Cyber Risk

Cyber Risks and ILS

The race is on to develop a CAT bond-like vehicle that could build an extra layer of protection against cyber threats.
By: | October 15, 2016 • 8 min read

As losses with cyber risks pile up, the insurance industry is looking for alternatives to offer capacity to buyers. Could capital markets hold the key to provide broader coverages and higher limits?


The answer may well be yes.

The race is on among underwriters and their advisers to develop CAT bond-like vehicles that could enable them to build extra layers of protection against cyber threats and to expand insurance and reinsurance capacity.

With pension funds and other institutional investors showing ever more appetite for insurance-linked securities (ILS), conditions appear to be set for a new market to flourish that could also extend in the future to corporations and government entities with a high exposure to cyber events.

Bill Dubinsky, head of insurance-linked securities, Willis Capital Markets & Advisory

Bill Dubinsky, head of insurance-linked securities, Willis Capital Markets & Advisory

“Many investors are looking for ways to take more risks,” said Bill Dubinsky, head of insurance-linked securities at Willis Capital Markets & Advisory. “Cyber risk is something that could work for them because a lot of it is catastrophic and it is generating real growth in insurance and reinsurance needs.”

The drivers behind the growth of ILS markets are the same that are pumping record levels of capital in the reinsurance industry.

As they look for alternatives to low-risk fixed income securities, institutional investors have taken a favorable view of CAT bonds and other ILS products, which offer solid rates of return and low probabilities of losses (although they tend to be huge when they take place).

But the development of a bond market to transfer cyber risks stumbles on difficulties that also affect the insurance industry in its dealings with a fast changing, hard to predict threat.

Cyber risks have fundamental differences with the catastrophes that constitute the traditional focus of ILS securities, which means that a lot of work still needs to be done before the new asset class takes flight.

“I do not think it is something that will happen quickly, but it is a natural evolution for the market,” said Ben Brookes, vice president of capital markets at RMS, the risk modeling firm.

Cyber Risks Are Unpredictable

One of the main challenges is that cyber risks are unpredictable and evolve all the time, and the same goes for the losses that they can generate.

“The scope of the coverages has continued to expand. Insurance contracts today have a much broader coverage than five years ago,” said Michael Carr, technology practice leader at Argo Group.

“For example, the privacy coverage has gone from just security-type triggers, such as hacking or malware, to any sort of privacy violation. In the area of business interruption, policies now also cover losses caused by failures of third-party software or even by failures of the insured’s own IT department.”

Companies use insurance coverages to protect their networks, physical structures and supply chains against cyber attacks, but they are also exposed to third-party liabilities, which should soon become the most important source of losses caused by cyber events.

The unpredictability of the peril frightens off investors who look at ILS investments as a source of portfolio stability in volatile times. Liability risks with a long tail are very likely to be the toughest one for asset managers to swallow.

So the first challenge that cedants and their advisers need to tackle before a cyber ILS market comes into shape is to develop reliable ways to measure, aggregate and model cyber risks, so that investors will feel more comfortable taking them in.


A very solid understanding of how the risk evolves is important as — different from hurricanes and floods — hackers learn from past experience, and they adapt their attacks accordingly.

“There is no standard way to quantify cyber exposures at the moment,” said Thomas Harvey, the product manager of emerging risks at RMS. “The human factor and the various motivations behind attacks add a huge element of complexity to the modeling of cyber risks. Also, the balance between attack and defense is shifting all the time.”


But he sees progress in this issue, as access to data on cyber attacks — for a long time a scarce commodity — is gradually becoming more available to the parties involved. Reporting rules in the U.S. are playing a large part in promoting the sharing of information, and the E.U. will make reporting on cyber attacks mandatory by 2018, Harvey said.

Big Data Models Cyber Risks

Some kinds of losses, such as extortion, which companies do not like to make public, present particular challenges, but modeling firms are negotiating with insurers and reinsurers to have access to all kinds of data about cyber events. Participants in the market have realized that sharing knowledge is good for everybody, Harvey said.

