The bankruptcy of cryptocurrency exchange FTX is the latest example of a corporate collapse resulting from governance failures, and carries some tough lessons for insurers, according to AM Best.
Although FTX is not an insurance company, the rating agency asserts that the series of events leading to its collapse should nonetheless provide “a sobering warning for the insurance industry.”
After receiving backing from some of the biggest names in venture capital, and ultimately becoming one of the world’s largest crypto exchanges by volume, FTX filed for bankruptcy on November 11th, 2022, in the US court system following a liquidity crisis.
The failure of Bahamas-based cryptocurrency exchange – launched in 2019 by Sam Bankman-Fried – is likely to result in years of litigation in numerous jurisdictions and major losses for both shareholders and customers.
Among the main governance issues flagged by AM Best was the lack of a board of directors at FTX and the concentration of power into the hands of a single individual, combined with a lack of experience amongst its senior management team
“Strength and depth of management teams are essential for an insurance company to successfully execute its strategy,” AM Best wrotes, comparing the management of the crypto exchange to that of a major re/insurer. “Conversely, a lack of accountability of executives or too much power held by a single individual may lead to poor management decision-making. Equally, companies without effective succession planning expose themselves to the risk of disruption and knowledge-drain caused by the departure of key staff.”
The rating agency also highlighted “a complete failure of corporate controls and such a complete absence of trustworthy financial information,” and emphasised the importance of high quality, independent financial reporting for re/insurers.
Analysts said they would take a favourable view of insurance company enterprise risk management (ERM) frameworks which incorporate lessons learned from recent events and emerging issues, and expect insurers with strong governance practices to be better able to manage risks.
“Insurers generally benefit from effective ring-fencing of, and/or reserving for, resources to meet obligations to policyholders, underpinned by market discipline and regulation,” AM Best concluded. “However, even insurers with healthy balance sheets and sound operating performance may in some instances experience rapid deterioration in their financial strength because of weak internal controls, or poor strategic decisions linked to inadequate governance.”
“The collapse of FTX has resulted in losses not just for shareholders, but also for its customers. Similarly, insolvency of an insurance company creates the risk of policyholder claims going unpaid. AM Best’s Financial Strength Ratings are focused on insurers and their ability to meet ongoing insurance contract obligations.”
