Cyber risk and the growth of the ILS market
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Cyber risk and the growth of the ILS market

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The continued growth of the cyber insurance market, increasing premiums and the potential for risk diversification is causing fund managers to consider the prospect of cyber risk as an asset class.

However, to date, only a handful of private transactions involving insurance-linked securities (ILS) funds have materialized. These transactions are, in relative terms, small and exploratory in nature. The managers taking on these transactions are mainly looking to understand cyber risk and collect benchmark loss data. It is worth noting that no cyber cat bond has yet been successfully brought to market — all the transactions executed to date are fully collateralized.

Below, we explore some of the reasons why this is the case and what stakeholders need to take into consideration regarding cyber risk and alternative capital markets.

The learning process of the capital markets

Even as the cyber insurance market continues to evolve, it is clear that most ILS funds are interested in cyber risk, with only a very small minority not considering cyber as an option. Fund mandate, an issue that some thought might slow adoption of cyber risk, is not a major problem as most funds don’t have cyber explicitly excluded from their mandate, which removes one of the potential barriers for future adoption. This demonstrates how the capital markets consider investment in cyber to be an opportunity.

However, given cyber is a completely new asset class, the level of understanding within the ILS sector still varies with some funds facing a steep learning curve. Given that up until now the number of potential transactions is still small, it is difficult for asset managers to justify dedicated resources to actively pursue this class of business. This has led to nat cat experts needing extra time to familiarize themselves with a new risk, slowing the process of the limited number of opportunities that have been brought to market.

What do asset managers need?

In order for ILS to truly break into cyber and achieve profitability, asset managers seek a certain set of characteristics on any given opportunity.

Having a clear and precise definition of events will provide much needed simplicity to a transaction. The same argument applies to the segmentation of cyber risk in clear differentiated perils, rather than one large and indistinguishable risk housing all perils.

Ultimately, players within the market must take steps to understand cyber risk better and how it affects their portfolios.

Flexibility when structuring a cyber cat bond will be key for the success of the first transaction. All stakeholders need to work together in a viable, scalable solution. Concerns regarding cyber risk and ILS expressed by some asset managers must be addressed, along with alternatives that will provide meaningful value to cedants in order to unlock capital for the segment's growth.