Drones Offer Risks, Underwriting Challenges
The increasing use of drones for commercial purposes has become one of the biggest emerging threats to the future of airplane safety, according to Allianz Global Corporate & Specialty (AGCS).
The expected rise in the use of drones or unmanned aerial vehicles (UAVs) for a host of different applications may leave operators exposed to a whole new set of risks, including third-party damage or injury and liability, according to AGCS’s Global Aviation Safety Study.
One of the biggest risks, it said, was from radio frequency interference, resulting in loss of control, and, in the worst cases, fatalities.
Other problems include invasion of privacy, aerial surveillance and data collection.
“With the ability to collect massive amounts of unsolicited data, UAVs present an enormous threat to individual privacy and a significant challenge for insurance carriers,” said Vikki Stone, senior vice president at Poms & Associates Insurance Brokers.
“In drafting policies, it is crucial for carriers to know how such information will be used,” she said.
The production of UAVs has increased by double-digits year-on-year since 2007, according to AGCS, with applications ranging from news gathering and surveillance to sporting events and crop dusting.
The benefits are obvious — the vehicles are smaller and generally easier to operate, particularly in hazardous environments, as well as have lower maintenance and running costs than conventional aircraft.
Such has been the take-up that the Federal Aviation Administration (FAA) estimates that by 2020, there will be about 30,000 small commercial unmanned aircraft in our skies.
However, coverage is limited, with only about 21 insurers and those that do offer policies have been hampered by a lack of historical and analytical data, the study said.
“Annual utilization, number of accidents and repair costs are not readily available and unmanned aircraft are not presently flying at the rate that they will be in the near future in the national airspace,” the report said.
Another problem is that, despite FAA plans to integrate UAVs into the U.S. airspace in 2015, there is a “lack of international, regional and local regulations for the safe operation of UAVs,” said Henning Haagen, AGCS’s global head of aviation EMEA and Asia Pacific.
Stone said that the No. 1 concern among carriers was the lack of certification of UAV pilots. That lack, she said, makes it prohibitive to get any kind of coverage at all.
“I think the bigger problems are going to be the people that don’t follow the guidelines required, so ultimately we’ll end up a number of rogue flyers out there — that’s the scary part,” she said.
Peter Schmitz, CEO of global aviation specialty at Aon, outlined other major risks of drones.
“The biggest threat is clearly the taking down of a major aircraft in a mid-air collision,” he said.
“The second issue is the application of these vehicles in urban areas where the risk of damage to properties and individuals is much greater than it would be in rural parts.”
David Williams, assistant professor of aerospace and occupational safety at Embly-Riddle Aeronautical University, said the scale of the damage caused by a mid-air collision was almost incomprehensible.
“These units [UAVs] would cause catastrophic damage if they were to collide with an aircraft,” he said.
Schmitz said that regulatory authorities across the world face an uphill task in getting to grip with these issues because UAVs are still a relatively new and unknown quantity in terms of repair costs and loss ratios.
“I think that a couple of years down the road, the FAA will have a much clearer picture of the types of risks involved and will be better able to police these kind of aircraft,” he added.
Patton Kline, senior vice president in Marsh’s aviation and space group, said another issue facing carriers was insuring the value of the whole asset.
“From an underwriter’s view,” he said, “the biggest perceived risks are both on the liability side as well as insuring the whole value of the asset, which tends to be much more difficult as there are a whole range of platforms, many of which are still unproven.
“There’s also a lot of debate right now about whether underwriters are going to step up to cover things like privacy and it’s likely that even if they do, we’ll continue to see exclusions in policies for these types of losses.
“Another big issue we foresee is in products liability, with litigators going after large manufacturers of drones with deep pockets in the event of any future accidents.”
Kline estimated that, while losses from UAVs were still in the “small single digits,” rapid year-on-year growth means that number is expected to expand in future years.
Stone added: “I think we’ll see more carriers throw their hat in the ring and because the pricing is so competitive at the moment; often the only way to distinguish yourself is through enhanced coverage forms.”
A recent government white paper reported that the increased use of unmanned aircraft by the U.S. Air Force had resulted in a dramatic rise in the percentage of non-combat accidents ending in death, permanent total disability or damage of at least $1 million between 2003 and 2013.
Of those 75 accidents, UAVs accounted for about 21 percent. By 2011, that figure had increased to 50 percent, however, it has improved over the last two years.
The AGCS report also said that, while technical advances have reduced the risk of dying in a plane crash, the reliance on computers has left the industry open to the threat of cyber attacks.