For example, the Association of British Insurers, ABI, made an appeal in May for the creation of a database with mandatory information about cyber incidents.

“We are confident it is possible to develop a mechanism to model cyber risks,” Harvey said. “Demand for it is strong, as there is a huge amount of risks that the insurance and reinsurance markets want to take on.”

But the uncertain nature of cyber risks also raises the question of what losses would trigger a contract. They could be either single, large events, or an aggregation of claims, according to Brent Poliquin, assistant vice president for insurance-linked securities at AIR Worldwide, the catastrophe modeling firm.

There are many ways that originators of insurance contracts can lose money because of cyber risks, some of them still unknown by the market, which make it much harder to pick a trigger than property destruction resulting from earthquakes or floods.

Separating cyber events from terrorism could be a difficult thing to do on some occasions. Hackers form a heterogeneous group, ranging from religious fundamentalists to corporate spies, government agents and activists, and as a result they can have many different targets and kinds of attacks in mind.

To make matters more complex, the main source of cyber events is usually found within the company, as employees are often at their origin, either maliciously or by accident.

The trigger issue should be an especially difficult one for reinsurance companies, which make use of ILS contracts to spread their own risks and reduce their regulatory capital reserves. If investors have doubts over the trigger events, or fear that contracts could end up in the courts, they will show little interest for them.

In Dubinsky’s view, one of the keys to tackle this issue will be to focus on proportional agreements, instead of the excess of loss deals that prevail today in the ILS market. By doing so, investors can share on the expertise of underwriters to deal with a complex and evolving risk.

Appetite for Cyber Risk

Even after the technical challenges are overcome, however, the appetite for cyber risk bonds may not be as strong as it has been for other ILS securities.

For instance, some investors consider that, differently from natural catastrophes, cyber risks may have a high level of correlation with other securities such as equities and bonds.

The reasoning is that, in the case of a large cyber attack against vital infrastructures, the economic effects could make the stock and bond markets stumble at the same time.

“Asset managers who focus on ILS portfolios should find cyber risks products appealing due to the very low correlation with natural catastrophe risks that they have in their portfolios,” Poliquin said.

“But there may be a challenge related to the root sources of capital that flow to these asset managers, such as pension funds. From their standpoint, they may potentially discourage an allocation of capital to cyber risks bonds because they could have a higher correlation with other investments that they are making.”

Paul Traynor, managing director, BNY Mellon

Paul Traynor, managing director, BNY Mellon

But demand for ILS products has been so strong that, in Dubinsky’s view, investors could be interested despite the correlation issue.

And, when a cyber ILS market becomes a reality, even individual companies with large exposures to the risk might be able to tap capital markets for further protection, in a similar fashion that corporations do today with CAT bonds.

In fact, Paul Traynor, a managing director at BNY Mellon, highlighted that an example of how the market could work was provided by Crédit Suisse, which issued in May a $222 million CAT bond to boost its coverage against operational risks like fraud and cyber crime.

“Take the case of a large financial corporation that has invested very heavily to protect itself against cyber risks, but for regulatory reasons, still has to put operational capital aside to cover that risk,” Traynor said.

If investors believe a cyber risk instrument is a sound investment, the corporation may get capital support from such a transaction.


This is a solution that could gain steam not only among banks, but also in other highly regulated industries such as telecommunications and health insurance, he said.

Traynor also thinks that the development of a cyber risks ILS market could go a long way toward helping underwriters make available more capacity for a segment where demand is booming, even if evaluating exposures remains a challenge.

