DBRS Morningstar has sent us some commentary on the Vesttoo situation and as many experienced investors know, you have to really do some very detailed diligence on the credit or funding package behind any fast growing company.
OK WHAT’S THE GEN ON THIS?
In short, Vesttoo has allegedly overstated the amount of credit it can call upon, or perhaps edited some documents. Let’s be diplomatic and say there’s a problem with liquidity, due to the paperwork not quite adding up. These are called Letters of Credit (LOC).
DBRS sums up the definition of how VC investors view letters of credit or collateral;
“Collateral can be in the form of cash, highly liquid securities, or LOCs issued by reputable banks. These LOCs are more formally known as standby letters of credit (standby LOCs), and they represent a guarantee made by a bank on behalf of a client, which ensures payment will be made even if their applicant (the client of the bank requesting the LOC) cannot fulfill its obligation.
A standby LOC is more of a payment of last resort from the bank and, ideally, is never meant to be used. In turn, banking
institutions should make sure that the clients for whom they issue LOCs have the credit strength to repay them in case the beneficiary withdraws a standby LOC.”
RIGHT SO WHAT’S HAPPENED?
The rug has been pulled from Vesttoo faster than Nigel Farage’s Coutts Platinum Card. Why? Well there seems to be a bank in China which has supplied letters of credit, except the bank says differently now, all of which leaves Vesttoo’s $4bn worth of reinsurance deals up in the air a bit. After all, it’s only resinsurance if someone picks up the tab when the music stops, otherwise it’s a carousel of commission based paper.
HMMM, BIT MESSY, WHAT’S THE OUTCOME?
DBRS can see some risks for insurance brands caught up in the Vesttoo hullabaloo. So can IE, because someone has to pay on claims anf if it isn’t Vesttoo’s banking backers, then it will be the last stop on that reinsurance trail. Estimates of exposure vary of course, since big claims haven’t actually happened – yet. Here’s the DBRS take;
“So far, insurance companies have reported varying materiality levels in their overall exposure to the Vesttoo platform. Besides the media reports suggesting that the total amount of allegedly fraudulent LOCs used by investors in Vesttoo is about $4 billion, we need additional visibility on the aggregate value of transactions cleared using the platform. However, we estimate the total size of outstanding transactions to be between $5 billion and $10 billion based on the Company’s total revenue of approximately $200 million in 2022. Several insurance companies have already suspended further transactions in the Vesttoo platform until their investigations are complete.
Nevertheless, cedents can only use the reinsurance capacity issued through the Vesttoo platform following the occurrence of a valid claim. More importantly, the reinsurance capacity placed through the Company is mostly for non-catastrophic risks, reducing the industry’s systemic risk. In the meantime, the cedents involved with the platform are verifying the validity of the standby LOCs received from investors.”
The key thing to remember in this is the reputational damage to the reinsurance sector long term. Like a State currency, cover is just a promise to pay. But for faith in that insurance system to remain strong, it has to deliver on that promise. It’s like a bank agreeing to loan you a mortgage and then when you come to exchange contracts they decide that they haven’t got the money after all, sorry n all that.
It destroys trust and once lost, that trust is hard won again. Perhaps the solution is a sharper insurance sector focus on utilising AI and data to enhance in-house corporate due diligence, the validity of the promise to pay? Making sure the backstop is rock solid might well be a series of awkward conversations, some milk may be spilled as new regulations are drafted and applied. But in the end, the result will be we can all forget about Vesttoo and move on. Do business. Settle claims.
That’s the core purpose of insurance; to heal broken lives, fix or replace assets. Not social engineering and climate change.