Memorandum submitted by the Civil Aviation
Authority
INTRODUCTION
1. The Civil Aviation Authority (CAA) is
responsible for running the current system of financial protection
under the Air Travel Organiser Licensing (ATOL) scheme. In July
2004 it published its advice to the Government on the future of
financial protection for air travellers. Its main recommendation
was to increase the scope of protection from package holidays
only to all UK-originating international flights, and to fund
this by a levy on each passenger.
2. The CAA's view is that the current regime,
which gives consumers financial protection when booking package
holidays only, is no longer effective because the number of passengers
protected by ATOL has fallen significantly and is likely to continue
falling. An increasing proportion of passengers now buy unprotected
flights directly from airlines, reflecting changing consumer preferences
for greater flexibility in their leisure travel and facilitated
by the booking opportunities provided by the internet. In 1997
98% of leisure air passengers were ATOL protected, but by 2004
this had fallen to only 66%. It is projected that this will fall
further—in the worst case scenario to 19% by as early as
2008. This situation is particularly concerning because over half
of unprotected passengers wrongly believe they are protected.[1]
3. Furthermore the current system based
on bonding is both inefficient and expensive, and imposes significant
regulatory costs on tour operators. Existing tour operators are
beginning to reorganise their business outside of the protection
provided by the ATOL scheme, partly because of the market distortion
with scheduled air travel created by the costs of bonding, which
scheduled airlines do not have to meet.
4. In its July 2004 report the Committee
endorsed an extension of financial protection to scheduled airline
flights.
5. In October 2004 the Department for Transport
(DfT) and the CAA issued a joint statement that announced further
work on the issue. A working group of industry representatives
was convened. Ernst and Young (E&Y) was commissioned to carry
out economic modelling of various options for financial protection,
to a brief agreed by the DfT and the CAA. The CAA delivered a
draft report, covering the outcome of this modelling and its recommendation,
to DfT in April 2005. This was amended and finalised in the light
of subsequent discussions with other government departments. The
CAA's advice to the Government is attached to this memorandum.
It is being published by the CAA on 22 September 2005.
6. The Committee's press notice announced
the hearing on financial protection in the context of the failure
of EUjet. The CAA is undertaking an assessment of the collapse
of the EUjet airline. Although registered and regulated in Ireland,
EUjet's main operation was from Manston airport in Kent. The CAA's
full analysis is not yet complete but a summary of the information
available to date is included at paragraphs 30-32.
THE WORK
CARRIED OUT
BY THE
CAA, DFT, THE
INDUSTRY AND
ERNST AND
YOUNG
7. Following the joint CAA and DfT statement
of October 2004, a work programme was initiated to produce objective,
weighty and robust analysis of the economics. As well as commissioning
E&Y to undertake the economic modelling, a working group was
convened to advise on the work. The working group included CAA,
DfT, DTI, British Airways, Easyjet, Virgin Atlantic, TUI, Cosmos,
First Choice, the Board of Airline Representatives in the UK (BARUK),
the European Low Fares Airline Association (ELFAA), the Association
of Independent Travel Organisers (AiTO), the Association of British
Travel Agents (ABTA), the Air Transport Users Council (AUC) and
the FTO (Federation of Tour Operators).
8. E&Y were engaged to build a model
that would assist in assessing different financial protection
regimes. E&Y put in place a framework to identify and define
distinct options covering different aspects such as the nature
of protection, scope, mandatory/imposition mechanisms and voluntary
protection. Data was collected from the industry (tour operators
and airlines), national surveys and the CAA itself. Research has
also been carried out using publicly available data to enable
E&Y to assess the key drivers that will impact the future
benefits and cost of the alternatives, and the risk around those
values.
9. The model is set up to calculate, for
each of the consumer protection regimes, the costs and benefits
of providing refunds and repatriation to affected air travellers
in the event of an airline or tour operator failure, looking at
a ten-year period. The model assumed a conservative failure rate
of 1% of firms, although the evidence suggests that it is, in
practice, around double this.
10. The options modelled were variants on
the extent of coverage of financial protection, from one in which
all scheduled flights were protected to one in which protection
was reduced to the bare minimum required by the EU Package Travel
Directive.
