Dr Mike Lloyd, CTO at RedSeal
How can you tell that cyber insurance is a hot topic today? When lawyers find the amounts of money involved worth fighting over. Major cases are emerging of serious disputes between multi-nationals and the companies they’ve taken out policies with to help mitigate their risk exposure. On the one hand, this is partly to be expected of such a nascent sector. Yet it may also be a sign of a deeper problem: a lack of visibility into which security controls and policies actually reduce risk and therefore need to be mandated as part of a policy. After all, in health care, we know precisely how bad smoking is, and this helps make the insurance market far more effective. We lack a quantified science of how much an organization will lose if they fail to follow any given security hygiene practice.
This is where digital resilience scores can help insurers draw up tighter contracts and reduce the chances of costly legal disputes down the line.
Insurance for everyone
A decade ago, most firms effectively self-insured for any cybersecurity losses. The attitude was that online threats could be pretty easily handled by setting aside a “rainy day fund” to deal with the fall-out of a major incident. Unfortunately, this approach is no longer sustainable at a time when the sheer volume and variety of cyber threats facing organizations has never been greater.
One vendor detected over 48 billion threats in 2018 alone and has been recording 10’s of billions of issues for several years now — an indication of the growing number of covert, targeted attacks. From BEC to phishing, credential stuffing to digital skimming attacks and IoT sabotage to ransomware, the black hats have a huge list of tools and techniques at their disposal, supported by a thriving underground economy.
The financial impact of such threats is growing rapidly. Not only must organizations fork out for remediation, clean-up and investigation of a successful attack, they could be hit by major new regulatory fines under legislation such as the GDPR. Then there’s the impact on corporate reputation which may also affect the bottom line: think tumbling share prices or customer attrition. Legal costs are also increasingly common as consumers band together to launch class action suits.
One report estimates the average cost of a data breach to be nearly $3.9m, which easily reaches the level where boards want to know that they have appropriate insurance coverage. Last year, Lloyds of London released a report estimating that a serious cyber attack on one of the top three global cloud providers could lead to outages costing US firms $19bn. Earlier this year another report claimed a global ransomware attack could cause losses of $200bn. It’s this concern about correlated losses that really holds back insurers, and leaves companies scrambling to stack up dozens of insurance products to give themselves enough coverage.
A brave new world
In an era where no organization is safe, cyber insurance has therefore become hugely popular as a way to transfer risk. An analyst report from last year claimed three-quarters (76%) of global organizations have some form of insurance in place to cover cyber-related losses, although far fewer (around half) had “comprehensive” coverage.
Yet as insurance coverage increases, so do legal disputes. Back in January it emerged that confectionary giant Mondelez was suing Zurich Insurance for failing to pay out following the infamous NotPetya ransomware attack of June 2017. The $100m lawsuit was launched after the insurer invoked an exclusion for any attacks resulting from “hostile or warlike action in time of peace or war.” Although governments including the UK and US have publicly attributed NotPetya to Russia, they have released no evidence to support this, which could make it difficult for Zurich to prove its case. War exclusions are commonplace, but seldom invoked, because most industrial or commercial claims aren’t war related. They exist precisely because of the correlated nature of losses in wars – too many people all claim at once, because we all get bombed together. Is this an appropriate mechanism for cyber warfare? It’s going to be interesting to see how this evolves.
Another major area of dispute in cyber insurance lies with exactly what should be required of companies before they can sign up to a policy and subsequently claim. It recently emerged that law firm DLA Piper is also in dispute with its insurer over a NotPetya-related payout, although this time not over any act of war exclusion. Interestingly, it has been reported that the firm was crippled globally by the ransomware worm because its network structure was too flat. Although the firm is now segmenting those networks, there is a case for arguing it should have been made clear by its insurer right from the start that this security failure would have invalidated cover for such an attack. Perhaps it was — we will no doubt find out in time.
Focus on resilience scoring
The problem for insurers is that they’re used to dealing with underwriting physical things like houses or cars. Cyber risk is more nebulous and harder to define. Yet it is important they do so in order to produce more accurate, watertight policies with less risk of dispute in the future. With third-party risk scoring tools they can take a “virtual x-ray” of a client network to see how resilient it is to cyber-threats. They can then assess whether a company is ready to sign up to a specific policy and/or attach various preconditions to it. In this way, a lack of adequate security processes and controls could increaser premiums or invalidate a policy altogether, for example. However, this only works if the risk measurement is really a view inside the organization, not just an outside view. Some insurers have turned to external scan techniques, but this is similar to giving a doctor a selfie the patient took rather than an x-ray.
In the case of DLA Piper, the policy itself wasn’t even a specific cyber-insurance contract but something more general. A seemingly similar dispute between a Virginian bank and Everest Insurance hinges on whether the former was covered under a separate rider for computer crimes. This is another sign of the relative immaturity of the sector.
