Aon Securities anticipates offering the first cyber catastrophe (cat) bond in 2023, potentially opening up a vast, new source of structured credit that is uncorrelated with traditional financial risk.
"We've estimated that we'll get our first cyber deal done in 2023, and that continues to move forward," said Paul Schultz, CEO of Aon Securities, a top broker in the insurance-linked securities (ILS) market that includes cat bonds.
In an August report, S&P Global Ratings noted that cat bond market participants were discussing cyber deals five years ago. Until recently, however, ILS-market returns were historically low and the public debt and equity markets offered more attractive investment alternatives, the report says.
Times have changed in five years. For one, ILS returns are now increasing, according to S&P. Schultz said that a combination of investor education and improved modeling of cyber risk have also played a role.
"We're at a point now where those sides are coming together as far as expectations to get something done," he said.
Cat bonds are issued through special purpose vehicles (SPVs) and primarily have focused on Atlantic hurricane risk, followed by earthquake and wildfire risk. A variety of secondary perils have been included in the deals, such as volcanic eruption, winter storms and meteorite impact.
The securities have traditionally provided insurers and reinsurers with another way to transfer peril risk—to Wall Street investors—when their capacity is insufficient, and they have been the most common sponsors of cat offerings. Corporate sponsors have sporadically tapped the market in recent years.
Schultz declined to discuss the type of cedent—or insurer looking to transfer risk—likely to sponsor the cyber cat bond, adding that his team have been in discussions with all three.
The lack of correlation between peril risk and traditional financial risk has been an important selling point for cat bonds that has held up this year when equity and bond markets have been very volatile. During market volatility in 2022, S&P Global notes, "ILS has allowed investors to obtain liquidity by selling their ILS without realizing losses."
Cyber should offer similarly uncorrelated risk, and while cyber-related losses are estimated to be in the trillions annually, coverage provided by insurers and reinsurers remains relatively small, indicating a potentially significant role for ILS.
Munich Re, a major reinsurance company, estimates that cyber insurance premiums topped $9 billion in 2021, and S&P Global said it assumes that figure is likely to increase by 25% per year, reaching upwards of $22 billion by 2025. It adds that while the forecast appears to indicate a rapidly growing market, much of the increase will stem from a significant increase in rates as insurers continue to hesitate covering the risk. Nevertheless, cyber insurance remains the fastest growing line of insurance business today and in the rating agency's base-case assumption for the coming years.
"A more mature retrocession and ILS market could increase the capacity and support the growth of the cyber insurance market, and lead to better returns on capital because of efficient capital management further down the (re)insurance chain," the S&P report says, adding that scenario is reminiscent of ILS' origins following a shortage of reinsurance in the wake of Hurricane Andrew in 1992.
Other factors indicating that cyber cat bonds may be forthcoming include CyberCube's October 24 launch of what it claims to be the first set of detailed exposure databases to enable reinsurers and brokers to perform a wide variety of benchmarking, sensitivity and real-time analyses for cyber risk. Such data has been critical to support the existing cat bond market.
Third party modeling of peril risk that cat bond investors can compare to their own risk analyses is another important component that some market participants, such as Swiss Re, a proponent of cyber ILS, see as still insufficient.
Risk modeling firm RMS, which Moody's Corp., acquired in September 2021, has developed its cyber model significantly over the last several years, according to Jin Shah, managing director, capital markets and resilience. It now has stochastic modeling capability as well as industry exposure databases and loss curves that enable the modeling of different trigger types to determine losses.
"RMS is very well positioned now to offer cyber modeling capability to the ILS market, and especially cat bonds," Shah said, adding, "And our cyber solution is being used quite widely in the traditional insurance markets already."
