MH370: How Do Insurers Put a Price on Life?

With the flight now declared lost, an even more mysterious undertaking begins—in the world of insurance. Who gets paid now?

Kim Kyung Hoon/Reuters

On Monday, when Malaysian Prime Minister Najib Razak said that Malaysia Airlines Flight 370 “ended in the southern Indian Ocean,” it wasn’t simply a concession to the reality of the situation. It was a signal to the carrier’s insurance companies, and to lawyers around the world.

The official conclusion that a plane isn’t likely to be located, retrieved, or salvaged triggers a “hull loss,” which meant insurers would begin making payments to compensate Malaysian Airlines for the loss of the plane. In fact, industry sources said insurers had moved to make payments in advance of the official announcement.

The official language deployed in natural and manmade disasters can often be formulaic and confusing. But it often functions as a sort of code—especially when insurance is involved. In this code, an obviously lost plane isn’t officially lost until the authorities declare it so, an obvious terrorist act like the Boston Marathon bombing may not officially register as such, and a monster of a storm like Sandy may not actually be a hurricane.

Disasters have their own languages, largely due to the influence of MBAs rather than MFAs. “Insurance policies are legal contracts, which means the language has to be very precise,” said Bob Hartwig, president and economist at the New York-based Insurance Information Institute. “And every word has a definition, even if the phrase is viewed as one way in the vernacular.”

To most people, it mattered not a whit whether the National Weather Service dubbed the powerful winds and rain that lashed the East Coast in the fall of 2012 a hurricane or a superstorm. (It turned out the storm lost just enough power before hitting land to disqualify it from hurricane status.) But the distinction turned out to be worth a couple of billion dollars—to homeowners. “Many home-insurance policies have a hurricane deductible that is higher than an ordinary deductible,” said Laurie Kamaiko, a partner at the law firm Edwards Wildman. “If it applies, it means the homeowner would be out of pocket for most costs if the home is damaged.” The application of a deductible is often tied to whether the National Weather Service identifies the event as a hurricane. Insurers paid out about $19 billion to cover property damage as a result of Sandy—about $2 billion less than they would have if the storm had been labelled a hurricane.

After the 9/11 attacks, insurance companies hastened to exclude acts of terrorism from the events they would cover. So the government in 2002 created the Terrorism Risk Insurance Program The idea: Insurers would offer coverage for damages due to terrorism, but the government would pay damages above a certain amount. TRIP only comes into play, however, if the Treasury secretary deems a particular event to be an act of terrorism, and if it causes more than $100 million in damages. It has never been invoked. “For insurance purposes, the government never certified the Boston Marathon bombing as an act of terrorism,” said Bob Hartwig of the III. Although it caused immense damage to life and limb, the bombing just didn’t cause that much property damage.

In the case of aviation, several forms of insurance are involved. Airlines typically buy “hull loss” insurance, which pays off in the event a plane is damaged beyond repair or salvage. They also have liability insurance, which helps them make payments to passengers who are harmed or killed. Most airlines, including Malaysia Airlines, have signed the Montreal Convention, which obligates them to pay a minimum of about $150,000 to passengers’ families in the event of an accident. Lawsuits can lead to further payments. (Malaysia Airlines’ announcement last week said that it would offer initial payments of $5,000 are mere down payments.)

Many airlines also purchase “war risk” insurance, which pays out in case a plane is hijacked, or destroyed by terrorists, or shot down by a foreign air force. And that’s why the early debate, confusion, and discussion about the fate of Flight 370 had significant consequences. If information had emerged that terror-related foul play had been involved, the “war risk” insurers, led by a unit of Lloyd’s, would have shared the significant liabilities associated with the lost plane.

Unless the black boxes are recovered soon, they’re likely to be off a sizable financial hook.

As the trade publication Post Online reported “A Credit Suisse report earlier this week put the estimated cost of the total insurance loss of flight MH370 at between $500m (£301m) and $600m, slightly less than the estimated $750m paid out for the Air France Airbus A330, which crashed off the coast of Brazil in 2009.”