The CrowdStrike failure highlights the potential risks of aggregation for reinsurers

The unique, evolving and often volatile nature of cyber risks has always lurked beneath the surface as cyber insurance premiums have risen in recent years.

The recent CrowdStrike software failure highlighted the latent threats posed by aggregation risk and the potential for significant and far-reaching losses that span industries and extend across lines of insurance. In terms of magnitude, Delta Air Lines alone estimated that the 5,000 canceled flights related to this recent CrowdStrike event will cost it $500 million.

CrowdStrike exemplifies the type of aggregation risk the industry is concerned about. A security bug or software failure has the potential to destroy businesses such as airports, airlines, financial institutions or even software companies. The interconnectedness of systems was on full display and demonstrated how business can be brought to a sudden and large scale halt. This incident is likely to affect several insurers.

While insurers rely heavily on models to estimate this type of cyber-related exposure, one could argue that the severity of a systemic event on such a large scale would thus far have left some of these models untested. It also provides a stark reminder of the key role reinsurance must play in cyber coverage as a means of protection.

Cyber ​​insurers rely heavily on reinsurance, with approximately 50% of cyber premiums being ceded to reinsurers. Reinsurers provide insurers with capital relief, earnings stability and, more importantly, valuable underwriting partnerships.

Delta Air Lines is just one of the companies affected in this recent incident, but it illustrates the potential for large-scale ransomware attacks or major data breaches to generate substantial or even extensive claims. Reinsurance allows insurers to maintain a more stable financial position by ensuring that they have the ability to meet their obligations to policyholders even in the face of significant losses.

Any withdrawal by reinsurers to limit their own cyber coverage capacity will certainly flow downstream to primary insurers and potentially limit primary insurers’ appetite for cyber insurance. A similar scenario is playing out in the U.S. property insurance market amid rising weather-related losses.

The systemic nature of cyber risks is another significant challenge. Unlike traditional property risks, which can often be limited by geography or line of business, cyber risks can quickly spread across borders and industries. A single vulnerability in widely used software such as CrowdStrike or a coordinated cyber attack can result in simultaneous losses for multiple policyholders. This interconnectedness amplifies the potential for large-scale losses and requires a comprehensive and coordinated approach to risk management.

Preferred risk transfer solutions

Quota reinsurance remains a common risk transfer mechanism in the cyber insurance segment. Under this approach, the primary insurer and the reinsurer share and loss premiums in proportion to the agreed terms. This simple distribution of risk is particularly attractive to those in need of cyber coverage, especially when the complexity and variability of risks require clear and manageable reinsurance solutions.

In addition to quota arrangements, another option involves aggregate stop loss and event hedges. This approach provides protection to insurers when their aggregate losses exceed a predetermined threshold. This type of coverage is especially valuable in managing the cumulative impact of numerous smaller claims that can add up to significant losses over time.

Event coverages provide protection against specific catastrophic scenarios. They are designed to respond to defined events, such as a major cyber attack affecting multiple policyholders.

Insurance-related securities

Insurance-linked securities (ILS) are another emerging trend in the cyber reinsurance market. ILS provide insurers with another means of transferring risk to the capital markets, providing an alternative source of capacity and risk management.

The ILS market’s appetite for cyber may be driven in part by the general perception that these risks are assumed to be short-term in nature and generally uncorrelated with broader financial markets. However, it should be noted that very few large-scale cyber events have occurred to date to fully test this market hypothesis.

In December 2023, a series of 144a cyber bonds totaling approximately $415 million were issued. So far in 2024 there has been a small private placement of a $14 million cyber bond by Hannover Re covering cloud disruptions for the first time and a $160 million 144A cyber bond by Beazley.

Growing demand from investors

We expect more cyber bonds in the future as some of the bonds issued so far have been raised, signaling investor demand. It is important to note that average loss multiples for cyber bonds appear to be at least twice that of natural catastrophe bonds, indicating that investors can expect much wider spreads for cyber bonds to to cover modeling risk and perhaps to include a novelty premium.

It is important to note that cyber risks are constantly evolving, driven by technological advances and the increasing sophistication of cyber threats. This dynamic environment makes it difficult for insurers and reinsurers to accurately assess and price risk. The emergence of new threat vectors, such as those enabled by artificial intelligence and machine learning, further complicates this task. Reinsurers must continually adapt their models and strategies to keep pace with these developments, requiring significant investment in research and technology.

Good cyber practices have proven beneficial for both policyholders and insurers. These practices have led to a steady decline in the segment’s loss rate, despite a sharp increase in ransomware attacks in 2023. The future of cyber reinsurance will depend on the industry’s ability to leverage technology, innovate and even collaborate on risk management. As the digital age and its complexities continue to mature, reinsurance has a key role to play in providing some buffers on the way forward.

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Reinsurance