Property Risk

Cyberattacks Reach the Physical Realm

Underwriters and risk managers are beginning to get their arms around the next wave of cyber exposure — an attack that causes property or bodily damage.
By: | July 27, 2017 • 7 min read

When the Baku-Tbilisi-Ceyhan pipeline exploded in 2008 in eastern Turkey, it damaged the pipeline in Refahiye, spewed oil into the environment and posed physical harm to firefighters called in to quell the flames.

Cyber attackers apparently hacked into the pipeline’s control system and manipulated valves to increase pressure inside the pipe, while suppressing alarms that would have alerted operators to an error.

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In 2014, an unnamed steel mill in Germany sustained extensive damage after hackers breached the plant’s computer network via a spear phishing email, then infiltrated industrial systems that control operational machinery.  The attack compromised the system so that a blast furnace could not be shut down.

In another well-known incident the year before, the Stuxnet computer virus engineered by U.S. and Israeli forces damaged thousands of centrifuges at an Iranian nuclear power plant, again compromising system controls while making it appear everything was working normally. The virus was introduced through an employee’s thumb drive.

These are only a few examples of cyberattacks that caused physical property damage and potential bodily injury.

“The breaches and cyberattacks we see in the news are usually around the theft of personally identifiable information,” said Tracie Grella, global head of cyber risk insurance at AIG.

“We’ve seen ransomware events, DOS attacks. The data disclosure and business downtime are usually the results of a network breach. But the potential for extensive physical damage is an emerging risk.”

As cyber risk rapidly evolves, the insurance industry is working hard to keep up. However, gray areas remain and there are unanswered questions about how to underwrite and mitigate such a dynamic risk.

Loss Scenarios

“Five to 10 years ago, cyberattacks were motivated primarily by financial gain and access to confidential data,” said Chris O’Byrne, cyber underwriting specialist at FM Global. “This has evolved into more attacks focused on causing business disruption, and others where the goal is physical damage.”

Tracie Grella, global head of cyber risk insurance, AIG

Though every type and size of company is susceptible to a cyberattack, those with industrial-control systems (ICS), such as manufacturers and energy suppliers, may be most vulnerable to an attack intended to cause physical damage. Industrial-control systems are comprised of many components relying on communication between separate computer networks. The less cohesive a system is, the more opportunities arise for hackers to find a way in.

“We’re seeing more reports of malware being written specifically to target these systems,” O’Byrne said.

“Companies first think to look at their GL or property policies for coverage … but these policies really were not designed to respond to cyberattacks.” — Tracie Grella, global head of cyber risk insurance, AIG

“The intent may not be to expressly cause physical damage, but that could certainly be a result.”

The physical damage that could result from an attack on ICS varies. It could be a fire that destroys equipment or a whole facility; it could be the simple wearing down and corrosion of machinery; it could involve environmental damage, or damage to any goods being produced.

“Hackers can spoof sensors by sending false data. They can force cyclical behaviors, like turning something on and off in rapid cycles, which causes machinery to wear out, fuses to be blown, leaking, and in some cases explosion and fire,” said Tom Harvey, product manager of cyber solutions at RMS, the risk modeling firm.

“It could be something as simple as disconnecting safety features,” he said. “Everything would be operating as it should, but there’s the increased risk for bodily injury.”

Spoofing sensors also can cause damaged goods, without harming any machinery or equipment. In a refrigerated truck, for example, hackers would feed sensors false data so they continually record a temperature of 0 degrees, even if it’s 70 inside the truck. An entire shipment of frozen goods would be ruined by the time it reaches its destination.

“It’s not that the refrigeration equipment was broken; it’s that the sensors were fed the wrong information, and no one had any indication that it was false,” said Robert Parisi, cyber product leader at Marsh. “These losses will not fall into the simple buckets in which the insurance community likes to put things.”

The scope of potential losses leaves risk managers wondering what insurance policy, if any, will cover the damage.

Looking for Cover

“The question in insurance becomes: where is that covered?” Grella said.

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The industry has no uniform way to address these losses. Cyber coverage typically excludes physical loss. Property or general liability policies likely cover property damage, even if the underlying trigger was a cyber event. Companies also might find coverage in crime or fidelity policies, if the breach was perpetrated by an employee.

“Companies first think to look at their GL or property policies for coverage, and they may find it there, but these policies really were not designed to respond to cyberattacks,” Grella said.

