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By Dimitris Karapiperis, Research Analyst III I As tens of thousands of drones are flying overhead1, the sky may not fall on our heads but some of these drones may in-deed come crashing down. Aside from the inevitable acci-dent, whose expected frequency is s ll being studied as fleets of commercial drones are added to those being flown by hobbyists, there are addi onal risks shared by both the peo-ple on the ground and drone operators. Before drones be-come a common sight in every neighborhood, a number of insurance liability and coverage issues need to be fully ad-dressed, ranging from personal injury to invasion of privacy. The commercial use of drones is booming, with the total commercial drones market expected to reach $1.3 billion by 2020 from just $15.2 million in 2014, an extraordinary 109% annual growth rate.2 With about 40% of businesses ex-pected to employ drones, also known as unmanned aircra systems (UAS), within the next five years, a Munich Re sur-vey revealed 69% of risk managers pointed to privacy issues as their biggest concern, while 12% thought inadequate insurance presented the greatest risk, followed by personal injury (11%) and property damage (8%).3 The insurance industry is responding to the increasing and poten ally ubiquitous use of commercial drones by devel-oping underwri ng tools to cover businesses’ growing liabil-ity exposures. At the same me, insurers are also interested in using drones on their own to reach remote and inaccessi-ble areas by claims adjusters, especially following catastro-phes, for be er, more accurate and faster evalua on of property damage. State insurance regulators are ac vely engaged to address all relevant regulatory challenges and concerns related to insuring commercial drone opera on. R D U Avia on regula on requires a cer ficate of waiver or au-thoriza on (COA) from the Federal Avia on Administra on (FAA) in order to lawfully operate a drone. As of April 2015, the FAA had issued 79 COAs to public agencies, local gov-ernments, law enforcement agencies and universi es.4

Commercial use of drones is generally not currently per-mi ed unless the FAA issues an exemp on known as a “Sec on 333 exemp on.” More than 840 exemp ons have been granted to operators, including insurers for aerial in-spec ons, companies conduc ng infrastructure inspec ons, farmers for precision agriculture, mo on picture and televi-sion producers for closed-set filming, and to companies working in law enforcement, first responders and search-and-rescue opera ons.5

Due to increasing interest in the commercial use of drones, the U.S. Congress told the FAA, in the 2012 FAA Moderniza-

on and Reform Act, to develop a plan for the safe integra-on of UAS by Sept. 30, 2015. The FAA has noted safe and

full integra on will be incremental, star ng first with pro-posed rules for small drones (less than about 55 pounds). The FAA’s first dra of proposed rules for commercial drone flights was submi ed in February 2015, li ing some re-stric ons but s ll barring ac vi es such as the delivery of packages. The rules require drone pilots to obtain special pilot cer ficates, stay away from bystanders and fly only during the day with a flying speed limit of 100 miles per hour and al tude limit of 500 feet above ground level.6 While states and municipali es may introduce regula on of the commercial use of drones addressing issues such as pri-vacy and nuisance, federal law can preempt any such state or local law and regula on. The Na onal Transporta on Safety Board (NTSB) confirmed in a landmark November 2014 decision the FAA has the authority to impose fines and other penal es for unsafe drone use and opera ons.7 How-ever, state and local governments retain their authority to enforce limita ons on the use of some types of aircra , in-cluding drones. According to the Na onal Conference of State Legislatures, 20 states have enacted specific legisla on about drones, defining what is a UAS or drone, its many pri-vate and commercial uses and the FAA rules and tes ng. In 2013, legislatures from 43 states introduced 130 UAS-related bills and resolu ons and 13 states enacted 16 new laws and 11 states adopted 16 resolu ons. In 2014, 10 addi onal states enacted new laws addressing the use of drones.8 While private drone use as a hobby is most likely covered under a homeowners insurance policy, which generally co-vers radio-controlled model aircra ,9 separate drone insur-ance is needed if the intended use is for commercial purpos-

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1 “Rise of the Drones: Insuring Unmanned Aircra Systems is Going to be Complicated.” Risk & Insurance, March 3, 2014. 2 “Commercial Drones Market by Type (Fixed Wing, Rotary Blade, Quad Rotor), Technolo-gy (Energy & Propulsion System, Automa on, Collision Avoidance), Applica on (Government, Agriculture, Manufacturing, Retail) & Geography—Global Forecast to 2020.” MarketsandMarkets, February 2015. 3 “Munich Re Survey Suggests 40% of Businesses Could Soon be Using Drones.” Claims Journal, June 9, 2015. 4 “Trending Now: Domes c Drones.” Arthur J. Gallagher and Co. Gallagher Public Sector, April 2015. 5 Ibid. 6 “Trending Now: Domes c Drones.” Arthur J. Gallagher and Co. Gallagher Public Sector, April 2015. 7 Huerta v. Pirker, NTSB Docket CP-217, Nov. 18, 2014. 8 “Unmanned Aerial Systems/Drones—Regula on, Liability, and Insurance Require-ments.” Na onal Associa on of Mutual Insurance Companies, Emerging Issue, Febru-ary 26, 2015. 9 “Does Your Homeowner’s Insurance Cover Your Drone?” DroneLife.com, June 17, 2014.

