Sending unpiloted vehicles into manned airspace may sound like a joyride to Amazon CEO Jeff Bezos, who’s speculated that when fully developed, commercial drones may be able to deliver an Amazon order to one’s door in 30 minutes.
But let’s face it: Some possible outcomes of the predicted exponential growth of Unmanned Aircraft Systems (UAS) are not all that pleasant to entertain.
Because it’s managed remotely by computer, a UAS could be hacked and its mission bent to destructive purposes. Or it could simply go awry due to operator error.
“What if a UAS shoots thousands of feet into the air and gets ingested into a commercial aircraft engine full of passengers?” asked Barton Duvall, assistant vice president with Starr Aviation’s West Coast office in Carpinteria, Calif.
Such a scenario “puts an entirely new outlook on the limit needs of UAS operators and the non-owned aviation liability limit needs of customers of UAS operators,” said John Geisen, an Aon aviation senior vice president in Minneapolis.
The loss involved is known as a foreign-object-damage loss or FOD, he said.
Video: Watch this Lakemaid Beer drone delivery.
“The airline’s hull underwriters would pay for the engine and other physical damage as well as any liability that ensues, but in this case you would also have a cause for subrogation to go after the UAS owning and operating parties as well as, I suppose, the customer of the UAS.”
Where adequate coverage limits for negligence actions are not secured, one can expect a search for “deep pockets,” said Geisen.
“Subrogation for FOD losses occurs today when a negligent party responsible for clean up or the owner of the object that is ingested can be clearly identified,” Geisen said.
“Today, it is often hard to identify who owned the foreign object that was left on the tarmac and damaged the engine at takeoff or landing or maybe you eat a bird that no one owns — the hull insurer pays the claim and has nowhere to turn to try and mitigate it — file closed.”
However, should another aircraft “eat or ingest a UAS,” it will be easier to determine who’s responsible, he said.
Starr Aviation’s Duvall said that the worst-case scenario could have the lives of hundreds of passengers at risk as well as damage to the aircraft — some valued at well over $100 million — besides potential grave bodily injury and serious property damage on the ground.
“The chain of liability could span from the operator of the UAS, to the prime manufacturer and subcomponent manufacturers to, depending how these systems end up integrated, the entities responsible for control and safety of the National Airspace System (NAS).
“The actuality of a catastrophic event such as this may be improbable, but it’s not entirely out of the scope of possibility,” said Duvall.
Besides the obvious navigational challenge of sending unpiloted commercial vehicles into the stratosphere, hijacking enabled by cyber terrorism is another real threat.
The Cyber Terror Threat
In 2012, University of Texas professor Todd Humphreys and a group of students intercepted a GPS-guided UAS, using a GPS device created by Humphreys and his students.
Video: Humphreys explains how he hacked the drone.
If that can occur, then what is to prevent a terrorist hacker from directing a drone to pick up a bomb and fly it into a university football game or some similar target, asked Geisen.
In such a situation, “plaintiffs are going to look for the deep pockets,” said Roberta Anderson, a partner in the Pittsburgh office of law firm K&L Gates.
Anderson, who represents policyholders in commercial insurance coverage disputes, said those tapped for indemnification in the terrorist plot described here would likely include “companies that manufactured or designed the software applications, or owned or controlled the networks that allowed a hacker to penetrate the [drone’s] system and gain control.”
“Managers and owners of the stadium would also be targeted for potential negligence and insufficient security, and you’d see cross claims and counterclaims as well, with the stadium pointing the finger at their own security vendors.
“There could be tens of thousands of wrongful death claims” as well as “loss of reputation, property damage and business interruption for the stadium, which will represent a deep-pocket certain to have liability insurance,” Anderson said.
And yet, there are clearly mitigating factors to help prevent things from going terribly wrong.
A lot of these aircraft are building in “triple redundancies,” with “some even having automatic return-to-base features if there are any control interruptions,” Aon’s Geisen said.
Still, there is little doubt, he said, that commercial drones currently represent “a big area of emerging risk and growth.”
The U.S. military’s use of drones “went from like 50,000 flight hours in 2006 to some 550,000 by the end of 2011,” said Geisen.
“So in just five years you had an 11-fold increase,” he said, suggesting that the growth trajectory on the commercial side could be similar. One reason for growth in drone use: Cost per flight hour “is suggested to be 75 percent less with a UAS than a manned aircraft,” he said.
The U.S. military’s use of drones “went from like 50,000 flight hours in 2006 to some 550,000 by the end of 2011.”
