Aircraft regularly change in value. Numerous factors are involved in determining an aircraft’s value at any time, including airframe and engine times, equipment, condition, damage history, and the resale market. As a result, each year before your policy is renewed, 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 (physical damage) coverage will be the amount the insurance carrier will pay in the event of covered total loss. Some people get confused about the insurance valuation of aircraft since most automobile insurance policies are written on an Actual Cash Value (ACV) basis. ACV is calculated by taking the replacement cost of the vehicle and subtracting the deprecation. In simple terms, ACV basis pays what the vehicle is worth on the day of the loss. It is important to understand this difference in how aircraft and automobile claims are valued.
Since aircraft are written on an Agreed Amount basis, it is vital to perform proper due diligence when determining the insured value for the aircraft. An aircraft blue book or another valuation service is one process used to determine an aircraft’s value. A blue book provides a middle-of-the-road measure of an aircraft’s value based on the aircraft’s year of manufacture, 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, component hours, and other upgrades to solidly determine 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 specified justification or a professional aircraft appraisal.
Another approach to help determine the aircraft’s value is to compare the aircraft on the resale market. This can be done by occasionally looking at what is for sale in the classifieds and visiting operators of similar equipment. Visiting with a knowledgeable aircraft salesperson for the make and model can also be helpful. A combination of these practices will provide a strong indicator of what it would take to replace the aircraft with one of a similar kind and quality. The most accurate way to determine the property value is to have an experienced aircraft appraiser value the aircraft.
Determining what it would take financially to replace the aircraft with one of similar kind 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 the 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 totaling it would be more desirable. Conversely, if the aircraft is underinsured, the policyholder may lose a significant amount of equity in the event an aircraft is totaled. It also creates the opportunity for the insurance company to total an aircraft when the desired result would be a repair.
When an adjuster reviews an aircraft hull loss, they look at 2 primary factors: 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. In most cases they will total the aircraft if the sum is around 90% of the insured value. This is called a constructive total loss.
Example: An aircraft owner/operator has an aircraft insured for an agreed amount of $100,000; however, the aircraft was actually worth $130,000. According to the repair bid, the aircraft had an engine failure, and the forced landing caused $50,000 in damage. While handling the claim, the adjustor gets a salvage bid of $60,000. In this case, it makes more economic sense for the adjustor to total the aircraft. This is an example of 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. Still, 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 often, aircraft owners have 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.
Conversely, 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 replacing the aircraft would be more desirable. 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, causing a repair rather than replacement.
If the aircraft had been insured at its actual value ($130,000), it would have been totaled and the full agreed value paid.
All this information warrants the importance of insuring the aircraft in amount that it would take to replace it with one of like kind and quality. As previously discussed, it is critical to review the aircraft’s insured value regularly. This should be annually at the insurance renewal at a minimum, and as any changes are made to the aircraft. Insuring an aircraft for its current market value to replace it with one of like kind and quality is the only way to avoid the pitfalls of overinsuring and underinsuring an aircraft.