Bubble wrapped
With the drop in airline bookings having a devastating affect on the travel industry, Michael Ward from International Passenger Protection (IPP) examines whose job it is to protect passengers against supplier bankruptcy, and whether insurance companies are doing enough to fill the gap in consumer protection
First published in ITIJ 108, January 2010
With the drop in airline bookings having a devastating affect on the travel industry, Michael Ward from International Passenger Protection (IPP) examines whose job it is to protect passengers against supplier bankruptcy, and whether insurance companies are doing enough to fill the gap in consumer protection
Two years ago financial protection, such as scheduled airline failure, was seen as ‘nice to have’ in a travel insurance policy. Misunderstood and undervalued, it was merely window dressing to be lumped in with pet cover, hospital benefits and ‘hole in one drinks at the bar’ coverage. However, the events of the last two years have highlighted that financial protection is more than just dramatic writing at the end of a policy; it has filled an important gap in consumer protection and provided relief to thousands who would have been out of pocket had they not purchased the right policy. Over 60 airlines have collapsed in the last 12 months and renowned economic futurist Rohit Taldwar has estimated a further 40 will collapse over the next two years. So, how did this happen, and what have the travel and insurance industries done to protect travellers?
Current market
Collectively, airlines reported losses of $11-billion last year and it is well documented that bookings are down due to the recession, but by what margin? Depending on which travel association is quoted, the drop ranges massively between five and 30 per cent.
Probably the best source when looking at a global level is IATA (International Air Travel Association), which orchestrates the ticket sales of around 230 airlines. Last June, IATA reported that sales were down 7.1 per cent compared to same month in 2008, a figure that itself had dropped considerably from 2007. More importantly to airlines, premium tickets, which make up the industry’s most lucrative sector, were down 21.3 per cent in June against the previous year. On a positive note, though, IATA has seen that since March 2009, the decline in numbers flying economy class appears to be levelling out – it is believed, however, that these figures have been artificially supported by volumes of passengers shifting to economy class from business.
As a company that runs an agency default insurance with IATA, IPP is in direct dialogue with airlines in various regions and was amazed to hear about the further impact of swine flu in the Far East, with one airline noting a drop in demand of an unprecedented 80 per cent. The key indicator of the performance of airlines is the ‘AMEX Airline Index’, which assesses the performance of key airlines. At the start of 2007, the index recorded a record high of 69 points, but by March 2009, 26 months later, this had dropped to a record low of 13 points. At the time of writing, the index has recovered slightly to around the 24-point mark, but is still a far cry from its former highs. (The points indicate the value of the airline in question, so a drop from 69 points to 13 is a significant decrease in the combined value of airlines around the world.)
So, demand for flights is down and airlines are losing money, but won’t they just have to react to the changing market like the rest of us and try to survive until the recovery? Some industry experts believe the airline industry will never recover to pre-2008 levels, resulting in a need to change business models to generate revenue from add-on and ancillary sales as opposed to ticket costs – following the successful Ryanair model. Other options available to airlines include cutting costs, reducing capacity, loans, mergers or acquisitions. Borrowing substantial sums of money from financial markets has become virtually impossible with banks losing around £1.5 trillion so far, with an estimated further $2 trillion to come.
Over 60 airlines have collapsed in the last 12 months and renowned economic futurist Rohit Taldwar has estimated a further 40 will collapse over the next two years
Governments, for so long the final port of call for airlines in financial trouble, have also run out of money following the bailing out of numerous failed industries. Collectively, the G6’s debt is 100 per cent of their GDP. These enormous national debts will be felt well into our grandchildren’s lifetimes. That is not to say money cannot be found elsewhere but, in reality, most airlines are facing the other options mentioned above.
For every person who does not fly, that is one less hotel room being occupied, one less restaurant meal eaten, one less seat on the boat trip excursion – the impact on local businesses that are reliant on incoming tourist and business trade is immense. As Rohit Taldwar stated at a recent international travel conference, globally we are heading into a decade of volatility with economic uncertainty for all.
Under attack
So, what happened? Airlines are international organisations that have faced market volatility and geographical demands from numerous sources before – from previous recessions to terrorist attacks. However, never have so many negative factors hit the industry at the same time as those currently being felt:
- Oil Price – Airlines purchase huge quantities of oil and hedge for volumes at certain prices so that they can budget and set seat prices. Oil prices became so volatile during 2008 that hedging at the wrong time, while your competition did at the right time could be terminal – prices over the past two years have ranged from US$48.40 a barrel up to $140.50.
- Credit withdrawal – As mentioned earlier, the UK’s banking industry has a combined loss in the region of £1.5 trillion, meaning that vitally all credit lines have stopped. This has had a devastating affect on all areas of industry, but especially airlines with the vast sums involved in their operation.
- Drop in demand – One of the more startling statistics is the drop in business travel. Companies tightening costs during the recession are unlikely to return to paying the high fares after the recession and developments in technology have resulted in organisations finding more efficient ways to communicate without losing key members of staff for days at a time.
- Competition – Fewer travellers means the airlines have to fight for each customer and consumers are very adept at searching for the lowest price, and will trail numerous comparison websites until a price is found that meets their expectations.
- Commitments – Airlines are committed to airport slots and aim to sell tickets many months in advance, so as bookings dropped you will have noticed airlines offering flights for free as they look to get passengers onboard so that revenue can be made from other sources. Some passengers book flights for £1 only to pay several times this to use their credit card for payment.
Poor exchange rates also resulted in a drop in demand, as popular destinations became increasingly expensive for British consumers. Added to that are the effects of increased government taxes and duty, rising security costs, airport costs, pandemics and the other knock-on effects from the worldwide financial slow downs.
