UK: Fraud In The Airline Industry - How To Plug The Gaps

Almost 148 million people passed through British airports last year¹ – many booked on e-tickets purchased online with credit cards.

Whilst this growth in self-service electronic bookings is encouraged by the industry which is keen to move to more cost-efficient e-ticketing, it places greater demands on airlines to ensure their IT is up to the challenge; and that internal and external IT systems are sufficiently robust to keep ahead of fraudsters.

Customers who provide numbers, addresses, security codes and other identifying information to companies need to know that their details are safe. However, as a recent global survey² into airline fraud reveals, credit card crime alone is costing each airline an average of £500,000 a year.

Weak IT security is blamed for a sizeable chunk of the total £1.5 million that the average airline is losing each year to fraud; a five-fold increase over the past six years. Low cost carriers, expanding rapidly in the UK, appear to be the hardest hit.

Even though some of this increase may be due to better detection capabilities, the rise in the level of fraud still makes dramatic headlines.

Whilst these losses of this magnitude may not be significant compared to the overall cost base, in the airline industry where margins are tight, they demand urgent attention. This is not to mention the potential impact upon company culture, employee performance, and customer service, all of which can be contaminated by unchecked fraud.

With the growing importance of protecting customer information and the need to comply with the Payment Card Industry Data Security Standard (PCI DSS) the importance has never been more obvious. The cost implications of a major breach and fraud occurring can result in organisations carrying the cost of remediation, the investigation required by the payment card companies as well as fines from acquiring banks.

At the end of this report, we will suggest three steps that UK airlines would be advised to take, in order to reduce the risk of fraud and to implement a more secure business environment.

Fraud-related losses have increased five-fold since 2000, with airlines suffering an average loss of at least £1.5 million in 2006 – £500,000 in credit card fraud. Most participants expect fraud to increase, or at least stay the same in 2007.

Many felt that airlines’ IT systems were not able to keep ahead of fraudsters, who were using constantly-evolving technologies to bypass internal and external controls.

Alarmingly, more than a third of fraud is discovered ‘by accident’; and more than 60% of airlines have neither an anti-fraud programme in place, nor perform regular risk assessments, tracking and recording of instances of fraud. Whilst 60% of airlines rely on internal audit to detect and handle fraud, they tend to have smaller internal audit teams than other comparable industries.

The dynamics of air travel have changed significantly since the last detailed review of fraud across the industry. Security risks, costs and regulatory requirements have all multiplied, and the market has become more competitive as traditional airlines, low cost carriers and industry newcomers compete to meet the increasing demands of record numbers of travellers.

The number of international passengers a year has passed record highs of 752 million (according to IATA estimates) and new airlines and more low cost carriers are competing to meet the demand.

According to the BAA, 147.7 million people passed through its airports last year, and this insatiable demand for travel is enabling low cost carriers to extend their networks.

Critically, technology has enabled airlines to interact with customers and suppliers in many more ways, as business conducted online has become the norm.

"In this fast-paced and highly-competitive environment, it’s not surprising that there are more opportunities for fraud," says Graham Pickett, Lead Partner – Aviation & Transport Services at Deloitte in the UK." This survey is therefore important in terms of understanding the risks, discovering the causes and identifying key steps that airlines could take to minimise them.

One of the most frequently mentioned reason for the growth in fraud is organised crime which is outside the control of airlines. None of us can do much to influence the way society is changing, but if airlines adopt more rigorous assessment and management of fraud, they can plug many of the gaps that are making them vulnerable today.

The average airline experienced 446 cases of fraud in 2006, with external fraud accounting for 413 of them. Although these included counterfeit or stolen tickets; cargo theft, false baggage claims, frequent flyer abuse and bouncing cheques, the main culprits were tariff abuse, cross-border ticketing, technology and web-based transactions, and credit card fraud.

More than a third of airlines have detected credit card fraud, which adds up to around 60% of all external fraud-related losses. Airlines based in Europe are among the most affected, which – given the high percentage of Europeans keen to use the Internet to search for and book flights – is not surprising.

Low cost carriers, who are major players in the European travel industry, are the hardest hit: their average losses from this type of fraud amounted to an average of more than £550,000, compared with an average of £450,000 for network airlines.

In recognition of the threats of online credit card abuse, the PCI DSS were introduced in June 2006. These data security standards were introduced following several incidents over the past couple of years where large companies, including some of the world’s leading banks, admitted that customers’ records had been lost or stolen.

All airlines which handle credit card data must adhere to these new security standards, and yet, according to the recent global survey, 24% of internal auditors said they were not aware of the changes or the implications for their business. Of those who were, 21% are already compliant with the new standards, 66% are taking action to become so, but 13% have no plans in progress.

Credit-card misuse is also an internal issue, as 20% of survey participants have experienced internal abuse of passengers’ personal details. According to 7% of internal auditors, there had been cases of employees stealing the identities of their airline’s passengers!

Looking at technology fraud as a whole, respondents have no doubts where the fault lies – IT security that cannot keep up with ingenious fraudsters.

Back in 2000, 44% of internal auditors thought that adopting new technology was putting their airlines at risk. This has grown to 67% and there is now a shared view that advanced technology is enabling abusers to bypass current control mechanisms.

The problem is exacerbated by the extended enterprise, whereby travel agencies and other third parties’ IT systems interface with the airline’s own system.