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es. Currently, the commercial use of drones is largely re-stricted and opera ons are authorized on a case-by-case basis.10 Nonetheless, a great number of drones are flying without any authoriza on, effec vely challenging the FAA’s proposed legal framework, as final rules have not yet been implemented so they can be enforced.11 Purchasing insur-ance is one of the challenges facing non-authorized com-mercial drone operators, whose opera ons may s ll be ille-gal even if insured.12 The FAA has stated that exis ng avia-

on regula ons, which apply to all unmanned aircra s and, therefore, drones, give it the authority to ban commercial drone flights opera ng without the necessary waivers.13 D U I A number of insurance companies have applied for, and been granted, exemp ons by the FAA for the commercial use of drones for the inspec on and evalua on of damages following catastrophes. Drones can be useful in accessing hard-to-reach areas a er hurricanes, tornadoes and floods by providing detailed aerial images of affected areas. Claims adjusters with the informa on provided by drones could handle more claims, process them much faster and expedite payments to policyholders. By using drones, insur-ers are expected to have fewer workers’ compensa on claims, as adjusters can do their jobs remotely from the safety of their offices.14 But insurers could be constrained by numerous FAA limits aimed at easing concerns about safety and the poten al invasion of privacy. For example, the approved insurers can fly drones over private or “controlled-access” property only with permission from the owner or other authorized party, according to the FAA’s approval. Drone opera on is also restricted to airspace away from airports and most urban areas, during day me and, in many cases, at least 500 feet “from all nonpar cipa ng persons, vessels, vehicles and structures.”15 D I I The availability of insurance coverage is absolutely neces-sary for the con nued development and growth of the com-mercial drone market, as the need for coverage is expected to be as high as the risk for poten al losses. The inherent risks in the opera on of drones may be amplified as their numbers, uses and capabili es increase. The combina on of elements of opera ng an aircra with the control hardware and so ware and remote communica on of a drone—as well as the possible carrying of payloads—make risk assess-ment, management and coverage a par cularly complex exercise.16

Opera on of drones for commercial purposes could expose operators, either directly or through third-party contractors, to a variety of risks and poten al liabili es, ranging from personal injury to invasion of privacy. Despite the absence of clarity and full understanding in the market regarding the risks involved and the general lack of relevant data, a num-ber of insurers are ahead of the curve trying to develop properly underwri en policies to cover all insurance expo-sures created by the use of drones. The work of underwrit-ers will ul mately define the extent and limita ons of cover-age based on risk assessment in order to adequately price drone insurance.17 Generally, the following general types of coverage will be needed for the use of drones and ancillary business ac vi es: liability; property; personal injury; inva-sion of privacy; and cyber risk. Liability exposure is the primary risk drone operators are facing. Although the unmanned drones’ remote opera on excludes risks on passengers or crew, drones present a sig-nificant risk to property and life in the event of accident due to faulty and inappropriate opera on or mechanical defects and component failure. Losses and damages could involve bodily injury to humans and animals and damage to build-ings and other fixed and mobile structures and vehicles.18

Standard commercial general liability policies cover bodily injury and property damage caused by an “occurrence,” which is defined as “an accident, including con nuous or repeated exposure to the same generally harmful condi-

ons.” However, most, if not all, such commercial general liability policies have exclusions for damage caused by the opera on of aircra , which would include drones. Commer-cial property insurance policies also have various forms of aircra exclusions that would apply to drones, including policies that may specifically exclude coverage while the drone is in flight.19

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10 Dawning of the Drones: The Evolving Risk of Unmanned Aerial Systems.” Marsh In-sights, June 2015. 11 “Insurers Step Up for Drone Pilots Unwilling to Wait on FAA Rules.” Bloomberg, March 6, 2015. 12 Ibid. 13 Ibid. 14 “The Future of Drone Use in the Insurance Industry.” Claims Journal, March 3, 2014. 15 “Insurers Get Approval to Use Drones.” The Wall Street Journal, April 8, 2015. 16 “Unmanned Aerial Systems/Drones – Regula on, Liability, and Insurance Require-ments.” Na onal Associa on of Mutual Insurance Companies, Emerging Issue, Feb. 26, 2015. 17 Ibid. 18 “Exploring Drones – How Unmanned Aircra Could Change the Way We Live, Work, and Think about Risk.” Verisk Analy cs, Insurance Services Office, 2014. 19 “Unmanned Aerial Systems/Drones – Regula on, Liability, and Insurance Require-ments.” Na onal Associa on of Mutual Insurance Companies, Emerging Issue, February 26, 2015.

