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Use Caution When Comparing Costs

by David Wyndham 1. June 2010 11:38
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Last month I talked about a methodology to compare costs. I suggested that Life Cycle Costing is the preferred method in order to fully understand the total costs of owning and operating an aircraft. Even if Life Cycle Costing, I want to bring another point of caution to you.

What is covered?

We've done many benchmark reports and analyzed the costs of hundreds of aircraft. It is vital to understand exactly what went into the number is that you have.  If you have used Life Cycle Costing yourself, then you will have put forth the effort into your costs. But what about costs from other sources?

If your analysis suggests that an aircraft costs $1,200 per hour and your friend, who operates the same type, tells you $900 per hour, who is correct? Well, you both can be. Just what was covered in each number and what were the underlying assumptions?

Fuel cost is an easy example. For each hour that you fly, your aircraft consumes so much fuel. The $1,200 per hour assumed fuel at $5.25 per gallon while your friend used $4.50 per gallon. At 85 gallons per hour, you are different by $63.75 per hour.

Next up in variable costs is maintenance. But what maintenance is included? Scheduled, unscheduled, retirement items, engines? Are major cost items such as engine overhauls accrued as a cost per hour, or just shown as an average or an interval not equal to the time accrued?

Say you spent $252,000 on an engine overhaul due at 3,600 hours. The accrual cost is $70 per hour. If you have had the aircraft for only two years and flew 600 hours during that time, the “cost per hour” to you is $420 per hour. Quite a difference!  While that cost jumps out as obvious, add up a lot of $1,000 and $500 items. Taken individually, they seem insignificant. In total the effect can be substantial.

Maintenance costs can vary considerably and their cyclical nature adds to the fog surrounding using a single number. While Life Cycle Costing helps, you need to be consistent in the methods and length of time used. Even so, a five year cost period for a new aircraft will differ than a five year cost for a 10-year old aircraft. What maintenance happens when is important.

Training costs, new avionics, upgrading paint and interior, how much insurance coverage you have, whether you have three full time crew or two full time crew and one part time contract pilot, and so on all can add up to significant differences in the cost. 

When you are analyzing and comparing costs from different sources, you need to know what methodology is used and what the numbers include (or exclude). The more detail the better as you can easily be lulled into a false sense of security when two big numbers are close together. Ideally you should run all the numbers yourself using as close to the same assumptions and sources as possible.

Lastly, please keep in mind that every serial number of a single model does not cost the same to operate. In the real world some folks will see higher costs than others, especially in the area of maintenance. Ask questions and understand that "your actual results may vary."

Morning Rundown: Casual Friday

by GlobalAir.com 7. May 2010 09:30
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With EBACE wrapped up, it looks like a somewhat slow Friday morning in the world of aviation. Attention spans dwindle. Imaginations run to the big cookout or trip to lake this weekend. Before we get to all that, though, we shall throw some news and links your way. 

EBACE kept a positive note throughout, in what was the highest attended since 2007 and the second highest in the event's history. Michael A. Taverna of Aviation Week wraps up coverage by again focusing on business being on an uptick in the first quarter of 2010.

JSSI announced it has enrolled its 1,000th engine on its coverage plan.

England's Prince Henry learned today that he will train to fly Apache helicopters for the British Army. He hopes to return to action in Afghanistan.

For those of you who want more than news on this casual Friday, it is recommended to check out WINGsReality, an Internet-based reality-style series where pilots practice in emergency scenarios, then get judged by a panel. Check out the show, hosted at AtlantaWebFoundry.com, where we also found the video embedded above.

Finally, a good weekend to all. We wish a Happy Mother's Day to the moms in your families. In celebration, here is a link from the Smithsonian National Air and Space Museum that highlights the history of women in aviation.

 

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GlobalAir.com | News

What Is the Insurable Value Of Your Aircraft?

by Darryl Abbey 1. December 2009 00:00
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Whether you are purchasing aircraft insurance for the first time or approaching your fifteenth insurance renewal, you face a decision about what is the most appropriate value for your Hull (Physical Damage) insurance. Too high a value and you increase the amount of premium unnecessarily. To low a value and you risk not getting what your aircraft is worth in the event of a total loss. But determining the right value isn't hard, it just takes a little time, research and thought.

There are, traditionally, three valuation types for insured property. Replacement Cost is where the insurance carrier pays to replace the destroyed property with a new like, kind and quality item(s) regardless of amount of age/use of the destroyed item. This is commonly available on home-owners insurance policies. Actual Cash Value is where depreciation is applied to the replacement value and the insurance carrier pays that amount for the destroyed property. This is commonly used in auto insurance policies. The third valuation method, and the one commonly used in aircraft hull insurance, is stated value or agreed value. This valuation method allows the owner of the aircraft to tell the insurance carrier what the aircraft is worth (within reason) and, in the event of a total loss, the insurance carrier agrees to pay that amount to the owner less any applicable deductible.

