Delta, Northwest Bankruptcies Leave Frequent Flyers Fretting Fate of Miles

For Consumers: Real Risk, Few Options

September 15, 2005 - These are scary times for frequent flyers.

Yesterday, in a one-two punch to already-shaky consumer confidence, Delta and Northwest filed for Chapter 11 bankruptcy protection.

With the third and fourth largest U.S. carriers joining United in bankruptcy, three of the Big Six carriers are now operating under the supervision of bankruptcy-court judges. Also within the past 12 months, Indianapolis-based discounter Independence Air filed for bankruptcy, as did Aloha Airlines. In November 2004, Southeast Airlines bypassed Chapter 11 and proceeded directly to liquidation. And in October 2005, regional carrier Mesaba, which flies under the Northwest Airlink name, filed for bankruptcy protection.

Historical First - At least for the two weeks between the filings of Delta and Northwest on Sept. 14 and Sept. 27, when US Airways' emerged from Chapter 11, more than 50% of the U.S. airline industry's flights were operated by carriers in bankruptcy.

Indeed it is the prospect of liquidation that has spooked more than 50 million frequent flyer program members who are sweating the possibility of losing trillions of miles worth millions of tickets.

Strangled by the lethal combination of stubbornly high costs and a marketplace awash in discounted fares, U.S. airlines have lost over $30 billion since 9/11 and are on track to lose more than $8 billion in 2005. And there's no light at the end of the tunnel.

As the likelihood of one or more of the mainline airlines disappearing outright has increased, so has consumers' fear of losing their frequent-flyer miles. At the same time, their options for hedging against that risk have decreased.

A Look Back

Since the introduction of frequent flyer programs in 1981 by American Airlines, three major airlines have shut down completely. In each case, program members' miles survived the death of the airline.

When Eastern Air Lines liquidated in 1991, Eastern miles were honored in Continental Airlines' program. In that same year, when Pan Am succumbed, WorldPass members and their miles were folded into Delta's program.

More recently, when TWA called it quits in 2001 after three Chapter 11 filings during 12 consecutive years of losses, 14 million Aviators members and their miles were transferred into American's AAdvantage program.

For members of smaller airlines' programs, the outcomes have been less reassuring.

Midway declared bankruptcy twice. The first time, in 1991, 700,000 members of its loyalty program were left empty-handed. The second and final time, in August 2001, members of Midway's FastPass frequent traveler program were allowed to convert their credits to miles in the US Airways program.

The shutdown of MGM Grand Airlines in December 1992 left 33,000 MGM Grand Premiere members with no miles. When Dallas-based Legend liquidated in February 2000, Travel Award members were also left mile-less.

And in November 2002, when National Airlines threw in the towel, members of the National Comps program lost their points.

The most recent case of lost miles went almost completely unreported in the U.S.

When Canadian discounter Jetsgo -- that country's third largest carrier -- abruptly shut down on Mar. 11, 2005, the estimated half-million members of the carrier's Jetmiles program found their accounts suddenly frozen, their miles lost.

A Look Ahead

While frequent flyer program members and their miles generally have fared well even when their airlines have not, the odds are that future major carrier liquidations will not play out so benignly.

A failed airline's frequent flyer program represents both a marketing asset (the loyalty and future business of vested members) and a significant contingent liability (the cost of delivering award travel when the miles are redeemed). In good times, the marketing benefits trump the costs. But in an environment of deteriorating balance sheets and financial desperation, airline managers are more likely to focus on costs.

Members of troubled carriers' programs who hope for a repeat of the TWA scenario should ask themselves: Today, which airline has the will and the financial resources to absorb the miles of a major program like Delta's or Northwest's?

Miles @ Risk

Unlike dollars deposited in a bank account, which are typically insured by the FDIC, there is no overarching protection for miles in frequent flyer accounts. In the distribution of assets following an airline's liquidation, frequent flyer program members are not considered creditors, so there is no chance of compensation for miles lost through bankruptcy court proceedings.

The one-time insurer of frequent flyer miles, AwardGuard, stopped accepting new customers in March 2003, no doubt reflecting the assessment of heightened risk by the company's reinsurers.

Recently, American Express began offering its cardholders Air Miles Protection, an insurance policy for frequent flyer miles.

For $5.40 per month, members can protect up to 60,000 miles in the programs of American, America West, Continental, Delta, Northwest, United and US Airways. Should one of the covered airlines liquidate, or for any other reason terminate its program, and the miles are not transferred to another airline's program, Amex will credit the policyholder's Amex card account at the rate of $50 for every 3,500 miles lost, up to the maximum number of covered miles, when an airline ticket is charged to the card.

More coverage of the Amex insurance is here.

Otherwise, barring the unlikely intercession of another airline willing to fold miles into its own program, members of a failed airline's program face the prospect of frozen accounts and lost miles.

Program members who have redeemed their miles for award tickets prior to an airline's liquidation are in somewhat better shape. While they would be under no legal or contractual obligation to do so, other carriers might honor tickets issued by a defunct airline on a space-available basis.

