insurance protection with high premiums, high deductibles, and high legal charges when involved in long, hard to win disputes. This doesn't mean that carriers should not be insured against this kind of losses, but relaying exclusively on insurance protection they miss to understand their true exposure to risk of aircraft damage and work on its prevention and better protection. In this way airlines let this kind of ground handling incidents grow unnoticed and, apart from the financial impact, contribute to slow but inevitable deterioration of system performance and safety, especially at congested airports.

How do airlines cope with these problems in real life? What are the challenges faced by people directly involved in recovering consequential costs of aircraft damage?

I asked Ivar Busk, a veteran of 34 years in this field to share with us his insightful views about this 'niche' industry problem with the not so 'niche' consequences on airline cost, revenue, reputation and ramp safety. Ivar's impressive career as an ex SAS Manager Insurance, Head of Airside Safety, Aircraft Accident Investigator, Aircraft Engineer, and member of IATA Airside Safety Group, combined with his commercial business degree from Copenhagen Business School, and education at USC and FAA makes him a respectable contributor to the discussions related to the improvement in this sidelined area of airline business.

JR: According to handlers, 'carriers have been asked to provide quantifiable evidence of their damages ('loss of aircraft use') and they found it difficult if not impossible'. What are the main reasons behind airlines' inability to provide the evidence of consequential losses resulting from aircraft damage caused by ground handlers?

IB: Aircraft damage incidents are sporadic and unpredictable events so their assessment and claim recovery has not always had a high priority, and therefore no specific development and practice for aircraft damage assessment and claim recovery really exists. The aim for an airline is to minimize both direct and indirect losses following the aircraft damage and at the same time try to establish preventive measures to prevent reoccurrences in conjunction with the line operation. And also, because of relatively small number of cases on a yearly basis, it is difficult to gain experience in dealing with claim recoveries which then require external expertise to help resolve the case. The problem is that there are not many companies with sufficient expertise. In order to minimize losses some airlines have established an extensive network of insurance companies and surveyors that can help them with reducing bureaucracy, ensuring quicker and more expedient resolution, and increasing the chances to win the maximum possible compensation.

Nobody expects losses related to aircraft damage on ground to be completely eliminated, but they can certainly be kept at minimum possible levels. This can be achieved first by raising awareness about the full scale of costs involved in aircraft damage incidents and by organising the process in an efficient way. This assumes continuous monitoring of operational risks, particularly at critically congested airports. It also requires preventive system measures and guidelines for dynamic approach to identifying event specific indirect costs of aircraft damage without which claims cannot be recovered. Many external influences including the latest economic crises have forced airlines (operating at low profit margins) to take actions to increase the claim recovery. As a result, they have started to make claims even for minor damages.

JR: Are there any estimates on how big the costs associated with 'loss of aircraft use' are?

IB: Consequential loss ("loss of use") is the big item and is on average approximately four to ten times higher than the direct costs. A special development of a model for calculation of “Loss of use” is therefore essential, for achieving the optimal results. Airlines are well equipped with figures representing structured information concerning, crew, maintenance, passenger interruption cost, ground operation, sales cost etc., however the knowledge of how to put them together and present them, has been hard to come by.

JR: The content of ground handling contract can increase or decrease chances for loss recovery. How difficult it is to reach the agreement on consequential losses? 

IB: Agreeing on contract is always a big challenge and it is hard and often impossible to agree about consequential losses related to disrupted operations. The recovery already starts when contracts (technical or ground handling) are negotiated with third parties. 

Very often these contracts contain an indemnity clause, which covers losses only partly (physical loss) versus IATA SGHA 1998 / 2003/ 2008/2013 Article 8 versions. Also limitation in relation to the degree of negligence relating to the reason for or cause of damage in the operation can limit the claim to a minimum, or claim can be simply rejected. Further, consequential losses (loss of use) are very often not included at all, or are preciously excluded. However, as this is optional, it can be included in a contract between the parties if agreed.