The stated value method works well for aircraft owners as it allows them to have some input into the value that is used and, therefore, to know exactly what they will get from the insurance carrier if their aircraft is destroyed or damaged beyond repair. However, this flexibility does give rise to the question "How do I determine what my aircraft is really worth?"

The first and most important thing to do is put your subjectivity aside. Most pilots love their aircraft and rightly so. It may be a new purchase with all the latest avionics (the envy of all your hangar-mates) or an old friend that has provided you with many years of faithful, reliable service. However, that does not mean that your aircraft is automatically worth twenty percent more than all other similar make and model ships just because it is yours. Take a step back from your personal feelings try to be as methodical as if you were performing a pre-flight check.

Step one in the process to a good valuation is to establish a baseline reference. There are some excellent industry resources available to you. Aircraft Blue Book and Vref are two highly respected sources that can be used to help establish an initial value. By looking across a wide volume of aircraft, these two entities provide an average value for most makes and models of aircraft and rotorcraft. You can also ask your insurance broker or underwriter as they typically have a good idea of what the current average value of a given make and model aircraft should be.

Now that you have a baseline, look at the variables with your own aircraft and be honest. Some items will reduce the value from the baseline average (like having an engine that is close to overhaul) and some will increase it (like the new avionics suite you just had installed). Certain items, like replacing a prop, may not have an appreciable impact on the value because, although they may be new parts, you cannot operate the aircraft without them. Once you have figured out the pluses and minuses of the variables which may affect your value, make adjustments to your baseline value accordingly.

Next, to test that value against the current market, take a look at some of the aircraft sales listings for similar aircraft to yours. There are lots of internet and print resources out there for you to use. By looking at comparable aircraft and the market pricing for those ships, you may be gain a more realistic idea of what your aircraft is worth at that particular time.

Once you have completed these steps, you should have a realistic and up to date valuation which you can use for your insurance policy. Supply this value to your broker and underwriter to make sure that they agree and are comfortable with this value. If the underwriter feels that the value is too high, he or she may ask for documentation of the equipment upgrades or other factors which have increased the value to that level. If he or she feels that the value is too low, they may not agree to use that value.

Underwriters are very wary of aircraft that dramatically over or under insured. If an aircraft is significantly over-insured (e.g. a $300,000 insured value on an aircraft that is really only worth $200,000), there is, potentially, a financial incentive for the Insured to have a total loss. This is called a moral hazard and goes against one of the fundamental principals of insurance: to make the insured whole after a loss, not to make a profit for the insured.

If an aircraft is dramatically under-insured, the owner faces potential financial loss. For example, let's say an aircraft is actually worth $500,000 but the owner opts to only insure it for $250,000 to save money on premium. Unfortunately, the aircraft is damaged and the cost to repair is $300,000. The insurance company will pay the owner $250,000 (less any deductibles) and take the aircraft. The owner will be stuck with no aircraft and only half of what it was worth to replace it. You can bet the owner will not be happy. In order to avoid this set of circumstances, many insurance carriers will not agree to a value that is more than 10% to 20% below the average value. In some cases, the insurance carrier will agree but will require a signed statement from the aircraft owner stating that they understand and agree to the potential consequences of underinsuring the aircraft.

The best way to avoid these two problems is to follow the three steps outlined above and use the most accurate value you can for your insurance coverage.

There is an alternative to taking the time and making the effort to determining the value of your aircraft for yourself and that is to hire a third party expert to determine the value for you. You can use a certified aircraft appraiser or other professional to do the leg work and save time and effort. They can furnish you with a report which you can supply to the insurance carrier as testimony to the stated value and how that value was determined.

While you may not choose to go through this process every year, it makes sense to do so at regular intervals so that, even if you do not update your insurance coverage level, you, as the aircraft owner, know what your aircraft is actually worth.

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GlobalAir.com

Three Reasons Why You Should Have a Guaranteed Aircraft Maintenance Program

by David Wyndham 1. November 2009 00:00
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We are working with someone who has a long range business jet. Within the next five years that aircraft's engines will need overhauls, to the tune of almost one million dollars, each! We are looking at keeping versus selling that aircraft and the budget spike for those engines in year five is huge. That aircraft's engines are not on any guaranteed maintenance programs, so the owner pays 100% of whatever the costs are. Sell the aircraft before the overhaul, and it may lose a lot of value and take longer than average to sell.