“Cyber terrorism may replace the hijacker and bomber and become the weapon of choice on attacks against the aviation community,” the report said.
The study said that less than two out of every 100 million passengers died on commercial flights this year, compared to 133 deaths in the 1960s.
But despite improved safety, the cost of claims is still rising, driven by the widespread use of new materials in plane design, as well as tighter regulations and increased litigation, the report said.
AGCS also estimates that the insured value of airline fleets will climb to more than $1 trillion in the next five years, from less than $900 billion this year.
Professional Liability Challenges
Rates in the professional liability market are coming under increased pressure as a result of overcapacity and greater competition, with industry experts warning of dire consequences in the long term if it continues.
Among the areas hardest hit are directors’ and officers’ (D&O) and medical professional liability (MPL).
John Lopes, vice president of programs at Freedom Specialty Insurance, said overcapacity posed the biggest threat to insurers in the short and long term.
He said new entrants and smaller players would find it hard to build profitable scale without a competitive advantage other than price, and those who succeeded would likely do so at the expense of existing providers.
“Either way, the longer term issue is one of market saturation and fragmentation,” he said. “This will put pressure on pricing and profitability until market forces break the cycle.”
Christian Gravier, president of professional lines at Allied World North America, said that rates and terms and conditions for public D&O and side A difference in condition (DIC) were under the greatest pressure from increased competition and capacity.
“Sustained profitability of the product has made it extremely attractive and hence capacity is drawn to the line and rates have seen, in some areas, a precipitous drop,” he said.
Gravier said the increased use of capacity by competing insurers was causing disruption in some of the bigger markets, with larger limits of $25 million and $50 million becoming more prevalent.
Jeff Klenk, senior vice president of bond and financial products at Travelers, however, said that despite the surfeit of capacity, some more specialist areas had experienced rate increases.
“Capacity continues to be plentiful and the state of competition is very risk-specific,” he said.
“In those lines of business that have had more challenging results, or on accounts with more complex risks, we have seen rate increases.”
But it’s really cutting-edge sectors like cyber and privacy liability that are offering the most potential for growth as companies realize the extent of their exposure to data breaches and attacks, and brokers gain a better understanding of the product.
Chris Duca, senior vice president at RT ProExec and 2014 president of the Professional Liability Underwriting Society (PLUS) — which will be hosting its annual conference in November — said that alongside cyber, errors and omissions (E&O), and D&O lines in privately held as well as publicly traded and initial public offering (IPO) corporations offered the biggest growth potential.
He added that there was also increased demand for management, professional and health care liability, and MPL.
D&O is one of the biggest professional liability markets by premium volume. It’s estimated to be worth $6 billion in the U.S. alone, according to Allianz Global Corporate Specialty.
But despite the sector’s size and success, it has not been without its problems, stemming largely from the increase in claims after the 2009 financial crisis.
Damian Brew, national practice leader, FINPRO claims, at Marsh, said the biggest challenge facing D&O brokers is getting clients interested in new products.
A prime example, he said, was the level of cover D&O policies provide for entity investigation costs, in light of the Securities and Exchange Commission’s (SEC) renewed focus on company investigations.
“From that standpoint, many of those costs can be covered under a D&O policy,” he said, “but there are times when they fall outside of that coverage, and as a result we are now seeing more insurers offering specific cover for entity investigation costs.”
Medical Malpractice Risks
As a sector, medical professional liability accounted for $7.7 billion in premiums in 2013, according to A.M. Best, making it the No. 1 professional liability market by size.
Best’s August 2014 market report said that MPL underwriting and operating returns continued to outperform most of the property/casualty industry in 2013, despite the soft market.
It attributed that success to improvements in tort reform, better patient safety, a greater emphasis on loss mitigation and risk management, and more aggressive legal defense tactics.
SNL Financial, meanwhile, reported that despite MPL premiums continuing to fall in 2013, losses also declined to $4 billion in 2013 from $4.17 billion in 2012. The bulk of the drop in written premiums was in coverage for physicians, which fell to below $6 billion in 2013 from $7.18 billion in 2008.
“Medical professional liability is still the largest professional liability market by size.”
However, cover for other health care professionals grew to $1.2 billion in 2013 from under $1 billion in 2008.
Despite its relative success, the market remains highly sensitive to any price changes, one industry expert warned.