When British Airways announced a £401-million loss in May 2009 and Ryanair announced a loss of €169 million in June 2009, this demonstrated the two sides of the spectrum and how deep the problem lies. In fact it seems that the larger and once-strong airlines are now at risk of financial collapse as cash reserves dry up.
Consumer Protection
So what protection is there currently on offer for the consumer in the event of failure? The Civil Aviation Authority (CAA) run the ATOL (Air Travel Organisers’ License) scheme, which means consumers purchasing a flight ticket plus another component part of their trip will be protected in the event of supplier collapse. So if a consumer books a flight ticket and another part of the trip at the same time from the same supplier they’re covered, but this means the following types of trip aren’t protected under the ATOL:
- Airline-only bookings
- Where other modes of transport are used (ferry, car, coach, etc)
- Self-assembled trips (independently booked components on the internet)
- Trips in the UK
- Hotel-only bookings
- Business trips
- Day trips
It is estimated that over 50 per cent of trips booked in the UK fall outside of the ATOL, a fact missed on the general public who see ATOL, IATA, ABTA (Association of British Travel Agents) or another logo from their retailer and assume they are covered by one association or another. After only one year of existence, the ATOL, which currently stands at a deficient of £46.5 million, has had to be increased by 150 per cent from £1 to £2.50 and incredibly, there are calls to extend it to all bookings by travel industry figures. Such proposals will be resisted by airlines, as this will be another levy imposed on such a fragile market, especially after the Air Passenger Duty (APD) increases were so vehemently opposed.
credit card companies are unsurprisingly furious with the amount they have had to pay out for travel industry collapses
It is true that the Consumer Protection Act (CPA) means that credit cards take responsibility on purchases made though them. Where the CPA fails some travellers, though, is that purchases must be in excess of £100, which means a huge volume of bookings fall outside of this threshold as budget airlines gain popularity and charge small amounts for the ticket but increasing costs for the credit card use. Also, credit card companies are unsurprisingly furious with the amount they have had to pay out for travel industry collapses leading to the dispute with ATOL when holiday company XL collapsed. Where credit cards also fall down is that they do not cover increased repatriation costs, which consumers always face when purchasing a one-way return ticket. The other surprising pitfall that the travel industry has found is in cases where the retailer has taken the credit card booking, meaning the bank has the right to charge their loss back to the retailer.
Insurance response
The travel insurance market in the UK has responded in a number of positive ways to help the travel industry and their customers obtain protection.
- Retail travel insurance policies – Retail travel insurance policies are extending their cover to include scheduled airline failure or end supplier failure (extended to meet all pre-booked component parts of the end supplier). This has been capitalised upon, providing not only a unique selling point, but also demonstrating that travel insurance policies evolve to meet changing market demands. This is important as we face a drop in travel insurance demand.
- Dedicated direct sell insurance policies – Direct-sell specialist consumer protection policies are also becoming more common, which allow a traveller to protect themselves against an airline or other end suppliers’ collapse. These usually offer affiliation programmes, which allow agents to receive commissions per sale.
- Distributors insurance – Under the ATOL, travel agents have to re-book their clients in the event of an airline booked through them collapsing. Insurers are taking this liability from the distributor, freeing up capital that the agents would otherwise have to reserve to meet claims. Some air ticket distributors are insuring themselves against re-booking their clients in the event of an airline collapse. This means the distributor has an additional service to offer their client, giving it a competitive advantage of such security. These policies also tend to cover the charge back from the credit card companies mentioned above.
- The CAA’s ATOL insurance – The CAA has confirmed that they have an excess of loss insurance in place to protect them from paying over a certain threshold per incident. The premium was reportedly £10,000,000 for excess of loss of £50,000,000 for any one incident, therefore no valid claims have been made under the policy, despite the CAA fund being in such a huge deficit.
Who would insure these risks?
Longevity and commitment is the key – like all credit insurances, there will be periods of relative inactivity before colossal losses during a downturn like the one we are facing right now and in the foreseeable future. By being there when the market is buoyant, the insurance market is ready for the collapse and as a result of proper reserving, investment and management of exposures then it can meet the liabilities which befall it.
Take a medium sized airline of 3,000,000 travellers per year with an average ticket cost of £80. It is reasonable to expect 250,000 tickets in circulation at any one time so that is a £20,000,000 exposure per collapse.
Considering that Ryaniar predict 30,000,000 ticket sales per year or the average British Airways ticket price being treble that in the example, you can see why so many insurers do not want these exposures on their books. Also basic capital adequacy rules dictate that a huge amount of premium needs to be assigned to meet claims. Therefore specialists are sought in the market. Reinsurance and co-insurance seem to be the only key for travel insurers to provide this cover competently and more importantly protect their risk portfolio.
As the decade of uncertainly looms, masses of column inches are taken up in the travel trade press relating to the issue of consumer protection. Various associations are giving ‘ideal’ solutions based on questionable financially foundations. Certainly, we don’t expect the Government to pay medical bills for someone who breaks their arm overseas or to replace a stolen iPod, this is what insurance is for.
The travel insurance market in the UK has responded in a number of positive ways to help the travel industry
ABTA has recently stated that it is looking for protection for all bookings, however, Parliament has stated that this is unlikely to happen. The opinion held at IPP is that it should be made law that the consumer must be advised by the retailer whether their booking is financially protected or not, and if the latter, provided with the facility to obtain cover if they want it. This would provide freedom of choice for everyone and allow those who buy budget and don’t want extra costs to make an informed decision.
Another inconsistency in the ATOL is why someone who spends £10,000 on a holiday has to pay the same protection levy as someone spending £50.
So arguments will rage and various solutions will be proposed, but in the meantime insurance companies and intermediaries are picking up the pieces and filling the gaps in financial protection to ensure that as many travellers as possible are securely packaged.