A proposed new source of capital for insuring cyber

With insured cyber losses growing, and the average digital ransom payments increasing by 82% (up US$570,000, according to Palo Alto Networks’ Unit 42), securities may help insurers survive the hard market ahead.

“For cyber insurance to remain a viable business, insurers and their customers need a new pool of capital to help address the risk of large, generally unlikely (but possible) cyber catastrophes — events that hit multiple companies and cost insurers hundreds of millions of dollars,” writes Tom Johansmeyer in Harvard Business Review. “That new pool of capital could help insurers manage their risk better, and give them more breathing room to write more cyber insurance.

“Insurance linked securities (ILS) could help give the industry what it needs to grow.”

Insurance-linked securities draw on capital provided by investors, not policyholders. A simple example would be an insurer offering a catastrophe bond to the capital markets.

The quid pro quo is that if no disaster happens during the period before the bond matures, the insurer pays investors back their money for the bond, plus interest. But if a catastrophe does happen during the period set for the bond, the investors lose the money, which then goes toward paying the insurer’s claims to insureds.

There is some interest among ILS investors in the cyber market, Johansmeyer reports.

Data analytics company Verisk recently spoke with 24 ILS funds, representing nearly 80% of the industry as measured by assets under management (AUM). “Only two have mandates completely excluding the cyber risk,” Johansmeyer writes. “Roughly 20% of them have engaged in at least one cyber ILS trade, although they have tended to be smaller, bespoke transactions intended to mirror traditional reinsurance.

“What’s more important, though, is the appetite for growth: Thirteen ILS funds, representing nearly $60 billion in AUM, reported they are interested in providing cyber reinsurance protection.”

This would be a boost to reinsurers, whose share of the cyber claims bills has increased from 45% a few years ago to 55% now. Globally, insurers collected about US$5.5 billion for cyber claims, Johansmeyer writes, up from roughly $5 billion a year ago.

But don’t be fooled by the 10% growth, he adds – reinsurers are barely keeping their heads above water, with cyber claims ratios reaching more than 80%.

In Canada last year, cyber writers reported an unprofitable loss ratio of well above 100%, which was a decided improvement from the 400%-plus ratio reported the first year of the pandemic.

ILS could serve as a means to raise more retrocessional insurance capital for reinsurers (‘retrocessional insurance’ refers to reinsurers insuring themselves). But the deal would have to be easily understood, so as to attract investors who may not understand the complexities of insurance.

“ILS funds need to see cyber ILS transactions that are easy to understand (and explain to their end investors),” says Johansmeyer. “Commoditizing those easy-to-understand deals will be crucial, particularly when it comes to the importance of minimizing frictional costs.

“Deals that are easy to analyze and use a common language are most likely to cause the first large wave of cyber ILS activity and create a foundation for the development of an ongoing, reliable and robust cyber retrocession market.”