By Peter Greenberg and Nicolas Rapp
May 1, 2014

CLICK ON THE GRAPHIC FOR A FULL-SIZE IMAGEIllustration: Fortune

The search for the missing Malaysia Airlines flight highlights an unspoken truth about the complicated world of aviation and other passenger-vessel insurance: While victims’ relatives go months or years before being compensated, airlines get paid right away.

May 25, 1979. It was the Friday of Memorial Day weekend. American Airlines Flight 191, a full wide-body plane headed from Chicago to Los Angeles, was taking off with 271 passengers and crew when suddenly the left engine flew off. The plane banked violently to the left, became inverted, and hit the ground, exploding into a huge fireball and killing all onboard. Within minutes phones were ringing — in New York, then American’s headquarters, and in London at the offices of Lloyd’s. Another phone rang in the office of John Selvaggio, at the time the assistant controller of corporate accounting for American. On the other end of the line was Thomas Plaskett, the airline’s chief financial officer. He gave Selvaggio the bad news. “We’ve lost one of our DC-10s,” he said, and then gave Selvaggio the tail number. “Please go and pull the books on the aircraft. We need to know right away what our exposure is.” Selvaggio drove out to a warehouse in Queens and found the records. But he couldn’t believe what he saw. He ran the numbers again, and the totals stayed the same.

He then phoned Plaskett. “You’re not going to believe this,” he said, “but we just realized our biggest quarterly profit in history.” It was true. American had bought the aircraft in 1972. It had written it down to just $10 million but had insured it for $26 million. Under the terms of its insurance policy, if American lost use of the plane for more than 72 hours and the aircraft was deemed not salvageable, the insurer had to write a check. And three days later that’s exactly what happened. In American’s 1979 10-K, the $26 million sits as its own line item, “insurance recovery on aircraft loss.” Selvaggio later explained the income to shareholders as the “involuntary conversion of an aircraft.”

Six years later, on Aug. 2, 1985, Delta Air Lines faced a similar situation. One of its Lockheed L-1011s was flying from Fort Lauderdale to Dallas, making an approach in a thunderstorm, when it got hit with severe wind shear and crashed 6,300 feet north of the runway, hit two water tanks, and broke apart. Of 163 people onboard, 134 died. Oddly, it carried the same flight number as the earlier American crash — 191 — and there were similar financial results. Delta received a huge insurance payout from the disaster.

And then there was one of the most interesting airline insurance payouts, which didn’t involve a crash at all — the story of British Airways Flight 149. On the night of Aug. 1, 1990, it flew from London’s Heathrow airport to Kuwait City, and landed in Kuwait in the early morning hours of Aug. 2. But by that time, Iraq had invaded Kuwait — and the plane was stuck on the ground for the duration of the war (and then torched by Iraqis after Kuwait was liberated). The 747 was the oldest in the BA fleet, but the airline had it insured for full replacement value. About 72 hours after the invasion, BA received a check — one that then-CEO Colin Marshall later called “the largest single check we had ever received.”

And now, perhaps most intriguingly, there’s the continuing and tragic story of Malaysia Airlines Flight 370 and the disappearance of the Boeing 777-200, tail number 9M-MRO. We may never know what happened to the plane, but we do know what happened with its insurance. The wide-body was completed by Boeing in April 2002 and delivered to the airline in May the same year. The 12-year-old $261 million plane was powered by two Rolls-Royce Trent 875 engines worth $20 million each.

And when the plane flew into thin air — or deep water — it sadly entered the strange and little-known world of airline insurance.

In the past 10 years, we’ve heard even less about this arcane niche because flying has become so safe. In 2013, out of 36.4 million flights, there were only 81 accidents and 210 fatalities, down from 90 accidents and 685 fatalities in 2009, according to the International Air Transport Association. An amazing and admirable statistic.

But when a plane does crash, is destroyed, or is simply lost as in the case of MH370, it triggers a long-standing protocol: Huge amounts of money are transferred to lienholders, lessors, and bondholders, thanks to insurance on the plane, or “hull insurance,” as it’s called. (Some airlines also finance aircraft by selling so-called enhanced equipment trust certificates; when a plane is lost, holders of the certificates get paid back their principal and any interest owed up to the point of repayment.)

