Will the fidelity market experience the one-two punch of lower premium volume and increased claims activity in what has traditionally been a low-risk, and growing, category? While concerned about fidelity bond customer demand in the near term..
Travel Agent Bonds: Hundreds of little Thomas Cook’s?
Author: Suretypedia Team
Posted On: 04-16-2020
As a result of persistent social distancing measures, many small businesses aren’t maintaining revenue necessary to stay afloat and travel agents are not expected to be spared. The Trump Administration’s State of Emergency declaration halting all non-essential travel, state and local Stay-at-Home orders and general fear surrounding the pandemic have decimated the travel industry, placing enormous strain on many travel agencies. Adding to the revenue-starved sector’s misery, travel agents have been inundated with cancellations.
Recently we analyzed how two bond types with historically higher loss ratios and sensitivity to economic cycles might fare in the current environment (see Sales Tax Bonds: “Tide’s Out, Time to Discover Who’s Swimming Naked and Utility Deposit Bonds: As Restaurants Go Dark, Claims Will Light Up). We now turn our attention to Seller of Travel bonds, a rather obscure obligation that has consumed little attention from Sureties for many years. However, as the 2019 bankruptcy of the travel agency behemoth Thomas Cook has so dramatically underscored, these bonds do pose risk to Sureties. While we’re not trying to identify the next $1 billion claim, Suretypedia attempts to answer the following questions to provide surety executives, underwriters and claims handlers a refresher on a somewhat obscure bond in an environment where principals are experiencing acute economic stress.
- Why Do Travel Agencies Need Surety Bonds?
- What Constitutes a Claim On a Travel Agent Bond?
- What Unique Risks Should Underwriters Consider on Travel Agency Bonds?
- Should Sureties Expect More Claims on Travel Agency Bonds?
- Will the Paycheck Protection Program Bail Out Sureties on Seller of Travel Bonds?
Why Do Travel Agencies Need Surety Bonds?
The primary reason travel agencies require surety bonds is because they accept deposits and payment from consumers prior to the customer receiving the service, i.e., the trip or experience.
Sellers of travel, also known as a travel agent or travel agency, are intermediaries that arrange lodging, car rentals, sightseeing tours, or land, sea, or air transportation, etc., on behalf of travelers. Six states - California, Florida, Hawaii, Iowa, Virginia and Washington - require travel agents operating within their borders to obtain a license to provide these services to the public. Another four states - Alabama, Illinois, Kentucky and Wisconsin - have similar requirements of Timeshare Agents. As a condition of their license, Sellers of Travel are required to post a bond with the relevant state license authority, usually the Department of Consumer Affairs. The surety bond provides a guarantee to the consumer that they will not be subject to financial injury as a result of the travel agent’s misrepresentation, fraud or financial failure. The last trigger, financial failure, the risk of which is substantially elevated given the complete halt in travel due to the COVID-19 pandemic, is the primary cause of claims for these bonds. Many small travel agencies are likely suffering from a total collapse of revenue threatening their ability to stay in business.
As Thomas Cook, in which customers had entrusted hundreds of millions of pounds in deposits, demonstrated so dramatically, the insolvency of a travel agency can easily result in full limit claims. While Suretypedia sees social distancing measures increasing risks for smaller travel agencies, the cumulative effect of a wave of small travel agency bankruptcies could precipitate adverse development for carriers with little reserves against this historically low loss ratio class of bonds.
What Constitutes a Seller of Travel Bond Claim?
Each state defines the activities of a travel agent a little differently, but claims most often result from travel agents failing to advance customer funds to vendors (airlines, hotels, etc.) or return said funds to the customer. Most bond forms state something to the effect of any person who has suffered monetary loss from unlawful activity by a travel agent has a right to file a claim on the bond for reimbursement.
Other violations that can result in claims against the bond include:
- Using deceptive practices to inhibit travel opportunities
- Defrauding or deceiving clients
- Failure to maintain funds in a segregated trust or escrow account (where required)
- Failing to follow any other licensing regulations and state statutes on how to conduct business
Fortunately for surety carriers, some states that require Seller of Travel bonds have complaint resolution mechanisms that involve the obligee early in the process. For example, in Iowa, the government can file a claim on behalf of the person who suffered loss, adding a layer of investigation before the Surety must get involved. Another example is Washington, where consumers are encouraged to file complaints directly against the travel agent with the Department of Licensing before filing a claim on the bond, which generally reduces loss and adjustment expenses for carriers as travel agencies can resolve the complaint, usually via a refund, before a claim is ever made on the bond. One complication with travel agencies simply refunding customer deposits, however, is that travel vendors are not regulated in the same way as travel agencies and maintain their own cancellation policies; once a travel agency forwards the funds to the vendor providing the travel service, the refund process will adhere to the vendor’s cancellation policy. If the customer does not receive satisfaction from the vendor, they could seek restitution from the travel agent’s bond.
