text: 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.
  @cite_16: 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.
  @cite_7: 
  @cite_6: This paper investigates how competitive cyber-insurers affect network security and welfare of the networked society. In our model, a user's probability to incur damage (from being attacked) depends on both his security and the network security, with the latter taken by individual users as given. First, we consider cyberinsurers who cannot observe (and thus, affect) individual user security. This asymmetric information causes moral hazard. Then, for most parameters, no equilibrium exists: the insurance market is missing. Even if an equilibrium exists, the insurance contract covers only a minor fraction of the damage; network security worsens relative to the no-insurance equilibrium. Second, we consider insurers with perfect information about their users' security. Here, user security is perfectly enforceable (zero cost); each insurance contract stipulates the required user security. The unique equilibrium contract covers the entire user damage. Still, for most parameters, network security worsens relative to the no-insurance equilibrium. Although cyber-insurance improves user welfare, in general, competitive cyber-insurers fail to improve network security.
summary: The timing of the insurer's intervention plays is an important strategic aspect. Ex-ante interventions for the insurer include risk assessments and security investments before the policy term begins. @cite_6 investigated an insurer who could assess security levels perfectly or not at all, concluding that the latter cannot support a functioning market. @cite_7 showed that ex-ante assessments in combination with discounts for adopting security controls can lead to an increase in social welfare. A more recent model introduces stochastic uncertainty about the policyholder's security level @cite_16 .