The bankruptcy court filings that emerged just before the Monte Carlo Rendez-Vous laid bare the sequence of events that Vesttoo alleges led to its LOC scandal.
The detail was gripping – involving fake aliases and call-forwarding – but ultimately doesn’t change much of the material impacts or near-misses for the reinsurance sector.
After all, echoing a finding in the report that “red flags abounded [internally] as early as 2021”, as we had argued, in many cases there had been a sense within the industry that the firm’s capacity had been used up despite some clear warning signals – use of Chinese bank LOCs, for example – even if the specific fraud was unforeseen or harder to detect.
As one source put it, there was a view that brokers had tried to “get the cheap capacity before it goes away”.
This means the case is generally viewed as a specific rather than systemic failure, with further scrutiny likely on LOC providers, or a preference for cash collateralised trust funds, as is standard in many other parts of the ILS market.
Among brokers, it may prompt a review of practices whereby cedants are asked to take on more inherent due-diligence risk by signing disclaimers over the use of certain trading partners, as this is not going to protect the segment against E&O claims in itself.
As Vesttoo’s participations had been most marked in the fronting segment, the direct impact on reinsurers has generally been somewhat lessened, relative to the primary market.
For some mainstream reinsurers the failure even brought up unexpected mid-year opportunities to consider. Cedants who found themselves exposed to the fallout had to explore options to replace and bolster coverage rapidly – whether in cat risk to compensate for unexpected capital strain in casualty lines, or in direct swaps.
Similarly, their relationships with fronting carriers may be enhanced by a flight to quality providers among that segment.
Fronting segment review
As this publication has argued, while the fronting segment remains under review by AM Best, there is a strong chance that fronting carriers will face more fundamental questions over their valuations and whether their risk-taking nature had been underestimated.
In essence, these businesses were being pitched as parallel businesses to MGAs or brokers. The best insurance service businesses over the last couple of years have been able to secure 18x-20x a heavily adjusted Ebitda multiple, with some curbing of multiples evident during the past year as the increased cost of capital started to bite.
The Vesttoo crisis will likely prevent any of these from securing those kinds of valuations in the near term.
Partially, this will reflect a worsened operating environment the fronts face in the aftermath.
It is likely that their growth will be checked by MGAs choosing to make different choices around capacity, with the trade-offs that come with using fronts and collateralised reinsurance no longer ignorable. (Sources have said this is already a boardroom-level preoccupation at MGAs, and some are known to have approached carrier-owned fronting units to explore moving business.)
In addition, fronts are likely to have to take on significant additional cost related to risk, compliance and underwriting to demonstrate their bona fides to trading partners. The second part of this evolution will be a move towards even greater risk-taking as a means of demonstrating skin in the game to persuade MGAs to work with them.
The consequences of Vesttoo will hurt the fronting companies, but the changes are less important than the role the crisis will play in uncovering what was already there.
