Brokers Balking at Cyber Insurance
Cyber crime, espionage and other “malicious cyber activity” cost the United States anywhere from $24 billion to $120 billion each year, according to a joint report by McAfee and the Center for Strategic and International Studies. That price tag comprises loss of intellectual property, sensitive business information and personally identifiable information (PII), reputational damage, and the costs of fixing security systems and recovering from data breaches.
As businesses become more dependent on technology, hackers likewise grow more sophisticated in their attacks, exposing businesses big and small to debilitating breaches.
Cyber crime, espionage and other “malicious cyber activity” cost the United States anywhere from $24 billion to $120 billion each year.
Entities as big as the New York Times, JPMorgan and Target have suffered hits, but research suggests that smaller, mom-and-pop shops make easy targets for cyber thieves looking to cash in on stolen debit and credit card numbers.
“It doesn’t matter what size company you are or what industry you are,” said Tim Francis, enterprise cyber lead, Travelers. “You should consider yourself a target.”
“From some things I’ve read,” said Marty Frappolli, senior director of knowledge resources at The Institutes, “the average cost of a data breach is more than $5 million, and the FBI is on record saying that most small businesses won’t survive a cyber attack.”
High-profile attacks have raised awareness about cyber liability, both among the business community and regulators. Forty-six states, the District of Columbia, Guam, Puerto Rico and the Virgin Islands all have laws requiring private or government entities to notify individuals of PII security breaches.
And yet the development of cyber insurance products and take-up by smaller and medium-sized businesses remains somewhat stagnant. Shouldn’t companies be scrambling to get coverage for one of their scariest business threats? Somewhere between the awareness of cyber risk and actually purchasing insurance against it, there’s a dangerous disconnect. Indications are that brokers may be the weak point.
Are Brokers Balking?
In internal research conducted by one major underwriter, a survey of both brokers and insurance buyers found that buyers expressed interest in purchasing cyber coverage, but hadn’t followed through mainly because their brokers hadn’t engaged with them or educated them about the topic.
Correspondingly, a much lower number of brokers claimed that their clients had a need, under-reporting the interest their customers had expressed. Taking the responses of both groups together, the underwriter concluded that a significant number of brokers may not fully understand cyber exposures or the insurance solutions on the market, and therefore are shirking the topic altogether.
A survey conducted by Marsh at their annual Communications, Media and Technology conference revealed similar findings. While 69 percent of attendees indicated increased concern about cyber security and liability over the past year, few had made moves to tighten their risk management.
Just 13 percent thought cyber risk was a matter for the risk management function, with most believing that the responsibility should fall to the IT department. Only about one-fifth of respondents said that their organization currently purchased cyber insurance, and only 11 percent of them felt confident that their coverage met their needs.
Clearly, there is a communication gap between buyers and the insurance community, and the onus falls on brokers to bridge it.
Emerging, Evolving Risk
Brokers could be side-stepping cyber coverage for several reasons. First and foremost, novelty and constant change.
“[One broker] felt that she couldn’t present the cyber quotes to her clients because she really couldn’t explain how the policies were different.”
- Nick Economidis, underwriter, Technology, Media and Business Services, Beazley
“Cyber risk, even though it’s been around for decades, is still an emerging, evolving risk,” Frappolli said. Exposures are ever-changing, and insurance solutions must change as rapidly to address them.
Lack of standardization in terminology also contributes to the confusion.
Nick Economidis, underwriter for Beazley’s Technology, Media and Business Services group, said he “met with one insurance broker who said that all the policy forms were different, and it was hard to understand how they compared to each other.
“She felt that she couldn’t present the cyber quotes to her clients because she really couldn’t explain how the policies were different,” he said.
Greg Gamble, director, Management and Professional Risk Group, Crystal & Co., said that while coverage is standard, policy wording varies among the 15 or so carriers that offer it.
“In that regard, it’s confusing because we have to make this understandable to our customer base and articulate it back to them in a way that makes sense.
“I would agree that there could be more standardization among carriers,” Gamble said, “but I don’t think that’s coming anytime soon because carriers have a lot of private ownership of their policies. They have people who’ve spent a tremendous amount of time developing those products, and they label agreements and write the policies their own way, and I don’t think they’re focused on coming together with industry standard categories of coverage.”
