Axis’ Freeman: Cyber cat bond will “accelerate” market, paving the way for more transactions

Axis’ Kyle Freeman hopes the company’s world-first 144A cyber cat bond – a $75mn Long Walk Re transaction – will be used as a template by its peers and “help accelerate the build-out of this cyber cat bond market”.

In a joint interview with Aon Securities' ILS CEO Richard Pennay on The Insurer TV, Freeman – who heads up ILS structuring, property, at Axis – said that the real measure of success for this industry-first cat bond will be if the market grows and gains traction moving forward.

“Having a successful transaction is great and we certainly want that, but that's not necessarily enough for us to see success,” said Freeman.

“We needed to help build this market. We needed to create a template that other sponsors could use for other transactions, so they didn't have to do all the hard work that we put in upfront, and to help accelerate the build-out of this cyber cat bond market.

“We know that once we have that market built, we can then go and tap into it, as an additional source of capital, to help support our growth needs going forward,” he added.

The cyber cat bond will provide Axis’ main underwriting subsidiaries, including its Lloyd’s syndicate and insurance and reinsurance companies, with reinsurance protection against systemic cyber events.

Long Walk Re 2023-1 provides coverage over a two-year term, commencing from the start of 2024, and is structured with an indemnity trigger on a per-occurrence basis.

On the timing, Freeman commented: “We do have a 1.1 placement on the traditional side and that's still being worked on. While it's a little too early to say what the impact is going to be on that traditional placement, I assume there will be some impact.

“But really, this was a long-term play for us. So, it wasn't built just for our 1.1.24 placement. This is a long-term process and at some point, we may decide that we need more than $75mn,” he added.

According to Freeman, $75mn “feels right” for now, but he asserted that the group wants to make sure it has access to “multiple sources of capital going forward”.

Enabling investor confidence

When it came to conceptualising a cyber cat bond that would align with Axis’ needs while enabling investors to comprehend its structure, Aon’s Pennay highlighted the company's experience in the cat bond market, which spans more than two decades.

The main challenge was to translate the fundamentally distinct nature of cyber risk into terms consistent with traditional cat bond norms and structures.

“First and foremost, what investors needed to really understand is that cyber risk lends itself very well to the cat bond market,” said Pennay.

“The first thing they needed to understand is that a loss that may cause principal erosion to the notes would ultimately be catastrophic. And so, what we worked with was an event definition that really lends itself and shows that the event that would cause principal losses is catastrophic, and therefore fits within the broader definition of what a catastrophe bond is in the first place.”

He added: “We needed to work with an expertised risk modeller [CyberCube] to provide an expert view of what probabilities are associated with this type of an event occurring – which enabled the investors to ultimately get comfortable with the fact that cyber is evolving.

“But there has been a very significant amount of research into understanding the probabilities of these systemic-type events occurring. So, once we had a well-defined event definition, and we had an ability to accurately or robustly determine what the general risk characteristics are, those investors were able to ultimately quantify the risk and apply a margin to that,” said Pennay.

While discussing the choice of an indemnity trigger, Pennay explained that the bond was driven by its ability to align coverage with the actual losses assumed by Axis. It ensures that the coverage provided accurately reflects the company's post-event financial position.

However, while the indemnity trigger was selected for this issuance, the market is exploring other trigger mechanisms, including industry loss indices, which may become more prevalent in the future.

Increased cyber cat bond activity predicted for 2024

Both Pennay and Freeman expressed optimism about the future of the cyber cat bond market, saying this “innovative instrument” will encourage insurers and reinsurers to seek event-based, catastrophic cyber protection.

Much like property exposures, as cyber risks accumulate, the need for protection against systemic events will drive companies to explore the catastrophe bond market and reinsurance markets to hedge their risks.

“The horizon is most certainly positive,” said Pennay.

“One of the key components to this is that this clearly articulates to the broader cyber insurance and reinsurance market that there is an appetite for event-based, catastrophic per or current cyber protection. This allows (re)insurers to really think about their cyber exposures, not just in receiving proportional reinsurance protection by quota shares, or aggregates and aggregate stop losses.

“But now what we're seeing is capacity being made available, so that (re)insurers can ultimately receive event-based per occurrence protection, to protect the tail and to shore up solvency margins and so on for this line of business.

“I think that's really where the innovation is, and over the long-term, we fully expect this market will continue to grow, and that insurance companies will have the ability to protect the tail from the accumulation of cyber exposures,” Pennay concluded.

Watch the 12-minute interview with Axis’ Kyle Freeman and Aon’s Richard Pennay for a deeper dive into the creation and structuring of the cyber cat bond.