11. The costs in the model include buying
protection (such as the cost of ATOL, a levy or suitable travel
insurance policies) and those incurred by unprotected customers
of collapsed companies (such as lost advance payments or the costs
of getting back home from abroad).
12. The benefits are the losses avoided
by whatever protection was bought, such as refunds made by ATOL
or insurance companies, and the value of a cheaper managed repatriation
system.
13. In order to make a proper comparison,
it was assumed that each option would be funded by a reserve fund,
raised through a levy, rather than bonding.
14. The costs and benefits vary in each
option because the proportion of air passengers covered by the
mandatory protection scheme varies in each case. For example,
in the "All Flights" option 100% are covered by the
mandatory scheme so the cost of insurance, credit card protection
and the value of uninsured losses are assumed to be zero, but
the benefits are higher because they include refunds and avoided
costs of self-repatriation for all.
15. The modelling demonstrated the ratio
of benefits to costs. Because collapses inevitably impose net
costs on travellers, the ratio is always less than one. This is
no different from all insurance, which in the long run at least,
has a payout ratio of less than one.
16. The modelling showed that the most efficient
option, and the one that minimised the cost of collapses to the
travelling public, was the mandatory protection of all flights.
More details are included in the attached CAA advice to the Government
of September 2005.
THE CAA'S
ADVICE TO
THE GOVERNMENT
17. The CAA's latest advice to the Government,
published on 22 September 2005, is attached to this memorandum.
The main points are:
— The current regulations are no longer
effective because:
— an increasing proportion of passengers
now buy unprotected flights directly from airlines;
— over half of unprotected passengers
wrongly believe they are protected;[2]
— the current system based on bonding
is inefficient, expensive and imposes significant regulatory costs
on tour operators; and
— existing tour operators are beginning
to reorganise their businesses outside of the protection provided
by ATOL, partly because of the market distortion with scheduled
air travel created by the costs of bonding.
— Consumers cannot rely on other forms
of protection. 90% of travel insurance policies do not cover air
carrier insolvency. Those that do cover insolvency would not,
unlike the ATOL scheme, help stranded passengers make the necessary
alternative practical arrangements to get home. Also, increasing
use of debit cards to avoid air carriers' credit card surcharges
means consumers lose the refund protection which credit card purchases
can provide.
— EU law means that the UK has to ensure
that, at least, customers of tour operators are guaranteed a refund
and/or repatriation if the operator becomes insolvent. In the
UK this requirement is met by the ATOL scheme, which requires
tour operators who sell packages to hold a bond to provide financial
protection.
— The analytical model created by E&Y
found that the "All Flights" option is the most economically
attractive. It has the highest ratio of benefits to costs and
delivers the greatest benefits at the lowest cost.
— The CAA recommendation is, therefore,
to implement the All Flights option: all passengers on UK-originating
international flights would enjoy financial protection for both
repatriation and refunds in the event that their tour operator
or airline became insolvent.
— The CAA proposes that the All Flights
option is backed by a reserve fund of around £250 million.
It proposes paying for this fund through a £1 levy per passenger
per UK-originating international flight, which should take 3-5
years to generate the required amount.
— There would also be a reduction in
the regulatory burden on tour operators, which the industry estimates
could be worth up to £80-100 million—primarily because
they would no longer provide bonds, but also because it would
allow other regulatory requirements on them to be relaxed. There
would be no material regulatory burden, in terms of implementation,
imposed on airlines. The CAA considers that it is therefore consistent
with the Hampton review on regulatory inspections and enforcement,
carried out for HM Treasury, and the "One in-One out"
approach to regulation proposed in the Better Regulation Task
Force's "Regulation—Less is More" report.
18. The objective of the economic modelling,
carried out by E&Y, was to identify the best option, in terms
of all of the costs incurred and the benefits delivered. It did
not show what size of fund would be needed to provide the protection.
19. Separately then, the CAA, using its
experience of dealing with tour operators, looked at the size
of fund that would be required. It is estimated that coping with
a major tour operator failure in low season is expected to cost
around £250 million (which is around the level that the CAA
currently requires major tour operators to be bonded at). It anticipated
that potential failures can be "managed" so that they
occur in low, rather than high, season. The CAA therefore recommends
that there should be a fund of around £250 million.
