Bankruptcy fears: Why your miles are safe

The airlines have started posting their Q2 results, and the outlook is quite bleak. AMR Corp has just posted a $390 million loss, with the other legacy carriers expecting to announce losses as well. Analysts are expecting bankruptcy filings to occur by winter if economic conditions do not improve, with American, United, and US Airways being the most likely contenders. The airlines are going through their worst crisis yet, and I would be surprised if by the end of 2010 there are still five legacy carriers in existence.

But what does this mean if you've collected a lot of frequent flyer miles with a doomed carrier? This article suggests that your miles are in serious risk. I, on the other hand, completely disagree. Sure, there's a slight possibility that all your miles would be completely worthless if your preferred carrier were to bite the dust. But it's not very likely, and I wouldn't lose sleep over it.

Here's why:

For one thing, frequent flyer programs are a significant revenue stream for the major carriers. Besides the obvious customer loyalty that these programs generate, the airline industry makes billions of dollars by selling their miles to credit card companies, hotel chains, car rental companies, etc. In fact, airlines have formed more or less a symbiotic relationship with credit card companies, to the point that one will not let the other go under: Ever seen those kiosks at major airports with people trying to get you to sign up for airline-affiliated credit cards? For many banks, these credit cards are among their most profitable products, and to continue offering them, the airlines need to stay afloat.

Also, from 2002-2006, we've seen four major airlines (US Airways, United, Delta, and Northwest) file for Chapter 11 bankruptcy. Under reorganization, these airlines had to make a number of changes: route frequencies were reduced or eliminated, service cuts were made, employees were laid off, labor contracts were renegotiated, etc. But the frequent flyer programs were virtually untouched. After all, why get rid of the only part of the business that has consistently been profitable?

The real cause for concern is if a carrier were to file Chapter 7 bankruptcy (liquidation). In this case, yes, there is a possibility that your miles will be rendered worthless. But even then, there's still a good chance of another airline stepping up to honor the frequent flyer program of the failed carrier, which is exactly what American Airlines did when TWA went belly up years ago. The legacy carriers each have tens of millions of customers in their respective loyalty programs; if one were to go under, its competitors will almost certainly take measures to pick up all these new potential customers.

Now, does this mean that you should be hoarding your miles? Absolutely not. It would be foolish to "save" miles as you would any other currency; you can't accrue interest on them or expect them to appreciate in value. If anything, miles devalue, particularly when airlines increase the number of miles needed to book award tickets. So if you have miles, spend them. But even then, if you have fears that your hard-earned points are going to be lost, there's really little to worry about.

That said, if United were to file Chapter 11 bankruptcy tomorrow, I would not be terribly worried. In fact, there's usually a bright side: airlines tend to have the most generous miles promotions during Chapter 11. I'll have a contingency plan, of course, and prepare to have my status matched with another carrier if things continue to look dire. But other than that, business as usual as far as I'm concerned.