Aviation Assistance: Compensation Criteria and Payment Equity	 
under the Air Transportation Safety and System Stabilization Act 
(04-JUN-04, GAO-04-725R).					 
                                                                 
In response to the September 11, 2001, terrorist attacks on the  
United States, the Congress enacted the Air Transportation Safety
and System Stabilization Act (Stabilization Act) that provided,  
among other things, $5 billion in emergency assistance to	 
compensate the nation's air carriers for losses incurred as a	 
result of the attacks. Pursuant to a previous congressional	 
request, we monitored the Department of Transportation's (DOT)	 
progress in administering the emergency assistance program. As a 
result of our work, we reported on the payment process DOT	 
employed to administer the program, details on the losses claimed
by the air carriers, and the payments disbursed under the	 
program. Now, Section 824 of the Vision 100 Century of Aviation  
Reauthorization Act requires that we report on the criteria and  
procedures used by DOT to compensate air carriers under the	 
Stabilization Act emergency assistance program with a particular 
focus on whether it is appropriate to compensate air carriers for
the decrease in value (asset impairment) of their aircraft after 
September 11, 2001, and to ensure that comparable air carriers	 
receive comparable percentages of the maximum compensation	 
payable. DOT published its criteria and procedures in a series of
guidelines and regulations promulgated between September 2001 and
August 2002. The DOT regulations relevant to asset impairment and
comparable compensation, among others, are the subject of a suit 
pending in the U.S. Court of Appeals for the District of Columbia
Circuit. Since DOT's regulations are subject to the court's	 
review, we will not specifically address the appropriateness of  
DOT's criteria and procedures as they relate to these matters.	 
The litigation is discussed in more detail later in this report. 
In light of the ongoing litigation, GAO met with staff and agreed
that we would (1) describe the measure(s) by which the air	 
carriers were compensated under the Stabilization Act as well as 
DOT's criteria and procedures, such as policies on impairment,	 
established to administer the program and (2) determine if there 
are possible scenarios under which air carriers, comparable in	 
size and type (cargo or passenger), conceivably could receive	 
different levels of compensation.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-725R					        
    ACCNO:   A10406						        
  TITLE:     Aviation Assistance: Compensation Criteria and Payment   
Equity under the Air Transportation Safety and System		 
Stabilization Act						 
     DATE:   06/04/2004 
  SUBJECT:   Air transportation operations			 
	     Terrorism						 
	     Losses						 
	     Disaster relief aid				 
	     Federal aid for transportation			 
	     Compensation					 
	     Evaluation criteria				 
	     Business assistance				 

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GAO-04-725R

United States General Accounting Office Washington, DC 20548

June 4, 2004

The Honorable John McCain
Chairman
The Honorable Ernest Hollings
Ranking Minority Member
Committee on Commerce, Science, and Transportation
United States Senate

The Honorable Don Young
Chairman
The Honorable James L. Oberstar
Ranking Democratic Member
Committee on Transportation and Infrastructure
House of Representatives

Subject: Aviation Assistance: Compensation Criteria and Payment Equity
under the Air Transportation Safety and System Stabilization Act

In response to the September 11, 2001, terrorist attacks on the United
States, the Congress enacted the Air Transportation Safety and System
Stabilization Act (Stabilization Act)1 that provided, among other things,
$5 billion in emergency assistance to compensate the nation's air carriers
for losses incurred as a result of the attacks. Pursuant to a previous
congressional request, we monitored the Department of Transportation's2
(DOT) progress in administering the emergency assistance program. As a
result of our work, we reported3 on the payment process DOT employed to
administer the program, details on the losses claimed by the air carriers,
and the payments disbursed under the program.

1 Air Transportation Safety and System Stabilization Act, Pub. L. No.
107-42, 115 Stat. 230 (Sept. 22,
2001). This act was later amended by the Aviation and Transportation
Security Act, Pub. L. No. 107-71,
S: 124, 115 Stat. 597, 631 (Nov. 19, 2001).
2 The Stabilization Act directed the President to take actions to
compensate air carriers. The President
subsequently delegated his authority to do so to the Secretary of
Transportation, 66 Fed. Reg. 49,507
(Sept. 27, 2001).
3 U.S. General Accounting Office, Aviation Assistance: Information on
Payments Made Under the
Disaster Relief and Insurance Reimbursement Programs, GAO-03-1156R
(Washington, D.C.: Sept.
17, 2003).