It is also important for airline to check on sub-contracted handlers operating in niche areas on the ramp that may not have the insurance coverage as this can be too expensive for some of them. But normally the main contractor is held responsible for the insurance coverage. If the company responsible for aircraft damage has no contract with the affected airline, the full liability will then apply according to the law of country where damage occurred. Very often this means that all costs can be compensated including the consequential loss.

Not only that situation and circumstances vary from case to case, but also jurisdiction from country to country. It is therefore essential to be very specific in obtaining the right information about each individual case, so that failures during the recovery process do not affect the final results. Different countries have often a time barred period which also should be considered. Guidelines for airlines and service providers should therefore be a part of IATA AHM which is currently not the case.   

JR: Problems with recovering indirect losses caused by aircraft damage have made insurance companies more and more involved, making the resolution of disputes and loss recovery more costly and even unattainable for some airlines. Could you tell us more about how well are airlines protected by insurance policies and how much does it cost them?

IB: An airline’s insurance premium will depend on many factors covered under the policy including the carrier’s fleet size and value, its frequency of departures, time spent in the air, accident record and so on. The nature of the financial markets will affect airlines’ premiums as much as it does handlers’. Thus, for example, premiums went up dramatic in the wake of 9/11; they have only recently returned to roughly pre-9/11 levels.

As already noted, the cost to an airline of any damage to its aircraft is large, and most of it is hidden. The ‘loss of use’ of a damaged aircraft has shown to be between four and ten times as much as the cost of repairing the damage. An important development would be a model for calculation of ‘loss of use’ for airlines.

For carriers it is vital to have an efficient system of assessment and claim recovery. And a vital part of this is consideration of all elements of insurance liability when agreeing contracts with a ground handler. All too often, carriers only include an indemnity clause which only covers physical costs which are limited in relation to the normal degree of negligence involved in the cause of damage.
The airline insurance (hull policy) will normally only be activated if the loss is caused by the airline itself and the deductible amount (varying from USD 100.000 to USD 1.000.000) is exceeded. But there is also a possibility to have a deductible insurance which covers up the hull deductible with a minimum of USD 50.000,00 or less depending on airline actual needs. This type of coverage offers some advantage to smaller carriers.  

Other circumstances, for involving the airlines own insurance could be, if a third party is responsible (standard contract exists) and the contracted limit for physical damage is exceeded. Again normally 'loss of use' is not covered.
If an indemnity clause is included (IATA SGHA version 1998/2003/2008/2013), the responsible company will be held liable up to the agreed maximum compensation (normally up to USD 1.500.000) depending on the aircraft type. If the damage exceeds this amount for the actual aircraft type, the affected airlines own insurance will take over, but consequential loss (loss of use) will normally never be covered. However, some of the services delivered to the airline that create a part of consequential loss are sometimes included in the contract.

JR: Insurance deductibles appear to be very high. How often claims cross the deductible limit and does it affect change in premiums?

IB: As long as damage is caused by the third party who caused the airlines, own insurance is very rarely involved. Ground damage exceeding the agreed maximum limit is also rare. But whenever the limit is exceeded and therefore involves airline's own insurance, it is counted as an airline's claim record.

JR: How much are airlines generally aware about the full impact that aircraft damage can have on their business? What happened when they underestimate operational and financial risks involved?   

IB: It is well known within the industry that some airlines nearly never raise claims aimed at recovery of losses caused by aircraft damage even if the damage losses are counted in the range of million USD. They are usually caught by surprise suffering from massive losses just because they didn't have a consistent system in place to handle this kind of events.

A professional assessment of damage and consequent claim for loss recovery will minimize the costs involved and have direct impact on airline profitability. Any airline could suffer badly from aircraft damage if an efficient system of assessment and claim recovery is not planned and implemented in due time. It can harshly affect smaller airlines especially when one or even two aircraft are taken out of service and even cause their demise.

JR:What is the role of regulators in easing these industry problems?

