Does cyber insurance make sense?

Insurance relies on pooled risk; when a business is exposed to a risk it feels is not manageable with internal controls, the risk can be deferred to the capital markets through an insurance contract. For events that are unlikely to hit a very large number of insurance customers at once, this model makes sense. The pooled risk allows the insurer to create capital gains on the premiums paid by the customers, and the customers get their financial losses covered in case of a claim situation. This works very well for many cases, but insurers will naturally try to limit their liabilities, through “omissions clauses”; things that are not covered by the insurance policy. The omissions will typically include catastrophic systemic events that the insurance pool would not have the means to cover because a large number of customers would be hit simultaneously. It will also include conditions with the individual customer causing the insurance coverage to be voided – often referred to as pre-existing conditions. A typical example of the former is damages due to acts of war, or natural disasters. For these events, the insured would have to buy extra coverage, if at all offered. An example of the latter omission type, the pre-existing condition, would be diseases the insured would have before entering into a health insurance contract.

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Risk pooling works well for protecting the solvency of insurers when issuing policies covering rare independent events with high individual impact – but is harder to design for covering events where there is systemic risk involved. Should insurers cover the effects of large-scale virus infections like WannaCry over normal cyber-insurance policies? Can they? What would the financial aggregate cost of a coordinated cyber-attack be on a society when major functions collapse – such as the Petya case in the Ukraine? Can insurers cover the cost of such events?

How does this translate into cyber insurance? There are several interesting aspects to think about, in both omissions categories. Let us start with the systemic risk – what happens to the insurance pool if all customers issue claims simultaneously? Each claim typically exceed the premiums paid by any one single customer. Therefore, a cyberattack that spreads to large portions of the internet are hard to insure while keeping the insurer’s risk under control. Take for example the WannaCry ransomware attack in May; within a day more than 200.000 computers in 150 countries were infected. The Petya attack following in June caused similar reactions but the number of infected computers is estimated to be much lower. As the WannaCry still looks like a poorly implemented cybercrime campaign intended to make money for the attacker, the Petya ransomware seems to have been a targeted cyberweapon used against  the Ukraine; the rest was collateral damage, most likely. But for Ukrainian companies, the government and computer users this was a major attack: it took down systems belonging to critical infrastructure providers, it halted airport operations, it affected the government, it took hold of payment terminals in stores; the attack was a major threat to the entire society. What could a local insurer have done if it had covered most of those entities against any and all cyberattacks? It would most likely not have been able to pay out, and would have gone bankrupt.

A case that came up in security forums after the WannaCry attack was “pre-existing condition” in cyber insurance. Many policies had included “human error” in the omissions clauses; basically, saying that you are not covered if you are breached through a phishing e-mail.  Some policies also include an “unpatched system” as an omission clause; if you have not patched, you are not covered. Not all policies are like that, and underwriters will typically gauge a firm’s cyber security maturity before entering into an insurance contract covering conditions that are heavily influenced by security culture. These are risks that are hard to include in quantitative risk calculations; the data are simply not there.

Insurance is definitely a reasonable control for mature companies, but there is little value in paying premiums if the business doesn’t satisfy the omissions clauses. For small businesses it will pay off to focus on the fundamentals first, and then to expand with a reasonable insurance policy.

For insurance companies it is important to find reasonable risk pooling measures to better cover large-scale infections like WannaCry. Because this is a serious threat to many businesses, not having meaningful insurance products in place will hamper economic growth overall. It is also important for insurers to get a grasp on individual omissions clauses – because in cyber risk management the thinking around “pre-existing condition” is flawed – security practice and culture is a dynamic and evolving thing, which means that the coverage omissions should be based on current states rather than a survey conducted prior to policy renewal.

 

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