No one would ever accuse any airline executive of wishing for these tragedy-induced windfalls. Nor would an airline executive see them as a benefit from a purely economic standpoint: “An airline would always prefer to have a plane in the sky” generating revenue, says Michael Boyd, president of aviation consultancy Boyd Group International. And he says there’s no “extra credit or kudos” given by Wall Street for these one-time insurance payouts — which airlines often refer to with accounting jargon like “involuntary conversions” — because they’re just that, one-time gains. Depending on the situation, an airline might even have to take its money and purchase or lease a new plane. But the insurance checks are large sums of cash in the door, which happen to put airlines in an awkward position when it comes to reporting them. “It’s just a hard thing to explain,” says Boyd.

These payouts have been de rigueur for as long as there have been transportation disasters. By the close of the week the Titanic sank, all the policies written for the ship had been met, with the New York Times reporting a $5 million payout on the vessel itself (that payment is much more than in the case of the Hindenburg, which was insured for only £500,000). In the Underwriting Room at the headquarters of Lloyd’s sits the Lutine Bell, the bell from a French ship that sank in 1799 — and for years, anytime the company had to pay a huge sum of money after a ship had sunk, the bell was rung.

But increasingly, the large sums paid immediately to airlines and lienholders stand in stark contrast to the lower payouts and long and painful delays victims’ families have to endure for their compensation. When it comes to negligence and wrongful death claims — the liability side of the insurance process — family members of the victims often have to wait years to get their settlements.

In the case of American 191, some families were not compensated for their losses until nearly eight years after the crash. In the Delta crash, the wait was nearly six years. “The reason this happens is that there is no provision in the law for the awarding of prejudgment interest,” says one aviation tort attorney — meaning there’s no requirement that interest has to accrue on any legal award from the time of the event until the judgment. “Therefore there is no incentive whatsoever for the insurance companies to settle quickly.” And almost always, they don’t.

Not so when it comes to the insurance on the plane itself. With MH370, the lead company for hull insurance is Germany’s Allianz. War-risk and terrorism insurance for the plane is covered by Lloyd’s. Allianz is also the lead insurer for liability. “I can tell you without a doubt,” says one attorney familiar with the finances of the case, “when it comes to hull insurance on this incident, the lienholders and the lessors have already been paid in full.”

How much? The plane had been written down from its list price of $261 million to about $100 million. But it was likely insured for full replacement value. (“I know of no airline that does not insure its aircraft for full replacement value,” says Peter Schmitz, CEO of global aviation for Aon.) The deductible was likely small, as is typical these days — the deductible on the Costa Concordia ship that was wrecked in Italy in 2012, for example, was 10% of the value of the ship. If Malaysia Airlines paid a deductible in the neighborhood of 10% of the list price of the plane, or $26 million, it would have received a payment north of $200 million. And that’s recorded as income on the books. (Allianz, Lloyd’s, Boeing, and Malaysia Airlines each declined to be interviewed for this article.)

That sum is not entirely on Allianz. The aviation insurance market is all about vertical placement and involves multiple consortia of different insurance companies — insurers and reinsurers. Allianz is only the lead company, and it took about 15% of the risk on both hull and liability insurance.

Of course, insurance isn’t free. So how much does an airline pay for these hull and liability policies? “It’s a ballpark figure, but it’s safe to say that American Airlines right now probably hull insures its entire fleet for $30 to $40 million a year, and liability insurance is another $40 million,” says one aviation insurance specialist familiar with the policy. Spread out over a fleet of more than 900 aircraft, it can be deemed quite affordable. And those premiums, because of the decade of safety, have actually gone down — by 5% this year alone — resulting in a 12% decline in the overall insurance cost per passenger, according to Willis Airline Insight. Prior to the disappearance of MH370, hull losses were “set to be lowest for a quarter of a century,” according to Aon’s 2012 end-of-year insurance market update, with the loss figure for 2012, excluding minor losses, at $31.6 million, compared with $530.9 million for the same period in 2011. Until MH370, aviation insurance coverage remained a buyer’s market.

As of this writing Allianz has already paid $110 million into an escrow account and also agreed to make hardship payments to the families of the missing passengers to cover basic costs while the search continues.

Other parties on the hook include a unit of Lloyd’s, which is the lead for the airline’s policy that covers the plane against a malicious act, such as terrorism or suicide.