IB: I feel that ICAO should show more interest for ground handling and the associated risks. Their Annexes related to flight operation say almost nothing about ground handlers' responsibilities apart from a general recommendation that ground handlers should have a Safety Management System (SMS) in place. IATA has covered this subject more in their AHM but these are generally only recommendations – without obligations on handler's side. That being said, some of the ground handling companies are doing a lot to follow these recommendations, but looking just at statistics is not enough.

JR:IATA Standard Ground Handling Agreement (SGHA) appeared to be the reason for many disputes due to ambiguities of over the 30-years-old Article 8 related to liability and indemnity, which doesn't mention airline consequential costs. Under pressure from airlines,  IATA introduced the 'Carrier Guidelines for Calculating Aircraft Ground Accident Costs' as a part of the Aircraft Handling manual (AHM660). Consequential losses have been finally recognised but the simplistic guidelines will hardly be sufficient to improve airline chances for disruption loss recovery. It has also caused a new wave of disputes, this time coming from ground handlers. What are the reasons for handlers' concerns?

IB: As for the new addition to IATA recommendation published in AHM660 ground handlers are concerned that changes in the SGHA will be followed by an increase in the premium charges they will have to pay to their underwriters, and therefore an overall increase in the aircraft turnaround charges to airlines, but by amending the SGHA we should aim at an improvement in the overall efficiency and safety awareness of ground operations, so that the cost of ground damage to the industry is reduced. This will not increase premiums.

Certainly, it is only the potential financial cost element that will really cause a handler to implement genuine accident prevention measures within its daily operational routine. If the consequent premiums become higher for that reason, perhaps that is the price the industry will have to pay, at least for the moment.

JR: Considering these opposing interests of airlines and ground handling companies and the absence of enforceable industrywide regulations, do you think that there is a need for a supra-industry body to help resolve these complex issues more quickly?

IB: Cases going to arbitration are rare - they are costly and take long time to resolve. There have been suggestions to have some kind of a arbitration board which should be available to handle the cases on a short notice bases without having to involve a number of experts and lawyers – but they lacked the support from the aviation industry. It should be somehow similar to what they have in the shipping industry.

JR: How realistic is it to expect improvement in this area bearing in mind that pressure on handlers to ensure on-time departures will continue to grow, especially at major airports where turnaround times are getting shorter and traffic more dense? 

IB: During the first stage of a recovery process it will be necessary to understand the airline structure and culture to point out the most efficient way of organizing the assessment and procedure. To optimize this phase of the process IATA has published the guidance in AHM 660 that reflects the situation of today. The outcome should be to find the most practical way of placing the responsibility for the claim and making settlement rather than entering the costly legal disputes.

JR: And finally, can you summarise your views on what needs to be done to make so much needed improvements?

IB: It is a mix of preventive measures and, when incident happens, defining responsibilities more clearly to create a healthy ground for reaching the settlement rather than being involved in long and costly disputes. The following are my suggestions that can lead to improvement:

  • Minimizing losses caused by aircraft damage by introducing workable practices based on experiential knowledge and clear guidelines  
  • Stronger impact in negotiation of contracts related to liability and indemnity clause in Article 8 IATA SGHA, so that less time is spent to resolve claims
  • Making the costs more transparent to inspire improvement through preventive measures
  • Stronger position in influencing industry regulators to improve current recommendations related to airline claim recovery
  • Reducing costs of external consultants (e.g. legal) and rely more on people with required  knowledge and experience inside the company
  • Sharing the knowledge gained through the increasing number of cases and consequently maximize compensation
  • Learning from different cultural environments and legal set ups that benefit all parties involved

Footnote: Contrary to unsubstantiated beliefs, disruption losses can be calculated with a high degree of accuracy. It however requires a good understanding of system issues and hands-on experience in applying the change tracking methodologies which is what Astute Aviation is now offering. This is an important missing part in current practices. Without it a just share of losses caused by aircraft damage will not be possible and will continue to hinder all improvement efforts.