Security Amounts - Increased Securities

Questions and answers regarding increased security amounts.What are the benefits of the new insolvency protection system?

The new system of insolvency protection is meant to be beneficial to travel agencies as well as consumers.

The Travel Insurance Fund is a system to protect consumer rights and refund in full any payment made for package travel or linked travel arrangements in the event of insolvency or bankruptcy of a trader or if a trader´s licence is cancelled pursuing to Article 27. of the Act on package travel and linked travel arrangements (failure to submit security, pay premium or base fee on the due date, or provide the information required to determine the amount of premium and security).

The aim of the insolvency protection system is also to benefit travel agencies. The system is a mutual system of insolvency protection, based on the following financing scheme:

• Base charge
• Annual premiums
• Security provided by each travel agency, according to the decision of the Icelandic Tourist Board based on the documentation and information provided.

Contribution of a base fee and annual premium to a mutual fund result in lower securities for travel agencies than according to the previous system. Through a fund-based, mutual insolvency protection system, financial commitments of travel agencies relating to bank guarantees (securities) are to decrease and hence improve their financial standing.

Why are some security amounts determined with a surcharge?

The new system of insolvency protection is set up to serve under normal conditions in tourism Given normal operating conditions, it is possible to determine the security amount (T) according to the general rules of calculation.

When determining the security amount of a trader, the Icelandic Tourist Board is legally obliged to, consider the financial situation of the trader as well as the risks ensuing from the trader’s operations. If the financial situation of a travel agency is such that the travel agency is likely to become insolvent, the Icelandic Tourist Board must take that into account.

In these cases, the security amount may be increased according to Article 10 of the Regulation.

Authority to increase security amounts

The security amount may be increased according to Article 10 of the Regulation on the Travel Insurance Fund, if the operations of the travel agency are considered to entail special risks. This refers for instance to cases where there is a significant increase in the sale of package travel or if credits that travelers have decided to keep rather than getting a refund, are not reflected in the security amount or, if there is a probability, for other reasons, that the Travel Insurance Fund may suffer financial loss.

When assessing the risk, the interests of the Travel Insurance Fund must be protected while equal standing of travel agencies and objectivity are observed.

To ensure equal standing and objectivity when deciding on increased security amounts, the Icelandic Tourist Board has established following criteria based on the financial position of travel agencies:

• The working capital ratio is below 1,5
• The equity ratio is below 20%
• Credits of travelers for package travel or linked travel arrangements that are not part of regular business and will not be delivered or refunded during the current year. This refers to credits for package travel that have been cancelled by the travel agency or the traveller or they postponed.

How is the risk assessed?

Two separate risk factors are taken into consideration when assessing the Travel Insurance Fund’s risks associated with the operations of individual travel agencies. These factors are used to determine a surcharge on the security amount according to Article 7 of the Regulation.

The authority to increase the security is found in Article 10 of the Regulation. The risk factors considered are:

• Risk of insolvency resulting from increased sale of travels subject to insolvency protection that are part of regular operations.
• Risk of insolvency due to customer credits that do not result from current and regular operations and hence are not covered by calculations based on Article 7 of the Regulation.

How is the surcharge determined?

The surcharge is based on the working capital ratio (VFH in Icelandic) and the equity ratio (EFH in Icelandic) of travel agencies.

When deciding the surcharge percentage, the VFH is weighted 2/3 and the EFH 1/3.

The maximum surcharge is 80% and the minimum surcharge is 13% of the calculated base security amount (GT) when surcharge is levied.

The percentage of the surcharge depends on the combined effect of the working capital ratio and the equity ratio. Each ratio is then divided into three risk groups.

The surcharge is calculated according to the following:

• The base security amount (GT) is calculated according to Article 7 of the Regulation.
• The security amount (T) is calculated according to the formula in Article 7 of the Regulation.
• The amount (T) is subtracted from the amount (GT); (GT-T)The surcharge percentage is determined based on the combined effects of VFH and EFH.The resulting amount from (GT-T) is multiplied by the surcharge percentage; (GT-T)*surcharge percentage = amount of surcharge (Á).
• The surcharge amount is added to the calculated security amount (T); T+Á. The result is the security amount the travel agency must provide.
• In the case of travelers holding credits for package travel and linked travel arrangements that will not be performed or refunded during the current year, the amount of the credits is added to the calculated security amount; T + surcharge + credits. The result is the security amount that travel agencies holding such credits must provide.

How is the surcharge divided between the working capital ratio and the equity ratio?

The combined effect of the two ratios and the possible surcharge percentages is best explained using colour-coding.

