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The US Federal Bureau of Investigation’s (FBI) has reportedly begun its own probe into allegedly fraudulent letters of credit linked to collateralized reinsurance transactions facilitated by Vesttoo, an Israel-based “insurtech” company which uses artificial intelligence technology to connect the insurance industry and capital markets.
As intended, Vesttoo’s role is to serve as a facilitator in finding investors interested in buying insurance risk. The investors are required to either post cash or apply for suitable banks to issue LCs in favor of fronting insurance companies (LC beneficiaries) as a form of collateral.
But in mid-July 2023, media reports first surfaced that billions of dollars of collateral presented by Vesttoo investors was missing or fraudulent and the company announced it was conducting internal and external audits after discovering “inconsistencies between an investor and a cedent in transactions that Vesttoo modeled the risk for”.
A Vesttoo spokesperson said: “We want to be clear that Vesttoo did not knowingly participate in any fraudulent acts, and there is no evidence of such acts. The collateral in question relates to LOCs provided under two specific transactions and were not issued by Vesttoo.”
LCs were allegedly issued by China Construction Bank, but CCB employees in New York have said the bank “was not authorised to write letters of credit” or that those related to Vesttoo deals did not exist, according to 20 July 2023 reporting by Insurance Insider based on its sources.
In a statement released 25 July 2023, Vesttoo said “the company is doing all it can to determine how and where the fraudulent LOCs originated. At a minimum, it appears that Vesttoo’s procedures were circumvented”.
By 1 August 2023, Vesttoo announced it was laying off around 150 of its 200 employees and would be closing its offices in Tokyo, Hong Kong, and Seoul. Days later, it confirmed that co-founders Yaniv Bertele and Alon Lifshitz left the company.
Ratings agency AM Best and global company Aon have also been impacted and initiated investigations.
In its review of fronting companies and other insurers that have significant reinsurance counterparty credit risk and reliance on LCs and other forms of collateral, AM Best placed the credit ratings of Clear Blue Insurance Group under review with negative implications out of concern over the company’s ability to rely on certain LCs and is engaged in discussions with Clear Blue management regarding its ability to replace the LCs to allow for proper reinsurance credit. If they cannot rely on the investors who supposedly reinsured policies issued by Clear Blue, and who purportedly forged the letters of credit received by Clear Blue, it would be expected that Clear Blue will remain obligated to honor claims under those policies by paying out of their own pocket.
Aon, whose intellectual property business has been involved in LCs linked to Vesttoo, faces possible legal proceedings over claims it failed in its alleged duty to require that investors post suitable LCs.
In its US Securities and Exchange Commission (SEC) quarterly report filed in July 2023, Aon stated: “In certain transactions in which Vesttoo identified third party capital providers to collateralize reinsurance obligations, including transactions in which [Aon] or its affiliates provided brokerage or other services, some letters of credit from third party banks are alleged to have been fraudulent. [Aon] is actively investigating those allegations.”
According to trade finance expert Buddy Baker, transactions where standby letters of credit are required are somewhat susceptible to fraud of this sort. It is not hard for an unscrupulous beneficiary to forge a convincing paper letter of credit and the fact a standby is unlikely to ever be drawn on means the forged LC may sit in a file folder for years with the fraud never being detected. Some insurance companies have implemented a policy of requiring all letters of credit they receive to be advised through their bank, thereby relying on the advising bank’s responsibility to verify apparent authenticity. Recognizing that this can be an expensive service for an insurance company that underwrites and reinsures thousands of insurance policies, some insurance companies have simply taken it upon themselves to verify authenticity of each LC they receive by calling the issuing banks. For insurance companies in the United States, the National Association of Insurance Commissioners (NAIC) requires that a specific form be used for reinsurance LCs and that they be issued by financial institutions approved by the NAIC, so the verification of authenticity might be just part of the intake process.