Tough Regulatory Environment
Varied state regulations also factor into non-uniform policies. Different legislatures have different notification standards, which affects what a company can stand to lose through notification costs alone.
“There are new laws coming through at the federal and state levels. European law is changing,” said Chris Keegan, senior vice president, Willis. “The ways in which technology is being used is changing, which can make those laws out of date very quickly.
“A lot of people are hoping for federal level simplification. We’ve seen Congress trying to put that in place for the last four or five years but they never seem to be able to get that legislation passed,” he said.
Notification laws can easily throw brokers for a loop.
Ken Goldstein, worldwide cybersecurity manager, Chubb Insurance, said it can be hard to keep track of who needs to be notified of a breach in which state. Some laws require attorneys general to be notified in states where customers were affected, and some require that credit monitoring agencies be alerted, depending on what type of information was disclosed.
“Different industry segments have different legal and regulatory requirements,” Goldstein said. “Identifying these exposures will ultimately help agents and brokers figure out how to protect clients from an insurance perspective.”
Not all brokers struggle with the changes, though. Larger brokerage houses and carriers have teams dedicated to researching, assessing and developing products responding to cyber risk. Brokers that have that in-house specialized expertise at their disposal have a much easier time finding the right solutions for their clients.
“There are only about five brokerage houses that have people with that level of expertise.”
- Chris Keegan, senior vice president, Willis
But indications are that the community of experts among brokers remains too small.
“There are only about five brokerage houses that have people with that level of expertise,” Keegan said. “For some of the other houses that don’t have that internal specialized expertise, they may struggle to get the consulting and policy advice that clients need.”
That explains why take-up is much lower among small and mid-sized businesses: They generally don’t have the same resources as large companies to work with the handful of big brokerages with in-house experts.
Some carriers also offer tools like breach cost calculators and risk assessment portals that allow brokers to estimate the financial impact of notification, data cleanup and business interruption. But those resources might not be enough. According to Travelers’ Francis, carriers could do more to work with and educate brokers on their coverages.
“One of the ways the industry can be working to address this issue is having carriers that not only deliver products, but are experts in the products they’re selling,” he said. Carriers should be helping brokers understand each account’s unique level of exposure and the insurance solutions available. “That collaboration right now is as important as, or more important than, the insurance product that is the end delivery,” he said.
“For smaller and mid-sized businesses, there really is great opportunity for the agents and brokers to fill that knowledge gap,” said Frappolli of The Institutes. “I would say that best-in-class agents are doing this for their clients. There’s always an opportunity for the broker to be not just somebody who sells you an insurance policy, but somebody who is your de facto risk manager.”
Solutions in Education
There are ways brokers can educate themselves on the evolving cyber environment, beyond reading journals and attending webinars. Conferences, for example, provide easy access to expert speakers, said Mark Greisiger, president of NetDiligence, which hosts twice-yearly educational forums on cyber risk.
“Both the speakers and attendees are the insurance companies, and their inside lawyers sometimes. We have retail and wholesale brokers attending. We have risk managers and CFOs who buy the insurance there, and various state and federal regulators. Many top security experts who can help customers safeguard their data come and speak as well,” he said.
“We also see a lot of smaller brokerage groups coming, because they need that technical expertise,” Greisiger said.
According to Willis’ Keegan, the industry can expect to see a lot of growth in take-up in cyber coverage among smaller clients in the next two to three years.
Brokers that can capitalize on that demand and independently stay up to speed on changing exposures will reap the rewards.
Coping with Cancellations
Airlines typically can offset revenue losses for cancellations due to bad weather either by saving on fuel and salary costs or rerouting passengers on other flights, but this year’s revenue losses from the worst winter storm season in years might be too much for traditional measures.
At least one broker said the time may be right for airlines to consider crafting custom insurance programs to account for such devastating seasons.
For a good part of the country, including many parts of the Southeast, snow and ice storms have wreaked havoc on flight cancellations, with a mid-February storm being the worst of all. On Feb. 13, a snowstorm from Virginia to Maine caused airlines to scrub 7,561 U.S. flights, more than the 7,400 cancelled flights due to Hurricane Sandy, according to MasFlight, industry data tracker based in Bethesda, Md.
Roughly 100,000 flights have been canceled since Dec. 1, MasFlight said.
