Aviation Insurance: Issues Related to the Reauthorization of FAA's Aviation Insurance Program

Published by the Government Accountability Office on 1997-05-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                    United States General Accounting Office

GAO                 Testimony
                    Before the Subcommittee on Aviation, Committee on
                    Transportation and Infrastructure, House of

For Release
on Delivery
Expected at
                    AVIATION INSURANCE
10 a.m. EDT
May 1, 1997
                    Issues Related to the
                    Reauthorization of FAA’s
                    Aviation Insurance Program
                    Statement by Gerald L. Dillingham,
                    Associate Director, Transportation Issues,
                    Resources, Community, and Economic
                    Development Division

Mr. Chairman and Members of the Subcommittee:

We appreciate the opportunity to testify before the Subcommittee on the
reauthorization of the Federal Aviation Administration’s (FAA) Aviation
Insurance Program (the program). The program, which is scheduled to
lapse on September 30, 1997, provides insurance coverage for aircraft
operations that are deemed essential to the foreign policy interests of the
United States when commercial insurance is unavailable on reasonable
terms. It is an important program for maintaining both the financial
security of U.S. airlines and U.S. foreign policy interests, because the
government must call on commercial airlines to move troops and supplies
when it has insufficient airlift capacity. The U.S. Department of Defense
(DOD) and the Department of State have relied on the program, as have
different commercial airlines.

Our statement today reviews changes made to the program since we last
reported on it in 1994.1 In that report, we found that the program did not
have sufficient funds available to pay potential insurance claims in the
unlikely event of a catastrophic loss. We are pleased to note that progress
has been made in addressing this matter. Specifically, the National
Defense Authorization Act for Fiscal Year 1997 made funds available to
indemnify the program for losses incurred under DOD-sponsored flights,
which account for the majority of flights insured.

While our major concern has been addressed, two other concerns that we
raised in our 1994 report remain unresolved. First, gaps remain in the
program’s ability to pay claims for non-Defense flights. Although these
flights account for a relatively small percentage of the flights that have
been insured by the program, a single major loss could liquidate the
program’s available funds and leave a substantial portion of the claim
unpaid. FAA would need to seek supplemental funding to pay the claim, but
the delay could cause financial hardship for the affected airline. Second,
we believe that some uncertainty about the program continues to be
caused by ambiguity in the statutory language and FAA’s current
implementing regulations about whether the President must make a
determination that a flight is in the foreign policy interests of the United
States before issuing insurance.

 Aviation Insurance: Federal Insurance Program Needs Improvements to Ensure Success
(GAO/RCED-94-151, July 15, 1994).

Page 1                                                                    GAO/T-RCED-97-115
                     Commercial airlines normally carry commercial insurance to cover losses
Types and Uses of    caused by such things as mechanical failure, weather, and pilot error. In
Aviation Insurance   addition, they carry war-risk insurance to cover losses resulting from war,
                     terrorism, or other hostile acts. Commercial war-risk insurance, however,
                     can be canceled or restricted in the event of a major war, its geographical
                     coverage can be restricted, and its rates can be raised without limit.
                     Therefore, to provide the insurance necessary to enable air commerce to
                     continue in the event of war, the Aviation Insurance Program was
                     established in 1951. The program authorized FAA to provide war-risk
                     insurance for those commercial aircraft operations deemed essential to
                     the foreign policy of the United States when such insurance is not
                     available commercially or is available only on unreasonable terms. In 1977,
                     the Congress authorized the program to provide aviation insurance due to
                     any risk, not just war risk, under the above conditions. To date FAA has
                     issued only war-risk insurance.

                     The fundamental premise underlying the program, according to FAA, is that
                     the government should not provide insurance on a regular or routine basis;
                     rather, the government should be the insurer of last resort. Consequently,
                     FAA is not statutorily required to issue insurance to air carriers. Rather, FAA
                     may issue aviation insurance only when certain conditions are met:
                     (1) The President must determine that the continuation of specified air
                     services, whether American or foreign flag, is necessary to carry out the
                     foreign policy of the United States and (2) the Administrator of the FAA
                     must find that insurance for the particular operation cannot be obtained
                     on reasonable terms from the commercial insurance market.

                     FAA  issues two types of aviation insurance: nonpremium and premium. FAA
                     issues nonpremium insurance for airlines performing contract services for
                     federal agencies that have indemnification agreements with the
                     Department of Transportation (DOT). Under the indemnification
                     agreements, the federal agencies that contract for aircraft reimburse FAA
                     for the insurance claims it pays to the airlines. This insurance is provided
                     at no cost to the airlines, except for a one-time registration fee of $200 per
                     aircraft. At present, only DOD and the State Department have such
                     indemnification agreements with DOT. Nonpremium insurance accounts for
                     about 99 percent of the aviation insurance issued by FAA. Since 1975, about
                     5,400 flights have been covered.

