A Bird’s Eye View
Unmanned aerial vehicles (UAVs) — aka drones — are an integral but polarizing part of 21st century life.
The benefits are well-known: whether used as a tool or a toy, miniature remote-controlled aircraft equipped with high-resolution cameras can provide stunning aerial shots as well as photograph hard-to-access areas, which explains their increasing popularity with both consumers and businesses.
Drones are also inexpensive. Starter kits cost only $75 to $150 and cheaper four-propeller drones typically sell for $600 to $700. Sophisticated models with cameras can run to about $3,500. But the pricing continues to drop while the optics packages steadily improve, said Grant E. Goldsmith, vice president of Avalon Risk Management and president of its overwatch division.
“Many new drones have 4K cameras, which are really nearly Hollywood quality,” he said. “It is really the drop in price point in good optics that is making them more practical to many kinds of users.
“All drones are subject to loss and damage in a hard landing situation but at $3,500 they approach the level of ‘disposable aviation’ assets for many users.”
However, growing demand is accompanied by increasing disquiet over the “nuisance potential” of drones to violate privacy and cause accidents, particularly when used in proximity to aircraft. Idaho-based Snake River Shooting Products recently launched the “drone munition” — a shot shell containing steel ball bearings that fits a 12-gauge shotgun, for customers seeking to repel the “Drone Apocalypse.”
These concerns haven’t prevented companies from seeking Federal Aviation Administration (FAA) authorization to use drones for commercial purposes. As Risk & Insurance® reported in April, four insurers — American International Group Inc., Erie Insurance Group, State Farm Mutual Automotive Insurance Co., and United Services Automobile Association — were among 125 companies submitting successful applications.
Applicants also included corn processing giant Archer-Daniels-Midland Co, which got the go-ahead to use drones for locating and assessing crop damage to accelerate claims processing. The company plans to start employing the technology during 2016.
Pennsylvania-based Erie Insurance said that FAA approval would enable the company to offer policyholders an improved service, yet retain the personal touch.
“We see drones as high tech meets human touch,” said Gary Sullivan, the company’s vice president of property and subrogation claims.
“Drones will help our claims adjusters get an early look at potential damage without putting themselves in harm’s way due to unsafe conditions, such as on a steep roof or at the site of a fire or natural disaster,” he said. “The sooner we can get in and assess damage, the sooner we can settle claims and help make our customers whole again so they can move on with their lives.”
At State Farm, spokesman Jim Camoriano said that employing drones is in line with the insurer’s work with vehicle manufacturers to advance airbag and seatbelt technology.
“Our use of unmanned aircraft is another example of State Farm’s commitment to the use of technology to better serve our customers. So far, feedback from those outside the industry continues to be optimistic on the potential benefits of using this type of aircraft.”
Since gaining the FAA’s approval to test and use drones as part of its commercial operations, State Farm has been engaged in flight testing UAVs at private test sites near its corporate offices in Bloomington, Ill. As yet, the insurer hasn’t determined a date for test completion.
Camoriano acknowledged that press coverage raises several questions regarding the use of the technology, but said that concerns arise mostly from recreational use of UAVs.
“We consider customer privacy one of our top priorities, and our use of this technology will adhere to all applicable laws and regulations to ensure consumer privacy,” he said.
Waiting on the FAA
Reports on UAVs’ potential usually mention their usage in the wake of disasters, to provide high-resolution images while accessing areas either too dangerous or inaccessible for manual inspection. A recent example cited is the explosions at a Chinese chemicals warehouse in Tianjin on Aug. 12. Footage shot from a drone shortly afterward vividly captured the extent of the damage.
To date, the reality for U.S. firms has been less dramatic, said Matt Ouellette, owner of Indiana claims service Ouellette & Associates and 2015-16 president of the National Association of Independent Insurance Adjusters (NAIIA). His firm uses drones mainly for commercial building inspections up to 300 feet above ground level and in the immediate aftermath of intersection vehicle collisions to assess the impact.
“Before we go to the expense of renting a boom lift, which costs around $1,500, we can use a drone for no more than $200 to $300 plus the adjuster’s fee for a preliminary inspection to ascertain the cause of damage and whether it is covered by insurance,” said Ouellette. “In some cases, it results merely from poor maintenance of the building.
“A fixed-wing drone flying over an area hit by hurricane or tornado can map out the area as a whole and provide insurers with valuable information on their likely exposure and how many of their insureds have suffered loss or damage. They can home in close and get good pictures.