— John Geisen, senior vice president, Aon
One forecast of global UAS demand by the Teal Group showed worldwide annual spending on research, development, testing, and evaluation, and procurement in this area rising from $6.6 billion in 2013, to $11.4 billion in 2022.
And in March, Dallas-based global market research and consulting firm MarketsandMarkets reported that the small UAS market alone is set to reach $582.2 million by the end of 2019.
Accelerating insurers’ and brokers’ efforts to assess and effectively bind risks in this space, meanwhile, was a National Transportation Safety Board administrative law judge’s March 6 ruling overturning the FAA’s first-ever fine against a drone operator.
NTSB Judge Patrick Geraghty ruled that when Raphael Pirker flew an unmanned Styrofoam drone over the University of Virginia in 2011, “there was no enforceable FAA rule or FAR [federal aviation regulations] applicable to model aircraft or for classifying model aircraft as an UAS.”
Pirker reportedly sold photos and video collected during the flight to the university to help it create a promotional video.
Reports about the ruling immediately went viral, leading the science and technology site Motherboard to boldly state that commercial drones had become “unequivocally legal” in American skies — at least temporarily.
Motherboard noted that UAS operations previously sanctioned by the FAA included beer deliveries, aerial photography, tornado watching, and equipment inspections.
The FAA appealed the ruling, saying “the agency is concerned that this decision could impact the safe operation of the national airspace system and the safety of people and property on the ground.”
Industry experts are trying to be patient.
A Feb. 26 post on the FAA’s website, titled Busting Myths about the FAA and Unmanned Aircraft, clearly stated: “Anyone who wants to fly an aircraft — manned or unmanned — in U.S. airspace needs some level of FAA approval.”
Commercial UAS flights are only authorized on a case-by-case basis, the agency emphasized, adding that “to date, only two UAS models (the Scan Eagle and Aerovironment’s Puma) have been certified, and they can only fly in the Arctic.”
According to Duvall, the September 2015 UAS integration deadline “may be quite difficult to meet,” considering that the preliminary notice of proposed rulemaking and public solicitation on the issue has been pushed back to November 2014.
Elsewhere, “this industry is growing by leaps and bounds,” with Japan, Greece, Canada and parts of Africa now using the technology for everything from farming to mapping to anti-animal poaching efforts, Duvall said.
On the other hand, Geisen said, the FAA is likely to propose some rules for commercially operating drones under 55 pounds before the end of this year.
Insurance carriers said they will not be asleep at the switch.
“Once the FAA have completed their work on integrating unmanned aircraft into U.S. airspace, I would assume that we will very quickly see their commercial use proliferate, particularly in relation to agricultural and utility operations,” said Chris Proudlove of aviation underwriter Global Aerospace Inc.
Complete coverage on the inevitable cyber threat:
Risk managers are waking up to the reality that the cyber risk landscape has changed.
Cyber: The New CAT. It’s not a matter of if, but when. Cyber risk is a foundation-level exposure that must be viewed with the same gravity as a company’s property, liability or workers’ comp risks.
Critical Condition. The proliferation of medical devices creates a host of scary risks for the beleaguered health care industry.
Disabled Autos. It’s alarmingly easy for a hacker to take control of a driverless vehicle, tampering with braking systems or scrambling the GPS.
An Electrifying Threat. There is a very real possibility hackers could devastate the nation’s power grids — for a potentially extended period of time.
Latin America Not Too Risky for U.S. Business
The risks of doing business in Latin America are worth taking, according to a presentation at the RIMS annual conference in Denver.
Rob Osha, global director of risk management for mineral exploration company Boart Longyear, and Carlos Caicedo, senior principal analyst at IHS Country Risk, acknowledged social unrest and drug-related violence as two of the top dangers throughout the region, but expressed confidence in the growth of opportunities for U.S. business.
Caicedo highlighted Mexico as one emerging region. There, drug cartels pose the greatest risk, but their power may be decreasing. “Over the past five months, top leaders of the cartels have been arrested or killed,” he said.
However, a reduction of violence directed by drug lords could be replaced by extortion.
“We are seeing more risk in Mexico on the extortion side,” Osha said. “Cartels are looking to diversify their revenue streams.”
Caicedo conceded that extortion has increased against domestic Mexican businesses. He also said that cartel retaliation could lead to greater frequency of arson against commercial establishments. Despite these threats, though, he said security in Mexico has stabilized and the economy shows promise, thanks to a growing middle class and lower poverty rates.