Robert Allen, president of Pro-Praxis Insurance, said, “All it takes is for one company to underprice the business and it has an effect on keeping pricing suppressed for the next year, raises the expectations of brokers looking for the best deal for their clients, and therefore makes it even harder for us to collectively move pricing to the right level.”
However, he added that there were areas of opportunity for growth, namely allied health facilities such as physical therapy and convenient care clinics, which have expanded at a phenomenal rate since the introduction of the Affordable Care Act (ACA).
“The growth in that space right now is just amazing,” he said.
Elke Kirsten-Brauer, executive vice president and chief underwriting officer of the medical liability division at MGIS Cos. Inc., said the MPL industry continues to face a multitude of challenges, including new patient populations entering the marketplace for insureds, and an increasing number of older patients with more complex illnesses.
Uncertainty surrounding tort reform in different states, a rise in vicarious liability claims and the heightened risk of cyber and privacy breaches add to those issues, she said.
As a result, she said, the industry needs to look at how it assesses and rates new liabilities and exposures.
“The insurance industry needs to look at data and tools from the past and make sure it revises and refines its approaches for the future,” she said.
Emergence of Cyber Liability
The hottest area in professional liability is undoubtedly cyber and privacy liability.
Philadelphia Insurance Cos.’ senior vice-president of underwriting, Ziad Kubursi, said that cyber liability was the main driver for demand in professional liability because it affected almost everyone.
Marsh’s Brew, meanwhile, believes the market will grow exponentially over the next five to 10 years as more insurers look to write the business and gain access to better loss history data.
“I think everyone is waiting for the next shoe to drop,” he said.
“It’s an exciting area where we have seen a lot of growth and I would expect to see more growth.”
Jim Whetstone, senior vice president and professions practice leader at Hiscox, said that companies were increasingly adding cyber and privacy data breach to their general professional liability policies to protect themselves against these new risks.
“We have seen increased demand for cyber and privacy cover as more brokers understand the product now and are able to explain it to their clients,” he said.
Impact of Legislation
Another big growth area is franchisors’ liability, which covers franchisers against lawsuits brought by franchisees.
Earlier this year, the National Labor Relations Board (NLRB) ruled that McDonald’s can now be considered a “joint employer” and held liable for the employment practices of its franchisees.
Peter Taffae, managing director at ExecutivePerils, said the ruling could have far-reaching implications for all company employment practices.
“The majority of franchisees don’t want to be told how to hire their employees or what to pay them because they are all independent businesses that operate on their own,” he said.
“What’s happened from an insurance E&O perspective is that some providers are now pulling back from offering this kind of cover and others are not offering it at all, meaning that prices are going up across the board,” Taffae said.
Planning for the Future
These are worrying times if you are the owner or principal of an independent agency and broking firm.
A recent survey by Reagan Consulting found that nearly six in 10 (56 percent) agency principals are 55 or older, meaning that most will probably retire in the next 10 years.
But according to the newly elected chairman of the Independent Insurance Agents & Brokers of America (IIABA), David Walker, many of them have no succession plan in place.
One of Walker’s first tasks in his new role will be to help IIABA — the Big “I” — draw up a long-term strategic plan to tackle the issue.
“I think the average agent nationwide is struggling with perpetuation and the process for them to continue their company moving forward,” he said. “It’s really a question of how do we attract and put in place the new talent that will succeed us as the company leaders of the future.”
Walker warned of the consequences of not addressing a succession plan until it’s too late.
“If this succession plan isn’t in place, then in most cases the only solution is to merge or sell the business,” he said. “You can’t wake up two or three years before you’re going to retire and say, ‘Wow, how am I going to monetize this great asset I’ve got and how do I perpetuate the business if I don’t want to sell it?’ ”
The onus, Walker said, is on trade associations like the IIABA to help provide the necessary structuring and financing tools for owners who want their businesses to live on after they step away.
Bob Rusbuldt, president and CEO of the IIABA, described Walker as a “true leader” of the U.S. independent agent and broker community.
“David is incredibly articulate and a great communicator, and he has a real vision of where he wants to take the independent agency and broker system,” he said.
Opportunity and Growth
And where he wants to take the system is to a larger focus on recruiting, doing more to entice young new talent in the door.
“We have got to show the young people of today what a great opportunity it is to be in this industry, particularly if you are an entrepreneur who wants to get out there and prove yourself and be in control of your own destiny — the sky’s the limit,” he said. “But we have got to do a better job of communicating that message and getting them engaged with it.”