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Drone manufacturers and component part manufacturers may also face liability for any defec ve design, manufactur-ing or failure to warn, as well as strict liability, negligence and breach of warranty. Therefore, product liability, per-sonal injury and property damage would be needed by these manufacturers, as well as distributors and dealers of drones. However, the exis ng typical product coverage for tradi onal avia on risk is generally narrower than what it is needed for the unique risks presented by the opera on of drones.20 Drone operators also need coverage for the actual drone, including all of its parts and necessary accessories. Hull cov-erage policies are among the many poten al policies availa-ble in the avia on insurance market covering damage sus-tained to insured aircra . Depending on usage, a drone may be carrying a payload whose value may be much higher than the values of the drone itself; therefore, it would need to be insured against all risks of physical loss or damage (par al and total loss) resul ng from any external cause while in transit, including extended coverage for loading and unloading. Also, coverage against the may also be required.21 Insuring against cyber risk of hacking is also cri cal, because drones are generally connected to electronic communica-

on systems. The risk is someone would hack into a drone’s system to take over its controls in order to divert it from its flight path for the purpose of the or inten onally inflic ng damage.22 Specific malware designed to infiltrate drone systems has already been developed, sugges ng cyber risk for drones is no longer theore cal.23 The developed mal-ware, dubbed Maldrone, can infect a drone, allowing the hacker to do anything from changing the des na on of the drone to making it drop out of the sky.24 Cyber insurance for drones may have to include coverage for a variety of risks, ranging from injury to physical dam-age. Considera on of coverage for cyberterrorism is also important and could be offered separately from other drone insurance policies, but, given the increasing levels of dependence on computerized systems in transporta on, it could be included in other coverages.25 It is also conceivable drone operators, and possibly the drone so ware engineers, may require errors and omissions (E&O) coverage, as accidents and mishaps due to opera ng errors could expose them to E&O claims.26 Also, as new technologies involve new and unknown or overlooked risks, there may be increased exposure for directors and officers of businesses that manufacture, support or use drones.27

Privacy issues top the list on many peoples’ concerns with many new technologies, and drones are not exempt. Com-mercial drones, as well as private drones, are o en equipped with on-board cameras and possess other data-collec on capabili es, poten ally posing a threat to privacy. Drones may capture private data whose illegi mate use and/or public dissemina on may be harmful to the owner of such data. Privacy concerns go beyond inten onal surveil-lance, as they may also arise with the unintended capture of images during rou ne and unrelated drone opera on. In 2013, the federal Drone Aircra Privacy and Transparency Act was introduced to create a regulatory framework for drone opera on, including privacy protec on, data collec-

on and enforcement. Insurers are developing policies to cover such exposures, but there has not been significant clarity or guidance in this area.28 Presently, the largest growth area for insurers is expected to be in the low-scale, visual line-of-sight (VLOS)29 opera ons for which the FAA’s proposed rules will apply. Insurers, be-ing inherently conserva ve in assessing risk, may o en ap-ply standards for issuing insurance policies that exceed what the FAA has already proposed. Following tradi onal avia on insurance prac ces, insurers may require a drone operator to develop standard opera ng procedures, just as a tradi-

onal charter-airline company must do; keep logs of flights and maintenance; and have, at a minimum, an elementary understanding of the FAA rules for tradi onal aircra pilots. Tradi onal aircra coverage is being updated and adapted by underwriters to be applicable for drone opera ons, o en by doing li le more than subs tu ng terms such as “aircra ” with “UAS” and “pilot” with “operator.”30 Howev-er, although insurers can extrapolate loss experience from

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20 “The Limits to the Sky: Insurance Issues Related to Unmanned Aerial Systems.” Chris-an & Small A orneys and Counselors, Nonstop Insights, April 24, 2015.