                     For example, in 1990 and 1991, during Operation Desert Storm/Shield, FAA
                     issued nonpremium insurance for over 5,000 flights of commercial airlines

                     Page 2                                                       GAO/T-RCED-97-115
that provided airlift services as part of the Civil Reserve Air Fleet (CRAF).2
The commercial insurers had canceled war-risk coverage for those airlines
that had clauses in their policies excluding CRAF activities. In addition to
the CRAF program, the commercial air carriers insured under the program
have flown many other important airlift missions for the United States,
such as 111 flights to Tuzla, Bosnia, in 1996.

For other regularly scheduled commercial or charter service, FAA issues
premium insurance. With premium insurance, airlines pay premiums
commensurate with the risks involved, and FAA assumes the financial
liability for claims. As a condition for obtaining premium insurance, the
aircraft must be operating in foreign air commerce, or between two or
more points both of which are outside of the United States. In total FAA has
provided this insurance for 67 flights since 1975. For example, FAA
provided premium insurance in 1991 for flights operated by Tower Air to
evacuate U.S. citizens from Tel Aviv.

Both forms of FAA’s insurance cover loss of or damage to the aircraft (hull
insurance), along with coverage for bodily injury or death, property
damage, and baggage and personal effects (liability coverage). The
maximum amount of hull and liability coverage that FAA provides under its
policies is limited to the amounts insured by an airline’s commercial

The program is self-financed through the Aviation Insurance Revolving
Fund (the Fund). Moneys deposited into the Fund to pay claims are
generated from insurance premiums, the one-time registration fee charged
for nonpremium insurance, and interest on investments in U.S. Treasury
securities. From fiscal year 1959 through March 1997, the Fund
accumulated approximately $65 million in revenues and paid out net
claims totaling only about $151,000. Appendix I summarizes the major
attributes of the program.

 CRAF is composed of the commercial aircraft and crews that airlines commit to support military
airlift requirements during national emergencies. CRAF provides up to half of the nation’s strategic
airlift capability without the government having to purchase additional aircraft, pay personnel costs, or
fly and maintain the aircraft during peacetime. According to information from the U.S. Transportation
Command, which oversees the CRAF program, as of December 1996, 34 different airlines had
contracted with DOD to provide up to 674 aircraft during CRAF activations. The Persian Gulf conflict
was the first and only time CRAF has been activated since its inception in 1951.

Page 3                                                                           GAO/T-RCED-97-115
                        In 1994, we reported that the Fund’s balance was insufficient to pay many
National Defense        potential claims and that delays in the payment of claims could cause a
Authorization Act for   financial hardship for affected airlines. Since then, however, the National
Fiscal Year 1997        Defense Authorization Act for Fiscal Year 1997 (P.L. 104-201) has
                        addressed these problems for DOD-sponsored flights.
Addressed the
Majority of Problems    When we reported on this issue in 1994, about 20 percent of the aircraft
                        registered for nonpremium insurance had hull values—the value of the
With Insurance          aircraft itself—that exceeded the Fund’s balance of $56 million. According
Program Funding         to FAA’s most currently available information, about 15 percent of the
                        aircraft registered for nonpremium insurance have hull values that exceed
                        the Fund’s March 31, 1997, balance of about $65.2 million.3 In other words,
                        the loss of any one of those aircraft would liquidate the entire balance and
                        leave the liability portion on any claim unpaid. FAA estimates that the
                        average contingent liability per incident for each registered aircraft is
                        about $350 million. Clearly, the Fund’s balance is inadequate to settle
                        claims of this magnitude. We also reported in 1994 on a related problem
                        with the timeliness with which the government could reimburse an airline
                        for a major loss. Because the FAA would have needed to seek supplemental
                        funding to pay any claims that exceeded the Fund’s balance, airline
                        officials had expressed concern that untimely reimbursements could cause
                        severe financial hardships and possible bankruptcy.

                        The National Defense Authorization Act directed that the Secretary of
                        Defense promptly indemnify the Secretary of Transportation for any loss
                        covered by defense-related aviation insurance within 30 days. Second, the
                        act authorized the Secretary of Defense to use any available operations
                        and maintenance funds for that indemnification. The appropriations made
                        to the Defense Department’s operations and maintenance accounts for
                        fiscal year 1997 totaled approximately $91 billion. The unobligated balance
                        remaining at the end of fiscal year 1997 is estimated to be $0.9 billion.
                        Thus, sufficient funds appear to be available to reimburse the airlines for
                        defense-related aviation hull losses, and there is a legislative requirement
                        to do so in a timely manner. According to the FAA, industry, and airline
                        officials with whom we spoke, these provisions generally resolve much of
                        the uncertainty that they had earlier expressed about the Fund’s
                        insufficient balance.

