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Aerial Physical Damage Coverage – Part II
Aircraft Loss Basis
When there is a total loss to an automobile, an auto insurance company will typically pay the book value of the automobile at the time of the loss minus any deductible. This loss valuation method is the Actual Cash Value basis. Most homeowner’s insurance policies for houses are written on some form of Replacement Cost basis. The means that the insurance company will pay the actual cost to replace the house in the event of a total loss if that amount is within a certain percentage of the insured value. The type of loss valuation basis used for a particular insurance policy will be specified in the policy.
Nearly all policies written for aircraft insurance policies are written on a Stated Value, also known as Agreed Amount, basis. Using this basis on an aircraft total loss, the insurance policy would pay the insured amount stated on the Declarations page in the policy, less any applicable deductible. This insured amount is agreed to by the Named Insured and the insurance company prior to the policy being bound.
The Importance of Insuring Aircraft to Proper Value
Aircraft change in value on a regular basis. There are numerous factors involved in determining an aircraft’s value at any time, including: airframe and engine times, equipment, and the re-sale market. Therefore, each year before your policy renews, your aviation insurance broker will ask you to confirm the desired hull value you would like for the policy’s renewal. The key in this process is to understand how to value your aircraft and what would happen in the event the aircraft had a partial or total loss.
Most aircraft policies are written on an “Agreed Amount” (Stated Value) basis. That means, in the event of a total loss, the amount listed in the policy under hull coverage (physical damage) will be the amount the insurance carrier will pay in the event of a covered total loss. This is different from the manner your other assets’ insurance policies are written. Cars and trucks are generally written on an “Actual Cash Value” basis, which pays the vehicle’s replacement value minus depreciation. Houses, hangars, and office buildings are usually written on a “replacement cost” basis, which essentially means that these policies pay the cost to replace the property at the time of the loss. As a result, there are usually requirements to carry the proper insurance to value.
Since aircraft are written on an Agreed Amount basis, it is important to perform proper due diligence when determining the insured value for the aircraft. One process utilized to determine an aircraft’s value is to use an aircraft blue book or other valuation service. A blue book provides a middle-of-the road measure of an aircraft’s value based on the aircraft year of manufacture and make and model with mid-time components and average equipment. Using the average base value, you then consider the above or below average airframe, engine, and component hours, as well as other upgrades to reach a solid determination of the aircraft’s value. Most insurance carriers will not insure an aircraft that is 25% above or below an aircraft’s average blue book value without substantiation or an appraisal.
Another approach to help determine the aircraft’s value is to compare the aircraft on the re-sale market. This can be done by occasionally looking at what is for sale in the classifieds, as well as by visiting with operators of similar equipment. Doing this will provide a strong gauge of what it would take to replace the aircraft with one of similar kind and quality.
Determining what it would take financially to replace the aircraft with one of similar like and quality is a key determining factor as to the value you should insure your aircraft. Insurance, or indemnification, literally means to restore one to whole when a loss has happened. Insurance exists to restore your aircraft situation to what it would have been had a loss not occurred. It does not exist for one to benefit from a loss. In the event of a covered physical damage loss, the insurance carrier has an obligation to either: repair the aircraft or pay the agreed value (at least one carrier specific policy condition that they can replace the aircraft with like kind and quality). Legally, it is at the insurance carrier’s discretion as to which option it chooses.
There are three general results when the hull value is selected for insurance: 1) the aircraft is property valued, 2) the aircraft is over-insured, or 3) the aircraft is underinsured. When an aircraft is over-insured, the policyholder is overpaying their premiums. It also creates a hazard where it might be more affordable for the insurance carrier to repair the aircraft when it would be more desirable to total the aircraft. Conversely, if the aircraft is underinsured, the policyholder may be out a significant amount of equity in the event an aircraft is totaled. It also creates the opportunity for a carrier to total an aircraft when the desired result would be a repair. This could cause a loss of equity for the aircraft owner.
When an adjuster reviews an aircraft hull loss, they look at a couple of issues: 1) the repair bid, and 2) the salvage bid. They add those two amounts together and, if the sum is greater than (or equal to) the insured value, they will usually total the aircraft and pay the agreed amount (insured value) in the policy.
Example: An aircraft owner/operator has an aircraft insured for an agreed amount of $100,000; however, the aircraft was actually worth $130,000. The aircraft has an engine failure, and the forced landing causes $50,000 in damage according to the repair bid. While handling the claim, the adjustor gets a salvage bid of $60,000. In this case, it makes more economical sense for the adjustor to total the aircraft. This is called a constructive total loss.
$60,000 Repair Bid + $50,000 Salvage Bid = $110,000 Net Loss
$110,000 Net Loss > $100,000 Insured Value = Constructive Total Loss
$130,000 Aircraft Value – $100,000 Insured Amount = $30,000 Loss of Equity to Aircraft Owner
In this example, there was enough insured value to cover the repair, but it made more economic sense for the insurance company to total the aircraft, leaving the aircraft owner having to come up with $30,000 to replace it. Too many times, aircraft owners have either unintentionally underinsured their aircraft or only carried enough insurance to cover the amount remaining on the aircraft’s loan. They didn’t consider the potential for a partial loss to lead to the aircraft being totaled under a constructive total loss scenario. This has led to unfortunate financial losses for these policyholders.
On the flipside an aircraft can be insured for more than the current market value of the aircraft. In this scenario the aircraft operator is not only overpaying premium, but it sets up the situation where it is more affordable for the insurance company to repair an aircraft when it would be more desirable to replace the aircraft. When aircraft with significant damages are repaired, there can be a loss of value upon resale, and some passengers may be hesitant to fly in a heavily repaired aircraft.
$60,000 Repair Bid + $70,000 Salvage Bid = $130,000 Net Loss
$130,000 Net Loss < $150,000 Insured Value = Aircraft will be repaired
$130,000 Aircraft Value – $150,000 Insured Amount = $20,000 in value overpaid in premium and causing a repair rather than replacement.
If the aircraft would have been insured at its actual aircraft value ($130,000) the aircraft would have been totaled and the full agreed value paid.
All of this information dictates one possible solution. Review the aircraft’s value on a regular basis (annually at the insurance renewal at a minimum) and insure the aircraft with the amount it would take you to replace the aircraft with like kind and quality. This can be accomplished by referencing the Aircraft Bluebook or VREF guides. It is also helpful to research current aircraft sales publications and online listings to see what aircraft of like kind and quality are listed for. However, the best way to get an accurate aircraft valuation is to engage the services of an experienced professional aircraft appraiser. Insuring aircraft for its current market value is the only way to avoid the pitfalls that over-insuring and underinsuring bring.
Should you like to discuss any of these additional coverages or policies, please don’t hesitate to Contact Us.