December 11, 2023

As the fallout from Vesttoo’s fraudulent or bogus letter of credit (LOC) claims spreads, the insurance and reinsurance industry faces a potential crisis of confidence in certain forms of collateral, which could raise the profile of the fully collateralized reinsurance model adopted by the insurance-linked securities (ILS) market.

collateral securityVesttoo, an insurtech company that aims to connect insurance risks from different sources to investors, has come under fire after it was accused of fraud with potentially billions of dollars in collateral.

Recall that the original claims indicated that a considerable amount of collateral could have been compromised, either fraudulently or with forged signatures, and letters of credit (LOCs) were seen as the most likely structure behind it, as Vesttoo used LOCs in some transactions.

Then, yesterday, new claims emerged that an audit conducted by Vesttoo had uncovered problems with the letters of credit (LOCs), which had significant collateral totaling around $4 billion, held for deals the company had brokered.

A number of top executives have left the insurtech company, while concerns are spreading rapidly about the integrity of the collateral the company trades and the extent of the fallout.

Details are still lacking as to the reasons for the incidental issues, or the specifics of what any fraud allegations might have been (and until some facts emerge, the allegations remain allegations), and there was no statement from the much-maligned company either yesterday or this morning.

Additionally, to our knowledge, no other parties involved in risk transfer and collateral chaining have made any statement or comment on the matter, while some firms have told employees not to discuss the issue publicly.

So the industry is still in the dark about the facts, so there’s still a lot of speculation. This is despite the general feeling that collateral management and quality control processes in the industry have gone so far wrong, or involved bad actors.

Leading experts involved, such as Clear Blue, which has a significant relationship with Vesttoo, face a particularly challenging time, as the collateral behind the deals they do for insurtechs and their clients now faces questions about the quality of the collateral, whether it exists or has any real value.

This could expose frontier companies to concerns about their own credit quality, as if collateral were found to be worthless, rating agencies could raise questions with frontier companies unless collateral can be replaced and other resources such as premium floats used to help provide integrity to completed deals.

We’ve heard comments from many interested parties about the integrity of the aspects of the Vesttoo deal, and another area of ​​concern comes from the ceding companies that the Vesttoo deal reinsures.

It now feels like there is a major hole in its reinsurance tower, so other reinsurer players in the same tower are also concerned because they believe the scheme has lost its integrity, one person said.

Vesttoo did say it was working with clients and other parties to try to resolve such issues, which led to a scramble for facts and information about the existence of collateral, but we have also heard that some of the exposed cedents were also scrambling to find alternative guarantees.

Questions were raised about who knew or should know, and what happened to the process of checking and assessing counterparty safety and collateral integrity or quality.

We are told that these processes often boil down to cursory checks to ensure that the counterparty’s credit rating still exists and has not been downgraded. So, in terms of the banks mentioned in the concerns related to Vesttoo-related collateral, China Construction Bank has been highlighted that as long as its ratings are intact, we are told that the market may not look deeper into the integrity of any particular letter of credit (LOC) it offers.

This begs the question, who is looking after the interests of the assignors in reinsurance and risk transfer transactions to ensure that their counterparties and collateral providers are in good standing of the commitments made?

The quality of collateral may become even more important in future discussions due to a possible crisis of confidence.

We have heard from market participants that they want more certainty about the integrity of collateral such as Letters of Credit (LOCs), regardless of the provider.

We also heard some concerns today about less capitalized cedents with reinsurance backed by the Vesttoo deal.

Any loss of collateral value, or even just concerns about its integrity, could damage some cedents’ own capital adequacy in the eyes of the rating agencies, as well as their ability to obtain alternative coverage if needed. Here, we’re thinking in particular of areas like Florida, where sources tell us Vesttoo has brokered some reinsurance deals.

All of this should speak to the fully collateralized nature of cat bonds and other insurance-linked securities (ILS), which are typically backed by cash or equivalents as collateral and then invested in highly liquid assets such as U.S. Treasury money market funds.

What really matters is that the collateral for any insurance, reinsurance or risk transfer transaction is held securely in a trust or similar, is readily accessible, and can be turned into cash for capital return when required by the terms of the risk transfer or re/insurance contract, upon repossession by the cedent or investor, or at maturity.

It is also important to remember that fraudsters can affect any type of collateral, and problems can also arise when payment promises on the balance sheet end up being broken.

Vesttoo has allegedly been using multiple types of collateral and using banks that are not commonly found in the market.

Many questions remain, some of which should be addressed following the results of the ongoing audit, which Kroll, as far as we know, is conducting an audit for the company’s board of directors.

As we said yesterday, the leaked information appears to have come from Vesttoo’s board or very high-level, as a publisher claimed yesterday that some of the findings of an audit had revealed wider problems.

However, the quoted figure of “approximately $4 billion” seems far too high given the stage of development Vesttoo is in. But how high the true figure is remains unknown.

We also learned more details about the whole affair, because a cedent apparently went to a New York branch of a Chinese bank that offered the LOC and tried to cash it out, but the bank told them they didn’t know what the cedent was referring to.

That sparked an investigation and notified Vesttoo, after which the board began its own audit and hired Kroll to help with the effort.

This particular divestiture relates to an intellectual property transaction in which Vesttoo was involved and involved only a letter of credit. But the fallout has turned into a full audit of all LOCs involved in the Vesttoo deal.

As far as we know, there has been no conclusive evidence of fraud by either party, but the audit is still ongoing, and apparently Israeli publisher Calcalist said its sources believe there is a wider problem, of which forged signatures may be part.

As a result, the real facts are still very murky, and the extent of the problem is unknown. But that has raised broader concerns about the collateral, its integrity and the origin of the letter of credit, all of which could make waves for some time to come.

The whole incident is not conducive to the market’s perception of the collateral and the chain of trust involved and the process of ensuring the safety of counterparties.

Likewise, the fully collateralized model of cat bonds used in the vast majority of insurance-linked securities (ILS) arrangements looks like a very solid option here.

Typical cat bond and ILS market practices are well established, well documented and governed by law, while the quality of the collateral used (mainly cash) is second to none in terms of counterparty creditworthiness and safety.

Sadly, it’s important to remember that bad actors can happen anywhere, and in the event of a sophisticated fraud attempt, any collateral, cash, balance sheet, LOC, or whatever it may be, can be considered 100% safe. In this case, the jury is still in the dark about what happened, although the level of skepticism remains high.

Trust-collateralized chains are an absolutely vital part of insurance, reinsurance, and ILS market processes. Here it has been called into question, but we suspect the market will respond with a healthy increase in scrutiny and surveillance and counterparty security controls.

Whether the incident will cause wider collateral damage remains to be seen.

Also read:

July 19th – Vesttoo: New report claims a large number of fake LOCs. The question is how?

July 18 – Vesttoo faces fraudulent collateral claims. Confirmation of the investigation, some leaders withdrew.

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