Uncharted Territory

Challenges to insuring commercial drones.

September 20, 2016 Photo

They are often seen flying around the park or buzzing across a neighbor’s backyard. Recreational drones flown for private use quickly are becoming ubiquitous, with nearly a million units having been sold by the end of 2015—and it’s only just taking off. Now the public is facing the prospect of deliveries, private security surveillance, and untold other potential applications in a wave of new commercial drone operations, which is raising serious questions for insurers.

In June 2016, the Federal Aviation Administration (FAA) released its final rules regarding the commercial use of drones weighing less than 55 pounds. Until these regulations were approved, the FAA was authorized under Section 333 of the 2012 FAA Modernization and Reform Act to grant exemptions for commercial drone operations only on a case-by-case basis, with the first exemption being granted in September 2014.

Before 2016, the FAA issued more than 5,300 such exemptions for a variety of uses, ranging from photography businesses to agricultural operations. The FAA has since stated that, in allowing commercial entities to begin using drones in their operations, the final rule “could generate more than $82 billion for the U.S. economy and create more than 100,000 new jobs over the next 10 years.”

But as businesses begin incorporating drones into their operations, business leaders face a difficult question: How can drones be used to help grow business without harming bystanders and customers? Companies need to reduce the risks of drone use and protect themselves in the event of an accident. For many businesses, an optimal way to mitigate such exposures might be to transfer some of that risk to an insurer. 

Questions of Liability

Drone liability is, in some ways, uncharted territory. But the implications of drone liability can be expressed with an analogy to auto insurance. Most automobile operators purchase auto insurance—whether prompted by state law or their own aversion to risk—to transfer some risk of an auto accident to an insurer. Following an accident, many drivers would attest to the benefits of having such liability coverage.

A similar situation might arise with respect to drones and their operators. For example, FAA rules require visual line of sight (VLOS), in general, between the pilot-operator and drone. As a result, some insurers could view the drone pilot as a crucial underwriting consideration, just as an automobile driver is typically a significant factor when underwriting an auto policy. After all, the driver brings an element of experience to the operation of a vehicle that usually becomes an important factor during the underwriting process. Will insurers begin to treat drone pilots in a similar way? Will flight hours logged and accident history become crucial factors for predicting future losses?

However, if the FAA expands its rules in the future, the analogy with auto insurance could end. Drone technology already has advanced beyond VLOS, with some drones capable of operating beyond line of sight. Some drone manufacturers are now producing drones with automatic crash avoidance systems and autonomous flying features. Insurers can expect the importance of the pilot to perhaps decrease as underwriting considerations such as technology look to take over the driver’s seat.

Coverage Conversations

Even if that is the case, though, drone liability implications could go beyond the owner-pilot/drone relationship. One rarely considered drone exposure doesn’t necessarily pertain to the owner-operator at all. Rather, it pertains to organizations that may unknowingly face exposures related to drone operations without owning or even using a single drone.

Consider the scenario of a grand opening of a family restaurant with a rooftop bar and outdoor lakefront seating on a beautiful summer’s evening. To drum up as much publicity for the new restaurant as possible, the owners invite local press to cover the opening. The owners also invite press photographers to capture breathtaking shots of the restaurant’s rooftop bar and lake by encouraging them to use drones to take pictures.

Taking the restaurant up on its invitation, one overzealous press photographer flies his drone too close to a group of patrons enjoying the rooftop bar. The drone lacerates the cheek of one patron before spinning out of control, knocking over an elderly woman. In the aftermath, the first patron receives stitches for his injury, and the elderly woman needs a hip replacement.

In this scenario, could the restaurant be held liable for the injuries of its patrons as a result of the drone accident? By inviting the press to use their drones to take pictures, did the restaurant inadvertently expose itself to some potential liability related to drone activity without conducting a single drone operation—or even owning a drone? And does an insurance agent typically ask if a family restaurant allows drones to operate on its premises? These types of questions may prompt drone coverage conversations.

In short, the proliferation of drones used for commercial purposes or in commercial settings likely will pose many challenges to insurers and risk managers alike. Suddenly, other organizations and entities could become exposed to drone hazards. Who, after all, could have imagined a family-owned restaurant had drone exposures when the restaurateurs do not fly drones themselves?

Potential for Property Damage

Let’s reshuffle the scenarios outlined in the liability discussion. From the property insurance perspective, the lakeside restaurant is now the opulent setting for a wedding reception, replete with a wedding photography team using several drones. One of the drones exhausts its battery as guests dance on below, falling from the sky and damaging a large gazebo, tables, and expensive dinnerware.

