“Two recent major events [have] completely changed the fronting market,” according to rating agency KBRA. These events brought alleged claims of fraudulent letters of credit (LOC) collateral from a single non-US bank, related to transactions facilitated by Vesttoo, and an US$81.5 million pretax write-down of a reinsurance recoverable by fronting carrier Trisura. These findings were released in KBRA’s report entitled ‘What Could Possibly Go Wrong? Fronting Market Changes Overnight’. Insurtech firm Vesttoo provides the insurance industry with access to capital markets through ILS — an alternative form of reinsurance. In Vermont, the allegations concerning fraudulent LOC related to insurtech Vesttoo programmes were a big topic of conversation, according to attendees. Captive industry experts have discussed the opportunities for more collaboration between capital markets and large captives. Captive insurers are examining collateral issues in the wake of the scandal. KBRA says: “The insurance fronting space was a fairly stable and predictable sector for over a decade. This was characterised by an attractive market opportunity, plenty of capital to start up businesses, demand for well-rated carriers to provide fronting services, and growth in aggregate managing general agent (MGA) premiums.” Commenting on the aftermath of the events, the report says: “The reputation of those in the insurance value chain is likely to suffer short-term damage as various fronting insurers, reinsurers, cedants, brokers, and MGAs assess the full financial and operational impacts.” KBRA notes that “recent negative events underscore the critical importance of effective enterprise risk management and could be positive catalysts for change”. Following this, rating agency AM Best released a commentary detailing bank issuers of collateral LOC to (re)insurance companies, as well as companies with LOC exposures to China Construction Bank Corp., which has been linked to the ongoing situation. AM Best commentary, named ‘Vesttoo Highlights Importance of Managing Counterparty Risk’, surveyed reinsurance counterparty credit risk and the forms of collateral held by US-domiciled insurers in statutory filing statements. Although it cannot identify which bank LOCs are related directly to Vesttoo transactions, a broad analysis shows that LOCs against business with unaffiliated reinsurers account for 22 per cent of total collateral held. The 2021-2022 data also shows insurers have added some new banks to their roster of LOC providers. AM Best adds that the growth in LOCs by some banks has been notable, particularly at China Construction Bank Corp., which increased its LOC exposure by US$1.2 billion in 2022. KBRA concludes: “The insurance sector is well-positioned to apply the lessons learned and potentially emerge as a stronger and more robust participant in the overall insurance market.”