                         FAA’s June 1996 listing of registered aircraft showed that of the 834 aircraft registered, 114 (14.5
                        percent of the 783 that had hull values listed) had hull values that exceeded the Fund’s March 31, 1997,
                        balance. FAA’s April 21, 1997, listing showed that 970 aircraft were registered; however, individual hull
                        values for these aircraft were not readily available from FAA.

                        Page 4                                                                           GAO/T-RCED-97-115
                              We have two remaining concerns about the program. The first is making
Further Changes Are           sure that the program has sufficient funds available to pay potential
Needed in the                 insurance claims for non-Defense-related flights in a timely manner. The
Aviation Insurance            second involves clarifying whether an explicit presidential determination
                              of the foreign policy interests of the United States is needed before FAA can
Program                       issue insurance.

Making Sure That the Fund     For the relatively rare flights for which FAA may extend nonpremium
Is Sufficiently Capitalized   insurance at the request of the State Department (one flight since the
                              program’s inception) and for the flights for which FAA provides premium
                              insurance (67 flights since 1975), the Fund may still be undercapitalized in
                              the event of a catastrophic loss. The insured State Department flight
                              occurred in January 1991, when U.S. personnel were flown from Oman to
                              Frankfurt because of the increasing unrest in Somalia. FAA also has
                              extended premium insurance relatively infrequently. Most recently,
                              premium insurance was issued for 37 flights to or from the Middle East
                              between August 1990 and March 1991, which included evacuating U.S.
                              citizens from Tel Aviv and ferrying cargo to Dhahran.

                              While FAA has paid no claims for premium insurance flights in the history
                              of the program, if there should be a catastrophe, the Fund may not have
                              sufficient money to pay the claim in a timely manner. Not counting the
                              liability associated with the loss of a flight, a claim for the loss of a single
                              aircraft—which can cost $100 million—could liquidate the Fund’s entire
                              balance and still leave a substantial portion of the claim unpaid for an
                              indeterminate period of time.

                              In 1994, FAA proposed alternative financing sources to make additional
                              funds available for the reimbursement of major claims. Those alternatives
                              included obtaining a permanent indefinite appropriation from the
                              Congress and the authority to borrow funds from the U.S. Treasury to pay
                              claims that exceed the Fund’s balance. FAA proposed using the permanent
                              appropriations to pay claims under premium insurance, and the borrowing
                              authority to pay claims under nonpremium insurance while awaiting a
                              supplemental appropriation from the Congress or reimbursement from the
                              indemnifying agency. However, the Office of Management and Budget did
                              not approve the proposal, and the administration therefore did not
                              forward the proposal to the Congress. Thus, the Fund remains potentially

                              Page 5                                                         GAO/T-RCED-97-115
                              FAA is proposing to raise the one-time fee that the airlines pay to register
                              each aircraft for nonpremium insurance. FAA published a notice of
                              proposed rulemaking in the Federal Register on April 17, 1997, that would
                              raise the registration fee from $200 to $550; the increase is based on the
                              changes in the consumer price index since the fee was set in 1975.
                              However, such an increase would have a limited impact on the Fund’s
                              balance in comparison with the potential costs resulting from a major loss
                              of a non-DOD flight.

Clarifying That Flights Are   In our 1994 report, we recommended that the program’s authorizing
in the Interests of the       legislation be clarified because there were ambiguities in the legislation
United States                 and in FAA’s implementing regulations about the need for FAA to obtain a
                              presidential determination that a flight is in the foreign policy interests of
                              the United States before issuing nonpremium insurance. No clarification in
                              the legislation nor in the current FAA regulations have been made, and we
                              believe that ambiguities still exist.

                              FAA does not see this situation as a problem. FAA considers presidential
                              approval of the indemnity agreement between DOT and other government
                              agencies to constitute the President’s having determined that the flights
                              covered by these agreements are in the foreign policy interests of the
                              United States.4 This position is based on FAA’s Acting Chief Counsel’s 1984
                              review of the legislation and its accompanying legislative history. He
                              concluded that the requirement for a presidential determination applied
                              only to premium insurance and that the President’s signature on an
                              interagency indemnification agreement was all that was required to issue
                              nonpremium insurance.5 FAA published a proposed rulemaking in the
                              Federal Register on April 17, 1997, that would revise its regulations to
                              point out specifically that the presidential approval required for the
                              issuance of nonpremium insurance is demonstrated by the standing
                              presidential approval of the indemnification agreements with other
                              government agencies.