“You can get FAA approval via a Section 333 exemption, which many businesses are applying for and getting these days. But the majority of drone operators likely operate without FAA approval.” — Grant E. Goldsmith, vice president of Avalon Risk Management
“We use four-prop hovercraft drones rather than the fixed wing variety for our commercial buildings and intersection accident inspections. They’re less expensive than fixed-wing, the latter being the type to which the FAA pays most attention.”
While insurers recognize the benefits of using drones for post-catastrophe inspection, they haven’t actually started using them, he added.
One obstacle is that the FAA’s readiness to exempt companies from the ban on commercial drone use isn’t yet accompanied by regulations setting out guidelines as to what work is and isn’t acceptable.
The FAA, said Avalon’s Goldsmith, “hasn’t yet published its rules for small drone usage with the national airspace, and these rules will likely not be published until 2017, so the interim period will continue to see a growing number of commercial users dodging both the FAA and local regulations at the state and city level while flying for business purposes.
“You can get FAA approval via a Section 333 exemption, which many businesses are applying for and getting these days. But the majority of drone operators likely operate without FAA approval.”
Ouellette said that in the absence of such clarification, some carriers are holding back from using drones themselves or authorizing their use by claims adjustment specialists.
“The passage of any legislation is likely to prove complex as many different parties need to be considered. The aim is for regulation that’s useful and not overly stringent.”
“I assume that many insurers are waiting for the dust to settle on the privacy and regulatory concerns before fully embracing drone technology,” agreed Stephen L. Brown, owner and president of Baton Rouge, La.-based Brown Claims Management Group.
“As an independent adjusting firm, we have had several insurers inquire about using our drone to assist in the inspection of roof claims.
“But it seems that it comes mostly from a place of curiosity, from the standpoint of seeing just what type of imagery this technology can produce in contrast to that generated by more traditional means.”
Brown also struck a note of caution on whether insurers could extend the use of drones beyond investigating catastrophe and hard-to-access risks to include more routine work.
“They could be, but to be honest, the small drones that we use are not easily flown in anything less than optimum weather conditions or where obstructions are nearby — and so we still only use them in a small percentage of investigations and inspections.”
However, there are some applications beyond property losses — specifically general liability and transportations losses — where aerial video can be a tool in documenting the scene of the accident, Brown said.
No Threat to Adjusters
Longer-term, does the drone spell the end of the traditional claims adjuster?
No way, said Ouellette, particularly as UAVs still have to be piloted.
“Certainly they can provide great images; however, the adjuster still needs to follow up with measurement and assessment work. He or she still has to provide much of the essential detail that drones aren’t able to capture.”
Brown agreed. “Drones will continue to be but one tool available to the field adjuster and will never fully replace the personal inspection. There will be instances in which the drone inspection is just not practical under the circumstances, due to adverse weather, physical obstructions, and the like.
“There will never be a day,” he said, “when drones can 100 percent be a replacement for adjuster ‘boots on the roof’ when it comes to property inspections or the personal touch that human claims adjusters can bring to loss investigations, appraisals and settlements.”
2015 RendezVous: Smiles or Scowls?
Nikolaus Von Bomhard was not a happy man this time last year. The CEO of German reinsurance giant Munich Re — in line with its general policy — is rarely outspoken. However, ahead of the September 2014 Monte Carlo gathering of the reinsurance industry’s key personnel, he spoke of being “disappointed, exasperated and even rather appalled by what is happening in the market.”
It’s unlikely that the past 12 months have offered much to lift his spirits. Guy Carpenter reports that global property catastrophe rates were down by 11 percent on average at Jan. 1 2015, the same rate of reduction as the year before. “Reductions were sustained across all lines of business with few exceptions,” the group commented. “We continue to see rate reductions and easing terms and conditions at the various key renewal anniversaries during 2015.”
Attendees at the 59th annual RendezVous in the tiny European principality of Monaco next month will therefore be confronting familiar problems; indeed, the mood could best be described as “the same, only more so.”
Low inflation, minimal interest rates and meager investment returns have regularly featured on the RendezVous agenda since the 2008 global financial crisis broke. More recently, Europe has seen low inflation turn to deflation, while some corporates have followed the lead of its more confident governments and been emboldened to offer negative rates on bond offerings. This year also began with the European Central Bank (ECB) belatedly adopting the experiment applied by both the Federal Reserve and the Bank of England, to kick-start an economic revival by launching a quantitative easing (QE) program.
As for Munich Re, more recent pronouncements have employed milder language — although when the group issued its annual results in May, board member Torsten Jeworrek admitted that market conditions looked fairly certain to remain soft.
“The question for us is not how far the rates can decline,” said Jeworrek. “The question is how to manage the cycle and where to find new business opportunities. We are proceeding on the assumption that the market environment will not change significantly in the upcoming renewal rounds in 2015, unless extraordinary loss events occur, or there are any major changes in the market.”