Under most standard property insurance, the scenario of damage to insured property on the ground that is caused by a falling aircraft is addressed by the insured peril of aircraft. (An analogous situation is an auto crashing through a storefront, as addressed by the peril of vehicles.) There are, of course, differences between the exposures created by falling airliners or runaway autos and those anticipated to be created by drones.

As drone use proliferates, frequency of accidents almost certainly will be higher than that of falling airliners and errant autos. But severity of property losses on the ground should be lower in comparison, at least while commercial drone use is limited by the FAA to drones weighing less than 55 pounds (although a 54-pound drone falling from up to 400 feet can be expected to inflict significant damage). The most likely types of property to sustain losses include roofs, plate glass, poles, trees, landscaping, and property in the open. In addition to damage by impact, there is the possibility of a burning drone igniting a fire. In that scenario, losses could mount.

Let’s get back to our harried restaurateur who is hosting the wedding reception. As is the case with virtually any first-party property loss, the issue of business interruption must be considered. Most standard business interruption policies address the same perils as first-party property damage insurance, but many businesses do not carry such insurance and may, therefore, be exposed to uninsured lost income and extra expenses. Let’s hope our restaurateur has business interruption insurance.

Now let’s examine the role of property insurance from the perspective of the wedding photographer, who owns the photographic equipment as well as the fallen drone. The photographer might have first-party insurance in the form of commercial property coverage and/or inland marine coverage, in part depending on whether the business includes a brick-and-mortar studio, the frequency of work conducted outside the studio, and the value of the photographic equipment. Using drones likely is a fairly new venture for the photographer, who may not have considered the insurance implications. Generally, commercial property policies and inland marine policies do not cover damage to aircraft, which traditionally is the province of specialty insurers.

But is our wedding photographer likely to seek specialty insurance such as a hull policy? The value of several small drones likely is far below the values and level of complexity found in most manned aircraft, although the specialty insurance sector has reportedly been active in developing products for certain unmanned aircraft. Yet the relatively low values of today’s commercial drones and those expected to be used in the imminent future for commercial pursuits could translate into an opportunity for commercial property and inland marine insurers to enhance such policies. The damage exposure to the drone is one for which certain policyholders would likely welcome coverage under their property or inland marine insurance policies as a convenient solution to a significant need. And just as the restaurateur could suffer business interruption when the photographer’s drone falls from the sky, so, too, could the photographer. 

For an insurer considering the launch of first-party property and business interruption coverage for drone operations, certainly it can be a challenge that involves an educational process for the underwriting and claims staff. For example, there are many models of drones, some with features that might mitigate the potential risk of loss. These include sense-and-avoid technologies and the capability to hover or “return to home” in the event of a lost GPS link between the drone and its remote control station.

There also are new perils to recognize and consider. Collision is an obvious risk, but potential causes of that peril must be evaluated, including exhaustion of battery, pilot error, weather conditions, and obstacles in the path of the drone.

Certain other perils also take on a new character, especially where cyber activity and drones intersect. Numerous articles in the general and trade press warn of the vulnerability drones face when it comes to hacking. That risk translates to potential for events such as diversion of the drone from its intended flight path, theft of the aircraft, or theft and corruption of electronic data generated in the course of drone operations, which could potentially raise both property as well as liability considerations.

Insurers also need to consider whether a drone is equipped with real-time information to enable the drone to avoid restricted airspace, such as that provided by the B4UFly application available for free from the FAA. Drones straying into restricted airspace are susceptible to takeover by antidrone defense systems that reportedly are now being deployed in an effort to address possible interference with passenger flights and the specter of terrorism.   

Embracing new technology and creating insurance solutions can be daunting, made more so by the fast pace at which new technology evolves. Like the metamorphosis of computers a generation ago, drones are gaining in sophistication, a trend that could complicate underwriting and claims handling, including valuation and detection of fraudulent claims. But insurers historically have adapted their policies to the changing needs of commercial enterprises and the attendant risks. Such adaptation is critical to helping organizations, including insurers, thrive.

About The Authors
Multiple Contributors
William Mauro

William Mauro is director of commercial casualty product development at ISO, a Verisk Analytics business. He has been a CLM Fellow since 2016.

Loretta Newman

Loretta Newman, CPCU, is a principal in commercial property product development at ISO, a Verisk Analytics business. She has been CLM Fellow since 2016. 

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