                              We disagree with FAA’s position. We believe that while FAA’s current
                              practice has the advantage of being easier to administer, it lacks sufficient
                              foundation in the authorizing legislation and current implementing
                              regulations. We believe that the act, as currently written, requires that a
                              presidential determination be made as a condition for issuing both
                              nonpremium and premium insurance.

                               The last agreement was signed by President Bush on April 12, 1990.
                               FAA obtains a presidential determination before issuing premium insurance.

                              Page 6                                                                        GAO/T-RCED-97-115
In our 1994 report, we recommended that the Congress consider
legislative changes that would address the Fund’s capitalization and the
ambiguities about presidential determination. During this reauthorization
process, we continue to believe that the Congress should consider
providing a mechanism by which DOT can obtain access to financial
resources so that it can pay claims that exceed the Fund’s balance within
the normal time frames for commercial insurance for those few flights not
sponsored by DOD. The source of funds could include (1) a permanent
indefinite appropriation to cover the potential losses incurred during
premium-insured flights and (2) the authority to borrow sufficient funds
from the U.S. Treasury to pay the losses incurred during nonpremium
flights made for qualifying government agencies other than DOD. DOT would
repay the Treasury after it was reimbursed by the indemnifying agency.
According to an analyst in the Congressional Budget Office, such changes
would have no perceptible effect on the federal budget.6 We also continue
to believe that the Congress should clarify the issue of whether or not a
presidential determination is required before FAA can issue nonpremium

This concludes our prepared statement. I would be happy to respond to
any questions that you or members of the Subcommittee might have.

 The Budget Enforcement Act of 1990 (P.L. 101-508) requires that all direct spending and tax
legislation enacted for a fiscal year must be deficit neutral in the aggregate. (Direct spending is defined
as entitlement authority, the Food Stamp Program, and budget authority provided by law other than
appropriations acts, such as what would be provided under FAA’s proposal.) If such legislation causes
a net increase in the deficit, it must be offset either by increasing revenues or by decreasing direct
spending in another program in the same fiscal year. According to an analyst in the Congressional
Budget Office, although this requirement would apply to a proposal such as this, an offset would
probably not be needed for the proposal, since it would likely be judged to have no effect on the deficit
on the basis of the historically low losses in the program.

Page 7                                                                             GAO/T-RCED-97-115
Appendix I

A Summary of the Major Attributes of the
Aviation Insurance Program

Item                                Nonpremium                                        Premium
Definition                          Insurance issued for American or                  Insurance provided to American or
                                    foreign-flag aircraft under contract to any       foreign-flag aircraft for regularly scheduled
                                    federal department or agency that has an          commercial or charter service between two
                                    indemnification agreement with DOT                or more points outside the United States
Coverage                            Hull and liability insurance                      Hull and liability insurance
Insurance premium                   None                                              Applicant pays FAA commensurate with
Registration fee                    One-time registration fee of $200 per aircraft None
Payment of claims                   Paid out of Aviation Insurance Revolving          Paid out of Aviation Insurance Revolving
                                    Fund                                              Fund
Claims paid since                   $151,000                                          None
the program’s inception in 1951
Reimbursement                       The indemnifying agency reimburses FAA            None
                                    for insured losses
Flights insured since 1975          About 5,400 (over 99 percent of the total),       67
                                    most of which occurred in support of
                                    Operation Desert Storm/Shield
Sponsors/users of insured flights   DOD—All but one flight sponsored by DOD Commercial air carriers
                                    as part of the Civilian Reserve Air Fleet or
                                    under individual contracts with DOD

                                    State Department—one flight
Aircraft currently registered       970 specific aircraft with 46 carriers under      Not applicable
                                    contracts with DOD

                                    10 carriers with State Department
                                    policies—but only two carriers have
                                    registered aircraft
Mechanism for reimbursement         The National Defense Authorization Act for        Not applicable. FAA assumes the financial
                                    Fiscal Year 1997 authorized the Secretary         liability for claims payable
                                    of Defense to use any available operations
                                    and maintenance funds for indemnification

                                    Department of State has no specific source
                                    of funds
                                    Source: GAO’s analysis of information from FAA.

                                    Page 8                                                                    GAO/T-RCED-97-115
Page 9   GAO/T-RCED-97-115
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Page 11   GAO/T-RCED-97-115
Related GAO Products

              Military Airlift: Observations on the Civil Reserve Air Fleet Program
              (GAO/NSIAD-96-125), March 29, 1996.

              Aviation Insurance: Federal Insurance Program Needs Improvements to
              Ensure Success (GAO/RCED-94-151), July 15, 1994.

              Military Airlift: Changes Underway to Ensure Continued Success of Civil
              Reserve Air Fleet (GAO/NSIAD-93-12), December 31, 1992.

(341518)      Page 12                                                    GAO/T-RCED-97-115
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