03rd Jun 13

Are Aircraft Becoming Disposable Assets?

We have seen an increasing trend in recent years for aircraft to be scrapped following major damage events, despite being economically repairable. So what is driving these decisions and where does it leave the industry with respect to major repair capability?

When aircraft are insured for figures exceeding their market values it has been understandable that many have not been repaired after sustaining major damage. In the main this is due to the estimated repair cost exceeding the market value, although the final position does not result in a total loss as the cost falls below the agreed value or constructive total loss trigger point. In general the outcome of such claims can be predicted at an early stage and it is really more a practical matter of establishing what would be a representative repair cost, bearing in mind the Policy conditions.

On occasions however, despite the aircraft being economically repairable with respect to market value, other factors have come into play which result in the repair solution not being pursued. Such factors can be the value of the salvage, the availability of similar aircraft and the airline or owner’s long term plans for the aircraft in question. Situations such as these have occurred over the last few years resulting in the aircraft being dismantled for salvage with the hull claim having been settled on a “cash in lieu of repairs” basis. This is perhaps reflective of the wider industry context where aircraft are being decommissioned earlier in their life cycles than ever before, particularly the B737 / A320 types.  More youthful aircraft with higher agreed and market values will be more likely to be repaired, although even this is not certain, depending upon the extent of the required repairs and the costs involved. There are of course exceptions to this with certain types holding their value and for which availability is generally restricted, such as the DHC6 Twin Otter and the 100 series Bombardier Dash 8. Our experience is that owners and operators will often strive to repair these aircraft even when the repair costs are in close proximity to the aircraft’s value. This is mainly due to a lack of good quality replacements being available.

So what are the driving factors that will render an aircraft unworthy of repair in the owner / operator’s view, despite the economics suggesting otherwise? Firstly, and perhaps most importantly, there is the “opportunity” factor. In general an aircraft owner will expect the asset to operate for a predicted length of time which will require periodic adjustment of its value depending upon market conditions. When a major damage event occurs it is in the context of the market conditions at that time, which may be different from those envisaged by the owner – i.e. there may be an over capacity of the type in question, values may have fallen more quickly than anticipated, new lessees may be hard to find etc. When all these factors are taken into account it may be the case that regardless of the aircraft’s perceived value being somewhat higher than the repair cost, the opportunity to realise capital from the damaged asset may be the best solution at that time, particularly when market conditions are set to be challenging for the foreseeable future. By its very nature commercial aviation has proved to be a cyclical business and this often results in a need to take opportunistic decisions where they present themselves.

Other less significant considerations would be specific to the aircraft owner‘s situation – i.e. future lease terms, book value, the state of the owner’s fleet portfolio, accumulated maintenance reserves etc. In some cases, where the lessor has other aircraft available to replace the damaged aircraft, it could simply be the case that a “cash in lieu of repairs” settlement presents a win/win solution with the ability to use another aircraft in their portfolio, realise a cash value for the repairs and perhaps realise some value from any commercial salvage that remains with the damaged hull, although there are costs associated with this.

So what are the implications for the Insurance Market? With less and less major repairs being undertaken the main concern is the gradual reduction in capability and capacity for third party maintenance providers to perform such repairs, particularly in remote situations. With less need for these type of repairs independent MROs will naturally be less willing to invest in the tooling and equipment needed to perform such repairs, particularly on the next generation of composite airframes. This leads eventually to the manufacturers becoming the sole providers of solutions needed in the field.

In certain regions an independent capability remains, however it is diminishing and the cost of an independent solution for large repairs is rising. The shortage is not so much in the practical “fingers and thumbs” repair requirement, there are still skilled structural repair technicians available, it is more in the project management and support of such repairs. The success of major repairs very much depends upon the management and oversight of these projects, which is why the manufacturers have traditionally presented the most risk free solution, albeit at a price. It is becoming more challenging to find an MRO at short notice who can provide a viable solution to a need for a repair that involves anything more than straight forward structural component replacements. Ultimately this means an increase in estimated repair costs which can ultimately prove attractive to the aircraft owner, hence the likely outcome may once again become a decision not to repair.

The conclusion is that for many of the legacy aircraft types it will become increasingly likely that repairs will not be undertaken following a major damage event, as the repair costs increase and the market values decrease, in some cases markedly. This coincides with less frequent occurrences of the type of events that lead to major damage and the introduction of new, more complex airframes for which only the manufacturer will be able to offer repair solutions. Clearly this is a trend and it is unlikely that overnight major repairs will become a thing of the past, however all the indications point to a reduction of capability where eventually there may be no independent MRO solutions available, much in the same way that the Power By the Hour and Total Care Agreements have radically altered the engine repair and overhaul business to the point at which there are only single solutions available for some engine types.