Now, Section 824 of the Vision 100 - Century of Aviation Reauthorization
Act 4 requires that we report on the criteria and procedures used by DOT
to compensate air carriers under the Stabilization Act emergency
assistance program with a particular focus on whether it is appropriate to
compensate air carriers for the decrease in value (asset impairment) of
their aircraft after September 11, 2001, and to ensure that comparable air
carriers receive comparable percentages of the maximum compensation
payable. DOT published its criteria and procedures in a series of
guidelines and regulations promulgated between September 2001 and August
2002.

The DOT regulations relevant to asset impairment and comparable
compensation, among others, are the subject of a suit pending in the U.S.
Court of Appeals for the District of Columbia Circuit. Since DOT's
regulations are subject to the court's review, we will not specifically
address the appropriateness of DOT's criteria and procedures as they
relate to these matters. The litigation is discussed in more detail later
in this report. In light of the ongoing litigation, we met with your staff
and agreed that we would (1) describe the measure(s) by which the air
carriers were compensated under the Stabilization Act as well as DOT's
criteria and procedures, such as policies on impairment, established to
administer the program and (2) determine if there are possible scenarios
under which air carriers, comparable in size and type (cargo or
passenger), conceivably could receive different levels of compensation.

In order to address the first objective, we reviewed the Stabilization
Act, analyzed DOT's regulations and implementation guidance, and
interviewed the DOT staff who administered the program. Additionally, we
reviewed and analyzed the arguments contained in the legal briefs filed by
the air carriers and DOT in the U.S. Court of Appeals for the District of
Columbia Circuit. For the second objective, we determined if there were
possible scenarios under which comparable air carriers could potentially
receive different amounts of compensation. On the basis of our previous
work,5 we identified various factors that influenced the amount of
compensation a carrier could receive and illustrated the impact of these
factors in several different scenarios. We discussed these scenarios with
the DOT officials who administered the program to obtain assurances that
our scenarios were representative of situations that they observed in
administering the program. We were unable to base our scenarios on details
from actual claim files because of the confidential and proprietary nature
of much of those data. We requested comments on a draft of this report
from the Secretary of Transportation or his designee. Written comments
from the Assistant Secretary of Administration are reprinted in the
enclosure. Our work was performed from February 2004 through May 2004 in
accordance with U.S. generally accepted government auditing standards.

RESULTS IN BRIEF

Sections 101 and 103 of the Stabilization Act established three criteria
on which to base air carriers' compensation amounts: (1) direct losses
incurred as a result of the

4 Vision 100 - Century of Aviation Reauthorization Act, Pub. L. No.
108-176, S: 824, 117 Stat. 2490, 2595
(Dec. 12, 2003).
5 Work performed for GAO-03-1156R was conducted from September 2001
through August 2003 and
was performed in accordance with U.S. generally accepted government
auditing standards.

federal ground stop order and incremental losses incurred from September
11 through December 31, 2001, as a result of the terrorist attacks; (2)
carrier type (e.g., passenger or cargo); and (3) a calculated formula
amount based upon each carrier's percentage of industry capacity and the
total amount of compensation available under the legislation. Because the
statute required that the maximum air carrier compensation amounts be
equal to the lesser of direct and incremental losses as determined by DOT
or this formula amount, the formula effectively "capped" the amount of
compensation an air carrier could receive for its September 11-related
losses. DOT published a series of procedural rules describing the
compensation process and provided additional guidance for how it would
determine, among other things, direct and incremental losses, including
policies relating to the exclusion of asset impairment losses. Generally,
DOT excluded impairment losses for a number of reasons, including DOT's
view that these losses were presumed to be typically experienced over a
period much longer than the September 11 through December 31, 2001,
compensation period and that it would be difficult, if not impossible, to
separate impairment losses due to the terrorist attacks from impairment
losses associated with the general economic slowdown generally
acknowledged to be under way at the time of the attacks.

