Cyber cat bonds to grow in importance despite potential teething problems: Solidum Partners

Amid high demand for capacity in the primary and reinsurance markets, analysis by Solidum Partners suggests the cyber cat bond segment will continue to grow in importance in the future and that market dynamics “should ensure adequate risk compensation in the medium term”.

In a recent report, the Swiss specialist ILS investment manager highlighted how the market for insurance against failure or malfunction of IT systems (resulting either in direct damage to an insured entity or in third-party liability claims) is growing rapidly.

“For 2023, the global premium volume amounted to approximately USD 14 billion. This figure is expected to double over the next four years and grow further to USD 50 billion by 2030,” Solidum’s analysts said.

According to the firm’s report, the capacity available in the traditional reinsurance market is “far from sufficient” to support such growth, and therefore, reinsurance companies active in this field have been “trying for years” to establish special risk transfer programmes.

“In 2023, this segment finally gained significant momentum, with some private transactions closing in the first half of the year and four public Cyber Cat bonds with a total volume of $415 million being placed in the last quarter,” Solidum’s analysts added.

Solidum’s report also observed that typically in the reinsurance market, new structures or coverage elements often involve an enhanced level of risk.

“Historically, the quality of contractual arrangements often improved only after a loss event had happened by learning it the hard way,” Solidum explained.

The report continued, “In later editions, gaps and ambiguities in the contractual wordings have been corrected by standardised clauses and clarifications.

“In the new class of cyber cat bonds, therefore, the question arises in particular as to whether the definitions of coverage terms will work as intended at the time when a possible event strikes.”

Solidum’s analysts noted that the risk is that every event that is “in some way or other related to IT” will be paid, regardless of where claims are arising from.

In addition to these contractual uncertainties, Solidum said questions remain to what extent the risk models used today are already sufficiently robust to be able to assess the risk with reassuring precision.

“Questions stem from the small number of historical events for the calibration of the models, as well as from the mentioned uncertainty as to whether the described (and thus modelled) risk actually corresponds to the one ultimately covered,” Solidum’s analysts said.

It is reportedly for these reasons that the Solidum ILS and Cat Bond Funds have “not yet” participated in the new cyber cat bonds.

However, due to the high demand for capacity in the primary and reinsurance markets, Solidum anticipates that the segment will continue to grow in importance in the future and that “market dynamics should ensure adequate risk compensation in the medium term”.

Solidum concluded, “Therefore, this risk class and its evolution in the market are currently closely monitored by management, in particular with regard to overcoming potential ‘teething problems’ and establishing widely accepted and functional coverage standards. Future participation seems possible.”