“For regulatory reasons, it is very difficult for insurers to offer sizable cyber covers if they cannot model them,” he said. “What they can do is to structure a special purpose vehicle to keep some of their cyber risk exposure and move most of it to capital markets, where entities that are not as regulated as insurers are can take it in.”  &

Rodrigo Amaral is a freelance writer specializing in Latin American and European risk management and insurance markets. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Risk Focus: Cyber

Expanding Cyber BI

Cyber business interruption insurance is a thriving market, but growth carries the threat of a mega-loss. 
By: | March 5, 2018 • 7 min read

Lingering hopes that large-scale cyber attack might be a once-in-a-lifetime event were dashed last year. The four-day WannaCry ransomware strike in May across 150 countries targeted more than 300,000 computers running Microsoft Windows. A month later, NotPetya hit multinationals ranging from Danish shipping firm Maersk to pharmaceutical giant Merck.


Maersk’s chairman, Jim Hagemann Snabe, revealed at this year’s Davos summit that NotPetya shut down most of the group’s network. While it was replacing 45,000 PCs and 4,000 servers, freight transactions had to be completed manually. The combined cost of business interruption and rebuilding the system was up to $300 million.

Merck’s CFO Robert Davis told investors that its NotPetya bill included $135 million in lost sales plus $175 million in additional costs. Fellow victims FedEx and French construction group Saint Gobain reported similar financial hits from lost business and clean-up costs.

The fast-expanding world of cryptocurrencies is also increasingly targeted. Echoes of the 2014 hack that triggered the collapse of Bitcoin exchange Mt. Gox emerged this January when Japanese cryptocurrency exchange Coincheck pledged to repay customers $500 million stolen by hackers in a cyber heist.

The size and scope of last summer’s attacks accelerated discussions on both sides of the Atlantic, between risk managers and brokers seeking more comprehensive cyber business interruption insurance products.

It also recently persuaded Pool Re, the UK’s terrorism reinsurance pool set up 25 years ago after bomb attacks in London’s financial quarter, to announce that from April its cover will extend to include material damage and direct BI resulting from acts of terrorism using a cyber trigger.

“The threat from a cyber attack is evident, and businesses have become increasingly concerned about the extensive repercussions these types of attacks could have on them,” said Pool Re’s chief, Julian Enoizi. “This was a clear gap in our coverage which left businesses potentially exposed.”

Shifting Focus

Development of cyber BI insurance to date reveals something of a transatlantic divide, said Hans Allnutt, head of cyber and data risk at international law firm DAC Beachcroft. The first U.S. mainstream cyber insurance products were a response to California’s data security and breach notification legislation in 2003.

Jimaan Sané, technology underwriter, Beazley

Of more recent vintage, Europe’s first cyber policies’ wordings initially reflected U.S. wordings, with the focus on data breaches. “So underwriters had to innovate and push hard on other areas of cyber cover, particularly BI and cyber crimes such as ransomware demands and distributed denial of service attacks,” said Allnut.

“Europe now has regulation coming up this May in the form of the General Data Protection Regulation across the EU, so the focus has essentially come full circle.”

Cyber insurance policies also provide a degree of cover for BI resulting from one of three main triggers, said Jimaan Sané, technology underwriter for specialist insurer Beazley. “First is the malicious-type trigger, where the system goes down or an outage results directly from a hack.

“Second is any incident involving negligence — the so-called ‘fat finger’ — where human or operational error causes a loss or there has been failure to upgrade or maintain the system. Third is any broader unplanned outage that hits either the company or anyone on which it relies, such as a service provider.”

The importance of cyber BI covering negligent acts in addition to phishing and social engineering attacks was underlined by last May’s IT meltdown suffered by airline BA.

This was triggered by a technician who switched off and then reconnected the power supply to BA’s data center, physically damaging servers and distribution panels.

Compensating delayed passengers cost the company around $80 million, although the bill fell short of the $461 million operational error loss suffered by Knight Capital in 2012, which pushed it close to bankruptcy and decimated its share price.

Mistaken Assumption

Awareness of potentially huge BI losses resulting from cyber attack was heightened by well-publicized hacks suffered by retailers such as Target and Home Depot in late 2013 and 2014, said Matt Kletzli, SVP and head of management liability at Victor O. Schinnerer & Company.