A number of factors influenced the amount of compensation air carriers
ultimately received under the Stabilization Act. Conceivably, these
factors could result in scenarios in which comparable air carriers could
have received different levels of compensation. For example, two air
carriers could have comparable losses related to September 11, but be
subject to different formula caps because they had different capacity
levels. If one or both carriers had losses that exceeded the formula
amount, the formula would cap the compensation amount at different levels.
Other factors unique to individual air carriers, such as geographic
location and carrier forecasts, influenced the amount of direct and
incremental losses an air carrier reported and affected the compensation
levels air carriers could potentially receive. For example, air carriers
located on the East Coast where the market showed a greater sensitivity to
the terrorist attacks may have incurred more revenue decline and more
direct and incremental losses than carriers on the West Coast. Also,
because forecasts formed the basis of a carrier's direct and incremental
losses, an optimistic forecast could have resulted in more direct and
incremental losses than a pessimistic forecast. These and other factors or
combinations of factors influenced the levels of compensation in different
ways for different carriers.

Three air carriers are seeking from the U.S. Court of Appeals for the
District of Columbia Circuit a judicial determination that DOT's
regulations implementing provisions of the Stabilization Act relating to
direct and incremental losses are inconsistent with that act and reflect
"arbitrary and capricious" administrative actions by DOT. As of June 4,
2004, the court had not issued its decision, nor had the carriers
participating in this lawsuit settled their compensation claims with DOT.
DOT officials also told us the claims of a small number of other carriers
also remain pending. Therefore, the emergency assistance program, although
substantially completed, is still ongoing.

In commenting on a draft of this report, DOT said it found our report to
be accurate and well reasoned. DOT offered additional support for and
amplification of what it felt were key issues. DOT's comments are
reprinted in the enclosure.

CRITERIA AND PROCEDURES USED BY DOT UNDER THE STABILIZATION ACT

The Stabilization Act established that air carriers could be compensated
for direct and incremental losses caused by the terrorist attacks and
related ground stop order, subject to a cap based on a formula allocation
of the total compensation amount. DOT published a series of procedural
rules describing the compensation process and provided additional guidance
for how it would determine, among other things, direct and incremental
losses, including policies relating to the exclusion of asset impairment
losses.

Statutory Criteria

Sections 101 and 103 of the Stabilization Act6 established three criteria
on which to base air carriers' compensation amounts: (1) direct losses
incurred as a result of the federal ground stop order7 and incremental
losses incurred from September 11 through December 31, 2001, as a result
of the terrorist attacks; (2) carrier type (e.g., passenger or cargo); 8
and (3) a calculated formula amount based upon each carrier's percentage
of industry capacity and the total amount of compensation available. Each
carrier was to receive maximum compensation equal to the lesser of these
demonstrated direct and incremental losses or the formula amount.

The Stabilization Act distinguished between passenger and cargo carriers.
It allocated $4.5 billion9 to be used to compensate passenger-only
carriers and combined passenger and cargo carriers; the remaining $500
million was to be used to compensate cargo-only carriers. The
Stabilization Act, as illustrated in step 1 of figure 1, specified how to
calculate the air carriers' formula amounts. For passenger carriers, the
available amount of compensation ($4.5 billion) was to be multiplied by
the ratio of the individual carrier's August 2001 available seat miles
(ASM), a measure of available capacity, to total available seat miles of
all applying carriers. Similarly, for cargo carriers, the available amount
of compensation ($500 million) was to be multiplied by the ratio of the
latest quarterly data available for revenue ton miles (RTM), a measure of
utilized capacity, to total revenue ton miles of all applying carriers.
This formula effectively capped the amount of compensation an air carrier
could receive for its September 11-related losses. Direct and incremental
losses exceeding the formula amount were not compensated.

