The market for insurance-linked securities backing cyber exposures reached critical mass in the first quarter and market participants are optimistic that more deals will be announced this year.
Demand for coverage and reinsurance capacity matched advances in modeling to facilitate transactions sponsored by London-based Beazley PLC and German reinsurer Hannover Re SE in January, with support from brokers, cyber insurers and key investors.
In some ways, the rise of capital market support for cyber exposures parallels the early days and development of the catastrophe bond market for hurricane and earthquake risks, which also initially featured smaller deals and was a response to market demand for coverage expansion, sources said.
The ILS market has expanded to include a variety of structures, such as sidecars and collateralized reinsurance vehicles, and has become a significant part of the overall reinsurance market, particularly the retrocession market.
“When you go back to why the disaster bond market was created about 25 years ago, it was because the demand for the product exceeded the supply from conventional sponsors,”
; said Paul Schultz, Chicago-based CEO of Aon Securities, a unit of Aon PLC.Cyber insurance markets are beginning to face a similar problem.
“The direct market now for insurance companies is very expensive and very limited,” said Jeff Mohrenweiser, Chicago-based senior director of global securities for Fitch Ratings Inc.
Cyber reinsurance markets are “materially underserved” by traditional reinsurers, and capital markets are critical to growing the business, said Theo Norris, London-based cyber account manager, insurance-related securities, at Gallagher Re, Arthur’s reinsurance broker. J. Gallagher & Co.
Paul Bantick, head of global cyber & technology at Beazley, said the cyber insurance market is generally considered to be around $10 billion in premiums. “If we’re going to go from $10 billion to $30 billion or $40 billion and deal with the systemic exposure as we do that, we’re going to have to create a cyber disaster market.”
The Beazley and Hannover Re deals broke the ice.
Beazley’s $45 million Section 4(2) private cyber cat bond is designed to cover remote probability catastrophic and systemic events and indemnifies Beazley against all perils in excess of a $300 million catastrophic event, with the potential for additional tranches to be released up to 2023 and beyond.
The Beazley cyber bond is backed by investors including Fermat Capital Management LLC, and was structured and placed by Gallagher Securities, Gallagher Re’s ILS business.
The Hannover Re deal involved Stone Point Capital investing $100 million in what it called “a proportional reinsurance solution” for retrocessional coverage. The deal “covers cyber risks in Hannover Re’s worldwide portfolio and has a long-term focus,” according to a Hannover Re statement announcing the deal.
Mr. Bantick said the Beazley bond used both internal and external models (see related story) and that the specialty insurer spent months informing and courting investors before the deal.
Since it went public, investor interest in the deal has multiplied, Bantick said. Some investors who were not ready to invest in January are likely to invest in similar deals later this year, perhaps in the second and third quarters, he said.
Capital market support for cyber exposure will likely begin in a measured fashion, not unlike the disaster bond market, Schultz said. “We are starting slowly. We will start attracting investors to these transactions. Comfort and transparency will grow over time.”
“I think there are investors who are willing to be ‘first movers,'” Mohrenweiser said, noting that against the multibillion-dollar scale of the investment funds involved, the size of the new cyber bonds does not represent an existential risk. Both he and Schultz said 2023 is likely to to lead to further business in the cyber capital market, a view that is widely shared.
Gallagher Res Mr. Norris said the broker is “currently working closely with a range of cedants to bring more cyber ILS deals to the markets – from bonds to sidecars.”
Oliver Brew, London-based cyber practice leader for Lockton Re, Lockton Cos. LLC’s reinsurance business, Beazley called the cyber bond “a precursor to business to come.”
One reason for the pivot to the capital markets for additional coverage is the exposure to risk accumulation for insurers and reinsurers, said Sharon Haran, commercial director in Tel Aviv, Israel, for Parametrix Insurance Services LLC. Parametrix provides index-based coverage for cloud service outages and regularly monitors that sector for such activity as part of its business.
With cloud market share largely concentrated in three top providers (see chart) and surveys showing 60% to 70% of businesses use cloud services, Haran said an insurer or reinsurer can have many unrelated customers exposed at once.
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Location plays an important role in evaluating such exposures because the cloud is not a monolithic entity but based in regions, so downtime at a given data center serving a specific region can lead to a contagion of exposure.
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