The insurance-linked securities (ILS) market, and London as an ILS market hub, can help cyber risk to flourish as a nascent and growing class of insurance and reinsurance business benefiting from capital markets support, according to a report from BNY Mellon.
The capital markets and ILS investors are the right source of capacity to help the nascent cyber risk insurance line grow and flourish, according to the report from investment management and investment services banking group BNY Mellon.
Meanwhile London, with its ambitions to become a leading ILS hub for locating structures from collateralised reinsurance to catastrophe bonds, could become a specialist centre for cyber risk ILS, the report suggests.
“The capital markets can help nascent classes of insurance flourish,” explained Paul Traynor, Pensions and Insurance Segments Leader, International at BNY Mellon.
“There’s huge potential for cyber risk to be transferred to the capital markets using ILS, in a similar way to how cat bonds underwrite hurricane and earthquake risks,” he continued.
A London ILS market could drive forwards the market for cyber risk insurance, providing the depth and liquidity of capital required, as well as the complex, tailored structures and leveraging the closeness to the expertise of the London specialty insurance and reinsurance market, the report suggests.
“The London insurance linked securities (ILS) market is perfectly positioned to become the global centre for cyber risk insurance,” BNY Mellon states.
There is an expectation that demand for cyber insurance will grow exponentially, with regulation such as new data protection rules from the European Union likely to drive demand for cyber liability protection, according to the report.
While insurance and risk markets are attempting to respond to the requirement for coverage and efforts are being made to standardise cyber risk data and design products for cyber terrorism, it is the insurance and reinsurance market for physical damage and bodily injury caused by cyber attacks that is nascent, but also the area that perhaps presents the biggest opportunity to ILS markets.
“The ability of cyber terrorists to target national infrastructure, power grids and other critical assets is a real and growing threat,” commented Karin Mulvihill, head of technology compliance at BNY Mellon. “This threat pervades businesses of all sizes and across all sectors.”
But work must be done before we see the first cyber catastrophe bonds and ILS structures, the report explains, with a focus on data and modelling likely to be key requirements before we see capital markets backing cyber risk transactions.
There is also a need to focus in on the specific risks that can be segregated, so as to be better understood, which could enable the creation of triggers based on parameters and data, which may help to generate new coverage requirements that the capital markets and ILS can assist with.
Traynor of BNY Mellon cautioned; “However, before cyber risks can be successfully securitised, significant progress is needed in aggregating and modelling the risk. This requires more collaboration between major insurers and technology experts to better understand the interdependencies between systems and the frequency of attacks.”
The BNY Mellon report recommends the new laws allowing for the establishment of special purpose vehicles (SPVs) onshore within the London market, in order to offer ILS sponsors and investors more choice and perhaps enable new and emerging risks to be transferred to the capital markets.
The report recommends tax incentives in London, to level the playing field between the city and other ILS domiciles, making it more conducive to locate an ILS vehicle there. It also suggests that the UK’s Prudential Regulation Authority (PRA) has a dedicated unit focused on ILS, in order to interact with the market and ensure swift approval of new applications.
BNY Mellon notes that London cannot just hope to be a me-too ILS domicile though, highlighting the need for the city to leverage its expertise within specialist insurance and reinsurance markets and the importance that London can offer ILS market participants something different.
“London’s position as the undisputed global market for specialist insurance is being challenged by competition from international hubs such as Bermuda, Singapore and Dubai,” added Traynor. “The development of a London ILS centre will help secure its leading status. It will also drive innovation by offering the ILS market direct access to the capital markets, not just for cyber risk but for other new areas such as pandemics, pension fund longevity risk and emerging market natural catastrophe risk.”
You can access the full report from BNY Mellon, titled Insurance Linked Securities – Cyber Risk, Insurers and the Capital Markets, here.