Working capital ratio (VFH):

VFH is below 1 the colour-code is red
VFH is between 1-1,49 the colour-code is yellow
VFH is 1,5 or above the colour-code is green

Equity ratio (EFH):

EFH is below 10%, the colour-code is red
EFH is 10-19,99%, the colour-code is yellow
EFH is 20% or above, the colour-code is green

VFH and EFH both red the surcharge percentage is 80%
VFH and EFH the surcharge is 67%
VFH and EFH the surcharge is 53%
VFH and EFH the surcharge is 53%
VFH and EFH the surcharge is 40%
VFH and EFH the surcharge is 27%
VFH and EFH the surcharge is 27%
VFH and EFH the surcharge is 13%
VFH and EFH there is no surcharge

Why must the working capital ratio be 1,5 or higher?

The working capital ratio (the ratio between working capital and current liabilities in the balance sheet) is used as a criterion since it is a key indicator for the ability of a company to pay its debt in the upcoming 12 months.

The nature of the operations of travel agencies makes the working capital ratio the most relevant criterion to use. It reveals the financial situation of individual travel agencies and their ability to pay debts and honour obligations during the upcoming months. A company with sufficient working capital (current assets) that can, with short notice, be turned into cash can pay its current liabilities. The credits of travelers, for travels that are subject to insolvency protection, are a part of the current liabilities of travel agencies, regardless of whether these credits are instalments towards future travels or credits, that travelers have chosen to hold rather than get a refund.

It must be considered that it may not be possible to convert working capital (current assets) into cash at full book value to honor liabilities with short notice, or maybe not at all. The real value can be, and often is, less than the book value. This is particularly true for the current challenging situation of tourism.

The Icelandic Tourist Board considers it normal and cautious to set the working capital ratio at minimum 1,5 and a ratio below that minimum is considered an indicator of increased risk of insolvency.

Working capital ratio between 1,0 and 1,49 is considered an indicator of increased risk of insolvency, leading to a surcharge on the security (T); working capital ratio below 1 indicates that the ability of the travel agency to honor its liabilities is highly questionable, resulting in a double surcharge.

The working capital ratio is a direct measure of the solvency of a company; hence it weighs heavier than the equity ratio in the Icelandic Tourist Board’s assessment of the risk of insolvency or 2/3 vs 1/3 for the equity ratio.

Why is the equity ratio set at 20%?

Equity ratio is the second main indicator to assess a company´s future operability; that is how likely the company is to stay in business for the upcoming year at least (going concern).

A company with negative equity is technically bankrupt, and a company with low equity is not as well prepared to withstand operational difficulties as is a company with a healthier equity ratio. For this reason, the likelihood of a travel agency becoming insolvent increases, as a rule, in the case of low equity ratio and the likelihood of insolvency significantly increases whit negative equity.

Thus, the Icelandic Tourist Board considers it fair and equitable to base the assessment of risk-involved surcharge on the equity ratio as well as the working capital ratio. Hence the Icelandic Tourist Board determines a surcharge on the security amount of companies with equity ratio between 10,0 and 19,99% and double surcharge on companies with equity ratio below 10%.

The equity ratio weighs 1/3 compared to the working capital ratio when determining the risk induced surcharge since the equity ratio is a more indirect indicator for solvency than the working capital ratio.

Why does the working capital ratio weigh heavier than the equity ratio?

The working capital ratio is a direct indicator of the solvency of the security provider for the 12 months following the date of the balance sheet and hence is given the highest weight when assessing the need for increased security due to poor operations (weight 2/3).

The equity ratio is an indicator of the financial strength of the security providerIt has considerable effect on the risk of insolvency, but in a more indirect way. Thus, the weight of the equity ratio is less than that of the working capital ratio, when deciding the surcharge (weight 1/3).

Why are customer credits included?

Confirmation deposits and installments towards future package travel.
Customer credits resulting from current operations and are reflected in the information that travel agencies submit to the Icelandic Tourist Board are a part of the premises for regular assessment of security amounts (T) and do not have to be considered further. This includes confirmation deposits and payments (installments) for future tours.

Credits that travelers have chosen to hold instead of getting refunds for travel that has been cancelled or postponed.
Credits that travelers have chosen to accept for package travel or linked travel arrangements that will not be settled either by refund or travel in the current year, are added to the security amount regardless of whether the security is decided with a surcharge according to Article 10 of the Regulation.

It is the opinion of The Icelandic Tourist Board that the interests of the fund and its members are best served if liabilities, in the form of customer credits that travelers hold for package travel or linked travel arrangements that has been cancelled or postponed due to extraordinary and unavoidable circumstances and will not be delivered during the current year, are the responsibility of the individual travel agencies.

