A few weeks before the crash of its Boeing 737 jetliner at Los Angeles International Airport Feb. 1, USAir Inc. made a cost-cutting decision that could turn out to be expensive.
Looking for ways to save money in the wake of huge losses last year, the carrier lowered the amount of insurance it carries on its 423-airplane fleet. The 737 had been insured for $33 million, but the new policy -- effective the day of the crash -- lowered the amount to $16 million.
USAir's decision to reduce its coverage was prompted in part by a sharp increase in premiums. After years of losses, the insurance companies that cover the world's commercial fleets are struggling to recoup.
In the case of USAir, which is insured by a pool of companies, the published premium rate jumped from 4.84 cents for every $100 of value insured to 10.81 cents.
"If you're looking at that kind of a bill, you start thinking, 'Are my valuations higher than what they need to be?' " said William M. Hawkins, vice president for finance for the airline industry's Air Transport Association.
USAir was looking at another reality, too, according to David Shipley, a spokesman for the carrier. Declining traffic and a massive recession in the airline industry already had forced the carrier to delay deliveries of new aircraft and reduced the likelihood that a lost aircraft would be replaced.
As a result, the carrier decided to buy what is called "hull" insurance for the book value of the fleet -- or about $9 billion, rather than its replacement value of $12 billion. The net saving was approximately $3.3 million annually, according to the carrier.
Airlines generally carry two types of insurance -- hull insurance, which covers the aircraft, and liability, which covers the cost of paying damages in an accident such as the collision in Los Angeles. USAir cut its liability insurance coverage, too, from $1 billion per occurrence to $850 million.
The airline's insurance cuts were reported earlier this week in the trade publication Business Insurance.
The increase in insurance premiums hits the airlines at a time when other costs have risen, too, and when revenue has been battered both by travel jitters related to the Persian Gulf War and by a travel slowdown resulting from the recession. Over the past three years, airlines had benefited from heavy competition among insurers and reinsurers (which help spread the risks). As a result, insurers lost approximately $1 billion last year, compared with only about $300 million in premiums collected.
This year, the insurance companies that survived the lean times set out to redress the balance. USAir may have received a particularly hefty increase in its premiums because of its high loss ratio for its aircraft -- $1.32 in claims for every dollar in premiums. The loss ratio is based on previous experience, including a Pacific Southwest Airlines jet that crashed in 1987 when a former employee boarded the plane with a gun an opened fire in flight. PSA had been acquired by USAir.
It is not clear whether USAir will suffer any actual loss because of its reduced insurance coverage. A preliminary investigation indicates that a federal air traffic controller cleared the 737 to land on a runway occupied by a Skywest commuter plane. That suggests a some portion of the blame will fall upon the federal government.
Jonathan M. Hoffman, an aviation attorney based in Portland, Ore., noted that in air crashes, most passenger claims are settled promptly, and then the airline, the Federal Aviation Administration, which employed the controller, and any other party potentially at fault thrash out how much each pays. This case will likely boil down to "a question of apportionment between the two airlines and the FAA," Hoffman said.