Volcanic Ash is Financially Risky

”Europe is closed,” I told my eight year old daughter that Sunday morning, letting her know that I wouldn’t be flying there that night.  When she asked why it was closed, I told her that volcano ash is dangerous to airplanes.  In her best smart-alecky voice, she threw right back at me what I’ve been trying to teach her about how to choose what to believe: “Are you sure, Dad, or is it just a guess?  Well??  I mean, do we have e-vi-dence?”  With those words I realized that I didn’t have enough evidence to convince an 8-year-old, but somehow I took it on authority that it was true.

It turns out that the European aviation authorities closed airports based on just one historic example of an airliner having trouble flying through ash.  Granted, that one episode in 1982 demonstrated catastrophic failure of all four engines due to that volcano’s ash, and in my opinion justifies the initial grounding of all flights.  But as soon as the authorities issued that no-fly order on April 15 this year, they should have also ordered immediate test flights to learn about the current volcano’s actually risks.  Instead, they waited – and ultimately it was the airlines that conducted those tests.

Let’s rewind to Wednesday April 14 – the day the Eyjafjoell volcano really started spewing ash, up to 30,000 feet.  This was just a normal day for the airline industry in Europe – about 29,000 flights took off and landed throughout the continent.  Late in the day, Norway announced it was grounding some flights due to the threat from the ash.

Thursday April 15 – European air safety officials progressively closed airports anywhere near the ash cloud.  Before you knew it, Europe had empty skies and crowded trains.  News stories popped up about the 1982 British Airways 747 flight in Southeast Asia that lost all four engines when it flew through an ash cloud and how the pilot glided the plane to 12,000 feet where the air was clear before he could get the engines back on.  To my knowledge, that’s it for the evidence we have that volcano ash is very dangerous to airplanes.

On Friday morning I learned that France, Germany and Poland closed their airports, and word was spreading that the volcanic ash was getting thicker.  I contacted my European colleagues to let them know that I might not get to Switzerland for the conference where I was speaking on financial risk management, nor to Dublin to meet with the Irish Financial Services Regulator about UCITS IV’s new provisions about financial risk.

On Saturday, KLM Airlines was the first to announce that it conducted a test flight to see what effects this ash really has on a plane following normal routes in Europe.  Those Dutch have always been good skeptics.  Later that day, several other airlines decided to run test flights.  Without a doubt, this is the single most important step in deciding whether or not to continue the grounding – testing whether it’s really necessary.

On Sunday morning I learned that my flight later that day was canceled and I also learned that some airlines were complaining vehemently that the no-fly rule was unjustified.  They pointed to the many test flights they conducted in the preceding 24 hours, showing no damage or unusual flight conditions.  On Monday, Europe started easing some of the restrictions and by the end of the week everything was back to normal.

From a risk management point of view, Europe (and the rest of the world for that matter) paid a huge expense for what amounts to an insurance policy against a phantom.  Most obviously impacted are the airlines, which estimate they lost about $200 million dollars per day.  In addition to the tremendous economic impact (estimates vary considerably but it’s certainly counted in the tens of billions of US dollars), consider the hardships that millions of travelers had to endure for days.  How many children slept on airport floors?  How many people didn’t get home in time to say goodbye to a dying loved one?  How many weddings were missed?

A good financial risk manager needs to weigh the impact of unlikely events against their probability of occurring.  Because of the asymmetric nature of things (there is no upside counterpart to downside’s death), special consideration has to be given to events that have tiny probabilities but carry catastrophic impact.  The European aviation authorities correctly assessed the possible impact of flying through the ash as catastrophic.  But they quickly assigned a very high probability to this outcome primarily based, it seems, on the evidence from that one flight through a different volcano about 30 years ago.  I am not a volcanologist nor an aviation expert.  But risk management is my profession, so I have to ask: do all volcanoes affect all aircraft the way that flight was affected in 1982?  Since the likely answer is no, I have to ask why they waited two full days to try the first test flights.  And why was it an airline that conducted the first test, rather than the aviation authority that ordered the no-fly rule?  Throughout the whole thing, all indications were that the European aviation authorities were prepared to continue the no-fly rule indefinitely, with no plans to verify their assumptions.

The lesson I take away from this episode is that you don’t have to look too far to see non-rational thinking and behavior, and that even good risk managers can miss the boat.  I know I did.  I’m just glad my daughter saw through the ash.

Note: this was written on April 18 2010, but not posted on this blog until May 12, 2010.

5 Responses to Volcanic Ash is Financially Risky

  1. Pingback: Learning from Mistakes « Risk-ology

  2. Pingback: Volcanic Ask Redux « Risk-ology

  3. Great writing! I wish you could follow up on this topic 😀

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