“Finding silent coverage is not really where insurers or insureds want to be. Clients want to know what they’re buying and what’s covered, and carriers want to know exactly what they’re covering.”

Coverage for cyber-triggered physical losses could extend in two directions. Carriers could begin offering affirmative coverage for cyber events in property policies, or cyber policies could expand to include property damage and bodily injury, not just loss of data, business interruption and other non-physical losses.

Tom Harvey, product manager of cyber solutions, RMS

“Market conditions will dictate that evolution to some degree,” Harvey of RMS said. “At the moment, the property market is very soft, which drives underwriters to try to win more business, which means they’ll be more generous with their cyber coverages. On the other hand, regulators want to ensure underwriting is done properly, with adequate controls in place, which could push property underwriters to move away from cyber endorsements.”

Property and cyber underwriters need to work together to ensure they are managing the risk appropriately. Marsh’s Parisi said some cyber insurers have offered to cover physical loss only if the insured’s property policy does not respond. This shows the industry is recognizing the widening coverage gaps.

“Cyber policies expanding to take in this exposure is the cleanest way to do it,” he said. “We are seeing greater flexibility on the part of the cyber market to adapt to changing loss scenarios that don’t have actuarial data behind them or underwriting standards.”

AIG, Marsh and FM Global are among insurers and brokers offering expanded cyber products designed to affirmatively cover physical harm.

“We’re starting to get more inquiries about our coverage and how it intersects with other cyber policies,” FM Global’s O’Byrne said. “What clients really want is contract certainty.”

Risk Mitigation

RMS has spent the past year modeling the severity of physical losses triggered by a cyberattack, but nailing down the frequency remains a challenge.

“We have developed models to confidently help insurers assess what the severity of cyber-physical events might be,” Harvey said. “RMS are continuing to explore methods of assessing the probability of these rare events as we know both the frequency and severity are critical components of quantifying the risk.”

With cyber risks evolving and uncertainties in the type and scope of losses and coverage gaps, the best approach risk managers can take is to treat cyber like any other operational risk and apply enterprise risk management.

“The best companies approach cyber risk the same way they do currency risk, or political unrest, or weather risk — like any other standard risk,” Parisi said. “Tech-based risks are really no different that any other risk and you need to manage them through the normal risk management channels. Make sure that technology risk is part of the ERM discussion.”

“If you are targeted by a sophisticated group of hackers, they will find a way in. You have to make sure you’re properly covered.” —Tom Harvey, product manager, cyber solutions, RMS

Cross-functional teams including risk management, IT, operations and security should work with senior executives to assess the scope of cyber risk and develop a multi-pronged strategy, O’Byrne said.

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“Buying the newest, shiniest piece of technology won’t necessarily solve your exposure. Assuming that the IT guys will somehow fix it ignores the fact that technology has crept into everything that we do. It’s an active risk to be managed, not a problem to be solved,” he said.

Patching cyber vulnerabilities in industrial-control systems, and separating critical control systems from business networks and other non-critical functions can make it harder for hackers to access machinery and production controls.

Risk managers also should conduct gap analyses to determine if and where they have coverage for physical damage from a cyberattack.

“Your broker or a third-party vendor can provide this service,” Grella of AIG said. “You want to make sure you have a primary policy that provides coverage for physical damage from cyber on an affirmative basis.”

Given the near impossibility of gauging and defending against all cyber exposures as the risk takes on new forms, closing coverage gaps will be the most critical risk management technique.

“If you are targeted by a sophisticated group of hackers, they will find a way in,” Harvey said. “You have to make sure you’re properly covered.” &

Katie Siegel is an associate editor at Risk & Insurance®. She can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Risk Report: Hospitality

Bridging the Protection Gap

When travelers stay home, hospitality companies recoup lost income through customized, data-defined policies.
By: | October 12, 2017 • 9 min read

In the wake of a hurricane, earthquake, pandemic, terror attack, or any event that causes carnage on a grand scale, affected areas usually are subject to a large “protection gap” – the difference between insured loss and total economic loss. Depending on the type of damage, the gap can be enormous, leaving companies and communities scrambling to obtain the funds needed for a quick recovery.

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RMS estimates that Hurricane Harvey’s rampage through Texas could cause as much as $90 billion in total economic damage. The modeling firm also stated that “[National Flood Insurance Program] penetration rates are as low as 20 percent in the Houston area, and thus most of the losses will be uninsured.”

