This blog was researched and written by participants in Pinnacle’s 2024 Pinnacle University development program.

Introduction

Trust and credibility are paramount in the business of insurance. Even in a highly regulated industry, fraud happens and can cause significant damage. The Vesttoo scandal, which rocked the insurtech world in 2023, serves as a stark reminder. Vesttoo was a promising insurtech startup but became involved in a scandal that eventually led to its downfall. For our 2024 Pinnacle University presentation, we examined what happened, who was involved, the effects on the industry, and potential solutions that could prevent similar fraud in the future.

What is Vesttoo?

In 2018, Vesttoo began as an insurtech startup that focused on smaller lines of non-catastrophe life and property/casualty insurance. Vesttoo quickly gained popularity due to their platform which, by utilizing AI, helped connect insurance companies with capital market investors as an alternative to traditional reinsurance. The Vesttoo platform was supposed to ensure that those investors had appropriate collateral to secure their respective investments. Vesttoo ultimately earned a valuation of over $1 billion, resulting in a unicorn rating.

What Happened to Vesttoo?

Letters of credit are a key to the Vesttoo story, so it is important to revisit the basics of letters of credit. Letters of credit serve as assurances to sellers that they will be paid for large transactions. An illustrative example is the relationship between an insurance company, a reinsurance company, and a bank. A reinsurance company would ask a bank to create an official document stating that if the insurance company were unable to pay its claims obligations, the bank would step in as a backstop.

Letters of credit are essential because U.S. companies that purchase reinsurance from foreign companies must fully secure the reinsured policies with letters of credit. They are considered the best form of collateral and are used by three-fourths of funded programs.

In 2023, a Vesttoo whistleblower accused the company of using counterfeit letters of credit to back insurance transactions. Vesttoo launched an internal investigation and found that four high-level individuals within the company had committed fraud. With the help of employees at two different banks, the Vesttoo executives were able to forge fraudulent letters of credit and identities. Over $4 billion dollars’ worth of Vesttoo letters of credit were found to be fraudulent.

Effects

The discovery of fraudulent actions had severe repercussions for both employees of Vesttoo and the companies Vesttoo worked with. About 75% of Vesttoo’s employees were laid off and many of their offices were closed. By September 2023, the company had declared bankruptcy, marking a dramatic fall for a once-promising startup.

The scandal had significant repercussions for other companies as well. For instance, Aon had to set aside $197 million for legal settlements related to the case. Another company adversely impacted was Clear Blue, which was the fronting carrier for several transactions involving Vesttoo. During this scandal, Clear Blue’s credit, as rated by credit rating agency AM Best, was placed under review with negative connotations. Clear Blue’s rating was later reinstated to an A- in November 2023. In general, companies that relied on reinsurance from Vesttoo were forced to scramble for replacement coverage, highlighting the far-reaching impacts of the letters of credit fraud.

Possible Solutions

Fraud exists in every industry. Companies and individuals can take potential steps to protect themselves with systems that make it difficult for fraud to occur or go unnoticed for long. 

Blockchain technology is a possible solution. Blockchain provides an immutable ledger, visible to regulators. The technology allows transactions involving letters of credit to be independently verified by regulators. It makes altering records much more difficult as more than just four people in a company would be aware of additions and/or changes to records associated with letters of credit.

A letter of credit penny test is another possible solution to mitigate the risks of fraud in the context of letters of credit. The idea is that when letters of credit are proposed as collateral for reinsurance transactions, the company having their policies reinsured will attempt to acquire a trivial amount of money from the bank for a “claim.” It confirms that the bank is indeed aware of the letter of credit so that the insurer can see that their policies are indeed reinsured.

Looking Ahead

The Vesttoo scandal highlights the need for vigilant fraud detection and robust regulatory measures in the insurance industry. As the case progresses through the courts, it is likely to have lasting implications for how insurtechs operate and how reinsurance transactions are conducted. The use of letters of credit will likely not be stopped by many (if any) companies. However, many companies will likely begin to take greater scrutiny in the companies from which they accept letters of credit and implement measures to mitigate risk of being exposed to fraudulent letters of credit.