The UK's Airline Insolvency Review: implications for Passenger Protection and Airlines

By Simon Phippard, Lucy England, Nicholas Puschman

09-2019

Commissioned shortly after the Monarch Airlines collapse in October 2017, the UK Government's Airline Insolvency Review has published its Final Report. This article looks at how the Report's recommendations – if implemented - would impact passenger protection if, in the future, airlines become insolvent and what these recommendations mean for airlines. We have also considered in a separate article the implications of the Report for aircraft lessors and financiers, which you can read here.

Background

The vast majority of travellers are carried by a small number of airlines, the top five of which have approximately 60% of the UK market. As the Report notes, there are currently three main forms of protection for passengers in the event of an airline becoming insolvent: (i) ATOL protection, (ii) voluntary travel insurance and (iii) credit card cover. 

With over 110,000 passengers stranded overseas and more than 300,000 bookings lost, the Monarch Airlines collapse in October 2017 highlighted the need to reassess the adequacy of passenger protection in the event of airline insolvency and how such protection should be funded. The Monarch Airlines collapse was also notable because, unlike other airline collapses, the UK Government intervened and instructed the CAA (at a cost of approximately £60 million) to provide repatriation assistance to all affected passengers overseas, regardless of whether these passengers were ATOL-protected.

The Report assesses the adequacy of both repatriation and refund protection. It also recommends a number of reforms to ensure passenger protection including alternative models for refund protection in the context of the travel insurance market and the options available to airlines to avoid (potentially costly) government intervention becoming necessary. While the risk of airline insolvency is low in any given year, the latest analysis of the top 17 airlines serving the UK market estimates a 13% chance of an airline insolvency event in the next year.

Key Recommendations

The Flight Protection Scheme (“FPS”)

The purpose of this new scheme, to be coordinated by the CAA, would be to provide "practicable, effectual and affordable protection" for all UK-originating passengers who have return flights to the UK with an airline if it became insolvent. It is not surprising that, given the public cost of repatriating stranded Monarch passengers in 2017, the Report proposes that the FPS should be funded exclusively by the private sector. This funding would come from airlines serving the UK market making financial contributions to cover the estimated cost of repatriating their own passengers. The Report adds that the funding could be achieved by making airlines' financial contributions to the FPS a licensing requirement for obtaining Operating Licences and Foreign Carrier Permits.

The Report suggests that the cost to airlines in funding this protection should reflect each airline's risk of insolvency - which in any given year is estimated to be between 0.1% and 3%. The Report recommends that airlines should be required to grant security through financial instruments that can be relied on in the event of insolvency. This would then be supplemented by a smaller, centrally-held fund to cover any remaining exposure. As the Report acknowledges, the proportion of loss that could be covered by an airline obtaining security will be limited by the market’s appetite for risk. As particularly risky airlines may not be able to obtain security that would be acceptable to the CAA, alternative mechanisms or options such as setting aside enough cash to cover the insolvency risk would need to be considered. In reality, the cost to fund the FPS will ultimately be borne by passengers: it is estimated that this new protection scheme would in total cost approximately £0.40 to £0.50 for each UK-originating passenger.

The Report outlines numerous examples of how repatriation will be achieved in practice including replacement flights, organised charter and certain regulatory changes. We consider these changes in more detail below.

ATOL

The Report puts forward a number of changes to increase the commerciality of the ATOL scheme, the UK financial protection scheme coordinated by the CAA which applies to package holidays that include a flight. The ATOL scheme differs from the FPS as it can provide a full refund for forward bookings if passengers cannot get away, in addition to repatriation protection for passengers stranded abroad. Despite the total financial exposure of forward bookings being significantly greater than repatriation, it is estimated that only 25% of passengers are protected through the ATOL scheme. ATOL is funded by ATOL holders (e.g. travel agencies) who must pay a flat-rate levy of £2.50 per person, which goes into the scheme’s back-up fund (the Air Travel Trust ("ATT")). The changes recommended by the Report include changing the appointment process for ATT trustees and mandating that at least some of the trustees are independent of the CAA.

Clearly there could be a risk of double payment between the protection already in place under the ATOL scheme and the new FPS. In addressing this possible duplication, the Report recommends that passengers protected under the ATOL scheme should not be covered by the FPS.

Regulatory and legislative changes:

Of particular interest to airlines are the regulatory and legislative changes proposed in the Report. These include:

• Enabling, via primary legislation, a Special Administration Regime (SAR) so that an insolvent airline can continue flight operations for a short period after entering administration. This would ensure passengers, who would otherwise be stranded, can be repatriated using the airline’s own aircraft (referred to as the "Keep the Fleet Flying" option in the Report);

• Delivering repatriation by ensuring staff, equipment and suppliers remain available and who would receive payment for their services during the administration period, as well as prohibiting essential suppliers from terminating contracts;

• Granting additional powers to the CAA to monitor and enforce airline licence compliance in relation to financial health as part of an "enhanced regulatory toolkit". This includes introducing measures as part of the Operating Licence framework such as requiring airlines to:

• provide annual certifications to confirm financial fitness;

• develop repatriation plans; and

• notify the CAA when there is a material adverse change in its financial situation.

Another proposal is to allow the CAA to grant a temporary special purpose licence to allow an airline to conduct a repatriation operation even if its operational and financial future is 'doomed'.

Comment

Up until now passenger protection has relied on financial fitness requirements mandated by EU Regulation ((EC) 1008/2008) with additional protection for package tourists and others where multiple providers may be involved. The UK Government's response to the Monarch collapse indicates that it is no longer regarded as acceptable to rely solely on these protections and sets a precedent that in future flight-only passengers should be assured of repatriation. The proposed FPS would not go as far as ATOL protection in assuring refunds in the event of financial failure before travellers leave the UK, but does go further than the current policy objective within the EU.

The proposals and measures put forward in this Report would in principle enhance passenger protection, and it seems right and sensible that the AAT trustees should be independent of the body that administers the scheme. However would a further levy on every flight make air travel less attractive in an already low margin market? Would it be appropriate for airlines from the UK, other EU countries and non-EU countries, all of which may be subject to different financial fitness regimes, to bear the cost equally? And how would the FPS interrelate with the ATOL scheme?

The effectiveness of the recommendations from the Report will no doubt be subject to much debate in the foreseeable future and the outcome will depend on the balance to be struck between the taxpayer interest and that of the airlines and their passengers. We will watch it unfold with interest.