Article published in World Aircraft Sales Magazine
Your chief pilot just informed you both engines on your jet are due for overhaul, potentially requiring the aircraft to be down for at least six weeks, possibly more.
Fortunately, loaner engines are available from engine manufacturers and overhaul facilities (hereafter referred to as Engine Owner) that enable aircraft operators to continue utilizing their aircraft in the event their owned engines are removed for servicing. Under these circumstances, the pilot arranges for loaner engines and as part of the process, is asked to execute an equipment bailment agreement. The insurance requirements in these agreements vary substantially depending on which Engine Owner is utilized and should be examined closely.
A common insurance clause from one such agreement might read:
- Customer shall carry and maintain all risk ground and flight hull insurance on the leased engine, its parts and accessories both when installed on the aircraft and while removed for the full value of the leased engine ($1,100,000 each) including while in transit and war risk.
- Customer shall carry aircraft bodily injury and property damage liability coverage of not less than $10,000,000 per occurrence.
- Engine Owner shall be named as additional insured and provided 30 days notice of cancellation or material change to said policy.
- Engine Owner shall be named as a loss payee on Customer’s policy.
This seems fairly benign but let’s examine, by example, how things can go south in a hurry if the insurance broker handling the equipment bailment agreement misunderstands the insurance policy coverage. Frank is the CFO at XYZ Corp. XYZ Corp owns a Citation Excel which is insured for an agreed value of $7,000,000. The chief pilot informs Frank the engines are due for overhaul, and they set about securing loaner engines from ‘Engine Owner’. Frank is forwarded an equipment bailment agreement, which he signs then sends to his insurance broker to handle issuing the certificate of insurance the Engine Owner will require prior to releasing the engines.
The insurance broker calls Frank to discuss the contract and tells him he has nothing to worry about since the insured value of the jet is $7,000,000 (more than enough to cover the loaner engine values) and XYZ Corp carries a liability limit of $50,000,000 (well above the $10,000,000 limit required by Engine Owner).
The certificate of insurance is issued to the Engine Owner evidencing the engines are insured under the policy hull coverage for $1,100,000 each. It shows the Engine Owner has also been added as an additional insured under the liability coverage and included as a loss payee under the hull coverage. The engines are subsequently installed and the world is right once again for XYZ Corp… isn’t it?
Not so fast: Just four weeks later, a freak snow storm dumps five feet of snow on the XYZ Corp hangar. The roof collapses under the weight of the snow, raining down roofing and steel support beams, crushing the aircraft and both engines. XYZ Corp reports the claim to its insurance broker for action. The insurance company handled the claim promptly, declaring the aircraft a total loss and Frank had a check from the insurance company sitting on his desk within a week. The check was issued for the agreed value of the aircraft, $7,000,000 and was made payable to the policy holder (XYZ Corp) and Engine Owner (Insurance Clause D).
Engine Owner, as set forth in the contract, demanded $2,200,000 for the loss of its loaner engines (Insurance Clause A) and Frank was contractually obligated to comply. XYZ Corp was left with only $4,800,000 in payment for the loss of its $7,000,000 aircraft. Frank assumed he could still get at least $2,200,000 for his engines that were in the shop. Unfortunately, he soon learned a hard lesson. When an insurance company pays a total loss they obtain title to the aircraft and any salvage that remains. This is an excerpt from an actual insurance policy: “With respect to any partial loss or total loss the following shall apply:
- The amount due under this policy shall not exceed the amount due where the loss payable was a total loss, and
- Any salvage value remaining shall inure to the benefit of the Company and the Named Insured shall provide clear title thereto…”
As you can see, focusing solely on complying with the requirements in the loaner engine agreement without really understanding the policy language and ramifications of that language can be a mistake fraught with peril.
Owned Engine Coverage
Let’s examine how to properly address this situation, making sure your engines are properly protected while they are removed from your aircraft and ensuring you’re properly covered while flying around on engines owned by a third party. The first step is to examine the definition of ‘aircraft’ in the insurance policy.
The following is another excerpt from an insurance policy:
Aircraft – The aircraft described on the declaration page of your policy and any aircraft qualifying under the Special Insuring Agreements including the propulsion system and equipment usually installed in the aircraft, while temporarily removed from the aircraft and while removed from the aircraft until such time as replaced by a similar item has commenced; also tools and equipment which are designed specifically for the aircraft and which are ordinarily carried within. In our example, both engines where removed from the aircraft and replaced with loaner engines.
