3 Ways Drones Could Change the Insurance Industry

By Markets Fool.com

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Drones aren't just for hobbyists and wannabe pilots. The insurance industry could soon use unmanned aircraft to reduce fraud, evaluate risks, and collect valuable data to reduce losses. It's not something out of a science fiction novel. Already, one reinsurance broker has established a drone rental service to provide drones to its insurance company clients!

There's a very good reason for the insurance industry's sudden interest in unmanned aircraft. An analysis by PricewaterhouseCoopers (PwC) estimated that drones could help save as much as $6.8 billion per year by eliminating costs that plague the insurance industry around the world.

Here are three ways drones could help insurers cut costs and reduce losses.

1. Fighting fraud

Fraud costs property & casualty insurance companies as much as $32 billion per year, or about $0.10 of every dollar paid out in loss and loss adjustment expenses. (Property and casualty insurers insure risks to property and provide liability coverage for injury or damage to other people or their possessions. Car and homeowners insurance are forms of property and casualty insurance.) PwC expects that drones will enable insurers to keep better tabs on their customers and reduce payments on fraudulent claims.

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One of the biggest risks to insurance companies is that their customers use a convenient event to claim damages that existed before the event that would reasonably cause a loss. For example, a homeowner might use a recent storm as cover to claim pre-existing damage to aluminum siding as a storm loss. By using a drone to consistently capture images of insured property before natural disasters, insurance companies can protect themselves from paying out on fraudulent claims.

Fraud losses are very often a local problem based on an area's laws, and one perhaps best attacked by the air. In 2011, Allstate (NYSE: ALL) cited New York and Florida as states where fraud ran particularly rampant. These two states have so-called "personal injury protection" policies for drivers, which pays medical expenses and lost wages regardless of fault in the event of an auto accident, resulting in higher fraud losses for insurers.

Fraud can also come from the inside. Markel (NYSE: MKL) cited employee error and misconduct as a risk in its most recent annual report, noting that "there have been a number of cases involving misconduct by employees in a broad range of industries in recent years, and we run the risk that employee misconduct could occur." It stands to reason that drones could be used to double check the work of adjusters whose claims deviate significantly from their peers.

Beyond the direct costs of fraudulent claims, there are also indirect costs like legal expenses. Berkshire Hathaway's (NYSE: BRK-A)(NYSE: BRK-B) Geico unit has been particularly aggressive in fighting what it believes are fraudulent claims. The company has successfully sued and settled cases with chiropractic and physical therapy offices it believes have improperly billed the insurance company, or provided treatment intended to maximize profits, according to the Boston Globe. It reports that Geico, Allstate, and State Farm Insurance are the most active in fighting fraud through the courts, an expensive process that insurers would likely prefer to avoid with documentation by drone, if possible. Fraud losses go well beyond amounts paid out on fraudulent claims.

2. Risk monitoring

Risk is difficult to measure and always changing. Winding roads are inherently less safe than straight roads, and they are particularly risky when coated in a layer of ice. Similarly, properties are at a greater risk of flood loss when nearby waterways have an elevated stage.

PwC suggests drones could be used for instantaneous data collection and risk monitoring. English insurer Aviva (NYSE: AV) used drones in January 2016 to assess flood damage and direct employees on the ground. But PwC sees a scenario in which drones are employed to prevent losses rather than measure losses that have already happened.

The report says drones could be used to immediately identify risks from natural disasters as they happen, from volcanic eruptions to floods and hurricanes. By collecting better data, and encouraging people to avoid particularly risky areas, insurers could help their customers avoid undue risk.

3. Tailored prices

Insurance is all about measuring risk and pricing policies appropriately. Increasingly, insurers are competing on their expertise in pricing policies in everything from homeowner's policies to car insurance. Progressive (NYSE: PGR) famously created its "Snapshot" device to record a driver's habits in real time, with a promise that less risky drivers would get discounts for their good driving habits. A company president noted that the device enables Progressive to collect data that has twice the predictive power of traditional rating variables.

Drones may be the next step in personalized premiums. PwC believes drones could be used to calculate better insurance premiums by assessing risks that can't currently be assessed efficiently. For example, an insurer might use a drone to survey a residential property, perhaps deciding not to insure the contents of an unlocked garage against theft, or to cancel a policy on a home with an undisclosed pool. Conversely, a drone could be used to confirm the existence of features that make properties less risky to insure, such as storm windows, specifically sloped rooftops, or a neighborhood gate.

We could be a long way from widespread use of drones, as the FAA only recently approved its first operational rules for routine commercial use of drones.But one thing is certain: The cost savings drones create for insurers would almost certainly result in lower premiums for the average person.

As Warren Buffett frequently notes in his annual letters to shareholders, robust competition in the insurance industry typically results in an environment in which insurers must pass on cost savings to customers. He's quick to point out that most insurers -- though not his insurance companies -- have historically paid out more in losses and expenses than they have earned in premiums, as savings are passed on to win over customers in a commoditized industry.

If the end game is lower premiums, perhaps we should all welcome drones as the 21st century's underwriters and claims adjusters of choice.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Markel. The Motley Fool recommends Progressive. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.