New Channels for Excess Capital?
With what Aon Benfield describes as “too much capital and less opportunity to deploy it” prevailing, 2015 has seen an upturn in merger and acquisition activity with more defensive and strategic deals than in any year since 2007. Swiss Re’s chief economist, Kurt Karl, said recently that activity pointed to a squeezing out of the middle-tier specialist insurers and reinsurers. “Some firms do not have the scale or the breadth of services to differentiate their offering from more commoditized reinsurance capacity,” he noted.
The unsolicited takeover attempt launched by Italian investment firm Exor for PartnerRe is still grabbing headlines. This has threatened to overturn the reinsurer’s planned “merger of equals” with rival Axis Capital Holdings that was announced at the start of this year.
The resulting turbulence was recently commented on by XL Catlin’s CEO Mike McGavick, who cheerfully admitted: “We’re awfully happy to be able to take advantage of the confusion that mergers create for others.” Admittedly XL can display a degree of schadenfreude; the group’s $4 billion takeover of Lloyd’s of London underwriter Catlin went through relatively smoothly — announced in January, it had wrapped up by April.
“While both XL and Catlin were major reinsurers pre-combination, we are now the eighth largest P&C reinsurer in the world and have a larger suite of products and a broader geographic reach together,” said Greg Hendrick, CEO of XL Catlin’s reinsurance operations.
“This will be the main thrust of our meetings at Monte Carlo; we can entertain any P&C risk that a client faces anywhere in the world and we will be very focused on the overall relationship across products and geographies.”
It will take rather more major M&A deals to change Aon Benfield’s assessment. However, Bryon Ehrhart, CEO of Aon Benfield Americas and a regular speaker at the RendezVous, said that while the pronouncement remains valid, he sees grounds for optimism. “The growth in reinsurance capital continues to outpace the growth in demand for reinsurance,” he said.
“However, material new demand has emerged for U.S. mortgage credit risk and certain life reinsurance transactions. While the industry clearly has the capital to deploy in these areas, the industry’s skills are still developing and currently limit the ability of the industry to match the opportunity.”
Ehrhart also believes that the industry’s leading players have made “material progress” toward incorporating lower-cost underwriting capital into their value proposition. “Reinsurers have seen that they have and can sustain their significant competitive advantages when they optimize their underwriting capital structures.”
So what else will feature on the Monte Carlo agenda next month? Negative interest rates are likely to be a key topic, said Jean-Jacques Henchoz, CEO reinsurance for Europe, the Middle East and Africa (EMEA) at Swiss Re. “After large parts of European sovereign yield curves dipped into negative territory during spring this year, investors have certainly become aware that zero may not necessarily be the lower bound for bond yields.”
“I think the debate now is less about Solvency II content, but about how companies are going to live with it.” — Eric Paire, head of global strategic advisory, Guy Carpenter’s EMEA region
He believes that deflation fears may diminish: While the ECB’s bond buying program under QE had a major negative impact on bond yields over the first half of 2015, it is unclear whether it will remain the dominant driving force. “There are other forces which may push bond yields higher,” said Henchoz. “The U.S. Fed is likely to start hiking interest rates later this year. In addition, it is expected that inflation rates will increase in the second half as oil prices stabilize.
“Overall, the outlook for interest rates remains highly uncertain at this point in time. What is clear, however, is that insurers’ investment returns will not improve significantly anytime soon. This is because even if bond yields increase, existing higher-yielding bonds in insurers’ portfolios will need to be reinvested into lower-yielding bonds. So insurers’ investment returns will recover only slowly and with a time lag.”
Long-established players are also coming to terms with the fact that many of the market’s newer entrants have joined for the long-term. “We believe that alternative capital is here to stay and will be a part of the capital base supporting the reinsurance market,” said Hendrick.
“The only open question in our mind is what size and portion of the overall market will this capital source attain in the coming years. We are positioning XL Catlin to be able to utilize all forms of capital, our own and third party, to ensure that we match each risk profile with the appropriate capital.”
Ehrhart suggested two other topics likely to feature in many discussions. “Cyber [risk coverage] will recur as a topic that is driving demand growth,” he said. “The discussion of alternative capital will move from the debate over whether or not it is a good or bad thing to how best it can be incorporated into a reinsurer’s value proposition to its customers and shareholders.”
Solvency II issues
Just over the horizon is the European Union’s Solvency II legislative program, which introduces a new and harmonized EU-wide insurance regulatory regime in all 28 member states. As it takes effect from Jan. 1 2016, it might be expected to feature highly on this year’s RendezVous agenda. Conversely, having been in the pipeline for several years, is the debate over Solvency II — and the industry’s objections to the directive — now largely over?