As part of that communication effort, Walker is a national faculty member for the CIC Agency Management Institute and The National Alliance Agency Management institutes throughout the country, said Darelle White, senior academic director at The National Alliance for Insurance Education and Research.
“In addition to serving as a CIC faculty member, he currently serves on our Agency Management Institute curriculum advisory committee,” she said. “His commitment to continuing education for himself and his students is a model for other instructors.”
One potential lure for new talent, Walker said, has been the launch of new cutting-edge products, such as cyber liability coverage.
“Right now, we’re only just starting to scratch the surface and figure out the exposures and losses in areas like cyber liability,” he said. “And I believe progressive new products like that are going to be real areas of opportunity for growth for agencies going forward.”
However, one of the challenges for brokers outside of recruitment and retention, Walker said, is getting a handle on — and pricing accordingly — catastrophe losses, which have increased dramatically over the last 10 years to 15 years.
“I think we have got to be wary of the fact that often we tend to be over-sensitive on the pricing side of the business,” he said. “As an industry, I think we have really got to start looking at the credibility of our pricing and not react so much when we are somewhat profitable, but instead look at what we should be doing in a 10-year timeframe, rather than a three-to-five-year one.”
It’s also been a challenging time on the legislative front, Walker said, with brokers waiting anxiously to see whether the Terrorism Risk Insurance Act (TRIA) will be reauthorized by the end of this year.
“One of the main concerns from the agency and broker perspective,” he said, “particularly for license renewals on medium to larger-sized accounts that have happened since the start of this year, is that we don’t know what that reauthorization will actually look like.”
The IIABA is also keen to see the National Association of Registered Agents and Brokers Reform Act (NARAB II) enacted by Congress, said Walker. That law would provide a one-stop licensing system for agents operating outside of their home state, while maintaining state regulatory authority.
Walker was introduced to insurance broking in 1981 by his father-in-law Richard Bayer, following a brief stint at Guarantee Mutual Life. Bayer had just started his own agency, Hartland Insurance Agency, in Hartland, Mich., and was looking to get it off the ground.
Walker started as a personal lines producer, selling home and auto insurance and swiftly moved up the ranks to president and principal, eventually taking over from his father-in-law, who passed away in 1992.
“I thought I might go back to school to do an advanced degree, but decided to try insurance broking for a couple of years and I’m still experimenting with it 33 years later,” he said.
Today, the agency has four offices nationwide and 37 employees, and it’s still growing, according to Walker.
During the time it’s taken to build the business, Walker has seen some big changes, most notably the advent of technology.
“We no longer have IBM Selectric typewriters and carbon paper — now everything is completely digital,” he said. “Twenty years ago, we had a large filing cabinet room, but now pretty much everything is stored digitally.”
While his own company’s transition to digital has been relatively smooth, Walker said, some brokers are still struggling with technology, and in many cases they are playing catch-up.
“In the 1970s and ’80s, when you wanted to get Special Multi-Peril (SMP) quotes [the forerunner to today’s commercial policy], if you had 10 insurance companies, you had to fill out 10 different applications, submit them in the mail to those companies, wait for their responses and then negotiate the pricing with the underwriter, before going out and selling them the account,” he said.
“If you fast-forward to today, since the advent of ACORD (Association for Cooperative Operations Research and Development), we have got the same problem, except this time instead of, ‘How many SMP applications do you have to fill out?’ it’s, ‘How many websites do you have to go onto to get those quotes?’
“In that respect, we have probably gone a bit backwards.”
Walker, who specializes in commercial insurance, was elected to the IIABA executive committee in September 2009.
Madelyn Flannagan, vice president of agent development, research and education at the IIABA, said that Walker has been active in the organization as well as a business community leader at the state and national level.
“Nationally,” she said, “David Walker is a recognized educator and advocate of the independent agency system whose leadership extends to his participation in continuation education efforts and the classroom.”
Rusbuldt said, “I like to call him the professor because of the great teaching work he does and he’s also a highly sought after speaker, as well as being a very successful business owner in his own right.
“I have known David for almost 20 years now and I can honestly say that he has the perfect skill set to be the chairman of our association.”
Walker also represents the state of Michigan as a board director on the IIABA national board of directors and serves on the IIABA professional liability committee and the IIABA advantage board. Previous to his current role, he was vice-chairman of the IIABA in 2012.
In the meantime though, he’s got plenty on his plate at the IIABA.
For the next 12 months at least, he’ll be focused on the task at hand of helping agencies to secure their future leadership and to unearth the next generation of brokers.