Pricing and Risk Mitigation Analysis of a Cyber Liability Insurance using Gaussian, t and Gumbel Copulas – A case for Cyber Risk Index

Anand Shah

MPRA Paper from University Library of Munich, Germany

Abstract: Cyber risk, a type of operational risk, is today considered a key component in the enterprise risk management framework. Under BASEL regulations, a bank could recognize the risk mitigating impact of the Cyber Liability Insurance (CLI) contract while calculating the minimum operational risk capital requirement. Despite this benefit and the onerous data protection acts, organizations are still reluctant to buy CLI contracts. In this work, we price and analyze a CLI contract using Gaussian, t and Gumbel copulas and evaluate the contract’s cyber risk mitigation effectiveness. We find that the current structure of the CLI contract with the limits and sub-limits may be inefficient at mitigating the cyber risk especially if the cyber risk losses were correlated and showed upper tail dependency. We then propose a case for a traded index for the cyber risk similar to the Property Claim Services (PCS) index for the catastrophic risk. A traded cyber risk index could offer wider cyber risk hedging alternatives to the insurers. Given such risk hedging alternatives, the insurers may have lower impetus to set conservative limits in the CLI contracts thus making the contracts more effective in mitigating the cyber risk of the organizations.

Keywords: Interplay between finance and Insurance; cyber risk index; cyber liability insurance pricing; Gaussian; t and Gumbel copulas; operational risk; value at risk (VaR); conditional tail expectation (CTE); BASEL regulations; pricing of contingent claims in incomplete markets; Monte Carlo simulations (search for similar items in EconPapers)
JEL-codes: G13 G21 G22 G28 (search for similar items in EconPapers)
Date: 2016-05-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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