6 Pub. L. No. 107-42, S: 101(a)(2)(A) and (B) and S: 103(b).
7 The Federal Aviation Administration ordered a federal ground stop order
(a shutdown of the nation's
airspace) from September 11 through the morning of September 13, 2001,
although some planes were
allowed to reposition and return to their starting locations during that
time. Certain airspace and
airports were not returned to pre-September 11, 2001, status until later.
For example, Ronald Reagan
Washington National Airport, which services Washington, D.C., was phased
back into operation
beginning October 4, 2001.
8 In addition to passenger and cargo carrier types, an amendment to the
Stabilization Act later
authorized the President to set aside a portion of the $5 billion for
certain classes of air carriers, such
as air tour operators and air ambulances. Pub. L. No. 107-71, S: 124.
9 Under the amendment to the Stabilization Act, $35 million of this amount
was set aside for smaller air
carriers and distributed using a modified formula calculation.

Figure 1: Calculation of an Air Carrier's Maximum Compensation Amount

Structured Payment Process

As we reported in September 2003, DOT developed a structured payment
process to implement the statutory provisions set forth in the
Stabilization Act and expedite the distribution of funds. Generally, DOT's
compensation process consisted of a series of payment rounds. In each
payment round, as initial estimates of losses were replaced with actual
accounting data for the compensation period, air carriers were allowed to
receive an increased percentage of their total compensation. Maximum
compensation equaled the lesser of the carrier's direct and incremental
losses as determined by DOT or the carrier's formula amount, as shown in
step 2 of figure 1.

The department published program guidance in a series of Federal Register
notices of final regulations10 that took effect immediately without a
formal comment period. However, in publishing each set of notices, DOT
solicited comments from air carriers and others, and responded to them in
subsequent notices. Table 1 summarizes the chronology of the procedural
rules and the amount of maximum compensation allowed under each payment
round.

                         Table 1: DOT Procedural Rules

                                  Significant issues       Maximum percentage 
                                                                           of 
     Publication      Date       addressed in guidance   compensation allowed 
                   October 1,                                    50%          
       Program     2001a       Structure of the payment  
Guidance Letter             process and policies for  
                               initial disbursement of   
                               funds                     
       Rule #1     October 29,                                   85%          
                   2001         Round 2 application and  
                                 submission deadlines    
       Rule #2     January 2,  Various air carrier       
                      2002     comments                  

     Rule #3     April 16, 2002       Round 3 application, audit         100% 
                                    requirements, clarification of   
                                       emerging issues, and air      
                                           carrier comments          

Rule #4 August 20, 2002 Various air carrier comments

Source: GAO analysis.
Note: Based on Program Guidance Letter (Oct. 1, 2001); 66 Fed. Reg. 54,
616 (Oct. 29, 2001); 67 Fed. Reg. 250 (Jan. 2,
2002); 67 Fed. Reg. 18, 468 (Apr. 16, 2002); 67 Fed. Reg. 54, 058 (Aug.
20, 2002).
aDraft versions of the Program Guidance Letter were distributed to air
carriers immediately after the Stabilization Act was
signed into law.

10 These regulations are codified at Title 14, Code of Federal Regulations
Part 330 (2004).

Principle for Determining Direct and Incremental Losses

An integral part of the payment process was the determination of direct
and incremental losses. DOT generally calculated an air carrier's direct
and incremental losses as the adjusted difference between forecasted and
actual financial results for the period September 11 through December 31,
2001. Specifically, DOT presumed that the difference between an air
carrier's pre-September 11 forecasted financial results and actual
financial results for the compensable period would approximate the
carrier's direct and incremental losses related to the terrorist attacks.
DOT expected the carrier to make adjustments to this difference for items
the carrier could demonstrate to the department's satisfaction were
unrelated to the terrorist attacks. For example, an air carrier could
exclude unrelated income, such as an unforecasted tax settlement from a
prior year that was received during the compensable period, if it was
substantiated with appropriate tax and accounting records.

Under DOT's basic principle of calculating losses, revenue decline was the
primary driver of losses. DOT offset these losses with any cost savings as
well as any incremental gains or profits incurred after the federal ground
stop order through the end of the compensable period that were deemed to
have resulted from the terrorist attacks.

Issues Addressed in the Procedural Rules

Although the basic principal for determining direct and incremental losses
appears straightforward, several issues arose during the administration of
the program. As a result, DOT published specific guidance on how
impairment and certain cost savings, among other issues, should be
considered in the calculation of direct and incremental losses.

