Introduction

The Airport Management Company Ltd (AMC) is listed on the Johannesburg Securities Exchange (JSE) and is responsible for managing an international airport close to Johannesburg in the Gauteng Province and seven regional airports spread across South Africa. AMC had experienced a decline in headline earnings and negative media coverage for a number of high-profile events over the last two years.

Governance

AMC was also criticised in the last annual general meeting (AGM) by a corporate governance lobby group for not complying with the King Code of Governance concerning risk management. The lobby group was quite vocal about the audit committee's role, taking responsibility for risk management oversight and was concerned that the internal audit function lacks independence. It also performed specific operational roles such as loss control and security. Stakeholders also demanded a restructuring of the board and its sub-committees when it transpired that the main board was ignorant of the scope and impact of the incidents experienced throughout the year.

Board fees

Risk related fees for non-executive directors are R20 000 per meeting, and four meetings were held with all the non-executive directors attending the meetings. The risk committee is chaired by a non-executive director with another two non-executive directors as standing members. The chair receives R40 000 per meeting.

Risk appetite

The board has reported to shareholders that the company has a low risk appetite, has identified all the risk and have the appropriate risk management and risk financing strategies in place.

Risk management department

The actual cost of the risk management department is R8 500 000.

Operations

AMC's board decided three years ago that the company must be the preferred airports' management company in Southern Africa and that the company will grow by acquiring small regional airports. AMC was very successful with the acquisitions, but the management and the board have become concerned with the operational capacity to manage the enlarged airports' portfolio. A number of events at the flagship airport in Johannesburg have highlighted that management is stretched and has limited capacity to handle more crises.

The operations of AMC are divided into Aviation and Non-Aviation Services. Aviation Services consist of:

Terminal and Traffic Management;

Airport and aviation security; and

Ground services.

Non-Aviation Services consist of:

Real estate management;

Airport retailing;

Parking management; and

Airport advertising.

Aviation revenue consists of all-inclusive landing fees, which is R250 000 per international aircraft and R100 000 per domestic aircraft. Non-aviation revenue consists of the letting of retail space, parking, and retail services.

AMC has experienced a number of incidents over the last financial year, which made national and international headlines in the media.

Fuel spills

The only fuel pipeline between the main international airport and the SanOil refinery in Johannesburg had been contaminated in June with 'off-specification Jet A 1. Ten million litres of fuel have been contaminated, which reduced the stock levels from the required five days to 1.5 days as the contaminated fuel was rendered unfit for use by the airlines. The fuel was drained into a spillage trap with a capacity of 0.5 million litres, which overflowed as all the contaminated fuel was released at once. The full impact of the contamination was initially estimated as 2 million litres. The full extent of the contamination was only realised after a thorough inspection by an independent consultant was undertaken after pressure from the airlines using the airport.

AMC also experienced spillage of 2 million litres in May when a mechanical failure caused a fuel valve to collapse. As the spillage exceeded the capacity of the spillage trap, the leaked fuel was released into the storm-water system, which caused extensive pollution and environmental damage to a nearby dam. According to the maintenance records, the fuel valve was inspected weekly rather than daily as required in the standard operating procedures for the fuel system. The cost to replace the spilled fuel was R15.95 per litre.

Although the incident in June was the biggest contamination event, AMC experienced two other incidents, which resulted in the loss of 1.5 million litres in March and 1.8 million litres in April, respectively. The cost to replace the contaminated fuel was R16.05 per litre for the June incident, R15.75 per litre for the March incident and R15.85 per litre for the April incident.

The fuel incidents led to the cancellation of 130 flights, of which 75 were international flights.

Baggage theft

AMC has been plagued with baggage theft for several years. The main airport in Johannesburg has topped an international list compiled by the International Air Travel Association (IATA) of the number of incidents per year, with 12 433 compared to 6 549 for the airport with the second-highest number of incidents. AMC appointed a security company, ShutEye Ltd, to oversee airport security, including baggage security. The contract for the Johannesburg airport alone amounts to R12 million per year, with an escalation cost of 10% per annum. ShutEye was appointed on a 5-year contract in July 2020, with the option to renew. International travel agencies have identified South Africa as a high risk destination and warned tourists and other travellers to be vigilant as the Johannesburg Airport was notorious for baggage theft.

The limit per claim that AMC will pay per customer is R 2 000. The current policy has not been reviewed since 2011. The information of the baggage losses is as follows:

YEAR NUMBER OF INCIDENTS JOHANNESBURG AIRPORT WITH 2 ND HIGHEST INCIDENTS

2021 12 433 6 549 2020 12 148 5 342 2019 11 875 7 418 2018 10 546 8 974 2017 9 879 8 678

NUMBER OF INCIDENTS YEAR JAN FEB MAR APR MAY JUN JULY AUG SEP OCT NOV DEC TOTAL 2021 1835 739 930 1127 972 764 1423 1270 653 741 782 1197 12433 The average losses per incident are as follows: AVERAGE LOSS PER INCIDENT IN RAND YEAR JAN FEB MAR APR MAY JUN JULY AUG SEP OCT NOV DEC 2021 3,500 1,800 1,900 1,950 2,000 2,050 2,100 4,000 2,500 2,600 2,800 5,000 Strike action There are 2 500 people employed at the Johannesburg Airport who are members of different unions. The unions demand increases of double the current inflation rate of 6.1%, which will have a negative financial impact on AMC and the outsourced services. According to a spokesperson for the unions, there is a high level of mistrust between the workers and management as there is a perception that workers are compensated far below the market rate, and management is regarded as 'fat cats'. The Johannesburg Airport experienced several violent strikes the previous seven years, and AMC's management is concerned that the current wage negotiation may also lead to a prolonged and violent strike. The airport reported damage of R750 000 to property and approximately R230 000 for theft at shops during the strike. Although airport security is outsourced to ShutEye, the company has been unable to contain the violence and instances were also noted on closed-circuit television where ShutEye workers participated in the damaging of property and looting. No claims were submitted for any damages related to the strikes. Insurance cover AMC uses insurance to transfer the financial consequences of certain, specified risks to an insurance company. The current premium is R3 million per month, and the policy conditions and premiums are reviewed annually. The relevant conditions for the case study are as follows: Fuel spills AMC is insured against fuel spills. There is a limit of 1 million litres per event, calculated at the purchase price at the time of the spill. A deductible of R1 million is paid per event. Baggage theft AMC is insured against baggage theft. A limit is set per event of R1 000 with a maximum of 500 events per month that AMC can claim from its insurer. Strikes Strikes are covered under SASRIA in the policy. Business interruption The business interruption section of the policy does not cover cancelled flights

1. The Chair of the Board Risk Committee was very concerned about the losses that were reported throughout the year and requested you to update the board on the losses. You have considered all the available information in this case study and decided to present the information in the in terms of a cost of risk framework. Calculate the cost of risk per event. Show all calculations. (25 marks) 2. Evaluate the risk financing strategy of the company (5 marks)