Suretypedia has compiled the statutory requirement for all states with a Seller of Travel requirement:
- AL - Chapter 790-X-4 Timesharing Registration and Licensure
- CA - Business and Professions Code 17550
- FL - Florida Sellers of Travel Act: Florida Statutes 559.926-559.939
- HI - Hawaii Revised Statutes 468L
- IA - Iowa Code Chapter 9D
- IL - Real Estate Timeshare Act of 1999
- KY - Rev. Stat. § 367.403
- VA - Code of Virginia, The Virginia Travel Club Act
- WA - Revised Code of Washington Chapter 19.138 and Washington Administrative Code Chapter 308-129
- WI - Chapter 707 Time-Share Ownership
What Unique Risks Should Underwriters Consider on Travel Agency Bonds?
Suretypedia analyzed the bond forms and requirements imposed on travel agents to better understand the underlying risk of these bonds. Our review identified the following risks associated with Travel Agent Bond requirements: collection of prepayment, government-mandated refund requirements, and liability tails. In a normal economic and travel environment, the criteria we analyzed would not constitute a worrisome level of risk, unless accompanied by other adverse underwriting criteria; however, in the context of COVID-19 we believe these risks could elevate loss experience for the Sureties writing these bonds.
Collection of Prepayment
The primary risk of these bonds stems from the travel agent accepting payment prior to services being consumed. California, Hawaii, Virginia and Washington require payments to be held in either a trust or escrow account. Florida and Iowa do not impose this requirement, so it is possible funds may be commingled with the travel agent’s operating funds. If travel plans are cancelled within the cancellation provisions, usually the travel agent will be able to refund the consumer in normal economic times. Leaving aside the fact that these are anything but normal economic times, any mismanagement or misappropriation of customer funds increases the risk of a travel agency defaulting on refunds.
Another aspect to consider is the residual liability of a travel agent who has already forwarded payment to the travel vendor. Once payment has been transferred, any cancellations may be subject to the vendor’s cancellation policies and fees. While this may transfer some of the refund responsibility from the travel agent to the vendor, angry or upset customers may instigate claims with the party who sold them the package (the travel agent). When payment leaves the control of the travel agent, they should ensure the consumer is provided with the vendor’s cancellation policies. Understandably, the customer may still be frustrated with the refund process, but the transparency could help mitigate potential for claims associated with refund policies.
To understand the degree to which travel agents will come under pressure in an environment where literally all travel plans are being cancelled, we must look into the cancellation and refund provisions that are mandated by each state. There are two primary periods to categorize the refund requirement risk of the various Travel Agency bonds - the length of time the consumer has to request a cancellation and refund following purchase and the length of time the Travel Agency has to pay. We believe the length of time the consumer has to request the cancellation is the primary risk factor, but to the extent travel agents are unable to immediately satisfy refunds, the length of time to make such payment could matter as Sellers of Travel scramble to arrange loans or other sources of liquidity.
Travel agents in Washington, California, and Florida are required to refund consumers for cancellations as far out as 30 days from the execution of the contract, and the travel agent must distribute the refund according to the State’s policies listed below:
- WA: The refund must be sent within 30 days of receipt of the cancellation request if the Agent has already submitted payment to the travel vendor or within 14 day of receipt of the cancellation request if payment has not been submitted to a travel vendor.
- CA: Refunds must be sent within 30 days from one of the following dates or within three days from the day the seller of travel is first unable to provide travel services, whichever is earlier :
- The scheduled date of departure.
- The day the passenger requests a refund.
- The day of cancellation by the seller of travel
- FL: The refund must be sent within 30 days.
Hawaii is much safer for surety carriers, requiring consumers to request cancellation within seven days of entering into the travel contract, from which time the travel agent has 14 days to complete the refund. Virginia is even more favorable to surety carriers, requiring consumers to submit cancellation within seven days of the purchase of travel services while providing travel agents 45 days to provide the refund, as specified in The Virginia Travel Club Act:
"The purchaser may cancel the travel service agreement until midnight of the seventh calendar day after execution of the contract by use of the form prescribed in subsection C of this section... If the seventh calendar day falls on a Sunday or legal holiday, then the right to cancel the travel service agreement shall expire on the day immediately following that Sunday or legal holiday... Within forty-five days after notice of cancellation is received, the travel club shall refund to the purchaser any payments made by the purchaser pursuant to the travel services agreement.”
Regardless of which state the travel agent resides in, the refund provisions for cancellation will be governed by the travel agreement to the extent that it follows the law, which may allow for cancellation fees.
The cancellation of a surety bond does not always mean that the travel agent and Surety will not be held liable for their actions during the time the bond was in effect. Claims may still be accepted against the bond as permitted by law. Liability tails are extremely important as consumers are often not prepared to file bond claims, or otherwise address disputes with a travel agent, immediately in conjunction with the need to cancel, particularly in a time like this where consumers are dealing with dislocations well beyond travel.