20. The CAA recommends paying for the reserve
fund through a levy set at £1 per passenger per UK-originating
international flight, which would last for a period of between
3-5 years. This would mean that consumers pay for their own protection
and the working capital of the airline or tour operator would
not be tied up. A £1 levy could be implemented in such a
way that it would not impose material compliance costs either
on airlines or tour operators, or the CAA—for example using
the Air Passenger Duty (APD) collection mechanism.
21. Transitional arrangements would need
to be in place to ensure that adequate resources were available
to cope with failures, as the fund was being built up. The CAA
would carry out further work to ensure that the amount required
for the fund was kept as low as possible. Once the fund reached
a level sufficient to cover the expected cost of a major low season
failure, the levy would be suspended until such time as the fund
needed replenishing.
22. As well as it being right in principle
for passengers to pay for the cost of their protection, it is
unlikely that it would be lawful to place obligations on airlines
directly through their licences. In that case any alternatives
to a passenger levy are likely to have to be voluntary (eg voluntary
insurance against airline insolvency or voluntary repatriation
arrangements). These will be less effective (see the section on
EUjet below).
OTHER ISSUES
23. The economic modelling carried out by
E&Y has been generally accepted as valid analysis. However,
as Ministers said in the Second Reading debate on the Civil Aviation
Bill, there are arguments on both sides about whether the scope
of financial protection should be extended. The CAA's view is
that these counter arguments have not been subjected to the same
level of analysis, but it has considered them in the course of
its work on these issues.
"Buyer beware"
24. One argument is that, as with other
consumer products, the onus should be on consumers to bear the
risk of their purchases and exercise their judgement accordingly.
While the CAA agrees that this is the right principle, certain
conditions exist that hinder consumers of air travel from doing
this. The survey evidence referred to earlier suggests more than
half of passengers think they are protected when they are not,
and also that they have proved unresponsive to consumer education
despite considerable effort and expenditure. Consumer education
is much more difficult when people wrongly believe they are protected,
than if they acknowledge that they "don't know".
25. Since a key problem appears to be the
current uneven scope of protection, one could address it by levelling
the playing field—ie so that either all or no air travel
is protected. However, it is not possible to remove all consumer
protection. In the absence of ATOL, another way would have to
be found to meet the requirements of the EU Package Travel Directive.
26. The CAA considers that extending financial
protection to all flights is a credible, coherent and comprehensible
approach to the issue.
The regulatory burden on firms
27. Because of the consumer confusion about
the coverage of regulation, the CAA considers that the levy proposal
restores consumer protection to those who thought they had it
anyway. In any case the levy is designed so that it is paid for
by passengers and not airlines or tour operators. This is particularly
important because, unlike bonding, a levy would not tie up the
working capital of the firms involved.
28. Furthermore it is estimated that the
actual regulatory compliance costs for airlines are negligible
since the levy could be collected in the same way as APD. For
tour operators, the industry estimates that the reduction in regulatory
costs from abolishing the current bonding system could be worth
up to £80-100 million.
The impact on the airline market
29. The CAA does not believe, as some have
argued, that the levy proposal effectively means well established
airlines end up protecting less well established ones:
— The levy proposal does not offer
financial protection to entrepreneurs or firms, since their businesses
are not insured by this proposal. Therefore the levy should not
encourage market entry by firms without sound business plans.
— Furthermore, one should not legislate
on the basis of particular airlines' financial positions today.
Well established airlines do get into financial difficulty from
time to time. Furthermore, the market is fluid. Airlines that
may be considered established players today were new entrants
in the recent past.
— In any case consumers make choices
about which carrier to fly with based on a range of factors and
may use a variety of carriers. They do not "belong"
to a particular airline. A £1 levy would ensure that sufficient
protection was in place regardless of the carrier used. Furthermore,
passengers cannot carry out financial checks on airlines. Financial
protection would give consumers the confidence to book with newer
firms which were competing on price, service etc, without having
to risk their money. This has been the experience for tour operators
with ATOL protection.
AIRLINE FAILURES—EUJET
30. The Transport Committee's press notice
of 9 August 2005 stated that it was going to further investigate
financial protection for air passengers following the failure
of EUjet.
