Airlines have to pay more compensation for death or injury, but it probably still isn't enough

The value of a preventable fatality (a more palatable term than the value of a statistical life) for New Zealand was increased last year to $12.5m (see here). That is the value that Waka Kotahi New Zealand Transport Agency uses in evaluating the benefits of road safety improvements, for example. The new value was a substantial increase from the previous value of $4.88 million.

So, I was interested to read this week that the International Civil Aviation Organisation (ICAO) has revised the amount that airlines must pay in compensation in the event of a death or injury, to just $335,000. As the New Zealand Herald reported:

Travellers will be eligible for higher compensation for international flights, with the International Civil Aviation Organisation (ICAO) setting new liability limits for death, injury, delays, baggage and cargo issues.

This means airlines must pay out at least $335,000 for death or “bodily injury” on flights as a result of the review of payment levels that come into force late this year.

While liability limits are set by the international Montreal Convention agreement, there are no financial limits to the liability for passenger injury or death if a court rules against an airline.

Why is the ICAO value so much lower? After some fruitless searching, I haven't been able to find anything to say how the ICAO sets its value. It dates back to 1999, where the value was set as 100,000 SDRs (Special Drawing Rights - an international reserve asset created by the International Monetary Fund, based on a basket of five currencies).

One reason that might account for this difference is the way that the two estimates are measured. The value of statistical life for New Zealand noted above is measured using the willingness-to-pay approach. Essentially, that method involves working out how much people are willing to pay for a small reduction in the risk of death, then scaling that value up to work out how much they would be willing to pay for a 100 percent reduction in the risk of death, which becomes the estimated value of a statistical life.

An alternative is to use the human capital approach, which involves estimating the value of life as the total amount of economic production remaining in the average person's life. The value of that production is estimated as their wages. Essentially then, this approach involves working out the total amount of wages that the average person will earn in their remaining lifetime. Typically, the human capital approach will lead to a much smaller estimate than the willingness-to-pay (WTP) approach (and for an unsurprising reason - people are worth more than just the value they generate in the labour market!).

So, this difference in approach might account for the different estimates. Why might the ICAO use the human capital approach? One reason may be that the human capital approach leads to lower liability for compensation (in cases where the airline is not found to be at fault - if the airline is found by courts to be at fault, then the compensation is uncapped). Given that many airlines that belong to ICAO are national carriers, each country has an incentive to try and limit the liability of their own airline to paying compensation. A second reason is explained in Kip Viscusi's book Pricing Lives (which I reviewed here). In the book, Viscusi argues that the WTP approach is more appropriate when considering what society is willing to pay to prevent deaths (e.g. in road safety improvements), and that the human capital approach is more appropriate approach when considering a particular life (e.g. in calculating a legal penalty for wrongful death). If we believe Viscusi's argument, then the human capital approach should be used by ICAO.

However, even if we believe that the human capital approach is the right approach (and I'm not convinced that it is), it probably still underestimates the compensation that should be paid, at least for New Zealanders. Consider the following details. The median age in New Zealand is 38.1 years (at the 2023 Census). Life expectancy (at birth) is 80 years for males, and 83.5 years for females. The median weekly earnings (from wages and salaries) was $1343 in June 2024, or $69,836 per year. Using those numbers, and assuming that the median-aged person works only until age 65, and using a social discount rate of 3 percent per year, the discounted value of future wages for the average New Zealander is $1.35 million. That is more than four times higher than ICAO's figure, and is estimated using the human capital approach. Even if we used a discount rate of 10 percent, rather than 3 percent, the value is still about $715,000, more than double the ICAO value.

The ICAO is seriously understating the value of compensation that should be paid in the case of a death on a flight (and where the airline is not at fault). It's just as well that these are rare events!