Turboprop engine overhauls can run to $250,000 and turbojet engines, up to a million. Within the engine are a number of components that will have different cycle limits. Typically they can last to the second overhaul, or perhaps even the third. These turbine wheels, blades, etc can add significantly to the cost of the heavy maintenance. More and more turbine business aircraft are heading into their twenties and will be facing these cycle-limited items' additional expenses.

What are the advantages of these guaranteed engine maintenance programs?

Budgeting for these major cost events can be difficult. In good times, reserving cash can be difficult for a company, and in today's economy, the cash may not be available. All the major turbine engine manufacturers offer some form of a engine guaranteed maintenance program (GMP). Plus there is one major third party provider of these plans that cover most popular business turbine engines.

Under a GMP, the aircraft owner pays in an hourly set-aside to the plan provider. The monies go into an escrow account. As engine maintenance expenses occur, the money is drawn out to pay for the expense.

The amount to be paid in is set by contract, and thus, a GMP offers a stable budget. Accountants love stability in budgeting. So should you. Take the hourly rate times the number of hours to be flown, and your engine budget for next year is mostly done. Yes, you have some minor line maintenance, but that is minor. There are no unplanned for costs and no surprises. An engine GMP offers a financial peace of mind.

A GMP also offers insurance against the rare, but costly unscheduled maintenance event. Most turbine engines make it to overhaul, but some do not. Even on-condition engines face similar heavy maintenance events at some time in their life. Once an engine is opened for inspection, the cycle-limited components are also subject to replacement or repair. I've heard from a few operators who went in for a $50,000 Hot Section Inspection and came out with a $150,000 repair bill. While turbine engines are reliable, when an unscheduled event occurs, they can result in significant expenses. An engine GMP provides protection against unscheduled engine maintenance costs.

An engine GMP can also be less costly than a pay-as-you go engine. Even without the unscheduled coverage, there are other plusses that come with a GMP. Engine removal, shipping, and loaner engines can all be covered by a GMP. Loaner engines alone can run several hundred dollars an hour to rent. Also, until you get a quote on your engine, the "typical average overhaul cost" is just that, an average. An engine GMP will cover those items and pay the actual overhaul cost, even if those costs are over budget.

An engine GMP will add value to your aircraft. Aircraft sale price sources such as Vref and the Aircraft Bluebook Price Digest either include the GMP in their typical selling price and subtract for engines not on a program, or the program itself is a added value. If you are selling your aircraft, and the GMP has accrued $350,000 in its account, that is value added to the aircraft in two ways:

  1. The cash value of the GMP account itself.
  2. The reduction of risk to the buyer as to the status of the engines.

Remember that long range jet's $1.8 million overhauls? Over the next five years, they will be flying about 1,500 hours, so their "accrual" would be $1,200 per hour if they are to pay for a pair of overhauls in five years.

One last possible advantage to a business is that the cost of the GMP can be a tax deductable expense. In house cash accrual accounts are not "expenses." Consult with your tax advisor, but this can be a definite advantage for the GMP.

Lastly, many financial institutions may require that the engines be on a GMP to help guarantee the value of the asset. It is common for an end of lease requirement that all major components have at least 50% of their life remaining and an adjustment (to the detriment of the lessee) is made for less than half-life remaining components such as the engines. Guess what dollar value per hour they may use in adjusting for engines nearing the overhaul at the end of a lease?

Engine guaranteed maintenance programs are a good way to insure your aircraft value, provide stable budgeting and perhaps even save money over a pay as you go engine. You'd be wise to evaluate these programs for next aircraft.

Recession-Proofing Your Next Aircraft Purchase

by Jeremy Cox 1. September 2009 00:00
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rationale that might save you a lot of grief; some may even call it a "recession busting plan."

I have heard a lot of debate this summer as to whether the used aircraft market is still getting worse, with values in free-fall; or whether it has hit hit bottom, with the market now stagnant; or whether yet, there are signs of improvement, with increased activity and the best valued aircraft being snatched up.
Regardless of the particular camp you side with, there is absolutely no doubt of two things:

- We have been down this runway before. - We shall go down this runway again.

Rather than continuing this debate which can be heard around any water cooler or on any shop floor across the country, I felt it better to work outside of the normal sphere by exploring what might constitute a suitable defence against the next recession and its impact upon business jet ownership. Before you bolt because you think this article is not worth your time, please at least let me stress to you that now is absolutely the best time for you to change your current strategy. If you will allow me, I will provide you with 5 ways to protect your investment: 1.) Separating Facts from Myths, 2.) Maintenance Tracking and Service Plans, 3.) Record Keeping and Historical Paper Trails, 4.) Cosmetic Design Schemes, and 5.) Safety Standards.