Section 145 - Passenger Protection (Perhaps)

In the wake of 9/11, Congress passed the Aviation & Transportation Security Act (ATSA). In response to the demise of Midway and in anticipation of more airline liquidations to follow, Section 145 of the Act specifically mandated that U.S. airlines assist passengers ticketed on insolvent carriers to the best of their ability -- i.e. on a space-available basis -- for a fee not to exceed $50 roundtrip.

Although the ATSA expired on Nov. 19, 2004, an amendment extending Section 145 for an additional 12 months was included in the intelligence reform act signed into law in mid-December. So the passenger protection afforded by Section 145 will remain in effect until Nov. 19, 2005.

While the extension is welcome news for stranded passengers holding revenue tickets, the amendment does not address one glaring omission carried over from original legislation: Congress never clarified whether Section 145 applied to frequent flyer awards.

What to Do?

The right approach to defending against lost miles depends on a number of variables, including the member's best guess as to the likelihood of the host airline's liquidation and the number of miles banked.

Sit Tight

A filing for protection under Chapter 11 of the bankruptcy code may well shake consumers' confidence. But miles are at risk only if the airline in question is headed for liquidation, Chapter 7. (For more on the distinction, see the "Bankruptcy Primer" section below.)

So unless an airline is on its last legs, its customers may continue earning and redeeming miles, secure that Chapter 11 won't translate into lost miles. At least not in the short term.

That was certainly the case with United and US Airways, both of which operated their frequent flyer programs normally throughout their stays in bankruptcy.

The difficulty, of course, is handicapping the airlines' chances of survival longer term.

United is expected to emerge from Chapter 11 in February 2006, after 38 months under protection of the bankruptcy court. But the company's reorganization plan -- its strategy for regaining and sustaining profitability -- is predicated on oil prices of $50 a barrel, a price point which today seems like wishful thinking. Will United survive, post-bankruptcy? No one can say.

Redeem

There's only one sure way to protect the full value of miles: use them now, for travel awards, while the airline which hosts the program is still flying and paying its bills.

If possible, book award trips sooner rather than later.

If later, book awards on partner airlines. Then, if the host airline shuts down, there's no need (or service fee) to have the tickets reissued.

And when booking award travel on partner airlines, there's a potential advantage to choosing carriers within the same global alliance as the distressed carrier. Reason: in the event of an alliance member's failure, other member carriers have an incentive to come to the rescue of stranded passengers, to preserve the alliance's brand equity.

Members of Delta's program, for example, might redeem miles for award travel on Continental, which is both a fellow member of the SkyTeam global alliance and, despite its own problems, arguably on firmer ground. Since Northwest is also a SkyTeam carrier, the same tactic could benefit WorldPerks members.

Redeeming miles for magazines, an option in most programs, also represents good dollar-per-mile value. But award levels start at 400 miles for some subscriptions, and there's a limit to the number of magazine awards anyone could practically use.

As a general rule, given the uncertain state of the industry and the devaluation of loyalty programs, consumers are probably best served by redeeming miles regularly, rather than succumbing to the hoarding instinct which leaves travelers with too many miles to dispose of quickly when things go bad.

Convert

The conversion strategy -- exchanging miles from an endangered program into miles in a program with better long-term prospects -- has always been attractive in theory. In practice, the number of miles lost in the conversion process makes it palatable only for those in the most desperate straits, or those with small caches of miles.

There are three variations on the conversion theme.

Points.com, an online mileage-exchange service, allows conversions between participating programs in a single transaction.

Of the most troubled carriers, Delta only accepts Points.com exchanges into its program, and neither Northwest nor United participate at all.

Other exchange options combine the miles-to-points and points-to-miles functions of the Diners Club Rewards and Hilton HHonors programs.

But Diners only permits miles-to-points conversions from American and United's programs. And in Hilton's program, none of the most distressed programs allows miles-to-points transfers.

Chapter 11 vs. Chapter 7 - A Bankruptcy Primer The roots of U.S. bankruptcy law in federal legal code trace back at least to 1800. Current bankruptcy regulations are included under Title 11 of the U.S. Code of Laws, enacted in 1978. Title 11 has eight sections, so-called Chapters, the best known of which are Chapter 11 and Chapter 7, dealing with reorganization and liquidation respectively. a) Chapter 11 - Bankruptcy Protection Chapter 11 affords ailing companies temporary protection from creditors, allowing them to restructure debt, reorganize and emerge from bankruptcy better able to compete and, ultimately, survive. Sometimes Chapter 11 is a first step toward liquidation, sometimes not. Continental filed for bankruptcy twice, in 1983 and again in 1991. Today, it is the country's fifth largest carrier and in relatively good shape. America West filed for Chapter 11 in 1991, but emerged in 1994. In both cases, no miles were forfeited. By itself, a Chapter 11 filing has no necessary effect on an airlines' frequent flyer program or members' miles. And to the extent that bankruptcy goes hand-in-hand with financial desperation, Chapter 11 protection is as likely to coincide with a period of increased mileage-program activity (United) as in increased fees or higher award levels (Air Canada). So while there may be changes at the margins, for better or for worse, frequent flyer program members are unaffected in the main by Chapter 11. b) Chapter 7 - Liquidation The same cannot be said of Chapter 7. Chapter 7 -- formally "Chapter 7 Liquidation" -- is the endgame, the rules governing the distribution of a failed company's assets among the various parties with competing claims to those assets.