Both sides could do better: insurers should work towards reducing the ambiguity of small print policy details, using reliable third-party risk scoring to help them draw up better policies and conduct more effective due diligence. But companies also need to be more transparent about their cybersecurity posture, and realistic about how far coverage can reach. If a firm bolts its digital front door but then leaves all the windows open, it should be in no doubt that any policy claims will be invalidated.
Much of the current churn is only good news for the lawyers. But in time, the rulings from these disputes should provide more legal clarity over who is liable for what. All parties have a reason to want insurers to improve their assessment of cyber risk: it will make the underwriters more competitive and profitable, and force their clients to improve baseline security across the board.
TWO TO TANGO? MARKET DATA AND OPINIONS IN INVESTMENT MANAGEMENT
Sebastien Lleo is Associate Professor of Finance and Head of the MSc in Risk and Financial Technologies at NEOMA Business School (France)
Analyst views and expert opinions matter. They are an invaluable complement to market data when it comes to formulating relevant capital market expectations and to strengthening risk management models and practices. But watch out for behavioral biases!
“Garbage in – garbage out!” Every investment management professional has heard the warning that poorly formulated capital market expectations will get portfolio optimisers to produce inefficient, unrealistic, and even outright dangerous portfolios.
Thus, considerable efforts have taken place to turn available economic and market data into accurate capital market expectations. These lead to the development of slick statistical methods, effective econometric techniques, and powerful machine learning algorithms.
Opinions can also be an invaluable source of insights to construct accurate capital market expectations.
What are the types of opinions on financial markets?
Opinions take multiple forms in financial markets. They include analyst views, opinions from political and economic experts, super forecaster predictions, and investor polls.
Moreover, opinions abound on financial markets. Consultancy Quinlan & Associates reported that the bigger banks and brokerages emailed over 40,000 pieces of research every week in 2016, despite continuing job cuts in the financial sector. Social media also contribute to the spread of opinions: according to the financial website Modestmoney.com, there are at least 839 active financial blogs published in English.
Why should I use expert opinions?
Opinions have three key benefits.
First, opinions can be a crucial complement to traditional economic, corporate and financial market data to construct realistic capital market expectation, and keep those up-to-date. This statement is especially true in times of heightened uncertainty, such as market bubbles and financial crises, when traditional data fail to provide an accurate assessment of market conditions.
Second, opinions can strengthen risk management models and practices. Opinions can widen the range of scenarios considered in portfolio optimisation and risk management. Dissenting opinions provide a cornerstone for the construction of meaningful stress test scenarios.
Third, we can use opinions, even when traditional data are not. For example, assessors evaluate insurance claims, and appraisers estimate the value of illiquid assets, such as real estate and collectables, periodically.
How easy is it to collect opinions?
The inclusion of opinions requires extreme care.
Let’s look at analyst views and expert opinions. We all know that not all experts or forecasters are equally accurate. A widely reported study by CXO Advisory Group LLC tracked 6,582 forecasts for the U.S. stock market published by 68 experts between 2005 and 2012. The study found that average accuracy across experts was 47.4%, with individual accuracies ranging from a low of 21% to a high of 68%.
Therefore, investment management teams need to implement a process to guarantee the relevance of the opinions used in their models. This process, known as “elicitation,” is described in abundant literature. The books by O’Haghan (2006) and by Meyer and Booker (2001) are an excellent place to start. Essentially, the elicitation process helps to construct views that are specific, explicit, and structured. Opinions need to focus on a specific variable or parameter, such as the price of a given asset or the mean of a distribution. Opinions need to explicitly provide a mid-point or most-likely scenario, a confidence interval, and to relate the confidence interval to a probability distribution. Finally, opinions need to be structured to provide a transparent and auditable trail.
What are the implementation challenges?
Three main implementation challenges need addressing.
The first and most dangerous challenge is that opinions are often subject to the behavioral biases. Behavioral biases, in particular overconfidence, excessive optimism, conservatism, confirmation bias, and groupthink play an essential role in how finance professionals perceive and process information, and on how they form their forecasts. Recently, in a simulation study, Davis and Lleo (2020) recently found that the presence of biases explained nearly 70% of excess risk-taking. Therefore, it is crucial to debias forecasts before using them in any model.
Second, expert opinion models are Bayesian and therefore require the specification of a prior distribution. We can overcome this difficulty with some original thinking, as with Black and Litterman’ reverse optimisation exemplifies.
Third, aggregating of multiple expert opinions is considered an essential conceptual and computational problem because it requires engineering a joint distribution out of a collection of univariate distributions.
How can I integrate opinions in my portfolio selection model?
Currently, several families of portfolio selection models use opinions as input. The best-known and oldest is the Black and Litterman (1992) model, which uses analyst views to generate capital market expectations in a Markowitz-style single-period optimisation framework. This approach has been extensively discussed and developed in a large number of subsequent papers and chapters.
