Improved data and models attracting ILS capital to cyber: Guy Carpenter

Insurance-linked securities (ILS) capital is increasingly becoming attracted to and getting more comfortable with deploying to cover cyber insurance and reinsurance risks, according to broker Guy Carpenter.

Helping to stimulate the increased appetite and interest are the improvements in data quality and cyber risk models, as well as the fact many ILS funds have suffered poor performance due to natural catastrophe events in recent years, the broker explained this morning.

There remains a need for alternative sources of capacity in the cyber reinsurance and retrocession space in particular, as traditional capital continues to fall-short of the levels required to support the growth some cyber underwriters are seeking.

But, “Event covers and nascent insurance-linked securities (ILS) structures have encouraged alternative capital to begin supporting cyber risk, which is expected to provide much-needed additional capital to support the ongoing market expansion,” Guy Carpenter experts explained in a report.

They note that as reinsurers reduced their exposure to cyber risks, the result was less efficient reinsurance and retro structures.

“Consequently cedents began to explore alternative structure options, opening the door for new capital to enter the space,” the report states.

A primary attraction to cyber risk has been the development of clearer triggers, helping alternative capital specialists to understand the risk of loss more readily.

The report continues, “Event covers have created an opportunity to attract catastrophe-specialist alternative capital to the space as a first foray into the cyber market.

“Despite the rapid evolution of cyber insurance, insurance-linked securities (ILS) funds have been slow
to enter the space. ILS funds rely on modeled output in conjunction with an understanding of the underlying risk to provide their investors with the level of comfort required to deploy capacity. Improvements in data quality coupled with poor performance from other catastrophe exposed lines has helped position cyber as a more attractive investment for alternative capital funds.”

As a result, the cyber market is seeing some progress, with a number of higher-profile cyber insurance-linked securities (ILS) deals now transacted and interest growing among both cat bond and private ILS fund managers in the space.

Key developments have been asset manager Stone Ridge providing US $100 million in capital to support an innovative retrocession cyber quota share arrangement for global reinsurance firm Hannover Re.

Coalition launching a third-party capital backed sidecar type vehicle with a cyber risk focus.

As well, of course, as the now two cyber cat bond issuances sponsored by specialist re/insurer Beazley, Cairney and Cairney II.

Guy Carpenter’s report says, “Some progress was seen in 2022, with several transactions providing a stepping stone for ILS funds to bring new capacity to the market.”

Adding that, “The changing reinsurance landscape and the beginning of a cyber ILS market is due, in part, to the increasing maturity of commercial cyber models. As the underlying data quality improves and the modeling continues to evolve, so will the ability of the cyber market to create a true view of an industry loss and ultimately draw new capacity into the space.”

However, while the models are maturing there remains a significant divergence in their output.

Although, it should be mentioned that such divergences also exist between the main nat cat risk models as well.

Guy Carpenter’s study of model outputs at the 1:200-year return period for a global cyber loss event shows a range of model outputs from US $15.6 billion and US $33.4 billion.

At the 1:50-year event return period, the modelled loss range was between US $5.5 billion and US $24.4 billion, the reinsurance brokers study found.

Explaining that, “These variations are driven by scenario interpretation, different views of event footprints, and the analysis of historic data points.”

Adding, “Model variations were surprisingly greater at lower return periods – a factor attributed to a greater need to interrogate the takeaways from precedents and “counterfactuals” to drive better consensus.”

The CyberCube risk model was highest in each case, with the Moody’s RMS cyber model providing the lowest modelled loss output.

Which shows that, while the data and models may be improving, ILS funds and investors wanting to deploy to cyber risks are going to need to be able to do their own modelling analysis and due-diligence on cyber ILS deals, just as they do today on catastrophe risk exposures.

Erica Davis, Global Co-Head of Cyber, Guy Carpenter, commented, “The improvements to data quality and nimbleness of the cyber models are instrumental in continuing to attract capital to the cyber market. As the models continue to evolve, reinsurance buyers and sellers will be able to hone in on what truly differentiates each portfolio and more accurately identify, price and trade key catastrophe risk. As structures evolve to laser out catastrophe events, reinsurance buyers will have more choice in how they manage their portfolios and the diversity that arises from divergent buying strategies will expand the opportunities for capital to flow into the market, thus feeding its ongoing growth.”

Anthony Cordonnier, Global Co-Head of Cyber, Guy Carpenter, added, There is no question that modeled losses from a significant cyber event would impact the market. However, given the industry’s resilience to significantly greater losses from other classes, in most cases these should not be insurmountable. Industry stakeholders recognize opportunities for continued growth and performance in this sector. As we contemplate what lies ahead, the focus must continue to be on further activating this valuable product category with commensurate traditional and alternative capacity.”