Cyber ILS looks to ‘expand the pie’ for institutional investors

Private reinsurance and fund structures could broaden the role of ILS capital in cyber beyond the cat bond market, opening a wider range of risks to institutional investors.

That is according to Richard Gray, head of third-party capital and general manager, Beazley Bermuda, and Richard Lowther, co-founder and managing partner of Integral ILS, who see scope for fund structures to complement the cyber cat bond market and bring additional sources of capital into the sector.

“The cat bond market is incredibly appealing in many ways, but it is a subset of a universe of risk,” Lowther told Bermuda:Re+ILS ahead of ILS Bermuda Convergence, held October 12-14.

By partnering with Beazley and running a fund structure, Integral wants to access cyber risks that may not be suitable for the cat bond market and would otherwise be difficult for institutional investors to reach, Lowther explained.

“Cat bonds will always be an important part of the platform. But cyber is a way to expand it. Different risk-return appetite, slightly different structure. So you’re just really opening it up to a wider audience of institutional investors.”

The two are working on an open-ended cyber fund, combining Beazley’s underwriting capabilities with Integral’s investment management expertise and relationships with institutional capital providers.

Lowther said Integral specialises in Bermuda-based open-ended funds and has, to date, focused solely on property catastrophe exposure. However, its investors are also looking for diversification and asking “what’s next” for ILS.

“What we bring to the table is the institutional and investor product in an open-ended fund,” he said. “All of the operational robustness that you need to tap into true asset-owning institutional investors in a fund structure.”

For Beazley, the development adds another source of third-party capital alongside traditional reinsurance and its existing cat bond programme. Gray described it as the “third leg of that stool”.

“We’ve got the rated paper, the traditional market, as many refer to it, and the cat bond market. Now we have this joint venture. We’ve got a well-diversified stable of capital providers, which obviously gives us comfort as we continue to grow the work,” Gray said.

Gray stressed that accessing alternative capital is part of Beazley’s risk management rather than an attempt to originate cyber risk simply to pass it on to investors.

“We like to write as much of this risk on our own balance sheet as we possibly can,” he said. “We think we do a good job of it. The results bear that out, and therefore this is ultimately part of risk management rather than us writing risks and passing straight on to the end investor.”

That alignment is also important in making cyber risk investable for institutional capital, according to Lowther. While modelling tools are important, he said investors also place considerable value on “transparency and alignment”, including knowing that the originating insurer retains exposure to the same risks.

“Investors are investing in something that Beazley understands and is actually exposed to. These investors that we’re talking to are large institutional pension plans and endowments, sovereign wealth funds. They’re not a competitor. They’re not an insurance company. So they’re partners in this, and they highly value transparency,” he said.

While cyber requires its own underwriting and modelling expertise, Lowther sees scope to use investment structures already familiar to ILS investors.

“In our open-end fund structures, not surprisingly, the cyber fund that we’re launching looks a lot like a natural catastrophe fund. It’s important to standardise the plumbing, but you don’t want to standardise the underwriting,” he explained.

Expanding institutional participation will, however, take time. Gray said Beazley’s experience in the cyber cat bond market has shown that investors can require multiple transactions before becoming comfortable enough with the underlying risk to allocate capital.

“Every single time we go to market with a new bond, the number of interested parties increases, and the number of institutions willing to invest in the bond increases,” he said.

Some investors have observed one issuance before participating in another, while others have taken “two or three iterations” to reach that point, Gray explained.

“They need to work with their investment committees and underlying capital providers. It’s an iterative process, and it’s a process which requires the time spent getting investors comfortable. And for some, that takes a few months. For others, it takes a year or more,” he said.

According to Gray, the process begins with understanding the underlying peril rather than the investment structure. Before discussing fund structures and return metrics, investors need to become comfortable with cyber as a risk and the underwriting behind it: “It’s education, education, education,” he said.

Lowther sees parallels with the earlier development of institutional investment in property catastrophe risk, where investors similarly had questions around a changing peril, modelling and underwriting.

As cyber insurance penetration increases, he believes external institutional capital could become increasingly relevant to the industry's management of systemic exposure. For Lowther, expanding private market access alongside cat bonds offers an opportunity to accommodate different risk-return appetites while widening the institutional audience for cyber risk.

“It’s really expanding the pie,” he said.

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