The mother of invention: why cyber ILS is needed now

Key takeaways

- Beazley and Hannover Re heralded as pioneers
- After almost a decade of talks, these deals represent a watershed
- New source of capacity welcomed as cyber risks grow exponentially
- Insurers must continue to invest in measuring cyber risks

January 2023 could come to represent a watershed moment in the development of the insurance-linked securities (ILS) markets. After almost a decade of wrangling and debate by the very best dealmakers in the risk transfer landscape, not one but two cyber ILS deals finally came to market.

First  Beazley, then Hannover Re  brought the deals. They are very different and thus significant in their own ways, but their importance cannot be  overestimated. Visionaries within the industry are clear that cyber risk will become as important to the risk transfer landscape, and as big in terms of gross written premiums, as property or casualty business—the term PC&C has even been coined to represent these three strands.

The notion that capital markets investors could become comfortable taking this risk represents a further game-changer—for many reasons.

That is the scenario three experts explored in a virtual panel discussion on this topic, titled “Cyber cat bonds and the future development of ILS”, organised and moderated by Intelligent Insurer. Lawrence Perret-Hall, director, CYFOR Secure; Jonathan Drake, partner and law insurance expert, DWF; and Juan Marcano, principal, cyber alternative risk transfer, CyberCube, offered three distinct perspectives on this issue.  In addition to this article, further comments from these experts can be found here. 

“This deal might give other investors the confidence to consider such triggers in the future.” Jonathan Drake, DWF

The wider picture

Drake framed the importance of the Beazley deal in the context of the wider dislocation in the reinsurance markets generally and specific concerns about the profitability of cyber insurance.

“Some have described the 1/1 renewal as one of the most difficult and challenging they’d ever seen. In a capacity-constrained market, to see this bright shining light in January with not one, but two cyber ILS transactions, is very interesting,” he said.

Drake noted that since the deal is a private placement with a panel of investors there is less publicly available information about its structure. Yet, he stressed, the deal proves that there are still capital market opportunities for reinsurance-type support for well-regarded underwriters even in classes of business that are proving to be challenging.

He stressed the importance of the Beazley deal’s use of an indemnity trigger. He said ILS investors have traditionally been wary of such triggers, preferring parametric deals. Their acceptance of this deal indicated a vote of confidence in the underwriting and claims departments at Beazley. He suggested such deals would be limited to re/insurers with a good track record but also that this deal might give other investors the confidence to consider such triggers in the future.

Perret-Hall offered the perspective of a cyber expert, albeit one firmly focused on the challenges of assessing, measuring and ultimately pricing cyber risk. He stressed the extent to which the nature and scale of the threat from cyber is increasing exponentially. He noted some of the high-profile recent cyber attacks on the Royal Mail and The Guardian. Use of catastrophe bonds to transfer this risk can only be a good thing, potentially enabling greater coverage for organisations, he said.

More work was needed around how insurers measure cyber risk and deal with inconsistencies around it in different territories, Perret-Hall added. He stressed the huge diversity in how insurers quantify the cyber risk of their customers. For insureds, it can be a complex, time-consuming task that doesn’t necessarily provide insurers with an accurate or full picture of risk appetite.

He said these deals could represent game-changers. “This is a big step towards the cyber insurance industry starting to mature. There’s always been a bit of stigma about cyber not necessarily covering as much as it needs to, or covering the bigger financial risks such as ransomware. This is a real sign of maturity and I’m looking forward to seeing what other deals might emerge and how things progress.”

“I’m looking forward to seeing what other deals might emerge and how things progress.” Lawrence Perret-Hall, CYFOR Secure

Breakthroughs

Marcano noted that CyberCube’s Portfolio Manager, a scenario-based data-driven model, was used on the Beazley deal. He acknowledged just how long the industry has been working on the notion of transferring cyber risks into the capital markets and described these deals as important breakthroughs.

“Cat bond investors and cyber experts have been in conversations for at least the past eight years with not much traction. There have been a few private quota share transactions in the past, though none of magnitude. So these deals are significant developments.

“They seem to signal that ILS investors are willing to take cyber risk in a significant way. The fact that these used a panel of investors suggests institutions might start to look at cyber as a new asset class,” Marcano said.

He said the key to the asset class’s continuing to grow would be education. The first catastrophe bonds were launched some 25 years ago and although that asset class might now be described as mature, it took a long time to develop. The same process will be necessary in the cyber space.

“In the past five years, there has been a significant development in the modelling and understanding of cyber risk to a level where asset managers feel comfortable making an investment decision. The fact that cyber models have evolved so quickly helps capital market investors get their heads around what many people consider to be one of the most difficult models to understand,” he explained.

“But when you consider that the cyber market is forecast to triple in the next four to five years, the opportunity for capital markets to participate is significant.”