Air Carrier E-surance (ACE): Design of Insurance for Airline EC-261 Claims

Spring 2016 SYST 699 Master's Capstone Project - George Mason University

Sponsored by the Center for Air Transportation Systems Research (CATSR) at GMU

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Introduction

The European Union (EU) successfully passed a consumer protection regulation for airline passengers. This European Commission Regulation 261/2004 (EC-261/04) is a regulation that establishes common rules for airlines based in the EU or servicing EU airports to compensate and assist passengers for delayed flights, cancelled flights, denied boarding (i.e. oversold flights). The regulation has caused the need for airline adjustments to both their schedule and protocols. With airline costs growing, there are more incentives to improve performance. This regulation also gives consumers recourse to address abuses by airlines. EC-261/04 went into effect in Europe on 17 February 2005.

As consumers become more aware of the regulation, airline costs are going to increase and could exceed 5% of the total direct operating costs. Further, these costs are variable costs and are difficult for the airlines to account for in their budgets. Litigation has resulted in consumer-friendly rulings. This proposal is for airlines to have a way to hedge against excessive compensation and move variable cost to fixed costs.

Problem Statement

Given

• European Union (EU) airline passengers’ protection regulation EC-261
• Airlines must compensate passengers for delayed flights, cancelled flights, or denied boarding
• As consumers become more aware of the regulation, airline costs are going to increase and could exceed 5% of the total direct operating costs

Problem Statement

1. Design an EC-261 insurance system for airlines
2. The system shall be automated (automated payout based on real time flight performance data) and web-based
3. The system must yield at least a 5% profit more than 99% of the time

By Choice of

• Burning cost model
• Ruin model
• Insurance premium assessment

Subject to

• DCA historical flight data
• Real-time flight assessment constraints

Deliverables

The following items are the deliverables requested by the project sponsor:

• Document the complete compensation rules for EC-261
• Document the transactions and processes that must be conducted to calculate premiums, sell insurance contracts, and payout the insurance
• Analyze the probabilities of compensation events for each major airline operating at DCA
• Calculate premiums for airline insurance based on their historic flight performance and event probabilities using insurance models (e.g. Burning Cost Model and Ruin Model)
• Conduct a sensitivity analysis on the insurance models to meet profit performance targets
• Design and prototype the Web-based/Automated insurance processing system

Related Work and Methodologies

Currently there are no products or services that exist to insure airlines against EC-261/04 claims from passengers. Costs are forecasted internally by airlines to potentially cover any compensation provided to passengers that may file an EC-261/04 claim.

The analysis approach was the following:

1. Analyze existing flight data for DCA arrivals (chosen as representative airport by sponsor)
2. Assess probabilities of compensation events
3. Use compensation probabilities to build cost models and premium assessment
4. Develop lightweight web interface as a prototype
5. Develop charts and descriptive documents to fully detail system functionality (companion to those portions that will be prototyped)