Clear Blue responded “quickly and aggressively” to limit Vesttoo impact: KBRA

The management of fronting specialist Clear Blue Insurance are praised for the rapid and determined response to the issues that arose when the company found itself caught up in the reinsurance letter of credit (LOC) fraud perpetrated by Vesttoo, according to rating agency KBRA.

Clear Blue’s management took decisive actions early on and KBRA sees this as both limiting the impact that could have been experienced, as well as putting Clear Blue on better footing to continue running its business effectively.

Both of which were achieved, according to KBRA’s latest rating analysis of the fronting specialist, in which it affirmed all of Clear Blue and its insurer’s ratings, putting them on a stable footing and citing the firm’s strong management, market position, capitalisation, structure and cash flow.

It’s a glowing report, but perhaps might not have been had the response to the Vesttoo fraud been less effective.

Clear Blue was particularly affected by the fraudulent letters of credit, having fronted a number of the reinsurance arrangements involved.

Recall that, Clear Blue had a significant relationship with Vesttoo and had said in 2022 it would help the insurtech deploy a billion dollars from the capital markets.

The company was far from the only major player to become embroiled in the fall-out after it emerged letters of credit were fraudulent.

But, the way Clear Blue responded to the crisis was critical, moving fast to reduce the impacts it felt after Vesttoo’s fraud was found out and coming through the experience with its business wholly intact, albeit not financially unscathed as there were definitely costs the company had to bear.

KBRA said, “During 2023, Clear Blue’s concentrated exposure to Vesttoo/China Construction Bank became a credit challenge – albeit one that the company quickly and materially addressed.

“In KBRA’s view, Clear Blue has leveraged lessons learned to strengthen ERM processes related to the use of unauthorized reinsurers and for accepting LOCs and trusts while simultaneously continuing to expand its franchise. The company is also exposed to key person risk but has been deepening its talent bench.”

Explaining one additional driver for the stable outlook for Clear Blue’s ratings, KBRA also said, “The Stable Outlook assumes that Clear Blue’s enhanced risk management procedures will serve it well, and that its reputation and market position will continue to remain intact as the Vesttoo matter recedes further into the past.”

Most importantly, KBRA explained that it believes the incident has not harmed Clear Blue’s reputation or business prospects.

“Clear Blue’s reputation and market position have remained intact post-Vesttoo with robust new business flows and a growing pipeline,” the rating agency explained.

In fact, KBRA believes that Clear Blue’s business is thriving in the wake of the Vesttoo fraud, reflecting the way the situation was dealt with effectively.

KBRA continued, “Management believes that its experience throughout the Vesttoo matter demonstrated its resiliency. In the wake of the discovery of fraudulent letters of credit, it replaced a significant amount of reinsurance in a short period of time for the current year book, while some prior year business was put in run-off. Management describes the market as responding favorably to it post-Vesttoo, as it is bringing in more and larger programs. Its pipeline remains robust.

“Additionally, the company reunderwrote its existing book of business, terminating certain programs and improving the quality of its book. A number of new programs have been added, including a federal crop program, the reinsurance panel for which includes relatively more high-quality reinsurers and less collateralized reinsurance compared with a number of its programs. Clear Blue has also enhanced processes and procedures and has supplemented enhancements with additional personnel. New hires include industry veterans in roles just below the C-Suite.”

It’s actually no surprise collateralized reinsurance participation would be lower for a crop book at this time. Crop is a line of business that many ILS managers and ILS capital providers view as less favourable, given the potential for attritional loss accumulation and weather volatility in the results of those books.

There were significant financial ramifications for Clear Blue’s management to deal with because of the Vesttoo fraud.

KBRA explained, “Beneath the headline results are various financial statement impacts related to the Vesttoo matter. Clear Blue took prompt action to replace reinsurance associated with the current year treaties where Vesttoo had provided reinsurance. Clear Blue obtained sufficient additional collateral from new reinsurers, and the replacement of the reinsurance on a significant portion of its portfolio resulted in a one-time adjustment to ceded premiums during 2023. Clear Blue did not replace the reinsurance of prior year treaties associated with Vesttoo and placed them in run-off. For the run-off business, Clear Blue recorded an allowance for credit losses. Any further loss related to this reinsurance would come through adverse development.”

Some of the moves Clear Blue had to make around the reinsurance exposure after LOCs turned out to be fraudulent resulted in a $21.1 million provision, related to prior-year Vesttoo treaties that were placed in run-off and KBRA noted this as a Schedule F penalty.

Clear Blue also made changes to its investment strategy, to ensure availability of cash it might have needed, but KBRA noted it has again extending duration to lock-in rates now that the impacts from the fraud are behind it.

The fronting company also set up a bank credit line, to support its solution to the Vesttoo matter, but that is expected to be closed once repaid, KBRA said.

The necessary moves Clear Blue had to make in response to the fraud did lift operating costs somewhat, but at the same time the company continued to invest in expanding the business and making new senior hires.

Clear Blue continued to expand its gross written premiums through 2023, continuing a growth curve that has been in effect since its formation and showing that the issues faced did not slow down its ability to attract new business.

KBRA sums up that, “The Vesttoo matter gave rise to financial, reputational, and ratings risk, and, potentially, to business model implications.

“The Vesttoo situation developed rapidly, and management responded quickly and aggressively to limit the impact. Management successfully implemented solutions that addressed its market position and reputation.”

One additional point of note, Clear Blue’s majority owner, investment firm Pine Brook, has been reported to have looked to sell its position in the fronting specialist in recent years, although has not yet found a deal that made it want to offload its stake.

But, when the Vesttoo fraud hit, the majority owner doubled-down and backed its investment, making an additional $10 million private equity investment in Clear Blue as part of the solution to the Vesttoo matter, KBRA explained.

That speaks volumes, as Pine Brook is a sophisticated investor and will have understood that Clear Blue’s management could pull the company through the challenges posed by the Vesttoo fraud.

It seems that proved a safe bet to make, given the glowing report and details of the actions taken and the way Clear Blue responded decisively.

Finally, Clear Blue remains in a court process with insurance and reinsurance broker Aon, having sued that company over the Vesttoo fraud transactions, accusing Aon of soliciting the fronting specialist’s involvement in a scheme it said was structured and masterminded by the broker.

Aon fired back and said the lawsuit was an attempt to distract from the depth of Clear Blue’s involvement with Vesttoo and its own financial distress.

The rating report would seem to suggest that Clear Blue is not in any financial distress now, but it has faced relatively significant costs and it’s no surprise the company continues to look for an avenue to recover some of that.

The latest in this lawsuit is that a law firm representing Aon plc and Aon Insurance Managers (Bermuda) Ltd. has called for the judge to give the opportunity for oral argument to be heard in the case.

Saying, “We believe that oral argument will substantially assist the Court in understanding and deciding the issues presented in this action. As this Court has not yet had the opportunity to hear any argument on the legal issues presented by the pending Motion to Dismiss, we believe that oral argument will helpful in elucidating the crucial issues raised in the motion.”

At this time there hasn’t been a response to that, but it will be interesting to see whether speaking can lead to mediating and potential resolution, or whether the arguments become even more vocal when not written down.

Read all of our coverage of the alleged fraudulent or forged letter-of-credit (LOC) collateral linked to Vesttoo deals.