The Problem
Before jumping in with the solutions, first we need to understand the problem. I will assume that you currently own your aircraft and you have a mortgage on it. During the most recent conversation that you had with your lending bank, you may have gotten the distinct impression that they (your bank) were extremely nervous about your current holding, because the on-paper loan/value ratio on your aircraft has become quite ugly. I can assure you without any fear of contradiction, that unless you have purchased your current aircraft within the last six months, your current market value has plummeted between 40% and 60% since last summer.
Unfortunately, as far your lender is concerned, you may have now vacated the V.I.P. seats that they had figuratively placed you in when your loan was first underwritten and approved. Your bank is probably showing signs of buckling under the intense pressure that is being brought to bear upon them from their internal management groups, federal regulators and public opinion. If you provide them with any indication of not being able to send the monthly payment to their processing centre, you may well trigger a telephone call to you which may have an underlying but discernable edge of malice to it. This unfortunate type of call is now very common for many aircraft owners today.
Whatever you manage to work out with your bank is great. But don't play around with your agreed payment plan too much, because once your personal loan manager is replaced by a committee, your loan will be in grave danger of being placed into default, and the bank will force it to foreclosure. By saying this I am not targeting the people that loaned the money to you to buy your aircraft. I can honestly say that I've truly never met anyone in the aviation finance industry that would ever be considered to be spiteful or vindictive. The reality of the current situation is that they are dealing with a trickle down problem (actually more like a fire hose) that has impacted our industry based on the larger international financial crisis.
Now let's assume that you still have a firm grip on the title to your business jet instead of you living under the threat of it being snatched away. Unless you have absolutely no reason to move out of your present aircraft, now is the time for you to pay attention to the used and possibly even the new aircraft marketplace. There are deals out there today that probably will not be repeated for another 15 to 20 years, or more.
As much as we would all like to, even in this digital age, no one can stroll down to Macy's and buy themselves a time-machine or an oracle's hat to predict the future of the world's markets. The biggest challenge in digging out of the present value conundrum is the ability to successfully find the 'right' replacement aircraft to hold sufficient future equity performance for your bank to roll your existing loan over into a higher value aircraft today. What do I mean by higher value? Anything that is younger, has less total-time, is better equipped, and has a higher present-day book-value than what you currently have.
Once you have located the 'perfect' aircraft, probably with the expertise of a market-savvy broker, you will most likely have to provide an additional 15% to 20% of the trade aircraft's book/loan value on top of your existing loan. This will give your bank sufficient confidence to make a new loan with you against a better value aircraft today. No doubt that some negotiating will take place between you and your bank on how to handle the pre-payment penalty that is written into your current loan. Often this can be waived. Effectively everyone that has the foresight to follow this procedure, makes a step sideways and up, while the trade-ins move further down into the abyss. Some may actually go to the scrap yard.
Once you, your bank and the broker have closed the deal, celebration is in order. However don't rest on the laurels of this transaction and relax your grip, because you still need to keep a close scrutiny on how your aircraft is being operated and maintained if you want to recession-proof this aircraft purchase.

Separating Fact from Myth
FACT: Business Jet Aircraft values mirror the Dow-Jones Industrial Average trends. I can prove it to you, if you contact me at my office at JetBrokers.
MYTH: You will never make money on an aircraft purchase. I have several clients that would strongly disagree with this statement.
FACT: The secret to making money is simple - buy low, and sell high. This sounds silly I know, but how often is this rule broken?
MYTH: If it Flies or Floats, lease it! This motto cannot be generalized. Everyone's economic position and goals are different. From an hourly cost perspective, the following 'Fact' completely refutes it.
FACT: The hourly flight cost of trips aboard a business jet, in order of expense from 'high-to-low' is as follows: Fractional (most expensive per hour) - Charter - Leasing - Ownership (least expensive per hour).
MYTH: You will make money, or at least your own flying will cost you nothing, if you place your aircraft into a managed charter program. You might defray your overall expense, but just like perpetual motion, 'free' does not exist. Is the reduction in your annual expense worth the diminished value from the added wear-and-tear?
FACT: People (buyers) don't like old and high-time aircraft. There was a time when charter companies thrived on them, but the fractional and independent audit companies have put paid to that. Now the resale market for vintage (older than 25 years) business jets is growing daily, while the number of willing buyers is shrinking at a greater rate.
MYTH: The factory did not make a mistake when they built your aircraft 'by building it better' than all of the other aircraft that came off the same production line. This is just posturing and hyperbole that buyers immediately see through. It is how the aircraft is treated through its operational career that determines its true value-enhancing pedigree.
FACT: Paying for and having accomplished maintenance, service bulletins, and industry standard up-grades on your aircraft while it is in your custody will not add value or enhance the price of your aircraft. It will merely maintain its natural market value. Failure to have any of these items accomplished in accordance with the manufacturer's mandated schedule will actually cause a reduction in value.

