Many of us have had the misfortune of dealing with a damaged automobile and experiencing first hand the way automobile policies handle physical damage. Auto policies are generally written on an Actual Cash Value basis, which means the payment made in the event of a total loss is adjusted for depreciation. When a total loss occurs, most owners find they are not able to replace the vehicle without adding something to the insurance proceeds.
Unlike most auto policies, aircraft physical damage (or “hull”) policies are written on an Agreed Value basis. This means that in the event of destruction or disappearance of the aircraft, the insurance company will pay the agreed value in the insurance contract less any deductible. Since many aircraft policies are now written with NIL deductibles, the insurance payment is often equal to the insured value stated in the policy. No guess work here!
Inherent in the Agreed Value contract is the danger of over-insuring or under-insuring. For now we will focus on the danger of over-insuring since declining aircraft values have made this a rather common problem over the last few years.
The challenge with the Agreed Value contract arises when the aircraft is not completely destroyed. Unless the aircraft has disappeared or is obviously destroyed beyond repair, the insured value becomes a key ingredient in the insurance company’s decision to pay for a total loss or to pay for repair of the aircraft.
Sharply declining aircraft values since 2008 have set the stage for some real-life examples of the dangers of over-valuing aircraft. On February 6, 2010, three out of four hangar bays collapsed and the fourth was damaged at the Dulles Jet Center facility at IAD following a heavy snowfall. The damaged hangar contained four Gulfstreams that were freed from the wreckage after a short period of time. The other fifteen aircraft were inaccessible for almost six months and most sustained some degree of damage. This event served as a rude awakening to some within the aviation community, and a welcome reminder to others, of the danger in over-valuing an aircraft on the insurance policy. Let me explain.
When an airplane sustains significant damage, the insurance company will consider the cost of repair, the value of the salvage and the insured value in order to determine whether they will pay for repair of the airplane or will pay the insured value as a “total loss”.
For example, let’s consider the owner of a 2009 Falcon 2000DX EASy. The aircraft was delivered in late 2009 and insured for the purchase price of $28,500,000. During the subsequent insurance renewal in late 2010 the owner elected to reduce the insured value to $28,000,000 – despite the fact that the average retail price at the time was probably closer to $23,000,000 according to the Winter 2010/2011 issue of the Aircraft Bluebook Price Digest (this data is provided for comparison purposes only and may or may not reflect the actual market value of the aircraft at the particular point in time). This decision may have been motivated by bank loan requirements or simply by the owner’s denial of the declining market value – motivation is immaterial. By summer 2011, the average retail book value – and we’ll presume the market value – had fallen further to $21,000,000.
In July of 2011, the aircraft sustained substantial damage. Make up your own scenario…the hangar collapsed, there was a hangar fire, the airplane was struck by an airliner taxing on the adjacent taxiway, whatever the case. A repair facility has now provided a (substantial!) repair estimate of $15,000,000 and a decision needs to be made to total or repair the aircraft. Since the insurance policy was renewed in late 2010 and the value has not been adjusted since that time the insured value remains at $28,000,000.
2009 Falcon 2000DX EASy
- Factory new list: $28,500,000
- Current market value: $21,000,000
- Insured value = $28,000,000
- Estimated cost of repair = $15,000,000
- Salvage value = $6,000,000 (market value – cost to repair)
The aircraft owner and the insurance company are now faced with the decision to repair the aircraft or to declare it a total loss. Although the decision to repair or not to repair is ultimately the aircraft owner’s, the agreed value insurance contract will determine the amount of the insurance company’s responsibility. Every policy differs slightly, but most state that an aircraft will be considered a total loss and the insured value will be paid when the following is met
Cost to repair + salvage value equals or exceeds the insured value
Using this formula, consider our Falcon example.
Cost to repair of $15,000,000 + salvage value of $6,000,000 does not equal/exceed the insured value of $28,000,000. Based on the policy definition, the aircraft would not be a total loss.
Keeping in mind that the insurance company has authority to determine which amount they will pay, here are the options. The math clearly leads to a decision to repair the aircraft.
- Option A – repair aircraft: $15,000,000 + $300,000 (extra expense) = $15,300,000
- Option B – total aircraft: $28,000,000 – $6,000,000 (salvage recovery) = $22,000,000
Now, let’s consider if the aircraft had been insured at the current market value of $21,000,000.
Cost to repair of $15,000,000 + salvage value of $6,000,000 does equal/exceed the insured value of $21,000,000. By policy definition this is a total loss and the agreed value of $21,000,000 is paid to the insured.
The insurance company has the following options based on an insured value of $21,000,000. This time the math and the policy definition lead clearly to declaring the aircraft a total loss.
Option A – repair aircraft: $15,000,000 + $300,000 (extra expense) = $15,300,000
Option B – total aircraft: $21,000,000 – $6,000,000 (salvage recovery) = $15,000,000
The Insured Value Decision:
Serious consideration should be given to the insured value for your aircraft. This number will not only determine the insurance payout should the airplane disappear or be totally destroyed, but it will be a key factor in determining if a damaged aircraft will be totaled or repaired.
The bottom-line is that the insured value must accurately represent the market value of the airplane. Although the insurance industry commonly refers to the value publications, clearly the best approach is to have the aircraft evaluated by a qualified appraiser who can deliver a certified appraisal report. Since every airplane is unique, the most accurate picture of the current market value can be provided by an on-site examination of the records and the aircraft taking into account the maintenance history, specific equipment, any damage history, condition of the aircraft, etc.
When asked the possible danger of over-insuring, most people respond that they will have paid too much in premium if the value is too high. This is true, but it is just the start. Consider these possible consequences:
- You may be forced to repair an aircraft that should be totaled.
- You may lose the use of your aircraft for a significant period of time-possibly up to a year or more? Most policies do have some provision for “extra expense” that will assist with the cost of charter or an aircraft lease, but this coverage is limited.
- You may be left with an aircraft that, after substantial repairs, your passengers may not be too excited about flying in or may even refuse to do so-and you may feel the same way, too.
- You may be left with an aircraft that is hard to sell and ultimately brings a lower sale price due to the damage history reflected in the logbooks.
The unnecessary premium cost of over-insuring your aircraft is only the tip of the iceberg! The real dangers in over-insuring your airplane hide just below the surface. The serious consequences lay in the process of determining a total loss and in the potential of being left with an impaired asset. There are real dangers in over-insuring your aircraft that are inherent in the agreed value insurance contract. Be sure that your insurance policy accurately reflects the market value of your airplane.