While claims of fraud at insurtech marketplace Vesttoo continue to capture headlines, this debacle also points to further challenges at fronting carriers, who typically pay reinsurers to backstop claim payments on policies issued on fronting carrier paper. In a number of instances Vesttoo facilitated reinsurance capacity, but as seen with other “new” entrants into the insurance sector as of late, they failed to appropriately secure financing to fund reinsurance treaties. As a result, fronting insurers are experiencing issues around capitalization, collateral arrangements, and possible credit downgrades by AM Best.1
This recent Vesttoo scandal is reminiscent of fronting insurer Legion Insurance’s rehabilitation and liquidation in 2002 and 2003,2 which resulted partly from the firm taking on added exposure, paying the additional premium, and questionable underwriting expertise. “Legion ran into a situation where they weren’t able to collect on their insurance or recoverables, or the reinsurers were just slow paying,” noted AM Best.3 Legion also had contract wording that led to the rejection of claims from reinsurers.4
What happened with Vesttoo?
Vesttoo is an insurtech that offers a marketplace for insurance companies to obtain reinsurance coverage from capital market investors.5 The $4 billion (and potentially more) in alleged fake letters of credit were provided by investors to insurers for reinsurance transactions on Vesttoo’s platform. Vesttoo received commissions on these transactions that are now under investigation.
Once a fast-growing “unicorn,” Vesttoo helped insurance companies to obtain reinsurance coverage through the capital market via a digital platform. But there are now allegations that some or all of the collateral presented by the company is non-existent.
Fronting partners and insurance companies that transacted on Vesttoo’s platform are now feeling the impact from the potential fraudulent letters of credit.
Why fronting carriers face potential challenges ahead
A fronting carrier is an insurance company that issues a policy and cedes out some or all of the risk to a reinsurer. Typically, fronting carriers have ceded out most (or sometimes all) of the risk to a reinsurer for a fee. Fronting carriers are licensed, admitted insurers who work with non-admitted insurers to issue policies that meet regulatory requirements. The fronting carrier takes on the risk and charges a fee.6
In recent years, the fronting carrier market has seen exceptional growth, with high levels of investor interest and an increase in direct written premiums. In 2022, aggregated direct written premiums from AM Best-rated fronting carriers increased by 43% year-over-year to $10.6 billion.7 However, the fast-growing companies in this segment also have potential issues and risks, and this investigation into claims of fraud at Vesttoo is just another issue for fronting carriers.
One major issue facing fronting companies concerns their business model as “hybrid” writers, taking on larger amounts of underwriting risk on their balance sheets. Given this new modified model, fronting companies take a 10-35% quota share risk on programs they write on their books.8 Taking on higher levels of risk requires underwriting expertise, including appropriate risk selection, pricing, and other important elements.
Another concern is the tail risk for fronting insurers. Fronting carriers are often buying reinsurance contracts that include loss ratio caps, (which limit a reinsurers loss to those below a certain maximum loss ratio). Losses in excess of this loss ratio cap are absorbed by the fronting companies. Now, some fronts may need to absorb losses that are not adequately collateralized by their reinsurance backers. Many fronting insurers are thinly capitalized and may not be able to absorb the claims.
Some fronting insurers now face possible downgrades by AM Best because of concerns of fraudulent reinsurance collateral on behalf of (reinsurance intermediary) Vesttoo.
Fronting carriers that are potentially impacted by the Vesttoo situation include Transverse, Sutton National and Clear Blue. These fronting carriers are looking to replace collateral that may have issues because they were done through Vesttoo.
In sum, the Vesttoo fraud allegations are ongoing and may take some time to settle. The fallout could have a ripple effect across the market, particularly for fronting carriers and the insurance brokers involved in these deals. The Vesttoo situation shows that fronting carriers’ collateral may not be as solid as originally thought – leaving fronting carriers exposed to losses that they are not adequately capitalized to absorb and are not backed by reinsurance. Reduced confidence in collateralized reinsurance transactions could have further impact on the industry, including a decline in the overall amount of reinsurance capital available to fronting carriers without a well-capitalized balance sheet.
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