“Not at all,” said Eric Paire, head of global strategic advisory for Guy Carpenter’s EMEA region. “I think the debate now is less about Solvency II content, but about how companies are going to live with it, and this includes topics such as internal model validation, volatility of capital requirements, and reconciling increased required capital with low prices and interest rates.
“Furthermore, with doubts about the readiness of some companies and indeed regulators, Solvency II is a long way from disappearing from the agenda.”
Henchoz agreed. “The focus is currently very much on implementation, on understanding how business operates under the new EU solvency regime as well as preparing for application,” he said.
“Many companies are still busy getting their systems ready by 2016, in particular on reporting, and the change towards an economic and risk-based regime has some wider implications which demand a different approach to strategy and products.”
RendezVous 2015 also poses the question of where delegates who usually check in at Monte Carlo’s five-star central Hotel de Paris will find a bed. The iconic venue began a major renovation program last October that won’t be completed until September 2018; until then many will have to settle for an address that is less prestigious — or located further out of town.
CROs Gaining Authority, Survey Finds
The forces of change are continuing to reshape the insurance industry and its chief risk officers (CROs) are at the forefront of that change, reports Ernst & Young Global, aka EY.
The professional services multinational just published its fifth annual survey of CROs in the insurance sector. Conducted between December 2014 and February 2015, the survey canvasses views from various senior risk executives at 20 North American insurance companies, with life, P&C and multi-line insurers all represented.
The findings show that “the most profound forces of change” are reflected in an evolution of the CRO role. They have greater authority, are assuming greater responsibilities and gaining an enhanced profile across the organization, with effective risk management increasingly regarded as contributing to market success.
Ways in which this enhanced profile is evidenced include direct participation on key strategic business matters, larger staffs than before and a wider use of stress testing. Nearly three in four CROs told EY that their department had expanded in the past year.
Along with more stress tests, additional staff are needed for operational risk, the own risk and solvency assessment (ORSA) and model risk management. Risk management today is closely “integrated with the business, rather than being an afterthought,” according to one survey respondent.
The report identifies three current key themes cited by CROs:
Capital Standards Still Confuse
The lack of common accounting standards and capital measures makes it difficult to compare performance and solvency across companies. Insurers employ various capital measures, many specific to the company, to analyze their risk exposures over a range of time periods and under different normal and adverse scenarios. The quantitative impact survey (QIS) launched last September by the Federal Reserve Board and field testing by the International Association of Insurance Supervisors (IAIS) persuaded several companies to consider new approaches to regulatory capital treatment.
Expanding risk management capabilities and the hiring of more risk staff confirms that it has become a team activity, played across and at every level of the enterprise.
More Regulations and Intrusive Regulatory Oversight
CROs from insurers not already regulated by the Federal Reserve Board accept, grudgingly, that they will also come under its spotlight. Until recently these CROs were confident that current state-based requirements would remain unchanged, but now accept that the two regulatory regimes, with different risk management standards, will probably converge around more stringent guidelines.
Risk Management Is a Team Sport
The 2015 survey shows CROs spending more time and effort on integrating risk management practices into the business. For some, the risk management function’s value is chiefly measured through its integration with the business. Expanding risk management capabilities and the hiring of more risk staff confirms that it has become a team activity, played across and at every level of the enterprise.
Past and Future Challenges
Asked to identify the main risk challenges currently occupying the insurance industry, 40 percent of CROs surveyed cite the slew of regulation and pending common capital standards. Although a distant second, 14 percent picked cyber risk, showing the CRO’s agenda now extends beyond financial risk. Easing concerns over interest rates and the economy as well as renewal of the Terrorism Risk Insurance Act (TRIA) saw both dip from a year ago to 13 percent and 10 percent respectively. Lingering worries that TRIA might not be extended was subsequently resolved at the end of January. Competition and pricing levels also scored 10 percent.
Looking ahead to the main risk challenges of the next 12 months, 28 percent of CROs surveyed cited capital modeling and stress testing. Three tasks: establishing an enterprise risk management (ERM) framework and governance; integration and transparency; and assessing risk appetite each attracted 15 percent, while both emerging risks and operational risks were cited by 9 percent. Still a high priority a year ago, ORSA has since fallen off the list as many institutions have since participated in one of the three pilots or produced an ORSA draft.
Longer-term, insurance industry CROs expect greater authority and accountability, increased influence and broader interaction over the next few years, with their role becoming more visible and more accountable as it becomes better defined. In the meantime, they are focused on performance and creating value for the business. As one respondent commented, “we are spending less time on defining and debating the role and approach and more time on executing our risk plan.”