Cyber Insurance-Linked Securities: Looking to the Future

Gallagher Re's report, Cyber ILS: Looking to the Future, examines the evolving role of cyber insurance-linked securities (ILS) as a critical alternative capital source for the expanding cyber-insurance sector. The report highlights that over $750 million has been deployed in underwritten 144A catastrophe bonds, reinforcing the growing investor confidence in cyber ILS as a risk management and capacity-expanding tool.

Per the report, cyber ILS addresses two major challenges in the cyber-insurance market: the increasing demand for capital due to heightened awareness of cyber risks and the need for market resilience in the face of systemic cyber events. As the market is projected to more than double in size over the next decade, ILS solutions provide crucial alternative capital, ensuring stability when traditional insurance markets may face capacity constraints.

According to Gallagher Re, key milestones in the cyber ILS market include the first collateralized cyber-catastrophe reinsurance transaction in 2017, which marked the entry of ILS capital into the cyber sector. Since then, the market has progressed with several significant issuances. Beazley's Cairney I, II, and III transactions in 2023 demonstrated the potential for scaling cyber ILS products and introduced cat bond lite structures tailored to institutional investors. The momentum continued into 2024 with underwritten Rule 144A catastrophe bonds such as PoleStar Re Ltd., Long Walk Reinsurance Ltd., and Matterhorn Re Ltd., culminating in the issuance of PoleStar 2024–3, the largest cyber-cat bond to date, securing $210 million.

Gallagher Re said that investor interest in cyber ILS is growing due to the potential for diversification and attractive returns. The pricing dynamics of cyber ILS currently resemble peak US catastrophe risks, carrying a risk-to-spread multiple of 4.6. However, as cyber-risk modeling and investor education improve, the report anticipates that the innovation premium currently associated with cyber ILS will decrease, leading to more competitive pricing and increased participation from capital markets.

Per Gallagher Re, product innovation is a driving force in cyber ILS market growth. The report highlights the expansion of cyber ILS offerings beyond catastrophe bonds, including sidecars and aggregate protections that provide coverage for multiple cyber events over a defined period. Sidecars, which allow third-party investors to assume a portion of an insurer's cyber risk, have already been deployed in the market and are expected to offer a scalable mechanism to enhance capital availability. Additionally, aggregate protections are emerging as a solution to midfrequency, midseverity cyber events, further strengthening resilience in the sector.

According to the report, refining contract terms and improving modeling capabilities are critical to the continued success of cyber ILS. The development of clearer and more precise definitions for cyber-event triggers, exclusions, and coverage terms is helping investors and sponsors align on risk expectations. Advances in cyber-risk modeling, driven by datasets from real-world loss events and enhanced analytical tools, are expected to further improve pricing accuracy and investor confidence.

Gallagher Re also noted that as cyber ILS matures, the market must address several key challenges, including pricing uncertainties, investor education, and regulatory considerations. While early investors faced an "innovation premium" due to limited historical data, ongoing advancements in risk assessment and market transparency are reducing barriers to entry. The report suggests that as these factors improve, more sponsors will enter the market, expanding the range of cyber ILS products and increasing the sector's overall capacity.