Impairment Losses

In its April 16, 2002, rule, DOT defined the criteria that certain items,
such as impairment losses, were required to meet in order to be included
in the calculation of losses and be compensated. The procedural rule said
such items must be presented to DOT for review on a case-by-case basis and
be (1) a direct result of the terrorist attacks of September 11; (2) fully
borne (incurred) within the September 11 to December 31, 2001, period; (3)
permanent; (4) nonduplicative; and (5) reported in accordance with U.S.
generally accepted accounting principles, except if these principles would
require or allow treatment inconsistent with the Stabilization Act. If
items claimed by air carriers did not meet these standards, DOT generally
excluded them from the calculation of direct and incremental losses.

Applying these criteria, DOT determined that impairment losses,
representing the permanent devaluation of an asset (such as aircraft) as a
result of a decline in the market value of the asset or revenue-generating
capabilities, ordinarily did not meet all of the above-stated criteria of
a compensable loss and were generally excluded. DOT believed that
impairment losses were typically experienced over a period of time much
longer than the September 11 through December 31, 2001, compensation
period and, therefore, generally would not qualify as "incurred"
compensable losses

under the Stabilization Act. DOT also explained that it lacked the
"practical ability to monitor accounting for those assets in the future to
ensure that they recapture excess compensation" if the assets were
returned to service. Additionally, impairment losses were considered
duplicative. DOT's April 2002 procedural rule stated "the theoretical
basis for an impairment charge is an expected decline in asset value that
reflects an expected permanently reduced demand and reduced ability to
generate revenue. However, since we are already compensating carriers for
the actual decline in revenue they are experiencing through the end of the
year, there is an inherent duplication in also compensating them for the
associated asset devaluation costs." Further, DOT claimed that its
position was consistent with a Financial Accounting Standards Board
Emerging Issues Task Force statement that "impairment of longlived assets
as a result of the September 11 events would in many cases be impossible
to measure separately from impairment due to the general economic slowdown
that was generally acknowledged to be under way."11

A number of carriers objected to the exclusion of impairment losses on the
basis that these losses had "real world" impacts on air carrier finances,
such as a carrier's ability to obtain credit, and that asset write-downs
are recognized as losses under U.S. generally accepted accounting
principles. Additionally, for some carriers, excluding impairment losses
reduced their direct and incremental losses to less than the maximum
possible compensation as calculated by the formula amount and therefore
decreased the amount of compensation they received.

Cost Savings

Generally, DOT presumed that management actions taken after September 11
to achieve cost savings were prompted by the terrorist attacks, implicitly
if not explicitly, and should, therefore, offset revenue decline, and in
turn reduce

12

compensable losses. In the April 16, 2002, procedural rule, DOT gave the
following reasons for its decision to offset revenue decline with cost
savings: (1) cost reduction plans developed prior to September 11 would
have been accounted for in the pre-September 11 forecasts, (2)
post-September 11 cost reduction plans were attributable to changed
expectations after the attacks, (3) excluding post-September 11 cost
reductions would result in compensating carriers for losses not actually
incurred, and (4) DOT interpreted the Congress's statutory language as
"indicating an intent that carriers not receive increased compensation for
achieving savings in costs, which they have an independent obligation to
their managements and shareholders to achieve, and which it is reasonable
to expect them to undertake to mitigate the need for compensation."

Some air carriers objected to DOT's presumption of considering all cost
savings as related to the terrorist attacks and requested a case-by-case
review approach. For example, one air carrier, which took significant
actions to reduce food service

11 The Emerging Issues Task Force (EITF) No. 01-10, "Accounting for the
Impact of the Terrorist
Attacks of September 11, 2001," November 14-15, 2001. EITF assists the
Financial Accounting
Standards Board by promptly identifying, discussing, and resolving
financial accounting issues within
the framework of existing authoritative literature.
12 Offsets, in some cases, may not necessarily reduce an air carrier's
resulting compensation amount if
the resulting direct and incremental losses exceeded, and therefore were
capped by, the formula
amount.

expenses, argued that its actions to cut costs exceeded the industry's
average expense decrease in food service. Therefore, the carrier
concluded, its actions went beyond what was reasonably expected of an air
carrier to accomplish after the terrorist attacks and the excess amount
should be excluded from the calculation. DOT did not agree with the air
carrier's argument.

