Pricing Cat Bonds for Cloud Service Failures

The use of clouds to store personal or company data and run programmes is gaining wide acceptance, thanks to its promise of higher efficiency and cost reduction. However, cloud services may not always be available. Their unavailability leads to losses for customers and the cloud provider as well, which is typically bound to compensate its customers. It can protect itself from such losses through insurance, which transfers the risk to the insurer. In the case of poor availability of the cloud, the amount that the insurer has to pay back to cloud providers may become so high as to endanger the insurer’s financial solvency. We propose to adopt cat bonds as a reinsurance tool and Nowak-Romaniuk’s pricing scheme. For the case where the frequency of outages is described by a Poisson process and the severity of losses is described by a Pareto random variable, we derive a closed formula for the price of a cat bond in a stochastic interest rates environment, using both one-factor and two-factor short rate models. We demonstrate the applicability of our pricing formula in a real context.