Understanding Cyber Catastrophe Bonds: A New Way to Hedge Cyber Risk

Introduction

In the modern digital age, cyber-attacks have become a major concern for businesses. The cost of a cyber attack can be significant, ranging from lost revenue and customers to expensive recovery costs. To protect against this risk, many companies are turning to cyber catastrophe bonds. In this blog post, I’ll explain what cyber catastrophe bonds are and how they can be used to hedge cyber risk.

What are Cyber Catastrophe Bonds?

A cyber catastrophe bond (Cyber CAT bond) is a financial instrument that is designed to provide coverage against large-scale cyber attacks. They are similar to traditional catastrophe bonds, which are used to provide coverage against natural disasters such as hurricanes and earthquakes. Cyber CAT bonds are issued by insurance companies, who then sell them to investors. The proceeds from the sale of the bonds are used to pay out claims in the event of a cyber attack.

Example Scenario

Imagine a scenario where a small insurance company sells $1,000/yr policies to 100 customers insuring against $10,000 worth of claim damages. All 100 customers are hit with a ransomware attack simultaneously, file claims, and must be paid out full value. The insurer is out $1M they can’t afford. The bond protects the insurer from going bankrupt while ensuring the policyholders still get paid on their claims since the insurer stays in business.

How do they work?

Cyber CAT bonds are structured as a type of insurance-linked security (ILS). The issuer of the bond (insurance company) will set a threshold for the amount of losses that have to be reached before a claim can be made. The threshold can be a monetary amount or a specific event (like a certain type of cyber attack). If a cyber attack occurs and the threshold is met, the bond holders will receive a payout. In exchange, bond holders will accept lower returns than traditional bonds.

Benefits of Cyber CAT Bonds

Cyber CAT bonds offer several benefits to companies looking to hedge cyber risk. One of the main benefits is that they provide a way for companies to transfer risk to the capital markets. This can help companies to manage their risk more effectively and free up capital for other uses. Additionally, because cyber CAT bonds are issued by insurance companies, they are considered to be relatively low-risk investments.

Conclusion

Cyber catastrophe bonds (Cyber CAT bonds) are a new and innovative way for companies to hedge cyber risk. They provide a way for companies to transfer risk to the capital markets, helping them to manage risk more effectively and free up capital for other uses. Additionally, because cyber CAT bonds are issued by insurance companies, they are considered to be relatively low-risk investments. As the threat of cyber attacks continues to grow, cyber CAT bonds are likely to become an increasingly popular way for businesses to protect themselves against cyber risk.