In addition to uninsured losses from physical damage, many businesses in unaffected surrounding areas will suffer non-physical contingent business interruption losses. The hospitality industry is particularly susceptible to this exposure, and its losses often fall into the protection gap.

Natural catastrophes and other major events that compromise travelers’ safety have prolonged impacts on tourism and hospitality. Even if they suffer no physical damage, any hotel or resort will lose business as travelers avoid the area.

“The hospitality industry is reliant on people moving freely. If people don’t feel safe, they won’t travel. And that cuts off the lifeblood of the industry,” said Christian Ryan, U.S. Hospitality and Gaming Practice Leader, Marsh.

Christian Ryan
U.S. Hospitality and Gaming Practice Leader, Marsh

“People are going away from the devastation, not toward it,” said Evan Glassman, president and CEO, New Paradigm Underwriters.

Drops in revenue resulting from decreased occupancy and average daily room rate can sometimes be difficult to trace back to a major event when a hotel suffered no physical harm. Traditional business interruption policies require physical damage as a coverage condition. Even contingent business interruption coverages might only kick in if a hotel’s direct suppliers were taken offline by physical damage.

If everyone remains untouched and intact, though, it’s near impossible to demonstrate how much of a business downturn was caused by the hurricane three states away.

“Hospitality companies are concerned that their traditional insurance policies only cover business interruption resulting from physical damage,” said Bob Nusslein, head of Innovative Risk Solutions for the Americas, Swiss Re Corporate Solutions.

“These companies have large uninsured exposure from events which do not cause physical damage to their assets, yet result in reduced income.”

Power of Parametrics

Parametric insurance is designed specifically to bridge the protection gap and address historically uninsured or underinsured risks.

Parametric coverage is defined and triggered by the characteristics of an event, rather than characteristics of the loss. Triggers are custom-built based on an insured’s unique location and exposures, as well as their budget and risk tolerance.

“Triggers typically include a combination of the occurrence of a given event and a reduction in occupancy rates or RevPar for the specific hotel assets,” Nusslein said. Though sometimes the parameters of an event — like measures of storm intensity — are enough to trigger a payout on their own.

For hurricane coverage, for example, one policy trigger might be the designation of a Category 3-5 storm within a 100-mile radius of the location. Another trigger might be a 20 percent drop in RevPAR, or revenue per available room. If both parameters are met, a pre-determined payout amount would be administered. No investigations or claims adjustment necessary.

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The same type of coverage could apply in less severe situations where traditional insurance just doesn’t respond. Event or entertainment companies, for example, often operate at the whim of Mother Nature. While they may not be forced to cancel a production due to inclement weather, they will nevertheless take a hit to the bottom line if fewer patrons show up.

Christian Phillips, focus group leader for Beazley’s Weatherguard parametric products, said that as little as a quarter- to a half-inch of rain over a four- to five-hour period is enough to prevent people from coming to an event, or to leave early.

“That’s a persistent rainfall that will wear down people’s patience,” he said.

“A rule of thumb for parametric weather coverage, if you’re looking to protect loss of revenue when your event has not actually been cancelled, you will probably lose up to 20 to 30 percent of your revenue in bad weather. That depends on the client and the type of event, but that’s the standard we’ve realized from historical claims data.”

The industry is now drawing on data to establish these rules of thumb for more serious losses sustained by hospitality companies after major events.

“Until recently the insurance industry has not created products to address these non-physical damage business interruption exposures. The industry is now collaborating with big data companies to access data, which in turn, allows us to structure new products,” Nusslein said.

Data-Driven Triggers

Insurers source data from weather organizations that track temperature, rainfall, wind speeds and snowfall, among other perils, by the hour and sometimes by the minute. Parametric triggers are determined based on historical storm data, which indicates how likely a given location is to be hit.

“We try to get a minimum of 30 years of hourly data for those perils for a given location,” Phillips said.

“Global weather is changing, though, so we focus particularly on the last five to 10 years. From that we can build a policy that fits the exposure that we see in the data, and we use the data to price it correctly.”

New Paradigm Underwriters collects their own wind speed data via a network of anemometers that stretch from Corpus Christi, Texas, all the way to Massachusetts, and works with modeling firms like RMS to gather additional underwriting information.

