How do airlines compensate for lost baggage?

I will speak out of my experience as an Airport Manager as well as as a head of Consumer Protection responsible for implementation of Air Passenger Rights.

Majority of the passengers do not know that airlines are bound to compensate passengers for the loss, theft and damage to the checked-in baggage. This has been mandated by various jurisdictions in line with Private International Air Law such as Montreal Convention 1999 or WARSA Convention 1929. Some States have not signed Montreal Convention 1999 as yet, therefore they follow WARSA Convention 1929.

Airlines tend to exploit on the ignorance of passengers and play down the compensation part as much as they can. in a recent survey only 1/3rd of the European passengers actually knew about air passenger rights.

WARSA Convention 1929 as amended by Hague Convention 1955 entitles passengers to the compensation for loss, theft or damage to the baggage at the rate of US$ 20 per Kg upto 20 kgs maximum. It is not based on the value of the contents packed in the baggage.

Then there is Montreal Convention 1999, the States that have signed and ratified this Convention pay upto 1000 SDR (Special Drawing Rights) for the loss, damage or theft of checked baggage.

An SDR is artificial basket currency of IMF. It is roughly equal to US$1.35, but its value keeps varying as the Dollar itself. Compensation, in this case, is not based on the weight of the baggage but its value. However, the value must not increase the limit of 1000 SDRs. If it does then it must be declared at the time of check-in. The airline may accept it after charging additional amount for the insurance.

The report must be made to airlines within 7 days of the missing or damaged baggage, which ought to be returned to the passengers within 21 days. Thereafter even if the baggage has been found, the compensation shall have to be paid in full.

Some jurisdictions have mandated that the airlines must pay some amount to the passenger an interim relief. This may be upto US$ 200 or more.