Rating Agency Examines Counterparty Risk in Wake of Vesttoo Situation

The situation surrounding the InsurTech Vesttoo, which was formed to help provide insurers access to noncatastrophe insurance-linked securities, highlights the importance of managing counterparty credit risk, according to A.M. Best.

Vesttoo has been associated with allegations of fraudulent letters of credit (LOCs) connected to transactions it was involved in. The company filed for Chapter 11 bankruptcy protection August 14.

In a Best's Commentary, titled "Vesttoo Highlights Importance of Managing Counterparty Risk," the rating agency details leading bank issuers of collateral LOCs to (re)insurance companies, as well as companies with LOC exposures to China Construction Bank Corp., which has been linked to the ongoing situation. 

"The Vesttoo situation, which entails allegations of fraudulent LOCs, highlights the importance of carefully managing counterparty credit risk," the commentary said. "Cedents should conduct appropriate due diligence on counterparties and contracts, as well as collateral reviews."

Best said it's monitoring the evolving situation and reviewing its rated fronting insurers, as well as other insurers that have material amounts of reinsurance counterparty credit risk and reliance on various forms of collateral. "Based on this review, rating actions will be taken as warranted," Best said.

The Best's Commentary noted that the level of collateral in a reinsurance transaction often depends on the ceding company's reinsurance counterparty risk appetite, in addition to regulatory requirements. Among the types of collateral used by reinsurers are LOCs, funds withheld, and trust agreements, Best said.

Best said it surveyed the reinsurance counterparty credit risk and the forms of collateral of the US-domiciled insurers available in Schedule F in National Association of Insurance Commissioners statutory filing statements.                                     

"Although A.M. Best 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 percent of collateral held," the commentary said.

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