Vesttoo scandal turns spotlight on blockchain

In the intricate realm of captive insurance, organisations are increasingly exploring novel strategies to optimise their risk management tactics. The surge of capital markets has opened new doors, prompting captive insurance companies to investigate the integration of insurance-linked securities (ILS) funds as a means of strengthening their risk coverage.

As the role of ILS funds grows, the spotlight is now turning to how blockchain technology can play a pivotal role in curbing fraud in private ILS deals, especially those secured through letters of credit (LoCs).

One company that has focused on handling such transactions is Vesttoo, which has been in the headlines recently. The startup is currently facing a fraud scandal that could revive the blockchain hype in the financial industry.

Reportedly, investors on the Vesttoo platform are suspected of presenting purportedly fraudulent LoCs to insurers for reinsurance transactions, with the estimated total reaching approximately $4 billion, according to information obtained by Israeli business newspaper Calcalist.

The majority of these letters, supposedly falsified, originated from a prominent Chinese bank that seems to have been unaware of the situation. Vesttoo has stated that it is unable to provide details on the full scope of the alleged fraudulent activity due to an ongoing investigation into the matter.

How could technology be used to ensure that such fraud scandals are eliminated? Here are some ideas and benefits of blockchain technology—around which the hype now seems to be over—which could now play a significant role in the future of collaboration between captive insurance and ILS funds and intermediary platform providers.

Captive insurance entities are purpose-built tools that allow businesses to tailor their insurance solutions to their specific needs. However, as these entities seek to diversify their risk portfolios, they are increasingly tapping into capital markets, where ILS funds have risen as a formidable option. These funds provide investors with the opportunity to engage in insurance risk, with potential for lucrative returns and a hedge against the volatility of traditional financial markets.

In summary, the benefits of private ILS deals for captive insurance companies encompass tailored risk management, diversification, access to niche risks, potential for enhanced returns, risk transfer flexibility, reduced market correlation, alignment with risk appetite, direct engagement with investors, cost efficiency, and a progressive approach to risk management.

As captive insurers seek to navigate the complexities of risk, private ILS solutions offer a dynamic and strategic avenue for optimising their risk transfer strategies. While the allure of private ILS deals is undeniable, navigating the intricate transactions and documents opens a Pandora’s box of potential fraud vulnerabilities.

In the context of private ILS deals secured through LoCs, the intricacies of financial operations and the lack of transparency in documentation can create fertile ground for fraudulent activities. These range from falsifying underlying asset details to unauthorised access, casting a shadow over both the captive insurers and the ILS fund investors.

Blockchain’s armour against fraud

Enter blockchain technology, equipped with its foundational attributes of transparency, immutability, and secure data-sharing. Blockchain presents itself as an impervious shield against the looming threat of fraud in private ILS deals, especially those grounded in LoCs.

Immutable transaction records: Blockchain’s indelible ledger ensures that every transaction linked to private ILS deals is etched in tamper-proof digital stone. This acts as a safeguard against fraud attempts, such as document forgery or asset misrepresentation.

Smart contracts: gatekeepers of integrity: By integrating smart contracts, the validation process for private ILS deals is automated. These contracts execute predefined conditions, ensuring that all stakeholders fulfil their obligations before funds are released. This automation reduces the risk of unauthorised transfers and fraudulent claims.

Real-time asset monitoring: The marriage of blockchain with internet of things (IoT) devices facilitates real-time tracking of the underlying assets. This synergy guarantees that assets align with declarations, creating a deterrent against fraudulent activities such as asset substitution.

Authentication and identity assurance: Blockchain’s cryptographic capabilities enhance identity verification. Participants can be securely validated, significantly mitigating the risks of unauthorised access or impersonation.

Decentralisation and fostering trust: The decentralised architecture of blockchain enhances trust among participants. With consensus required to alter records, the risk of executing fraudulent activities without multiple parties’ involvement is significantly reduced.

Regulatory adherence and auditable transactions: Blockchain’s transparent and traceable nature facilitates regulatory compliance. Regulators gain the ability to independently verify transactions, eliminating potential financial misconduct.

Exemplifying blockchain’s impact

Consider a captive insurance company entering a private ILS deal through an LoC. By leveraging blockchain’s unalterable recordkeeping and automated smart contract execution, the investment’s terms are confirmed before the transaction progresses. The integration of IoT devices into the blockchain ensures that asset movements are verifiable in real time, deterring fraudulent activities.

Strong identity management mechanisms prevent unauthorised access, and the decentralised nature of the blockchain network bolsters trust among all stakeholders.

Conclusion

The convergence of captive insurance entities and capital markets heralds a transformative era in risk management. Blockchain technology emerges as a formidable tool against fraud in private ILS deals secured through LoCs. Through its core attributes—immutability, transparency, real-time tracking, smart contracts, authentication, and decentralisation—the vulnerability to fraud is drastically minimised.

As the alliance between blockchain and the captive insurance landscape matures, a more resilient, efficient, and transparent risk transfer ecosystem takes shape. This partnership reshapes risk management and forges an era of trust and resilience for insurers and investors, propelling the industry forward.

Marcus Schmalbach is chief executive officer of Ryskex. He can be contacted at: schmalbach@ryskex.com