Florida allows claims to be filed within 120 days of the alleged violation. Hawaii will accept claims up to six months after the alleged violation. Washington has an even lengthier time period to submit a claim after the bond has ended:
"...A civil action brought in court pursuant to the provisions of this section must be filed no later than one year following the later of the alleged violation of this chapter or a rule adopted under this chapter or completion of the travel by the customer”
Will Seller of Travel Bonds Experience Higher Claims Due to COVID-19?
As discussed, Travel Agency bonds often benefit from the obligee’s early involvement in customer complaints. However, in order for the complaint resolution process to work as intended, the travel agency must remain a going concern with funds set aside to satisfy refunds. The current environment is certainly challenging that assumption. Travel agencies are approaching the 30 day anniversary of near-universal travel bans, reducing revenue to zero for many while fixed costs of the business remain (at the very least the owner must support their own livelihood).
One of the key benefits to most agency business models is the strong cash flows relative to earnings. Unlike many other types of businesses, most agencies don’t require much in the way of working capital or long-term capital expenditures to support growth of the business. However, now that business is severely, or even completely, curtailed for travel agencies, there is no inventory to sell off or much in the way of receivables to collect, and the business is probably not accustomed to the need to hold excess cash. In other words, the very factors that make agency-type business cash flows so attractive in a stable to growing environment, work in reverse in an unprecedented environment where revenues are severely curtailed or even eliminated. Put simply, many travel agencies may not have been able to survive 30 days with little to no revenue. While governors are beginning to announce plans to slowly lift social distancing measures, we expect travel agencies will have to endure months of severely curtailed revenue before business is back to normal.
As if the inability to absorb fixed costs with new bookings weren’t damaging enough to the business credit profile, many sellers of travel are facing substantial variable costs against past revenue - trip cancellations. While many airlines, hotels, cruise lines, etc., require the consumer to submit the cancellation request, we expect travel agencies are spending the bulk of their time right now fielding calls from angry consumers, and thereby increasing operating costs.
Handling cancellations proves an especially difficult task for travel agents, as they have to navigate the interests of both the customer and the travel vendor. Given that travel agents work with many different types of vendors, possibly even multiple vendors per trip, seeking a refund is often a time-consuming process. Industries, such as airlines, have their own regulations. The US Department of Transportation Aviation Enforcement Office issued a reminder that airlines are obligated to refund customers promptly for cancellations. Travel credit may be offered to the customer only when the airline has offered a refund as well. Travel agencies that did not segregate and hold in trust customer funds and only recognize their commissions as earned once cancellation periods have passed are in danger of not being able to satisfy refund requests in a period where literally all travel is cancelled. Moreover, many of the customers have seen their incomes decimated at the same time and will likely fight harder than ever for refund over travel credit.
Unfortunately for surety companies, trip cancellations not only increase the insolvency risk of the principal, they could be a direct cause of Seller of Travel bond claims.
Will the Paycheck Protection Program Bail Out Travel Agency Bonds?
While the PPP certainly has the potential to keep some businesses with limited revenue afloat for a month or two, we do not believe this will materially reduce the increased risks faced by surety carriers on Seller of Travel bonds during the COVID-19 pandemic.
Only a small portion of the $349 billion available to businesses with less than 500 employees has actually been distributed and the clock is still ticking on travel agents, many of whom have mere days to survive if they haven’t defaulted on customer refunds already. Most businesses without lending relationships have experienced difficulty submitting an application, further inundating small business owners already worrying about how to keep their businesses afloat. As we discussed above, this is particularly concerning for agency models who lean heavily on daily, weekly or monthly inbound cash from customers to support their operational expenses, not to mention paying their employees.
Should travel agents receive loans in time to keep their doors open, they must spend 75% of the proceeds on payroll in order to qualify for loan forgiveness. While potentially good for the employees, this limits the options for a business that really doesn’t need its employees during the period in question. We suspect the travel agents with the most cash reserves and strongest franchise value will eventually secure loans, a portion of which may have to be carried as debt.
Should Sureties Brace for Hundreds of “little Thomas Cook’s”?
Obviously, Thomas Cook was an extreme example with very high aggregate exposure to the surety carriers, but if one of the most recognized names in the travel industry can cause massive surety losses due to bankruptcy in good economic times, it’s not a stretch to suggest small agencies could create full limit claims in nothing short of a global depression in the travel industry. Smaller travel agencies are likely experiencing an unprecedented level of cancellations beyond their capacity to provide refunds. With a high number of cancellations and the uncertainty of when it will be safe to travel again, small travel agencies are at risk of liquidation, likely resulting in unpaid refunds. With no funds available at the travel agency where the trip was booked, suddenly cash-strapped customers would have to turn to filing a claim on the bond to receive reimbursement for their travel plans. In the case of Thomas Cook, refunds were in the hundreds of millions of dollars. It is unclear what the damage will be for small U.S. travel agencies, but the possibility of significant losses is very real.