Maintenance Tracking and Service Plans
It is extremely important to either start, or keep your aircraft enrolled onto a computerized maintenance tracking program. If you don't keep pace with the multitude of calendar and hourly inspection, servicing, overhaul and replacement items that are required on your aircraft, safety along with your aircraft value is severely compromised. The same applies to the applicable manufacturer's engine service plan on your engines, though it is exclusively an issue of value, not safety. When the time comes to sell, if your aircraft is not enrolled in an available service plan, many buyers will not give your aircraft a moment of consideration. At a minimum, you may have to discount your asking price by the plan's quoted enrolment cost. In a tough market, this strategy might prevent your aircraft from attracting sufficient interest from buyers to actually make it to a sales transaction.

Record Keeping and Historical Paper Trails
Keep all maintenance records, logbooks, warranties, airworthiness tags, work order packages, invoices, etc., in a secure, fire and waterproof safe. Consider access to them on the same level as you would if you owned an original copy of the Declaration of Independence. If anyone other than you, your pilots or your Director of Maintenance wants to handle your documents, make that person justify why they need your records before you let them out of your safe keeping. Never ship your records either. The best way for your records to travel, when it is necessary for them to do so, is to be carried on-board the aircraft or, at the very least, 'hand-delivered' by someone that you trust. It is also vital that you take an active role in how, and what, entries are made in the logs as routine maintenance and inspections are accomplished and recorded. The erroneous stroke of a pen could cost you thousands later on. Content and form of entries are extremely important. So often a simple miscalculation of total-time in a log book entry can span thousands of hours before it is caught by a diligent inspector. If this happens, the pedigree of your aircraft is severely reduced. Lastly, don't limit your accumulated historical paper trail to only airworthiness records. Invoices, receipts and work order copies all add to the pedigree of your aircraft, thus ensuring a higher resale value.

Cosmetic Design Schemes
When you are ready to refurbish both the interior and the exterior of the replacement aircraft, don't allow your wife or girlfriend to make their mark as an amateur designer. Remember that beauty is always in the eye of the beholder, but your eye is unlikely to be in the same taste of the next buyer of your aircraft. Wild, gaudy, lavishly over-the-top styling and flamboyance will only reap you a lower selling price later on. Many of the aircraft that are selling today are what I like to refer to as 'ghosts', i.e. they are painted all white with absolutely no design stripes to turn a buyer off. A clean canvas, so to speak. I'm not suggesting that you ride around in a 'ghost' yourself, but at least try and keep your appreciation of Jackson Pollock's work in your home and not on your aircraft exterior.

Safety Standards
If you decide to upgrade your aircraft to a higher safety standard than what is currently mandated by the FAA, it is my professional opinion that the best blueprint that you can use is the specified requirements presented within the European JAR-OPS-1 document. Over the years we have seen a gradual shift of safety philosophy from Washington, DC over to mainland Europe. There are a lot of changes afoot in European regulatory circles now that the European Aviation Safety Agency (EASA) has been established. It is highly likely that JAR-OPS-1 will be superseded by a new document in the not-too-distant future. I suggest that you keep on the look-out for this change. In the meantime, I want to stress that when it comes to guaranteeing yourself the highest possible resale value, 'less is most definitely not more' when you are specifying planned equipment and safety upgrades.

Looking Forward
How long will you have to hold on to this replacement aircraft before cashing in? Remember my earlier statement about Macy's? Without an oracle hat myself, I am willing to make a prediction based upon my experience. I believe that your new loan should run for at least the next 60 months before it is allowed to come due, because you probably have longer to wait before we reach the stratospheric pricing that we saw in 2007. Also remember that during this holding period, it is best to try and keep your flight-hours under control and within reason, because 10% or more of the subsequent sales price realized will depend upon the total-time on your aircraft. The average rate that a business jet is flown here in the United States is 450 hours per year which equates to 8.65 hours per week.
I sincerely wish you the very best of luck with successfully beating the next recession by using this, or a similar rationale to recession-proof your next aircraft purchase. I am always available for consultation at JetBrokers, if you need any help or advice on this topic.
See you next month.





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