“The economy is expected to grow at the end of 2014 and pick up even more in 2015,” he said.
Brazil, on the other hand, received a less favorable review. The region, in the view of IHS, is “a costly country to do business in.” The economy there has been poor since 2011, with inflation on the rise and a widening fiscal deficit. Social unrest, including World Cup protests, has been increasing this year.
In addition, state interventionism has undermined investor confidence, with domestic businesses stalling due to government influence in pricing.
Caicedo also addressed the terrorism threat in Colombia, where FARC continues to pose a danger, particularly to the country’s oil and energy infrastructure. However, the revolutionary faction and the government appear to be “very close to reaching a peace agreement,” Caicedo said.
FARC’s manpower has dropped from 20,000 at its peak to 8,000, and has been pushed into isolated areas of the country. The progression of peace talks will be critical in securing Colombia’s status as an emerging market and attractive place to do business, he said.
Even terrorist activity, however, didn’t scare off Boart Longyear from opening an office in Medellin, Colombia, where it had no prior experience.
“My first impression was, ‘Are you kidding me?’ I wasn’t sure we could do business there,” Osha said. The company established a “High Risk Country Committee” to examine the political, physical and travel risks in the region.
They identified general crime, bribery, extortion, and dangerous travel as the top risks facing the launch of a new facility.
“We gave [the project] the green light,” Osha said, as long as certain precautions were taken.
As part of the process, Boart Longyear hired a third-party firm to conduct a security review of the proposed location. “Don’t rely on your corporate real estate guy to tell you your location is safe,” Osha said.
After the review found the facility to be seriously under-guarded, the company added security cameras, remote locks, key cards, and after-hours guards.
They tackled travel risk next, by examining every route their workers could potentially take between sites and color-coded them by level of danger, establishing some “no-go” areas that were entirely off-limits.
Osha pointed to security assessments by IHS Country Risk and iJET, a travel risk provider, as vital resources for determining the safety of a travel route.
The company also hired a contractor to drive over every travel route and pinpoint areas with poor infrastructure or hazardous conditions like steep grades. Boart Longyear also established travel policies for its crew, instructing them to travel only by daylight and always with a partner.
Finally, they implemented a strict Foreign Corrupt Practices Act training and compliance program to address bribery attempts. Thanks to these efforts, the Medellin office was opened two years ago and has had no safety issues to date, Osha said. Follow-up assessments and ongoing monitoring have contributed to that success.
“We have to monitor the environment to make sure it is still stable,” he said. “Things can change in an instant with an election, a riot … things can get out of control.”
Should that happen, Boart Longyear put together a crisis plan that identifies the nearest resources like hospitals and police stations, and includes an emergency hotline.
While Latin America still presents big safety challenges to U.S. companies looking to capitalize on its emerging markets, those intrepid companies willing to take on the expense and effort of extensive risk planning and mitigation can expand to the area in a secure way.
Pathogens, Allergens and Globalization – Oh My!
In 2014, a particular brand of cumin was used by dozens of food manufacturers to produce everything from spice mixes, hummus and bread crumbs to seasoned beef, poultry and pork products.
Yet, unbeknownst to these manufacturers, a potentially deadly contaminant was lurking…
What followed was the largest allergy-related recall since the U.S. Food Allergen Labeling and Consumer Protection Act became law in 2006. Retailers pulled 600,000 pounds of meat off the market, as well as hundreds of other products. As of May 2015, reports of peanut contaminated cumin were still being posted by FDA.
Food manufacturing executives have long known that a product contamination event is a looming risk to their business. While pathogens remain a threat, the dramatic increase in food allergen recalls coupled with distant, global supply chains creates an even more unpredictable and perilous exposure.
Recently peanut, an allergen in cumin, has joined the increasing list of unlikely contaminants, taking its place among a growing list that includes melamine, mineral oil, Sudan red and others.
“I have seen bacterial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant.”
— Nicky Alexandru, global head of Crisis Management at AIG
“An event such as the cumin contamination has a domino effect in the supply chain,” said Nicky Alexandru, global head of Crisis Management at AIG, which was the first company to provide contaminated product coverage almost 30 years ago. “With an ingredient like the cumin being used in hundreds of products, the third party damages add up quickly and may bankrupt the supplier. This leaves manufacturers with no ability to recoup their losses.”
“The result is that a single contaminated ingredient may cause damage on a global scale,” added Robert Nevin, vice president at Lexington Insurance Company, an AIG company.