Just United, alone, the world’s second-largest airline, reported that it had cancelled 22,500 flights in January and February, 2014, according to Bloomberg. The airline’s completed regional flights was 87.1 percent, which was “an extraordinarily low level,” and almost 9 percentage points below its mainline operations, it reported.
And another potentially heavy snowfall was forecast for last weekend, from California to New England.
The sheer amount of cancellations this winter are likely straining airlines’ bottom lines, said Katie Connell, a spokeswoman for Airlines for America, a trade group for major U.S. airline companies.
“The airline industry’s fixed costs are high, therefore the majority of operating costs will still be incurred by airlines, even for canceled flights,” Connell wrote in an email. “If a flight is canceled due to weather, the only significant cost that the airline avoids is fuel; otherwise, it must still pay ownership costs for aircraft and ground equipment, maintenance costs and overhead and most crew costs. Extended storms and other sources of irregular operations are clear reminders of the industry’s operational and financial vulnerability to factors outside its control.”
Bob Mann, an independent airline analyst and consultant who is principal of R.W. Mann & Co. Inc. in Port Washington, N.Y., said that two-thirds of costs — fuel and labor — are short-term variable costs, but that fixed charges are “unfortunately incurred.” Airlines just typically absorb those costs.
“I am not aware of any airline that has considered taking out business interruption insurance for weather-related disruptions; it is simply a part of the business,” Mann said.
Chuck Cederroth, managing director at Aon Risk Solutions’ aviation practice, said carriers would probably not want to insure airlines against cancellations because airlines have control over whether a flight will be canceled, particularly if they don’t want to risk being fined up to $27,500 for each passenger by the Federal Aviation Administration when passengers are stuck on a tarmac for hours.
“How could an insurance product work when the insured is the one who controls the trigger?” Cederroth asked. “I think it would be a product that insurance companies would probably have a hard time providing.”
But Brad Meinhardt, U.S. aviation practice leader, for Arthur J. Gallagher & Co., said now may be the best time for airlines — and insurance carriers — to think about crafting a specialized insurance program to cover fluke years like this one.
“I would be stunned if this subject hasn’t made its way up into the C-suites of major and mid-sized airlines,” Meinhardt said. “When these events happen, people tend to look over their shoulder and ask if there is a solution for such events.”
Airlines often hedge losses from unknown variables such as varying fuel costs or interest rate fluctuations using derivatives, but those tools may not be enough for severe winters such as this year’s, he said. While products like business interruption insurance may not be used for airlines, they could look at weather-related insurance products that have very specific triggers.
For example, airlines could designate a period of time for such a “tough winter policy,” say from the period of November to March, in which they can manage cancellations due to 10 days of heavy snowfall, Meinhardt said. That amount could be designated their retention in such a policy, and anything in excess of the designated snowfall days could be a defined benefit that a carrier could pay if the policy is triggered. Possibly, the trigger would be inches of snowfall. “Custom solutions are the idea,” he said.
“Airlines are not likely buying any of these types of products now, but I think there’s probably some thinking along those lines right now as many might have to take losses as write-downs on their quarterly earnings and hope this doesn’t happen again,” he said. “There probably needs to be one airline making a trailblazing action on an insurance or derivative product — something that gets people talking about how to hedge against those losses in the future.”
Construction’s New World
Get off a plane at Logan Airport and cross the harbor toward Boston and you will see construction cranes, a lot of them.
Grab an Amtrak train from Philadelphia into New York and pulling into Penn Station, you will see more construction cranes, many more of them. The same scene repeats in Denver, Los Angeles, San Francisco and Chicago.
All that steel and cable in the skyline signifies a construction industry that is growing again, after having the rug pulled out from under it in the Great Recession of 2008-2010.
The cranes these days look the same as cranes looked in 2008, but the risk management and insurance environment in construction is anything but the same now.
A variety of factors are now in play that have drastically changed construction risk underwriting, according to Doug Cauti, a senior vice president and chief underwriting officer with Boston-based Liberty Mutual’s construction practice.
Doug Cauti characterizes the current construction market.
Talent and Margins
For one thing, according to Cauti, the available talent pool in construction is nowhere near what it was pre-recession.
“When the economy went into its downturn, a lot of talent left the business and hasn’t returned,” Cauti said.
Cauti said recent conversations with large contractors in Ohio and Pennsylvania confirmed once again that contractors are facing a workforce that is either aging or very inexperienced. That leads to safety management and project quality concerns at just the moment in time that construction is rebounding.