SCENARIOS RESULTING IN DIFFERENT LEVELS OF COMPENSATION

On the basis of our previous work and interviews with DOT officials, we
determined that a number of factors influenced the amount of compensation
air carriers ultimately received under the Stabilization Act. Conceivably,
these factors could result in scenarios in which comparable air carriers
could have received different levels of compensation. For example, as
described in scenario 1 below, two comparable air carriers could have had
comparable losses related to September 11, but be subject to different
formula caps because they had different capacity levels. If one or both
carriers had losses that exceeded the formula amount, the formula would
cap the compensation amount at different levels. Additionally, as
illustrated in scenarios 2 through 5, other factors unique to individual
air carriers influenced the amount of direct and incremental losses air
carriers reported as well as the affected compensation levels they could
potentially receive. Scenarios 2 through 5 assume that the two carriers
were comparable in terms of size (in this case, capacity as defined by the
Stabilization Act) and incurred losses less than their formula caps, thus
making them eligible for compensation not to exceed their direct and
incremental losses. DOT officials who administered the compensation
program agreed that these illustrations are representative of situations
observed during their review.

Scenario 1: Formula Impact

As discussed previously, each carrier's formula amount was calculated
based upon the air carrier's measure of capacity. It is possible that two
carriers could be comparable in organizational structure or even annual
revenues, but yet report different amounts of capacity. As a result, two
comparable air carriers could potentially have comparable losses related
to September 11, yet be eligible to receive different formula amounts. If
both of these carriers had losses that exceeded the formula amount, the
formula would cap the carriers' compensation amounts at different levels.

For example, carrier A and carrier B are comparable carriers in that they
both reported $50 million in annual revenue and incurred $10 million in
direct and incremental losses related to the attacks during the
compensable period. However, carrier A reported more available seat miles
for the required August 2001 period than did carrier B. As a result, and
as shown in table 2, carrier A received $10 million while carrier B's
compensation was capped by the formula amount.

         Table 2: Impact of the Statutory Formula (Dollars in Millions)

Gross Direct and Compensation revenues incremental losses Formula cap
received Carrier A $50 $10 $11 $10

Carrier B $50 $10 $8 $8

Source: GAO analysis of hypothetical data.

In another example of the formula impact, two cargo carriers similar in
all aspects except that they transport different types of cargo could also
receive different levels of compensation as a result of the formula cap.
For cargo carriers, the statutory measure of capacity used in the formula
calculation is actual revenue ton miles flown (not available capacity, as
was the case with passenger carriers.) This could result in a carrier that
transports generally heavier cargo reporting more revenue ton miles than a
carrier hauling lighter cargo. For example, assume that carriers C and D
are similar in all aspects except for the nature of their cargo. Although
both carriers fly identical planes that generate the same revenue, carrier
D, as a result of its lighter cargo, transported less tonnage than carrier
C and, therefore, if compensated pursuant to the formula, would receive
less compensation than carrier C.

Scenario 2: Geographic Location

The primary location of an air carrier's operations may have influenced
the amount of losses an air carrier incurred after September 11. As stated
previously, revenue decline was the primary driver of an air carrier's
direct and incremental losses. If a carrier, due to its geographic
location or affiliation with a particular airport, suffered more revenue
decline (i.e., flew fewer passengers due to the terrorist attacks or had
planes grounded for an extended period due to security concerns)13 than a
carrier comparable in size and type, it is likely that this carrier could
have incurred more losses and received more compensation than the
comparable carrier.

After the terrorist attacks, passenger traffic declined across the nation;
however, traffic through the northeast corridor (where the terrorist
attacks occurred) declined more sharply than in other areas. To illustrate
how this situation affected comparable carriers, assume a majority of
carrier E's operations are centered in the northeast, while a majority of
carrier F's operations are centered in the Northwest. In this case,
carrier E in the Northeast carried fewer passengers during the
compensation period and reported a larger revenue decline than carrier F.
Although carriers E and F are comparable in size, carrier E received more
compensation as a result of larger direct and incremental losses.

