Thursday, November 30, 2023

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Vesttoo, White Rock fallout could influence future cell regulation, legislation

  • Result of cell ownership, insolvency dispute could prompt legislative changes in other jurisdictions
  • Captive owners and insurers advised to do extra due diligence on collateral, fronting arrangements
  • Vermont confident no impact on their own captive programmes

Regulators and lawmakers in cell captive jurisdictions around the world should be monitoring the fallout from the Vesttoo collateral scandal concerning White Rock cells in Bermuda.

Vesttoo, which connects capital market participants with (re)insurance risks, has been utilising Aon’s cell facility in Bermuda, but now finds itself embroiled in claims regarding fraudulent collateral.

The insurtech has filed for Chapter 11 Bankruptcy Protection in the US District Court in Delaware, with filings from Aon showing 37 letters of credit are thought to be invalid or fraudulent representing up to $2.35bn in assets.

White Rock Insurance (SAC) Ltd and the Bermuda Monetary Authority (BMA) have sought to liquidate the cells concerned, but Vesttoo is fighting against that action in Delaware and have now filed to have the cell company and the joint provisional liquidators held in contempt of the bankruptcy court proceeding.

The Vesttoo platform has been facilitating insurance linked securities (ILS) transactions through White Rock and it is not thought any traditional, pure captive-type programmes are impacted.

However, speaking on the Global Captive Podcast Joseph Holahan, partner at BakerHostetler in Washington DC and an experienced lawyer on captive governance and cell company matters, said those working with cells should be paying attention.

Cell consequences

“The interesting thing is now we have a little bit of a legal tussle going on between the regulatory authorities in Bermuda, and the Bankruptcy Court in the US,” he said.

Holahan believes this dispute and the ultimate outcome of decisions made in Bermuda and by the Delaware court should be of particular interest to those in the captive market.

“It could be important for how cells are regulated and treated in the future, but I haven’t seen anything at this point that would challenge the integrity of the cells, in other words, the ring fencing of assets and liabilities among the cells,” he added.

“But that could become an issue at some point. In the Bankruptcy Court, one of the things that Vesttoo is arguing is, under Bermuda law, if you want to put the segregated account company in liquidation, you have to put the whole thing in liquidation; you can’t just put some cells.

“That certainly has implications for anybody who’s participating in a protected cell facility.

“What you don’t want is to be in a facility where there’s some problems with one cell or maybe some group of cells. You don’t want those to become your problem if it throws the entire facility into liquidation.”

Holahan cited a 2022 Cayman case, In the Matter of Performance Insurance Company SPC, as “good case law” that reaffirms the integrity of cells within segregated portfolio companies (SPCs), but legislators and regulators that oversee similar structures in their jurisdictions might need to react if the Vesttoo fallout goes a different way.

“When you come to the lawmakers and the regulators, they should pay attention to what happened in Cayman and what’s developing in Bermuda and then look for ways to strengthen their authorising legislation for protected cell facilities to ensure that it does recognise the division of interests among the cells and is protective of each cell,” Holahan added.

“It goes beyond just the segregation of assets and liabilities. The independent interest of each cell needs to be protected if there’s a liquidation that involves one cell. We don’t want, for example, the cost of that liquidation to be visited upon the owners of other cells.

“Certainly that’s something that all of the captive jurisdictions will want to look at and make sure that if we see any fault lines in Bermuda, that those get addressed in the authorising legislation in each domicile.

“So that if things don’t go the way we’d like, or the way that the regulator in, say, a US domicile would want its statute to be interpreted, you may need to enact some clarifying legislation or regulations that clarify how the statute is to be interpreted and applied.”

Fronting and collateral questions

While the Vesttoo story may end up being an important one concerning the future look of cell captives, it started as an alleged collateral fraud.

The seriousness and scale of the alleged fraud has prompted some in the captive market to look again at whether the processes captives, fronters and banks have in place are sufficient to guard against something similar happening in this corner of the industry.

“LLC fraud is very rare in the insurance industry, and so it’ll be interesting to see how this was able to happen,” said Andrew Christie, a senior manager in EY’s Americas Captive Services team, on the podcast.

“From a captive perspective, the banks issuing the LOCs on the captive programmes as collateral should expect additional compliance diligence from carriers. Captives procuring reinsurance should maintain a KYC process as far as they’re able to on all counterparties; the reinsurers, the retrocedants, the banks issuing the collateral.

“Ultimately, the captive management firms should be doing this anyway, and so will be able to help here.”

Holahan agrees and said while it usually should be as simple as presenting an executed letter of credit, the Vesttoo case could be a “cautionary tale” that more verification is required.

“Call the bank or call the trustee, or take some other sort of second step, just to be certain that whatever you’re receiving as documentation of the collateral is true and correct,” he added.

Christie believes captives should be aware of the “relatively low bar to entry” for fronting partners, reinsurers and investors contributing capital and it is key they have “right due diligence procedures in place, and the right service providers assisting the captive to help mitigate the risk of bad actors”.

Sandy Bigglestone, deputy commissioner for captive insurance at Vermont’s Department of Financial Regulation, said while she was comfortable and confident in the collateral processes and due diligence of long established fronting carriers, it might be prudent to take another look at new entrants into the market.

“I think we have to get to know and dive a little deeper into the front; how it’s structured, what resources of additional capital they might have, how they are structuring collateral,” Bigglestone explained.

“Maybe confirm or look at the contracts to make sure that risk takers can’t get off the hook and that there are truly assets backing what they’re collateralizing.”

The Vermont regulator took the step of writing to local captive managers on 26 July as the fraud allegations first surfaced as a cautionary step to ascertain whether any captive programmes in the Green Mountain State had exposure.

“This was an important step to provide notification and awareness of the issue if they didn’t already know and to request companies and service providers to review fronting and collateral arrangements to identify and report any impacts related to the Vesttoo case,” Bigglestone added.

“We allowed 30 days for companies to tell us about any exposed captives. With our own research and searches of our company information, we’re hoping that there are no surprises.

“Although we asked to be notified about any impacted captives, many are sending in confirmations of no exposure. So I’m encouraged by the results so far and it just speaks to how cooperation and communication are critical in this industry.”