Abstract We introduce a game-theoretic model to investigate the strategic interaction between a cyber insurance policyholder whose premium depends on her self-reported security level and an insurer with the power to audit the security level upon receiving an indemnity claim. Audits can reveal fraudulent (or simply careless) policyholders not following reported security procedures, in which case the insurer can refuse to indemnify the policyholder. However, the insurer has to bear an audit cost even when the policyholders have followed the prescribed security procedures. As audits can be expensive, a key problem insurers face is to devise an auditing strategy to deter policyholders from misrepresenting their security levels to gain a premium discount. This decision-making problem was motivated by conducting interviews with underwriters and reviewing regulatory filings in the US; we discovered that premiums are determined by security posture, yet this is often self-reported and insurers are concerned by whether security procedures are practised as reported by the policyholders. To address this problem, we model this interaction as a Bayesian game of incomplete information and devise optimal auditing strategies for the insurers considering the possibility that the policyholder may misrepresent her security level. To the best of our knowledge, this work is the first theoretical consideration of post-incident claims management in cyber security. Our model captures the trade-off between the incentive to exaggerate security posture during the application process and the possibility of punishment for non-compliance with reported security policies. Simulations demonstrate that common sense techniques are not as efficient at providing effective cyber insurance audit decisions as the ones computed using game theory.
Our contribution to the literature is the first theoretical consideration of post-incident claims management. Our model captures the trade-off between the incentive to exaggerate security posture to receive a premium discount and the possibility of punishment for non-compliance with the reported security policies. We consider misrepresenting security posture a strategic choice for the insured and allow the insurer to respond by auditing claims. Not allowing the insurer to do so leads to market collapse @cite_10 .
@cite_10
2031535643
An insurer has to know the risks faced by a potential client to accurately determine an insurance premium offer. However, while the potential client might have a good understanding of its own security practices, it may also have an incentive not to disclose them honestly since the resulting information asymmetry could work in its favor. This information asymmetry engenders adverse selection, which can result in unfair premiums and reduced adoption of cyber-insurance. To overcome information asymmetry, insurers often require potential clients to self-report their risks. Still, clients do not have any incentive to perform thorough self-audits or to provide comprehensive reports. As a result, insurers have to complement self-reporting with external security audits to verify the clients reports. Since these audits can be very expensive, a key problem faced by insurers is to devise an auditing strategy that deters clients from dishonest reporting using a minimal number of audits. To solve this problem, we model the interactions between a potential client and an insurer as a two-player signaling game. One player represents the client, who knows its actual security-investment level, but may report any level to the insurer. The other player represents the insurer, who knows only the random distribution from which the security level was drawn, but may discover the actual level using an expensive audit. We study the players equilibrium strategies and provide numerical illustrations.