13 For example, Ronald Reagan Washington National Airport was closed due
to security concerns after the September 11, 2001, terrorist attacks until
October 4 when flights gradually resumed.

Scenario 3: Impact of the Inherent Imprecision of Forecasts

Forecasts of financial results for the September 11 through December 31,
2001, period formed the basis of DOT's calculation of direct and
incremental losses.14 The precision of the forecasts influenced the amount
of direct and incremental losses an air carrier could report on its
application. Recognizing the importance of the quality of the forecasts,
DOT required the air carriers to provide the two most recent forecasts
(e.g., August and July forecasts) and their corresponding actual
performance. DOT officials said they extensively reviewed this information
and generally requested additional data to determine the reasonableness of
each carrier's forecast. DOT reviewed year-over-year trends of historical
data, comparisons to similar carriers' forecasts, related documentation
maintained by other DOT offices, and rates of return. As a result of these
procedures, DOT said it revised, amended, or recreated many air carrier
forecasts in order to normalize or control for forecasts that could
significantly affect the calculation of a carrier's losses.15 Even with
these procedures, the inherent imprecision of forecasting could still have
influenced many carriers' ultimate compensation determination.

Assume carriers G and H are comparable passenger carriers that reported
the same financial results for the compensable period. However, carrier G
had forecasted $100 million in revenues for the compensable period,
whereas carrier H had produced a slightly more optimistic forecast of $105
million. Although the revenue forecasts for both carriers G and H might
have been considered reasonable, carrier H received more compensation as a
result of its more optimistic forecast, as shown in table 3.

          Table 3: Impact of Optimistic Forecast (Dollars in Millions)

Pre-9/11 Actual Direct and forecast financial results incremental losses

Carrier G                                          
        Revenues            $100            $80                ($20) 
        Expenses            $110            $110                  $0 
        Gain/Loss           ($10)          ($30)               ($20) 
Carrier H                                          
        Revenues            $105            $80                ($25) 
        Expenses            $110            $110                  $0 
        Gain/Loss           ($5)           ($30)               ($25) 

Source: GAO analysis of hypothetical data.

Scenario 4: Quality of an Air Carrier's Application

To receive compensation, the Stabilization Act required that air carriers
demonstrate losses related to terrorist attacks to the "satisfaction of
the President using sworn financial statements or other appropriate data."
DOT's procedural rules specified the nature and content of the data to be
included in applications as well as additional criteria and requirements.
For example, in the third payment round, DOT required

14 As previously discussed, baseline losses used to determine compensation
for individual air carriers
were calculated as the difference between forecasted and actual financial
results for the September 11
through December 31, 2001, period.
15 DOT said several small air carriers did not produce forecasts. In that
event, DOT created forecasts
for them based upon historical financial and operational data.

agreed-upon procedures to be performed by independent public accountants
on the information submitted by the air carriers. 16 The purpose was to
verify that the amounts submitted either agreed with or reconciled to the
carriers' financial systems and other supporting documentation. Despite
these guidelines, the review team stated that the quality and amount of
supporting documentation accompanying the air carrier applications varied
widely. Some applications contained extensive supporting documentation; in
other cases DOT staff had to request that additional information be
submitted to support the carrier's claims. DOT told us that if losses or
adjustments to losses submitted by the air carriers were ultimately not
supported to DOT's satisfaction, the losses were excluded from amounts
eligible for compensation.

Scenario 5: Management Response to the Terrorist Attacks

After the terrorist attacks occurred, the federal government shut down the
nation's airspace. When air travel resumed, passenger traffic had
significantly declined, reducing operating revenues for most carriers. To
mitigate the reduction in revenue, some carriers took aggressive measures
to reduce costs, conserve cash, and preserve liquidity. Alternatively,
some carriers did not take as immediate or aggressive actions to reduce
costs, while others that already had low-cost structures had fewer
opportunities in their business models to cut costs. As previously
discussed, DOT offset cost savings, whether achieved through management
action or as a by-product of volume decline, against revenue decline in
the calculation of direct and incremental losses. Said in another way, the
amount of cost savings achieved reduced the levels of compensation air
carriers could potentially receive.

