AM Best will review the collateral arrangements of all fronting companies that it provides ratings for, the rating agency stated in light of the claims that collateral involved in transactions facilitated by insurtech Vesttoo could be fraudulent.
“Although the details and scope of this issue remain unclear, AM Best is monitoring the rapidly evolving situation and reviewing fronting carriers and other insurers that have material amounts of reinsurance counterparty credit risk and reliance on various forms of collateral,” AM Best said in a press release. “Based on this review, rating actions will be taken as warranted.”
Multiple letters of credit (LOCs), now believed to be fake, were allegedly provided by investors to insurers for Vesttoo platform reinsurance transactions. Because of this, there is a risk to fronting specialists that capacity is not there to support the functioning of client programs.
In its update, AM Best noted that the level of collateral in a reinsurance transaction will typically depend on a cedent’s reinsurance counter-party risk appetite, in addition to regulatory requirements.
Reinsurers use different types of collateral, and letters of credit are often used, the agency explained. Other forms of collateral include funds withheld (premiums held in a segregated account for reinsurance claims), trust arrangements, other invested assets, or a combination of these solutions.
In its assessment of the balance sheet of an insurance company, AM Best considers factors that could influence the rating, such as the quality of reinsurance, reinsurance dependence, and the appropriateness of the reinsurance program.
Its criteria recognizes that a reinsurance program should be appropriate to an insurer’s risk appetite and the program should be diversified and include reinsurers of good credit quality. In addition, the agency looks at support such as collateral that protects the cedent against counterparty credit risk.
AM Best noted that when it reviewed fronting carriers recently it found that “14 of the 19 companies analysed ceded more than 85% of their business to reinsurers, resulting in elevated credit risk on counterparties to provide cover when claims arise.”
The rating agency stated: “If risks are not initially assessed properly, the fronting company can be subject to residual tail risk, which could strain the collateral. Credit risk associated with reinsurers can be mitigated through the use of highly rated reinsurance panels, tight exposure limits, a regular review of collateral and letters of credit, trust agreements, etc.
“Effective fronting companies demonstrate their value through robust ERM practices, strong underwriting capabilities, effective reinsurance programs, and a focus on managing credit risk.”
