Vesttoo's Issues With Allegedly Fraudulent Letters of Credit Highlight the Importance of Sound Counterparty Risk Practices for Insurers

DBRS Morningstar published a commentary discussing the potential credit implications of allegedly fraudulent letters of credit (LOCs) for insurance companies, as well as the importance of sound counterparty risk practices for the insurance industry.

Key highlights include the following:

-- Vesttoo Ltd. (Vesttoo) disclosed that it is investigating discrepancies in the LOCs used by investors to guarantee reinsurance transactions.

-- According to media reports, the allegedly fraudulent LOCs issued to insurers could total $4 billion.

-- The credit implications for most insurance companies in relation to the allegedly fraudulent LOCs should remain manageable, but a number of fronting specialist insurers could have more significant exposure.

“Although insurance and reinsurance companies rely mainly on financial strength ratings to assess their counterparties’ credit risk, proper validation procedures and strong know-your-client controls should be in place whenever collateral is used as a credit mitigant”, said Marcos Alvarez, Global Head of Insurance. “For cedents where Vesttoo accounts for only a small fraction of their reinsurance strategies, we expect any fallout from collateral failure to remain manageable. However, some fronting insurance companies have more significant exposure to Vesttoo and could see a weakening of their credit profiles in the short to medium term”.