To illustrate, suppose carriers I and J were comparable in size and
forecasted identical financial performance for the compensable period.
After the attacks, carrier I aggressively cut costs and reduced expenses
10 percent during the period September 11 through December 31, 2001.
Carrier J took fewer, less aggressive measures to reduce costs, and at the
end of the period, expenses were reduced by only 5 percent. As shown in
table 4, carrier I's cost savings reduced its direct and incremental
losses by more than carrier J's, and therefore carrier I received less in
compensation than carrier J.

Table 4: Impact of Aggressive Cost Reduction (Dollars in Millions)

                         Percentage of      Actual financial       Direct and 
               Pre-9/11   cost savings          results           incremental 
               forecast     achieved    (after cost reductions)        losses 
    Carrier I                                                    
    Revenues     $400                             $320              ($80)     
    Expenses     $450         10%                 $405              ($45)     
    Gain/Loss    ($50)                           ($85)              ($35)     
    Carrier J                                                    

                   Revenues $400                            $320        ($80) 
                   Expenses $450                    5%      $428        ($22) 
                  Gain/Loss ($50)                          ($108)       ($58) 
     Source: GAO analysis of hypothetical data.                     

16 Small air carriers were required to submit simplified agreed-upon
procedures.

PENDING LITIGATION

DOT's regulations as partly described in this report are the subject of
pending litigation. Three air carriers are seeking from the U.S. Court of
Appeals for the District of Columbia Circuit a judicial determination that
DOT's regulations implementing provisions of the Stabilization Act
relating to direct and incremental losses are inconsistent with that act
and reflect "arbitrary and capricious" administrative actions by DOT.17 In
particular, the air carriers contended that DOT's payment rules and
assumptions improperly combined two categories of losses under Section
101(a)(2) of the act into one by offsetting losses that were incurred
during the federal ground stop order with any incremental gains after the
federal ground stop order. Also, the air carriers contended that DOT
improperly excluded aircraft impairment costs, among others, as
compensable losses under the act. They argued that these rules establish
"overly simplistic" criteria and "irrebuttable presumptions," and,
further, that they result in "impermissibly" different percentages of
allowable maximum compensation among comparable air carriers.

DOT, in defending its regulations argued that, among other reasons, it
permissibly interpreted the Stabilization Act as providing for one "loss
period," September 11 through December 31, 2001, with two types of
compensable losses, direct and incremental. It also argued that its
regulations provide a rational basis for determining how certain items,
such as aircraft impairment or cost savings, should be recognized in
calculating carriers' compensation.

The court held oral arguments on these issues in October 2003 after
receiving the parties' legal briefs from April through June 2003. As of
June 4, 2004, the court had not issued its decision, nor had the carriers
participating in this lawsuit settled their compensation claims with DOT.
DOT officials told us the claims of a small number of other carriers also
remain pending. Therefore, the emergency assistance program, although
substantially completed, is still ongoing.

AGENCY COMMENTS

We requested comments on a draft of this report from the Secretary of
Transportation or his designee. The Assistant Secretary for Administration
provided the department's written comments, stating that the report
correctly described DOT's administration of the program and concurring
with our finding that various factors can cause differences in
compensation amounts. The department characterized our report as accurate
and well reasoned and provided additional support and amplification of
what DOT considered to be key issues. Its comments are reprinted in the
enclosure. DOT also provided separate specific technical comments that we
considered and incorporated into this report as appropriate.

17 The carriers also allege that in promulgating the April 16, 2002, and
August 20, 2002, rules, DOT failed to follow proper rule-making procedures
required by the Administrative Procedure Act, 5 U.S.C. S: 553.

We are sending copies of this report to the Secretary of Transportation
and interested congressional committees. This report will also be
available at no charge on GAO's Web site at http://www.gao.gov. If you
have any questions about this report, please contact me at (202) 512-9508,
or Phillip McIntyre, Assistant Director, at (202) 5124373. You may also
reach us by e-mail at [email protected] or [email protected]. Other key
contributors to this report were Abe Dymond and Ruth Walk.

Linda M. Calbom
Director, Financial Management and Assurance

Enclosure
Comments from the Department of Transportation

(190119)

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