Cyber attacks against U.S. entities, including public finance issuers, continue to increase, with the number nearly doubling in 2020. While maintaining cyber insurance does not directly prevent or mitigate cyber risk, S&P Global Ratings believes it serves as a financial safeguard and can help issuers recover from the financial losses and liabilities associated with a successful attack. Amid the increased attacks, insurers have increased their premiums and requirements, potentially pressuring issuers' resources. Adding pressure to the situation is the potential for recession: S&P Global Ratings Economic anticipates a very shallow U.S. recession in its baseline forecast, but the recent volatility in the banking sector has added uncertainty regarding the economy's health and inflation is expected to remain high in the near term. With the increasing number of cyber attacks and the growing challenge of maintaining robust cyber protections, credit ratings may be pressured if issuers are unable to sufficiently respond and recover from a cyber attack.   

Recession, Rising Costs Could Leave Issuers With Fewer Cyber Security Options 

During a recession, growing expenditure costs would likely outpace revenue growth for many issuers, resulting in fewer available resources for cyber security and information technology (IT) departments, making some issuers face the difficult decision of reducing funding and/or staffing for their IT departments. We believe reductions would result in weaker cyber security protection and increase the risk of more impactful cyber attacks in the U.S. public finance (USPF) sector.  

The challenging job market coupled with high inflation that has outpaced salary growth, may challenge issuers to keep their IT and cyber security departments fully staffed. And we believe these challenges will only increase considering the high inflation environment, higher compensation available in the private sector versus the public sector, and recession risk. Failure to staff these departments will ultimately result in weaker cyber security protection, which could pressure ratings.  

To cut costs during a recession, some issuers may turn to outsourcing for more of their services, including IT and cyber security needs. However, we believe this may introduce issuers to third-party vendor risk, which could increase their vulnerability to cyber attacks if not properly mitigated. We believe issuers will need to understand the risks associated with third-party vendors and incorporate them into their risk-management policies to maintain their ability to respond and recover from a cyber attack. For more information, see the article "Cyber Risk In A New Era: Are Third-Party Vendors Unwitting Cyber Trojan Horses For U.S. Public Finance?" published Oct. 25, 2021, on RatingsDirect. 

We believe that how an issuer navigates the challenge of maintaining its cyber security protection during a recession will factor into our assessment of management and has the potential to be the deciding factor between maintaining and lowering a rating. 

Advancements In AI Could Herald More Sophisticated Attacks 

The advent of more advanced artificial intelligence (AI) tools, such as ChatGPT, may make creating malware or other malicious programs easier and could act as a catalyst for more cyber attacks. ChatGPT may also increase the proficiency in creating phishing attacks in the form of more sophisticated and realistic-looking phishing emails. Threat actors would also be able to easily write these phishing attacks in several languages, which would increase the scope of their phishing attacks. Overall, we have seen an increase in the sophistication and frequency of cyber attacks throughout USPF and we expect this trend will continue for the foreseeable future.  

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We believe increased cyber attacks could escalate both the financial and operational risk for issuers in the public sector and may lead to weaker reserves and worsening credit quality. 

Rising Premiums And Declining Coverage Could Lead To Increase In The Use Of Pooled Cyber Insurance Risk Funds 

In recent years, we have seen many USPF issuers maintain a certain degree of cyber security insurance. But as recessionary pressures increase with worsening macroeconomic factors, such as historically high inflation, issuers may be forced to reduce their level of cyber protections in place due to rising operational costs, difficulties in maintaining IT and cyber security staff, and rising cyber insurance policy premiums. 

As the number of successful cyber attack claims under insurance policies rises, insurers are adjusting their policy offerings to maintain their own fiscal solvency and remain within their risk limits. (Please see "Cyber Risk In A New Era: The Rocky Road To A Mature Cyber Insurance Market," July 26, 2022.) We believe the trend of insurers reducing the amount of coverage offered under their cyber insurance policies may accelerate and that insurers could even cancel insurance policies held by issuers under a recession scenario. 

Compounding this issue is that cyber security insurance premiums have increased annually since 2019, with S&P Global Ratings projecting that these increases will continue through 2025. (See "Cyber Risk In A New Era: The Future For Insurance-Linked Securities In The Cyber Market Looks Uncertain," published Aug. 24, 2022). 

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This trend could lead to more issuers having less cyber insurance coverage, potentially resulting in increased financial and operational risk and additional credit risk if not sufficiently mitigated.   

Another potential outcome of growing insurance costs is that issuers could turn to pooled cyber insurance risk funds offered at the state or county level. These funds serve as an alternative to private cyber security insurance and could offer a sufficient level of protection while remaining affordable for issuers. We anticipate more issuers will turn to publicly offered cyber security insurance during a recession, which could provide more access and keep coverage affordable. (See "As Threats Rise, U.S. Public Finance Entities Take On Mounting Challenges To Secure The Digital Front Line," published Dec 13, 2022.) 

As Cyberattacks Rise In Frequency And Sophistication, Issuers Will Need to Remain Vigilant  

S&P Global Ratings would consider it a credit risk if issuers are forced to lower their cyber security insurance coverage or forgo it altogether due to rising insurance premiums and reduced revenues. But it's a double-edged sword, because without insurance, issuers may not be able to effectively respond or recover from a cyberattack. Lack of insurance, if not offset by self-liquidity or other protection measures, would make issuers more vulnerable to significant financial and operational consequences from a successful attack.

We believe issuers will need to be able to adapt quickly to an increasingly harsher economic environment with a potential recession looming and maintain sufficient cybersecurity protections and/or insurance to limit the financial and operational risk that comes with a successful cyber attack. If issuers are not able to respond and recover from a cyber attack, resulting in a material weakening of its financial position or operational ability, then we believe credit ratings could be negatively pressured if left unmitigated.