In almost every case, where a plane crashes is what determines how much money is at stake. The classic case: In 1949 an Eastern Airlines DC-4 was making its approach to Washington National Airport when it collided with a Bolivian P-38 — a plane that had just been purchased by the Bolivian government. Despite its name, Washington National — now Reagan National Airport — is actually in Virginia, which is separated from the District of Columbia by the Potomac River. When the two planes smashed into each other, the DC-4 was cut in two. The forward part of the plane fell into the Potomac River, within the area of the District of Columbia. The rest of the passengers were scattered on the Virginia shore.

A real problem surfaced when attorneys discovered that Virginia had a $15,000-per-person limitation on damages for wrongful death — and that Washington, D.C., had no limits at all. Ultimately the jury ruled that the “injurious impact” took place over the District and that all of the victims’ families got to go for the big numbers.

Nearly 65 years after the Eastern-Bolivian midair collision, it’s still where a plane goes down that determines the damages — and lawyers often try to file suits in states where the payouts are bigger. Countries matter too: “If an attorney can get cases heard in the U.S., then the average settlement in wrongful death cases in airplane disasters is $3 to $5 million” per victim, says Aon’s Schmitz. Outside the U.S., pursuant to the Montreal Convention, an international treaty adopted in 1999 to reduce protracted litigation, there’s a cap of $175,000.

So it was not surprising that a petition for discovery against Boeing and Malaysia Airlines was quickly filed at the end of March in Cook County, Ill. — where Boeing is headquartered — on behalf of a father of one of the victims, with the plaintiffs claiming, “We believe that both defendants named are responsible for the disaster of flight MH370.”

The petition was dismissed, but any legitimate claims in the case of MH370 may take years to resolve — and that’s a conservative estimate. Why? Major liability payouts typically come only when there’s proof of negligence on the part of the airline: pilot error, say, or terrorism if the plaintiffs can prove that the airline was to blame in any way for security lapses. But without any evidence that’s impossible to prove. “It’s as simple as it is complicated,” says one attorney. “If they can’t find the black box or any other evidence, the plaintiff attorneys can’t prove anything other than wrongful death. And then the families are stuck with the Montreal Convention limits.”

“The rules are clear,” adds Robert Alpert Sr., senior counsel and co-leader of a crisis management practice at the Atlanta law firm Morris Manning & Martin. The Montreal Convention, Alpert points out, has a two-tiered approach: It grants up to $175,000 in automatic compensation regardless of fault for proven damages, but also allows for unlimited damages above that if the airline can be proved negligent. Payouts for previous crashes in which negligence was proved were high: Pan Am had to pay a total of more than $500 million when Flight 103 was blown up over Lockerbie, Scotland (the plaintiffs prevailed in their claim that the airline was to blame for lax security), and ComAir paid $264 million in the case of Flight 5191, which crashed in Lexington, Ky., in 2006 after pilots used the wrong runway during takeoff.

But in the case of MH370, unless they find the airplane, the cockpit voice recorder, and the flight data recorder — and those devices can categorically prove terrorism or some other form of negligence — there’s a distinct possibility these families will get little or nothing above the standard $175,000. This crash, Alpert says, “might turn out to be very inexpensive.”

Other lawyers expect that MH370 could result in five years of litigation, with some families waiting even longer for compensation. “There are some people here who won’t be compensated for at least 10 years,” says Marc Bern, a New York-based attorney handling wrongful death lawsuits for family members of victims of the Costa Concordia cruise ship and a veteran of many aviation liability cases. “It’s really a quirk in the system,” Bern points out, that favors airlines at the expense of victims. “The people who own the plane get a whopping check; the people who financially secured the equipment on that plane get a whopping check, but the family members will be stalled by the defendants,” he says. “The commodity is more valuable than human life. And the owners of that commodity are somehow entitled to swift justice — and huge payments — as opposed to the victims.”

In the end, Bern predicts, most of the family members will give up and take a smaller payout. “The overwhelming majority of the people on that plane come from countries where there is no effective civil justice system,” he says. “The deal will be take it or leave it, and they’ll be bought off cheap.”

And at least for the moment, Lloyd’s and Allianz may be off the hook for more serious damages. While there is no information or hard evidence to suggest it wasn’t terrorism or criminal negligence, there is also no information to suggest it was. From a financial perspective, some of the parties facing the most risk would be better off if the plane is never found.

Peter Greenberg is the Emmy Award-winning travel editor for CBS News and host of public television’s The Travel Detective.

This story is from the May 19, 2014 issue of Fortune.

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