Quality and food safety professionals are able to drive product safety in their own manufacturing operations utilizing processes like kill steps and foreign material detection. But such measures are ineffective against an unexpected contaminant. “Food and beverage manufacturers are constantly challenged to anticipate and foresee unlikely sources of potential contamination leading to product recall,” said Alexandru. “They understandably have more control over their own manufacturing environment but can’t always predict a distant supply chain failure.”
And while companies of various sizes are impacted by a contamination, small to medium size manufacturers are at particular risk. With less of a capital cushion, many of these companies could be forced out of business.
Historically, manufacturing executives were hindered in their risk mitigation efforts by a perceived inability to quantify the exposure. After all, one can’t manage what one can’t measure. But AIG has developed a new approach to calculate the monetary exposure for the individual analysis of the three major elements of a product contamination event: product recall and replacement, restoring a safe manufacturing environment and loss of market. With this more precise cost calculation in hand, risk managers and brokers can pursue more successful risk mitigation and management strategies.
Product Recall and Replacement
Whether the contamination is a microorganism or an allergen, the immediate steps are always the same. The affected products are identified, recalled and destroyed. New product has to be manufactured and shipped to fill the void created by the recall.
The recall and replacement element can be estimated using company data or models, such as NOVI. Most companies can estimate the maximum amount of product available in the stream of commerce at any point in time. NOVI, a free online tool provided by AIG, estimates the recall exposures associated with a contamination event.
Restore a Safe Manufacturing Environment
Once the recall is underway, concurrent resources are focused on removing the contamination from the manufacturing process, and restarting production.
“Unfortunately, this phase often results in shell-shocked managers,” said Nevin. “Most contingency planning focuses on the costs associated with the recall but fail to adequately plan for cleanup and downtime.”
“The losses associated with this phase can be similar to a fire or other property loss that causes the operation to shut down. The consequential financial loss is the same whether the plant is shut down due to a fire or a pathogen contamination.” added Alexandru. “And then you have to factor in the clean-up costs.”
Locating the source of pathogen contamination can make disinfecting a plant after a contamination event more difficult. A single microorganism living in a pipe or in a crevice can create an ongoing contamination.
“I have seen microbial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant,” observed Alexandru.
Handling an allergen contamination can be more straightforward because it may be restricted to a single batch. That is, unless there is ingredient used across multiple batches and products that contains an unknown allergen, like peanut residual in cumin.
Supply chain investigation and testing associated with identifying a cross-contaminated ingredient is complicated, costly and time consuming. Again, the supplier can be rendered bankrupt leaving them unable to provide financial reimbursement to client manufacturers.
“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet. Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”
— Robert Nevin, vice president at Lexington Insurance, an AIG company
Loss of Market
While the manufacturer is focused on recall and cleanup, the world of commerce continues without them. Customers shift to new suppliers or brands, often resulting in permanent damage to the manufacturer’s market share.
For manufacturers providing private label products to large retailers or grocers, the loss of a single client can be catastrophic.
“Often the customer will deem continuing the relationship as too risky and will switch to another supplier, or redistribute the business to existing suppliers” said Alexandru. “The manufacturer simply cannot find a replacement client; after all, there are a limited number of national retailers.”
On the consumer front, buyers may decide to switch brands based on the negative publicity or simply shift allegiance to another product. Given the competitiveness of the food business, it’s very difficult and costly to get consumers to come back.
“It’s a sad fact that by the time a manufacturer completes a recall, cleans up the plant and gets the product back on the shelf, some people may be hesitant to buy it.” said Nevin.
A complicating factor not always planned for by small and mid-sized companies, is publicity.
The recent incident surrounding a serious ice cream contamination forced both regulatory agencies and the manufacturer to be aggressive in remedial actions. The details of this incident and other contamination events were swiftly and highly publicized. This can be as damaging as the contamination itself and may exacerbate any or all of the three elements discussed above.
Estimating the Financial Risk May Save Your Company
“In our experience, most companies retain product contamination losses within their own balance sheet.” Nevin said. “But in reality, they rarely do a thorough evaluation of the financial risk and sometimes the company simply cannot absorb the financial consequences of a contamination. Potential for loss is much greater when factoring in all three components of a contamination event.”
This brief video provides a concise overview of the three elements of the product contamination event and the NOVI tool and benefits:
“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet,” he said. “Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Lexington Insurance. The editorial staff of Risk & Insurance had no role in its preparation.