31. EUjet, an Irish registered airline which
mainly operated services out of the UK, failed on 26 July 2005
leaving approximately 12,000 passengers stranded abroad and approximately
27,000 customers with forward bookings. The CAA had no locus to
help passengers, as EUjet was an airline and not a tour operator.
However, the CAA is undertaking research to find out more about
how passengers were affected by the failure of this small carrier.
The CAA has sent out an email questionnaire to EUjet passengers
and has had around 1,000 replies, which is it currently analysing.
32. The findings from the initial research
carried out so far suggest:
— There was no information available
at departure airports, consequently many stranded passengers called
the CAA, ABTA and AUC for advice.
— While four UK airlines (Easyjet,
Monarch, MyTravelLite and Flybe) offered to repatriate EUjet passengers
for a set fee of £25 (some inclusive of taxes, but others
made additional charges), these offers were not widely publicised.
Initial reports suggest that many passengers who were overseas
were unaware of the offers and booked with whoever could get them
home on time. Although Easyjet made its offer on the day of failure,
this was not communicated effectively to overseas airports and
many passengers travelling that day were unaware of the offer.
Furthermore, there was no co-ordination of the repatriation effort.
Conversely, a small number of passengers had booked packages with
ATOL holders who organised their repatriation or provided refunds.
— Customers were unable to return to
Manston Airport, as only EUjet served this airport, and therefore
all were subject to additional costs to return to their departure
airport to pick up their car (Manston has no effective public
transport links so the majority of passengers arrive by car).
For a family of four travelling from Gatwick Airport to Manston
it would cost approximately £120 (this is based on train
fares from Gatwick to London Victoria and Victoria to Ramsgate,
and taxi to Manston). The train journey from Victoria to Ramsgate
alone takes two hours. Travel to Kent from Birmingham and Southampton
(the airports served by Flybe and MyTravelLite) would significantly
increase the cost and travelling time.
— Many passengers who were abroad were
unable to benefit from the reduced fares. The airline offers were
all time limited and only covered the period from 27 July to 2
August. Around half of those abroad (6,600 passengers) were due
to return in the period ending 2 August. Approximately 1,700 passengers
took advantage of the Easyjet £25 flight offer, 26% of those
abroad due to travel home during the offer period.
— Airlines withdrew the reduced fare
on 2 August, when there were still around 5,300 passengers due
to return after this date. Therefore only 14% of total passengers
returned using Easyjet's reduced fare. Over a thousand passengers
were due to fly back from Murcia; the only airline offering reduced
fares at this airport was Flybe, with a choice of flights back
to Birmingham and Southampton. There is no data available on the
number of passengers who travelled back with the three airlines
other than Easyjet, but as they served fewer routes and flew to
less convenient airports it is unlikely this number will have
been high.
— From the CAA's perspective the EUjet
case happened as predicted by the model. In particular EUjet was
a small operator, with only four small aircraft. Consequently
there was sufficient capacity on other carriers for passengers
to make alternative travel arrangements. However, these were at
significant additional cost and there was no co-ordination and
little information about the repatriation effort, leaving stranded
passengers confused.
— The CAA will provide the Committee
with a more comprehensive analysis of the EUjet case when this
is completed.
SUMMARY
— The simplest and most economically
rational option, as shown by the model, is protection for all
flights. All passengers on UK-originating international flights
would enjoy financial protection in respect of both repatriation
and refunds.
— The CAA proposes implementing this
option through a £1 levy per passenger per UK-originating
international flight. Over 3-5 years this should build up a reserve
fund of around £250 million.
— The CAA recognises that there are
counter arguments and proposals, but considers that these should
be subjected to the same level of detailed analysis as its proposal.
— The CAA considers that its proposal
is consistent with the current objective of better regulation
(the Hampton review and the Better Regulation Task Force's "Regulation—Less
is More" report). It would have no material impact on airlines
and would bring deregulatory benefits to tour operators.
— The CAA's recommendation would restore
financial protection to consumers who think they already have
it.
19 September 2005
1 "Financial Protection for Air Holidays",
NFO Transport and Tourism survey for CAA. Back
2
"Financial Protection for Air Holidays", NFO Transport
and Tourism survey for CAA. Back
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