Airline safety rules damage profitability

example Warning signsThe safety rules and rigorous enforcement of these regulations damages the profitability of the entire industry – just not in the way you might think.

Regulations and Big Bank Buildings

Why have banks historically had impressive  marble-slathered floors and columns, high ceilings and ornate, heavy front doors? Would you really deposit your salary and savings into an operation run out of a caravan parked on a corner on your way to work?

The fixed, permanent high-investment nature of the impressive buildings is one way that banks can  communicate their seriousness, their high investment requiring a long-term relationship with a large customer base to recoup their upfront costs and their inability to up and off and disappear with all their assets overnight. This communication of financial strength and longevity gives customers the confidence to trust in them and bank with them.

If you’ve thought about this for more than a few seconds, you should be asking an important question. “How do Internet-only banks, with their apparent lack of real, physical assets and high upfront investment in their operations support this argument?”

The answer is that the world has moved on in the last hundred years or so. Banking regulations and rules, smarter prudential supervision, deposit insurance (in some countries) generally provide an additional safety net not present in the past when the huge, expensive bank buildings were constructed. We now have greater trust and confidence (even after the testing and trying of the Global Financial Crisis) that our money is safe with a regulated bank.

In fact, in South Africa, I’m not aware of a retail depositor losing money in a regulated  bank in decades. The financial  crisis in the US, in which many banks failed (41 that I’m aware of) no individual depositors have lost money. Northern Rock in the UK was fully guaranteed by the Bank of England.

We have many reasons to be confident in our banks, and thus the physical demonstration of stability is no longer required.

Would you fly on my airline?

I have a plane. You don’t know when it was last inspected, let alone service, and certainly not by whom. You can’t be sure that the pilots are trained, awake and  sober. We’ll land at airports we chose, but you won’t know whether we considered weather conditions, have working communication with air traffic control or whether we bothered to check that the runway is long enough for our type of aircraft.

Did I mention that our prices are very low?

Somehow I doubt that our low prices are much of an incentive. In fact, I would argue that many passengers would choose to fly on a carrier where the prices reflected sufficient profit and margins for investment in safety and maintenance, for paying trained pilots and not skimping on fuel because cash flow was tight.

Choosing a strong, profitable airline as as proxy for a safe airline

Many would choose airlines with strong balance sheets and long histories of profitable trading. Airlines could differentiate themselves through safety records and the use of highly paid independent safety inspectors and consultants.

Sure, the prices would probably be higher than the are today. This might be a strong recommendation for safety regulations in that they may well increase the number of passenger miles flown since they lower costs subject to a minimum level of safety enforced through the rules.

The safety regulations, imposed by a credible regulator and inspector, give us confidence to fly on airlines irrespective of other indicators as to the safety or otherwise of plans and the training of staff. The regulations fill the requirements of fancy bank buildings and strong financial track records.

Without regulations, we might have a more profitable airline industry, not because of the costs imposed by the regulations themselves but rather because of the removal of pricing power.

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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1 Comment

  1. One small difference between banks and planes – when a bank crashes and depositors don’t get money back, depositors don’t die. (They may have a much more miserable life and some may even resort to taking their own lives, but the bank cannot be said to have DIRECTLY caused their death). Also, a government can guarantee my deposit, it can’t guarantee that I will survive a plane crash

    One death from a plane going down would be considered one too many, and a less than 100% safety record for an airline is not something I would like to leave to market forces to determine.

    IMHO plane safety records would become a bit like credit ratings, and I am not sure I want the same kind of reliance that investors placed in credit rating agencies on my airline.

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