Cyber catastrophe could deter ILS investors: Conning

In a new report, insurance focused investment manager Conning raises a valid point, that a nascent cyber insurance-linked securities (ILS) market may be based on fragile investor confidence, so the occurrence of a major cyber catastrophe loss could deter them before the market even has a chance to mature.

Cyber risk is a burgeoning insurance market, one lacking reinsurance capital, and seen as a growth opportunity for the insurance-linked securities (ILS) industry.

In the last year, the first two private cyber catastrophe bond deals have been sponsored by specialty re/insurer Beazley, while we’ve also seen the first publicised cyber sidecar, or private quote share deal, between Hannover Re and investor Stone Ridge.

These transactions are helping to drive more awareness and interest in cyber ILS, as a source of risk capital that can support insurance and reinsurance markets as the cyber exposure they underwrite continues to grow.

In a new report Conning raises a topic worth considering, that the relatively untested, from a catastrophic loss point of view, cyber marketplace could face even more capacity challenges if a significant event occurs before it has time to build-out the capital support it needs, from traditional and ILS sources.

The company notes that cyber risk sits on the “edge of insurability” and looks at some potential future scenarios for this line of business.

Under a no major loss scenario, Conning says that the cyber insurance market will continue to grow at double digit rates, with strong new business inflows to be expected, both in the US and internationally.

Explaining that this rapid growth, if it continues, will result in a cyber insurance market with a far greater ability to absorb future catastrophe losses.

The other scenario is that “a still immature cyber market is rocked by one or more near-term catastrophe events on a scale not previously seen,” Conning says.

Such an occurrence of a major cyber insurance market loss event will dent confidence in the cyber risk models that are available today, the company notes.

But, more importantly for this market, Conning believes a major cyber catastrophe could quickly serve to deter investors from committing capital to the nascent cyber catastrophe bond and ILS market.

Importantly, this could also derail the cyber insurance and reinsurance market in general, as “In the absence of a large and liquid market for tail risk, the overall market lacks the capacity needed to meet demand at affordable prices,” Conning explains.

It could also cause pricing to rise steeply to a level where self-insurance looks like the best option, and increase calls for taxpayer funded risk transfer solutions for cyber risk.

“Cyber has grown faster than any other line of business in recent years,” William Pitt, a director at Conning and author of its cyber insurance report commented. “But it is still a small and immature market. The growth opportunity remains unrivalled, but investor confidence and carriers’ risk appetites are both fragile. Given this, the scale and imminence of catastrophe losses could permanently affect the market’s growth trajectory.”

Conning states, “The cyber insurance market today is located on the edge of insurability. The scale and imminence of catastrophe losses in the next few years will likely determine on which side of that fault line cyber risk ultimately falls.”

It’s true, that the cyber insurance market itself has yet to be tested fully, let alone cyber ILS structures that exist today.

Events of a smaller nature will actually help to foster the market, by testing and validating modelling technology. But, as is also true for natural catastrophe risks, a major loss event that falls outside of modelled expectations could test confidence of traditional and alternative capital providers alike.