The hospitality industry is reliant on people moving freely. If people don’t feel safe, they won’t travel. And that cuts off the lifeblood of the industry.– Christian Ryan, U.S. Hospitality and Gaming Practice Leader, Marsh

While severe weather is the most common event of concern, parametric cover can also apply to terrorism and pandemic risks.

“We offer a terror attack quote on every one of our event policies because everyone asks for it,” said Beazley’s Phillips.

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“We didn’t do it 10 years ago, but that’s the world we live in today.”

An attack could lead to civil unrest, fire or any number of things outside an insured’s control. It would likely disrupt travel over a wide geographic region.

“A terrorist event could cause wide area devastation and loss of attraction, which results in lost income for hospitality companies,” Nusslein said.

Disease outbreaks also dampen travel and tourism. Zika, which was most common in South America and the Caribbean, still prevented people from traveling to south Florida.

“Occupancy went down significantly in that region,” Marsh’s Ryan said.

“If there is a pandemic across the U.S., a parametric coverage would make sense. All travel within and inbound to the U.S. would go down, and parametric policies could protect hotel revenues in non-impacted areas. Official statements from the CDC such as evacuation orders or warnings could qualify as a trigger.”

Less data exists around terror attacks and pandemics than for weather, though hotels are taking steps to collect information around their exposure.

“It’s hard to quantify how an infectious disease outbreak will impact business, but we and clients are using big data to track travel patterns,” Ryan said.

Hospitality Metrics

Any data collected has to be verified, or “cleaned.”

“We only deal with entities that will clean the data so we know the historical data we’re getting is accurate,” Phillips said.

“There are mountains of data out there, but it’s unusable if it’s not clean.”

Parametric underwriters also tap into the insured’s historical data around occupancy and room rates to estimate the losses it may suffer from decreased revenue.

Bob Nusslein, head of Innovative Risk Solutions for the Americas, Swiss Re Corporate Solutions.

“The hospitality industry uses two key metrics to measure loss of business income. These include occupancy rate and revenue per available room, or RevPAR. These are the traditional measurements of business health,” Swiss Re’s Nusslein said.  RevPAR is calculated by multiplying a hotel’s average daily room rate (ADR) by its occupancy rate.

“The hotel industry has been contributing its data on occupancy, RevPAR, room supply and demand, and historical data on geographical and seasonal trends to independent data aggregators for many years. It has done an exceptional job of aggregating business data to measure performance downturns from routine economic fluctuations and from major ‘Black Swan’ events, like the 9/11 terrorist attacks, the 2008 financial crisis or the 2009 SARS epidemic.”

Claims history can also provide an understanding of how much revenue a hotel or an event company has lost in the past due to any type of business interruption. Business performance metrics combined with claims data determine an appropriate payout amount.

Like coverage triggers, payouts from parametric policies are specifically defined and pre-determined based on data and statistical evidence.

This is the key benefit of parametric coverage: triggers are hit, payment is made. With minimal or no adjustment process, claims are paid quickly, enabling insureds to begin recovery immediately.

Applying Parametric Payments

For hotels with no physical damage, but significant drops in occupancy and revenue, funds from a parametric policy can help bridge the income gap until business picks up again, covering expenses related to regular maintenance, utilities and marketing.

Because payment is not tied to a specific type or level of loss, it can be applied wherever insureds need it, so long as it doesn’t advance them to a better financial position than they enjoyed prior to the loss.

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Parametric policies can be designed to fill in where an insured has not yet met their deductible on a separate traditional policy. Or it could function as excess coverage. Or it could cover exposures excluded by other policies, or for which there is no insurance option at all. Completely bespoke, parametric coverages are a function of each client’s individual exposures, risk tolerance and budget.

“Parametric insurance enables underwriting of risks that are outside tolerance levels from a traditional standpoint,” NPU’s Glassman said.

The non-physical business interruption risks faced by the hospitality industry match that description pretty closely.

“Hotels are a good fit for parametric insurance because they have a guaranteed loss from a business income standpoint when there is a major storm coming,” Glassman said.

While only a handful of carriers currently offer a form of parametric coverage, the abundance of available data and advancement in data collection and analytical tools will likely fuel its popularity.

Companies can maximize the benefits of parametric coverages by building them as supplements to traditional business interruption or event cancellation policies. Both New Paradigm Underwriters and Beazley either work with other property insurers or create hybrid products in-house to combine the best of both worlds and assemble a comprehensive risk transfer solution. &

Katie Siegel is an associate editor at Risk & Insurance®. She can be reached at [email protected]