However, the Black-Litterman approach has two fundamental limitations. First, it is static, meaning that it locks portfolio managers into a “buy-and-hold” strategy, ignoring the possibility that portfolio managers may shift their asset allocation as financial market conditions change. Second, it ignores the presence of behavioral biases in expert opinions.
To address the first limitation, Frey et al. (2012) and Davis and Lleo (2013,2020) proposed two closely-related dynamic portfolio management models. Although both models are developed in continuous time, we can transpose them to a multiperiod discrete-time setting.
The second limitation has proved more elusive. At the moment, Davis and Lleo (2020) is the only dynamic portfolio selection model that addresses for behavioral biases.
Black, F., Litterman, R., 1992. Global portfolio optimisation. Financial Analyst Journal 48 (5), 28–43. Davis, M., Lleo, S., 2013. Black-Litterman in continuous time: the case for filtering. Quantitative Finance Letters. 1 (1), 30–35.
Davis, M., Lleo, S., 2020, Debiased expert forecasts in continuous-time asset allocation. Journal of Banking and Finance. 113.
Frey, R., Gabih, A., Wunderlich, R., 2012. Portfolio optimisation under partial information with expert opinions. International Journal of Theoretical and Applied Finance 15 (1). O’Hagan, A., 2006. Uncertain Judgments: Eliciting Expert’s Probabilities. Wiley.
Meyer, M., Booker, J., 2001. Eliciting and analysing expert judgment: a practical guide. ASA-SIAM Series on Statistics and Applied Probability. Society for Industrial and Applied Mathematics.
AN ULTIMATE GUIDE TO TURNING YOUR EARLY RETIREMENT DREAM INTO A REALITY
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ.
This article is for all those who are counting their IRAs, 401 (k), self-directed 401k and other retirement planning options to enjoy that late-life freedom as early as 45 or 40. Financial freedom at 55 has become a thing of the past because today it all depends on your ability to take the right decisions. If your 9 to 5 life has left you drained and you are serious about an early retirement, here are 8 ways to coach you from scratch:
- Free yourself from the vicious circle of debt
The first step to securing an early retirement is getting yourself free from debt. If you do not wish to enter your early retirement with any financial lags or large payments that can eat away a massive chunk of your modest savings, you need to increase your cash flow by clearing all your debts. Paying off your mortgage or lease early will help you divert the funds into a Roth IRA or other retirement savings.
- Start living a frugal life
Saving is the only way to increase the cash flow as your career progresses and this can be done by controlling your expenses. It does not mean giving up on all your desires but only requires you to live a frugal lifestyle. A few compromises and you can save a significant amount which will eventually bring you closer to your early retirement dream. From giving up on your expensive memberships and cutting down your HVAC usage to making a few compromises in your lifestyle and sacrificing a few golf games, your day-to-day frugal acts will free you from your cubicle and give you the freedom to retire early.
- Be open to the idea of changing
Prioritize between your wants and your needs. This will help you break free from the shackles of your tiring nine to five schedule. Enjoying life to the fullest sounds like a great idea to most of us, but it also means that you are losing on the real joy of retiring at 40 for momentary happiness. If fancy dinners and long drives in luxury cars mean more to you, an early retirement is obviously out of your reach. Mindful spending needs major lifestyle changes for which you may need to give up on stylish clothing, lavish parties, exotic vacations and more. This is only possible if you change your perception of conventional societal programming which demands that you give up on your desires of bigger houses and new cars. It calls for a complete mind shift from spending to saving.
- Take a head start with a high-paying industry
It is possible to retire well before you turn 60 if you are working for an industry that pays really well right from the start. A good-paying job plays a critical role in paving your path to a financially independent future. You too can enjoy a retirement of rest and relaxation if you are willing to take up personal responsibility in professional life. Getting closer to your goal of early retirement requires you to be self-sufficient early on in life.
- Automate 50% of Your Annual Income to Retirement Savings
Allocate as high a percentage of your annual income as possible to pay up your previous debts, pending bills, leases, and loans. Once you are done with of all these, automate your income towards retirement savings. You can start with 30% and raise the bar every year as your income increases. Every time you get a raise, increase the amount you add to your retirement reserve.
- Be sure to invest in a 401 (k) plan
Many employers are offering 401 (k) plans where you can invest a certain amount of your income and your employer makes a matching contribution to bolster your retirement savings.
- Stick to a frugal lifestyle
You need to revamp your investment plan as your career keeps progressing. What you want to achieve – an early retirement is an extraordinary goal and so your efforts should be focused on living frugally. Always keep a rewarding retirement at the top of your mind and you will remain motivated to keep the passion alive and pursuit kicking.
- Invest in an IRA
An IRA is a preferred and popular choice for retirement savings. You can consult an experienced and reputed financial advisor to guide you in selecting right IRA. An IRA will allow you to enjoy tax benefits if you choose to retire early. It will get to where you want faster than you think.
Start investing right away and make your retirement the best phase of your life.
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