Doug identifies one of the top risk management issues facing construction firms today.
Workers compensation risks in construction, already a problematic area, are seeing an impact from that dynamic.
Contractors are also facing much more competition. In the past, contractors might have bid on 10 jobs to get one, now they have to bid on 50 or 60 jobs to get one. That’s putting pressure on margins.
“There are a lot of contractors out there competing for business,” Cauti said.
“Margins are going up but not at the same rate as the industry’s recovery,” he added.
Financing and Risk Transfer
Another factor impacting the way construction risk is being underwritten is the size of projects and the way they are being financed. Construction’s recovery from the recession might be slow and steady, but the size of projects requiring risk management and insurance has increased substantially.
In 2010, there were 85 projects under contract nationally that were worth $1 billion or more, according to Cauti. One year later, the percentage of projects of that value or higher had grown by 30 percent, and the trend continues.
A lot of those projects are design-build, a relatively new approach to construction that Liberty Mutual has grown comfortable underwriting over the years. But design-build is still an additional complication, blurring the traditional lines of responsibility.
“We did it when the growth in contractor-controlled insurance programs happened, we did it with the evolution in design-build and we’re laying the groundwork to be a thought leader in public-private partnerships and integrated project delivery.”
– Doug Cauti, Chief Underwriting Officer, Liberty Mutual National Insurance Specialty Construction
Given the funding demands of these much larger and more valuable projects — many of them badly needed public sector infrastructure improvements — public-private partnerships, otherwise known as P3s, are now coming into vogue as a financing option.
But deciding how risk should be allocated, underwritten and transferred in this new arrangement between contractors, the state, and private partners is a relatively new and untested science.
As a thought leader in the underwriting of the design-build approach – and the more traditional design-bid-build – Cauti said construction experts within Liberty Mutual are growing their knowledge to stay in step.
“We did it when the growth in contractor-controlled insurance programs happened, we did it with the evolution in design-build and we’re laying the groundwork to be a thought leader in public-private partnerships and integrated project delivery,” he said.
That means attending relevant industry conferences like the annual IRMI Construction Risk Conference where Liberty Mutual has maintained a significant presence, and engaging in dialogues with contractors and government officials, and maintaining clear and active lines of communications with brokers.
Doug discusses emerging approaches to construction.
Legal and Regulatory
Another change that is creating challenges for construction risk underwriting, according to Cauti, stems from what’s happening in United States courtrooms.
Across the country, how a court interprets coverage can vary widely, especially in the area of construction defect.
“In the past, many jurisdictions viewed construction defect simply as shoddy workmanship and they had to go back and redo it,” Cauti said.
But now, on a state by state basis, courts are ruling that a construction defect is an accident under certain circumstances that may be covered by a contractor’s general liability policy.
In 2014 alone, according to Cauti, Supreme Courts in West Virginia, Connecticut and North Dakota ruled that construction defects can sometimes be considered accidents.
Cauti said doing business with a carrier that pursues contract clarity whenever possible – and that possesses an experienced claims team that can navigate the wide variety of state interpretations – is absolutely essential to the buyer.
Having claim teams not only dedicated to construction but also to construction defect, adds a lot of value to a carrier’s offering.
Doug outlines another top risk management issue facing construction firms in today’s booming market.
Now, as never before, contractors are relying on experienced construction insurance teams to help them address these complexities.
Insurers need to have the engineering expertise to analyze a project, to make sure the right contracting team is in place and to insure that risk exposures are being properly assessed. Another key in a construction insurance team, according to Cauti, is the claims department.
A Strategic Approach
The legal and financing changes that are taking place in the construction market, from a risk transfer standpoint, aren’t going to get ironed out overnight.
Cauti said it could be 10 years until the construction and insurance industries fully understand the complications of public-private partnerships and integrated project delivery, these approaches gain traction, and the state-by-state legal decisions that are causing so much uncertainty can be digested.
In the meantime, an engaged, collaborative approach between carriers, brokers, contractors, and their financing partners will be necessary.
Doug discusses how his area can provide value to project owners and contractors.
For more information on how Liberty Mutual Insurance can help assess your construction risk exposure, contact your broker or Doug Cauti at firstname.lastname@example.org.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty Mutual Insurance. The editorial staff of Risk & Insurance had no role in its preparation.