Far more business is conducted online today than was the case six years ago, particularly in the low cost market where airlines make it financially beneficial for passengers to book online. However, along with the rewards comes the increased risk.

As Graham Pickett comments: "Technology has done so much to help airlines cut their operating costs through customer self-service and online bookings, and it gives travellers easier access to information. The interactive approach can do a lot to improve customer relationships, but if new technology is not properly implemented and robust enough to deal with the risk of fraud, then airlines are losing control of their online business."

Low cost carriers bear the brunt of external fraud, as the average number of fraud cases for the low cost companies was over 1,000, compared to around 300 for the network carriers. Charter airlines, whose business model gives them the least contact with the mass market – have the least to worry about.

Trends follow the same pattern for internal fraud too, with low cost carriers impacted most and charter airlines the least. Inventory theft and frequent flyer abuse are the most common threats here, as well as employees’ misuse of passengers’ personal details.

Airline staff have easy access to personal and financial details of passengers, which are all presented during telephone bookings and when using the airline’s website. This presents fraudulent employees with more opportunities for theft, particularly where there is no anti-fraud programme in place – as is the case with many airlines.

The fact that 72% of airlines who completed the survey have no policy on fraud, 65% have no anti-fraud programme, 63% have no whistle blowing mechanism that would allow staff to report fraud, and 61% have no formal system to track fraud provide useful benchmarking figures for all airline executives.

Less than half of the airlines surveyed perform a frequent risk assessment. Of those that do, 39% carry out an annual check, but many internal auditors felt they did so with little support from the locations and across management as a whole.

When fraud is uncovered, only 21% of airlines have stringent procedures to follow that are consistent across the enterprise.

"The current assessment programmes are not comprehensive enough," says Graham Pickett. "Nor are the processes that should detect, report and track fraud. And when we asked who was responsible for the prevention, detection and investigation of fraud, IT security is not even in the picture. Clearly, with weak IT security being cited so often as one of the reasons for escalating fraud, there is an urgent need for the IT function to be brought into the team."

Currently, the survey suggests that the size of the internal audit department – which is relied upon by 60% of airlines to hold the front line when it comes to fraud – is a matter of concern. Across all businesses, airlines appear to have among the smallest number of people in their internal audit teams⁴. 64% of airlines have an internal audit department of between one and ten people.

Not every business issue can be solved with more people, but the level of staffing in this critical area and the inclusion of IT specialists does need further attention by most airline Chief Executives.

Internal auditors, according to the survey, have plans in place to tackle fraud. They intend to improve internal controls, by introducing whistle blowing processes and hotlines for example, and want to encourage a more open culture, supported by an Ethics Policy. They also propose tougher security checks on new employees.

However, this strategy does not really go far enough, nor does it tackle the big issues of technology, web-based fraud and credit card crime. It also needs the full support of all management before it can be effective – not just the lone internal auditor!

Deloitte has therefore defined three critical steps forward that will help airlines fight back against fraud.

• With credit card and Internet payment fraud escalating, IT security is on the front line.

• Internal controls must adapt to keep up with new technologies. The pace of technological innovation, while generally good for customer-focused businesses, has to be matched by robust controls across the enterprise IT systems.

• Compliance with the new PCI standards is vital. Customers will need to be reassured that this is in place, and IT security will need to facilitate it.

• Fraud risks must be assessed regularly, in the same way that any successful company will assess all the risks that could impact its profits and sustainability. Fraud risks need to be linked to controls, so management can be assured the right barriers are in place.

• Define a fraud policy and ensure all employees understand it, and their role in making it happen.

• Involve all relevant stakeholders – third party suppliers for instance, and increase the focus from senior management.

• Expand the internal audit team to ensure it has the capabilities and resources to match the risks. Ensure the team is fully-trained in fraud and that its scope and reach encompasses every aspect of the business. Make sure that internal audit reports to the right level of management which should be at the highest level.

• Put in place a whistle blowing, speak-up mechanism, so that anyone who suspects fraud knows where to go to report it.

• Create a central repository so that cases of fraud are recorded and monitored and can be escalated if necessary.

Lower oil prices have made many operators optimistic about future profitability, UK regional airports are expanding with the government’s blessing; and the country’s low cost carriers are particularly ebullient about the year ahead.

However, no company can afford to ignore an average loss of £1.5 million especially as the expected slowing of the UK economy and increasing household expenditure could put a dampener on people’s desire to travel.

There is a pressing financial need, then, to tackle the issue of airline fraud, which hits not only the balance sheets, but also raises the question of good corporate governance.

Legislative requirements and governance guidelines – as set out in the Combined Code, the Companies Act 2006 and Sarbanes-Oxley for instance – place the responsibilities for quality management firmly on the shoulders of company executives, and anti-fraud programmes are core to good governance.

Unchecked fraud, as we pointed out at the beginning of this report, can also have a knockon impact on employees’ behaviour and customer services, all of which can tarnish a company’s image.

With e-tickets costing airlines around a tenth of the paper version, operators are obviously keen to push more people onto their web sites, but they must ensure their IT infrastructure and business controls can cope.

Airlines need to comply with the new data security standards and should consider bringing the expertise of their IT security specialists into the anti-fraud team. These changes will not only cut losses through fraud, they will enable airlines to operate in a more secure business environment.

The airlines surveyed by Deloitte and the International Association of Airlines’ Internal Auditors (IAAIA) comprised network carriers, low cost airlines and charter firms worldwide. 44% of them were based in Europe.

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