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I saw something interesting in the recent fourth quarter 2004 financial releases of Continental, Northwest and United Airlines. My guess is that other major carriers will show similar unusual items. The unusual item? Increases in the financial liability of their frequent flyer programs. What’s interesting is the story that is told by these items. Continental reported a $24 million adjustment for future frequent flyer liability, Northwest reported a $77 million increase and United noted a $47 million increase. These liability increases are actually good news for members of these and other airlines. Let me explain. Financial liability for frequent flyer programs essentially evolves around assumptions of breakage, redemption on partner airlines (for which the airline actually does pay) and the use of “anytime” awards. Breakage is an internal financial system and mostly connected to expiring miles and trends indicating the potential use of total liability toward redemption. Anytime award liability is a little trickier, since a frequent flyer program typically has to pay the revenue side of the airline a pre-determined amount based on the award being redeemed. A financial transaction is not based on a single mile-per-award basis. Rather, it is different for a saver award than for an anytime award. Frankly, it is usually more expensive for the frequent flyer program, since in the eyes of the revenue police, you are taking something they can sell. Saver awards are generally viewed as seats that may go unused under normal circumstances. If there is any increase in the percentage in which members redeem anytime awards vs. saver awards, then it “costs” the frequent flyer program more from its internal financial structure.
But that’s not the important part of these liability increases. The single item that I see is important is that we are now seeing how these frequent flyer program alliances are starting to pay dividends for members. These increases are the result of more and more members of these programs using partners to redeem their awards. It could be that there are additional destinations not served by the parent program members are redeeming to. More likely it’s members using partner airlines to get free awards that were not available on their parent program. It’s more expensive for the program, since they are paying out money to their partners to carry members of their program, but the news seems to indicate that these alliances are becoming more and more beneficial to all members. But we can’t compare apples to apples, even with just these three airlines. Each airline has a different method and price per settlement of their frequent flyer liability with partners, so United is not necessarily redeeming twice as many partner awards as Continental.
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April 8th, 2005 at 12:31 pm
I think your analysis is WAY off. The increase in estimatated liabilities is most likely due to four things: first, the largest overhang (unredeemed miles)in history; second,the precarious financial health of the airlines; third, the low number of capacity controlled seats being made available, and fourth, the airlines expectation of an increase in non-capacity controlled (i.e. double miles) milage use. I think the airlines are not explicitly stating this because to do so would result in either a “run on the bank” or drastic changes to the redemption standards and/or termination of the airline’s frequent flyer program and loss of the ancillary revenue from non-milage partners who buy awards for their programs. It will be interesting to see if the SEC picks up on this and requires more detailed disclosure or at least a risk factor disclosure. Boilerplate disclosure should not be tolerated but rather the SEC should require disclosure of the percentage of capacity versus non capacity controlled seats awarded, the method by which such seats are allocated and the “tipping point” at which the particular airline would expect to modify or shut down its program. If the airlines do not want to disclose this information, let them go private.
May 4th, 2005 at 2:56 pm
The dreaded “liability” of airlines with regard to frequent-flyer miles is a mirage. Airlines can easily control any liability by increasing the number of miles required to fly, and by secretly decreasing the number of seats available for award travel. Pity not the airlines. The frequent flyer miles — which they sell to merchants and directly to customers — are the one sure source of revenue and profit to the airlines. Even airlines in financial trouble benefit from the miles programs.
May 18th, 2005 at 3:18 pm
There’s a few factual things wrong with your hypothesis: It starts with assuming that airlines make up their own “funny number” show. Actually. in the late 80s. the AICPA (American Institute of CPSs) issued guidelines to the industry for reporting liabilities and other matters related to this topic, so what you see is fully authorized and updated. This issuing guidelines has been updated several times by this organization over the years. As for a “tipping point.” The programs recently passed the 24 year mark of existence and over that length of time there is a very well channeled set of experiences of redemption and liabilities given that it includes periods of other airline insecurity and even bankruptcies, ala the early 90s in the first Middle East crisis. My comments were framed within the 19 years of experience i have working full-time observing and reporting on this industry.
I certainly respect all views and hope that one would recognize that my thoughts on this are from a very educated point-of-view.
Thanks for your own comments.