Vesttoo scandal likely to drive more ILS scrutiny

MONTE CARLO, Monaco – The scandal surrounding Vesttoo Ltd.’s use of allegedly fraudulent letters of credit in insurance-linked securities transactions will likely increase scrutiny of similar deals but won’t slow usage of alternative reinsurance structures, reinsurance experts say.

While the extra work may increase costs, confidence in the ILS market does not appear to have deteriorated as a result of concerns about the Tel Aviv, Israel-based reinsurance intermediary, they said during discussions this week at the Rendez-Vous de Septembre reinsurance meeting in Monte Carlo, Monaco.

Vesttoo, which filed for Chapter 11 bankruptcy protection last month, used fake LOCs from China Construction Bank to support various nontraditional ILS transactions, according to court filings.

The alleged fraud does not signal a wider problem in the industry or undermine the established catastrophe bond and wider ILS market, several reinsurance industry executives said.

“I don’t think it’s the canary in the coal mine. I don’t think it’s systemic,” said Tim Gardner, New York-based global CEO of Lockton Re, a unit of Lockton Cos. LLC. “We’ve been doing this a very long time as an industry; we’re good at it and have controls and processes in place.

“Vesttoo clearly slipped through the cracks, so it sharpens the mind on being diligent, but I don’t think it’s indicative that it’s a flawed model,” he said.

LOCs have been useful tools in ILS structures and likely will continue to be used, said James Vickers, London-based chairman international, reinsurance, at Gallagher Re, a unit of Arthur J. Gallagher & Co.

“It would appear reasonable to assume that regulators and rating agencies will look more closely, not at the structures but the substance of what is behind them,” he said.

Regulators and investors will likely scrutinize LOCs used in alternative reinsurance structures more closely as a result of Vesttoo, said Robert Mazzuoli, Frankfurt, Germany-based director EMEA insurance, at Fitch Ratings Inc.

“I would not expect at this time that letters of credit go out of favor, but the costs associated with them, the compliance costs, will increase,” he said.

The scandal has not had any effect on Hannover Re SE’s insurance-linked securities business, said Jean-Jacques Henchoz, chairman of the reinsurer’s executive board.

“We don’t see any difference in terms of confidence and the pipeline when it comes to our own business,” he said. But the revelations have been “an eye opener” for the industry and show a need for strong checks and balances, he said.

More diligence and transparency around LOCs supporting collateral reinsurance products may be required, which could lead to higher costs, said David Priebe, New York-based chairman of Guy Carpenter & Co. LLC.