21 Dawning of the Drones: The Evolving Risk of Unmanned Aerial Systems.” Marsh In-sights, June 2015. 22 “Exploring Drones – How Unmanned Aircra Could Change the Way We Live, Work, and Think about Risk.” Verisk Analy cs, Insurance Services Office, 2014. 23 “The Limits to the Sky: Insurance Issues Related to Unmanned Aerial Systems.” Chris-

an & Small A orneys and Counselors, Nonstop Insights, April 24, 2015. 24 Dawning of the Drones: The Evolving Risk of Unmanned Aerial Systems.” Marsh In-sights, June 2015. 25 Ibid. 26 “Exploring Drones – How Unmanned Aircra Could Change the Way We Live, Work, and Think about Risk.” Verisk Analy cs, Insurance Services Office, 2014. 27 Ibid. 28 “Rise of the Drones: Insuring Unmanned Aircra Systems is Going to be Complicated.” Risk & Insurance, March 3, 2014. 29 The drone must always remain within sight of the operator or visual observer. The operator must be capable of seeing the unmanned aircra with vision unaided by any device other than correc ve lenses. 30 Dawning of the Drones: The Evolving Risk of Unmanned Aerial Systems.” Marsh In-sights, June 2015.

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the avia on industry, they should consider the experience of the U.S. Air Force, whose highly sophis cated drones proved three mes more likely to be involved in an accident as tradi onal manned aircra .31 At this early phase of the market, only bespoke policies are wri en by a few specialist carriers whose numbers should increase as more insurers enter the market once the FAA rules are finalized. The coverages currently available include physical loss or damage to the drone, components and spare parts during opera on, tes ng or transit; liability cov-erage for direct loss or damage resul ng from failure of the drone (excluding coverage for consequen al losses of third par es); non-owned drone liability coverage; and premises, hangar keepers and product liability coverage.32 Insurance companies that decide to provide, or not to pro-vide, drone coverage face certain concerns. Liability could also exist for insurance company directors and officers who decide to provide drone coverage that is in known conflict with exis ng laws and regula ons, or fails to consider such laws and regula ons in deciding to provide coverage. Be-cause the regulatory framework for drone opera ons is s ll being formed, insurers that write drone policies need to do proper due diligence to make sure provided coverage would not be inadvertently negated due to exis ng exclusions. Insurers and their agents who mistakenly promise coverage that does not exist may face legal ac on regarding that un-covered liability.33

C The new technology of remotely operated unmanned air-cra (drones) and its commercial use has many poten al benefits for business, individuals and society. At the same

me, along with the benefits, the widespread use of drones—private and commercial—poses various risks, rang-ing from safety to privacy of individuals. These risks arising from the use of drones could best be mi gated and managed by property and casualty insurers, but only in an environ-ment of clearly defined drone opera onal requirements and performance standards. Complete and clear regula on of drones, by the states and the FAA, is necessary for insurers to step in and meet current and future policyholder needs.

31 “Drones Most Accident-Prone U.S. Air Force Cra : BGOV Barometer.” Bloomberg, June 18, 2012. 32 “The Limits to the Sky: Insurance Issues Related to Unmanned Aerial Systems.” Chris-

an & Small A orneys and Counselors, Nonstop Insights, April 24, 2015. 33 “Unmanned Aerial Systems/Drones – Regula on, Liability, and Insurance Require-ments.” Na onal Associa on of Mutual Insurance Companies, Emerging Issue, February 26, 2015.

A A Dimitris Karapiperis joined the NAIC in 2001 and he is a researcher with the NAIC Center for Insurance Policy and Research. He has worked for more than 15 years as an economist and analyst in the financial services industry, focusing on economic, financial market and

insurance industry trends and developments. Karapiperis studied economics and finance at Rutgers University and the New School for Social Research, and he developed an extensive research background while working in the public and private sector.

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© 2015 Na onal Associa on of Insurance Commissioners, all rights reserved. The Na onal Associa on of Insurance Commissioners (NAIC) is the U.S. standard-se ng and regulatory support organiza on created and gov-erned by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best prac ces, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collec ve views of state regulators domes cally and interna onally. NAIC members, together with the central re-sources of the NAIC, form the na onal system of state-based insurance regula on in the U.S. For more informa on, visit www.naic.org. The views expressed in this publica on do not necessarily represent the views of NAIC, its officers or members. All informa on contained in this document is obtained from sources believed by the NAIC to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such informa on is provided “as is” without warranty of any kind. NO WARRANTY IS MADE, EXPRESS OR IM-PLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY OPINION OR INFORMATION GIVEN OR MADE IN THIS PUBLICATION. This publica on is provided solely to subscribers and then solely in connec on with and in furtherance of the regulatory purposes and objec ves of the NAIC and state insurance regula on. Data or informa on discussed or shown may be confiden al and or proprietary. Further distribu on of this publica on by the recipient to anyone is strictly prohibited. Anyone desiring to become a subscriber should contact the Center for Insur-ance Policy and Research Department directly.

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