Cyber ILS evolving, but market yet to experience catastrophic loss, AM Best warns

The market for cyber insurance-linked securities (ILS) continues to develop, but as cyber insurance itself has not faced a catastrophic loss yet, AM Best believes the use of capital to buffer underwriting operations may end up revisited, when any major loss event occurs.

Cyber insurance-linked securities (ILS) are, of course, one of the insurance classes of business “du jour” for the ILS market.

As a segment of the market that has actually been in development for a few years, if you look at the activity some ILS managers have been entering into, in terms of collateralizing cyber risks, the recent activity seen has sparked much discussion and resulted in questions over the sustainability of ILS within an as-yet relatively untested line of insurance business.

Rating agency AM Best notes the progress being made in a recent report, citing the Beazley cyber catastrophe bond, the Feria Re reinsurance sidecar focused on cyber risks from Coalition, and the Hannover Re quota share cyber ILS deal with asset manager Stone Ridge.

While cyber ILS activity is growing, AM Best’s report is also cautionary, as the cyber insurance market has not faced a major cyber catastrophe loss event really, with the largest to-date actually a property loss (Merck).

“The cyber insurance market has yet to encounter a catastrophic loss. With around $5 billion in premium in 2021, a $1 billion loss event would strain the system. A larger loss would be difficult for insurers to cover,” AM Best explained.

While that is a very small loss, in property catastrophe terms, in the cyber market it could already send losses to many ILS investors that are allocated to cyber ILS structures, especially as the market remains relatively small.

There’s a need for cyber insurance to be properly tested, but also for cyber reinsurance and retrocession, which the ILS market activity is really part of, to grow to better protect the segment and diversify the risks outwards to more players when major loss events do occur.

“As insurers learn from these transactions, the market should be able to bridge the gap between complexity of a proportional cyber risk cession with the needs of a capital markets investor,” AM Best said.

Adding that, on the cyber ILS arrangements seen so far, “The cyber market has not yet faced a comprehensive test, so any cyber catastrophe—and how losses are paid—could cause the markets to revisit these solutions.”