As set forth in the definition of aircraft above, the moment the loaner engines are installed, the owned engines are no longer considered part of the aircraft. At that point they become spare parts by definition. Many policies include a default limit of $500,000 for spare parts coverage which is often not enough to cover one turbine engine, let alone two. If XYZ Corp’s engines are somehow destroyed while they are removed from the aircraft, in transit or at the engine servicing facility, $500,000 in spare parts coverage is certainly not going to cut it. The spare parts coverage limit obviously needs to be raised to cover the value of the owned engines. It is up to you to contact your insurance broker and discuss the replacement cost of your engines. Engine values can vary and the spare parts coverage will need to be amended accordingly. Many aircraft owners mistakenly believe the maintenance facility’s hangar-keeper’s Liability Policy will provide coverage for their engines and/or aircraft while in the shop’s care, custody, or control and therefore the cost of increasing spare parts coverage is a cost they can avoid. Truth is, maybe the hangar-keeper’s theory will work and maybe not.
Look at the typical definition of hangar-keeper’s Liability Coverage under a service facility’s policy:
We will pay those sums that the Insured becomes legally obligated to pay as damages because of direct loss or damage, including loss of use, to an “aircraft” and parts of “aircraft”, which are someone else’s property and which are in the care, custody or control of the Insured, as bailee, for storage, repair, servicing, or safekeeping…
In order for hangar-keeper’s Coverage to respond, the policyholder (repair facility) would have to be legally responsible for damage to your aircraft while it is in their care, custody or control. If the aircraft is damaged by an act of God, the repair shop will normally not be held legally liable and therefore its hangar-keeper’s coverage would not respond.
Loaner Engine Coverage
Now that we have examined how best to cover our owned engines, let’s examine how to best cover the loaner engines. Under Insurance Clause A, the borrower is responsible for “all risk ground and flight hull insurance on the leased engine, its parts and accessories both when installed on the aircraft and while removed for the full value of the leased engine ($1,100,000 each) including while in transit and war risk.” Obviously, the worse-case scenario would be a total loss. As illustrated in our example, if the insured value of the aircraft isn’t amended you are potentially creating a large coverage gap. All equipment bailment agreements require the policyholder to add them to the policy as a Loss Payee. This means in the event of a hull loss, the insurance company makes the check payable to you and the Engine Owner.
Anytime you have loaner engines, the insured value of your aircraft needs to be raised by the value of the loaner engines. For our example, we would need to increase the insured value of the aircraft by the stated value of the engines in the contract ($2,200,000) resulting in an insured value of $9,200,000. If there is a total loss, Engine Owner gets its $2,200,000 and you get your $7,000,000.
‘INSURANCE REQUIREMENT C’
If you’re still with me, let’s take it a step further to illustrate the potential downside to the insurance requirement that did not play out in our example, Insurance Requirement C. Let’s assume instead of the hangar collapsing, the aircraft crashes while shooting an approach in severe weather conditions, destroying the aircraft and resulting in several fatalities.
As an additional insured (Insurance Requirement C), Engine Owner is given liability protection under your policy. Keep in mind, if you carry a $50,000,000 liability limit, the policy doesn’t provide a $50,000,000 limit for you and a $50,000,000 limit for the Engine Owner; you share the limit. After the accident, lawsuits fly. Both XYZ Corp and Engine Owner are sued. There is a distinct possibility that based on the court docket, the Engine Owner could have their day in court first and exhaust the policy liability limit in a judgment, leaving XYZ Corp with little or no liability protection for their day in court.
There is a common sense solution. It is possible to limit the amount of liability given under the policy to an additional insured. In our example, Insurance Requirement B stipulates that XYZ Corp must carry a liability limit of $10,000,000 and add Engine Owner as additional insured (Insurance Requirement C). If the additional insured status afforded to the Engine Owner is restricted to a $10,000,000 limit and Engine Owner has its day in court first, the maximum amount they have access to is $10,000,000 leaving the aircraft owner with $40,000,000 in protection for its day in court.
You’re probably thinking it will cost some money to make all of these changes to the policy and you’re absolutely correct. There is good news though. The extra premium you will pay to properly protect yourself will be pro-rated, so you only pay for the coverage enhancements for the period of time you need them. Once your engines are back on and the loaner engines have been returned to
“Engine Owner”, you can lower your limits down to the appropriate level.
All insurance polices and loaner engine agreements are worded differently. It is vital to pick a knowledgeable aviation insurance broker to represent you. There are circumstances just like loaner engine contracts that arise all the time and if your broker doesn’t know the ins and outs of aviation insurance you could be on the outs yourself in the event of a loss.
Be sure to review any changes in your operation with your broker no matter how mundane they may seem. Like the old saying goes, it’s better safe than sorry.