However, the incidents didn’t initially alarm smaller, less high-profile businesses, which assumed they wouldn’t be similarly targeted.

“But perpetrators employing bots and ransomware set out to expose any firms with weaknesses in their system,” he added.

“Suddenly, smaller firms found that even when they weren’t themselves targeted, many of those around them had fallen victim to attacks. Awareness started to lift, as the focus moved from large, headline-grabbing attacks to more everyday incidents.”

Publications such as the Director’s Handbook of Cyber-Risk Oversight, issued by the National Association of Corporate Directors and the Internet Security Alliance fixed the issue firmly on boardroom agendas.

“What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.” — Jimaan Sané, technology underwriter, Beazley

Reformed ex-hackers were recruited to offer board members their insights into the most vulnerable points across the company’s systems — in much the same way as forger-turned-security-expert Frank Abagnale Jr., subject of the Spielberg biopic “Catch Me If You Can.”

There also has been an increasing focus on systemic risk related to cyber attacks. Allnutt cites “Business Blackout,” a July 2015 study by Lloyd’s of London and the Cambridge University’s Centre for Risk Studies.

This detailed analysis of what could result from a major cyber attack on America’s power grid predicted a cost to the U.S. economy of hundreds of billions and claims to the insurance industry totalling upwards of $21.4 billion.

Lloyd’s described the scenario as both “technologically possible” and “improbable.” Three years on, however, it appears less fanciful.

In January, the head of the UK’s National Cyber Security Centre, Ciaran Martin, said the UK had been fortunate in so far averting a ‘category one’ attack. A C1 would shut down the financial services sector on which the country relies heavily and other vital infrastructure. It was a case of “when, not if” such an assault would be launched, he warned.

AI: Friend or Foe?

Despite daunting potential financial losses, pioneers of cyber BI insurance such as Beazley, Zurich, AIG and Chubb now see new competitors in the market. Capacity is growing steadily, said Allnutt.

“Not only is cyber insurance a new product, it also offers a new source of premium revenue so there is considerable appetite for taking it on,” he added. “However, whilst most insurers are comfortable with the liability aspects of cyber risk; not all insurers are covering loss of income.”

Matt Kletzli, SVP and head of management liability, Victor O. Schinnerer & Company

Kletzli added that available products include several well-written, broad cyber coverages that take into account all types of potential cyber attack and don’t attempt to limit cover by applying a narrow definition of BI loss.

“It’s a rapidly-evolving coverage — and needs to be — in order to keep up with changing circumstances,” he said.

The good news, according to a Fitch report, is that the cyber loss ratio has been reduced to 45 percent as more companies buy cover and the market continues to expand, bringing down the size of the average loss.

“The bad news is that at cyber events, talk is regularly turning to ‘what will be the Hurricane Katrina-type event’ for the cyber market?” said Kletzli.

“What’s worse is that with hurricane losses, underwriters know which regions are most at risk, whereas cyber is a global risk and insurers potentially face huge aggregation.”


Nor is the advent of robotics and artificial intelligence (AI) necessarily cause for optimism. As Allnutt noted, while AI can potentially be used to decode malware, by the same token sophisticated criminals can employ it to develop new malware and escalate the ‘computer versus computer’ battle.

“The trend towards greater automation of business means that we can expect more incidents involving loss of income,” said Sané. “What’s possibly of greater concern is the sheer number of different businesses that can be affected by a single cyber attack and the cost of getting them up and running again quickly.

“We’re likely to see a growing number of attacks where the aim is to cause disruption, rather than demand a ransom.

“The paradox of cyber BI is that the more sophisticated your organization and the more it embraces automation, the bigger the potential impact when an outage does occur. Those old-fashioned businesses still reliant on traditional processes generally aren’t affected as much and incur smaller losses.” &

Graham Buck is editor of He can be reached at