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.”
Why Marine Underwriters Should Master Modeling
Better understanding risk requires better exposure data and rigorous application of science and engineering. In addition, catastrophe models have grown in sophistication and become widely utilized by property insurers to assess the potential losses after a major event. Location level modeling also plays a role in helping both underwriters and buyers gain a better understanding of their exposure and sense of preparedness for the worst-case scenario. Yet, many underwriters in the marine sector don’t employ effective models.
“To improve underwriting and better serve customers, we have to ask ourselves if the knowledge around location level modeling is where it needs to be in the marine market space. We as an industry have progress to make,” said John Evans, Head of U.S. Marine, Berkshire Hathaway Specialty Insurance.
CAT Modeling Limitations
The primary reason marine underwriters forgo location level models is because marine risk often fluctuates, making it difficult to develop models that most accurately reflect a project or a location’s true exposure.
Take for example builder’s risk, an inland marine static risk whose value changes throughout the life of the project. The value of a building will increase as it nears completion, so its risk profile will evolve as work progresses. In property underwriting, sophisticated models are developed more easily because the values are fixed.
“If you know your building is worth $10 million today, you have a firm baseline to work with,” Evans said. The best way to effectively model builder’s risk, on the other hand, may be to take the worst-case scenario — or when the project is about 99 percent complete and at peak value (although this can overstate the catastrophe exposure early in the project’s lifecycle).
Warehouse storage also poses modeling challenges for similar reasons. For example, the value of stored goods can fluctuate substantially depending on the time of year. Toys and electronics shipped into the U.S. during August and September in preparation for the holiday season, for example, will decrease drastically in value come February and March. So do you model based on the average value or peak value?
“In order to produce useful models of these risks, underwriters need to ask additional questions and gather as much detail about the insured’s location and operations as possible,” Evans said. “That is necessary to determine when exposure is greatest and how large the impact of a catastrophe could be. Improved exposure data is critical.”
To assess warehouse legal liability exposure, this means finding out not only the fluctuations in the values, but what type of goods are being stored, how they’re being stored, whether the warehouse is built to local standards for wind, earthquake and flood, and whether or not the warehouse owner has implemented any other risk mitigation measures, such as alarm or sprinkler systems.
“Since most models treat all warehouses equally, even if a location doesn’t model well initially, specific measures taken to protect stored goods from damage could yield a substantially different expected loss, which then translates into a very different premium,” Evans said.
That extra information gathering requires additional time but the effort is worth it in the long run.
“Better understanding of an exposure is key to strong underwriting — and strong underwriting is key to longevity and stability in the marketplace,” Evans said.
“If a risk is not properly understood and priced, a customer can find themselves non-renewed after a catastrophe results in major losses — or be paying two or three times their original premium,” he said. Brokers have the job of educating clients about the long-term viability of their relationship with their carrier, and the value of thorough underwriting assessment.
The Model to Follow
So the question becomes: How can insurers begin to elevate location level modeling in the marine space? By taking a cue from their property counterparts and better understanding the exposure using better data, science and engineering.
For stored goods coverage, the process starts with an overview of each site’s risk based on location, the construction of the warehouse, and the type of contents stored. After analyzing a location, underwriters ascertain its average values and maximum values, which can be used to create a preliminary model. That model’s output may indicate where additional location specific information could fill in the blanks and produce a more site-specific model.
“We look at factors like the existence of a catastrophe plan, and the damage-ability of both the warehouse and the contents stored inside it,” Evans said. “This is where the expertise of our engineering team comes into play. They can get a much clearer idea of how certain structures and products will stand up to different forces.”
From there, engineers may develop a proprietary model that fits those specific details. The results may determine the exposure to be lower than originally believed — or buyers could potentially end up with higher pricing if the new model shows their risk to be greater. On the other hand, it may also alert the insured that higher limits may be required to better suit their true exposure to catastrophe losses.
Then when the worst does happen, insureds can rest assured that their carrier not only has the capacity to cover the loss, but the ability to both manage the volatility caused by the event and be in a position to offer reasonable terms when renewal rolls around.
For more information about Berkshire Hathaway Specialty Insurance’s Marine services, visit https://bhspecialty.com/us-products/us-marine/.
Berkshire Hathaway Specialty Insurance (www.bhspecialty.com) provides commercial property, casualty, healthcare professional liability, executive and professional lines, surety, travel, programs, medical stop loss and homeowners insurance. The actual and final terms of coverage for all product lines may vary. It underwrites on the paper of Berkshire Hathaway’s National Indemnity group of insurance companies, which hold financial strength ratings of A++ from AM Best and AA+ from Standard & Poor’s. Based in Boston, Berkshire Hathaway Specialty Insurance has offices in Atlanta, Boston, Chicago, Houston, Los Angeles, New York, San Francisco, San Ramon, Stevens Point, Auckland, Brisbane, Hong Kong, Melbourne, Singapore, Sydney and Toronto. For more information, contact [email protected].
The information contained herein is for general informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any product or service. Any description set forth herein does not include all policy terms, conditions and exclusions. Please refer to the actual policy for complete details of coverage and exclusions.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Berkshire Hathaway Specialty Insurance. The editorial staff of Risk & Insurance had no role in its preparation.