Example of surcharge with credits:

Example: VFH is below 1 and EFH is below 10% (both ratios are red)

Calculated GT = 32.000.000 (according to Article 7 of the Regulation)

Calculated T = 4.500.000 (according to Article 7 of the Regulation)

Both ratios are red, hence the surcharge percentage is 80%(GT-T) * surcharge percentage = (32.000.000-4.500.000) * 80% = 22.000.000. The surcharge amount is 22 million.

The surcharge is added to the T: 4.500.000 + 22.000.000 = 26.500.000 that becomes the final security amount.

In the case of credits as described above, e.g., ISK 6.000.000, the credits will be added to T + surcharge: (4.500.000 + 22.000.000) + credits (6.000.000) = 32.500.000.

In this example the security amount is set at ISK 32.500.000.

(GT-T)* surcharge percentage = surcharge amount

T+ surcharge amount = amount of securityIn the case of credits;

T+ surcharge amount + credits = amount of security.

What is the base security amount (GT) and what does it cover?

The base security amount (GT) is a measurement of the risks incurred involving pre-payments that have been collected and tours in progress in the event of bankruptcy or insolvency of the travel agency.

GT is meant to account for credits that are part of regular business operations in normal conditions. GT covers the payments that have been collected at any given time and the costs of the tours in progress.

What is the security amount (T) and what does it cover?

The security amount (T) is a calculated amount that is considered to be sufficient when operations are sound.

The security amount (T) is seen as a reduction from the base security amount (GT). Generally, the security amount is 12% of (GT) but can be as low as 3%. The percentage is based on the preceding year’s income that is subject to insolvency protection. 12% applies if the income subject to insolvency protection is below 300 million ISK, 3% applies if the income is above two billion ISK. In the light of experience, the reduction is higher for larger companies since the risk of bankruptcy decreases with increased operations.

How is the security amount determined when no surcharge is administered?

When determining security amounts the base security amount (GT) is calculated according to the rule: GT = G*N/30 + G*h + G*d/30 and the security amount (T) is calculated according to: T = a(V)* GT, which gives the security amount to be provided.

Base security amount:

• (G) base number, the average of income subject to insolvency protection for the two highest-income months of the preceding and current year of operation
• (N), average number of days from full payment until the start of package travel
• (h) average proportion of confirmation payments of the total payments
• (d) average duration of package travel in days

The above values are determined for the preceding and current year of operation.

Security amount:

Also, to be determined is the turnover (V) of the preceding calendar year that is subject to insolvency protection and the ratio (a).

The ratio a(V) shall be:

12% if annual turnover is less than ISK 300 million,

12% - 6% * (V - 300 million ISK.) / 700 million ISK if V is between 300 million ISK and 1 billion ISK,

6% - 2% * (V - 1 billion ISK.) / 1 billion ISK if V is between 1 billon and 2 billion ISK,

4% - 2% * (V - 2 billion ISK) / 3 billion ISK if V is above 2 billion ISK

The security amount becomes T = a (V) * GT.

The results of the preceding and current year are compared, and the higher figure shall be the amount of the security.

The amount of the security can never be below ISK 500.000.

Which travel agencies are subject to raised security- amounts?

Travel agencies that are subject to increased security are those with working capital ratio below 1,5 and/or equity ratio below 20% according to their annual financial report for the preceding year.

Customer credits that do not result from current, regular operations and will not be delivered or reimbursed during the current year must be fully secured.

Is it possible to apply for a reassessment of the decision?

Security amounts are decided on the documents submitted by the travel agencies.

It is important that the information provided is correct so that security amounts are determined on the correct premises.

It is possible to apply for a reassessment of the security amount if the financial situation of a travel agency has changed, the information provided was incorrect or credits have been delivered or refunded etc.

According to the Administrative Procedures Act - No. 37/1993, a party to a case has the right to have the case reviewed if the decision was based on insufficient or wrong information.

If the financial position of a travel agency has improved, it is possible to apply for a review of the decision. The request for review must be accompanied by an interim financial statement for the first seven months of the current year. The interim financial statement must be confirmed by a competent party.

If the amount of customer credits has changed, new information regarding the amount of credits can be submitted. The information must be confirmed by the managing director of the travel agency.

Requests for the review of the decision on can be submitted by e-mail to arlegskil@ferdamalastofa.is.

When is the deadline for providing a new security?

If the amount of the security increases a new security must be provided no later than September 1st each year.

When is the due date of the annual premium?

The due date of annual premiums is September 1st each year.