The collapse of the cryptocurrency exchange FTX highlights the importance of effective corporate governance, according to a new AM Best commentary.
The Best’s Commentary, “Corporate Governance Lessons for Insurers in the Wake of the Failure of FTX,” notes that although FTX is not an insurance company, the series of events leading to its collapse should nonetheless provide a sobering warning for the insurance industry. AM Best typically takes a favorable view of an insurance company enterprise risk management (ERM) frameworks, which incorporate lessons learned from recent events and emerging issues. Equally, AM Best expects insurers with strong governance practices to be better able to manage risks.
The commentary notes that FTX surprisingly did not have a board of directors. “An experienced, informed and independent board is vital for effective governance practices, to ensure insurance companies are run and challenged in an appropriate way,” said Michael Dunckley, director, analytics, AM Best. “As part of its ratings process, AM Best seeks to assess the substance of an insurer’s governance, as well as its stated policies. The board should be able to effectively hold senior management to account and ensure that stakeholders’ interests are protected.”
FTX’s revenue grew massively by more than 1,000% during 2021. For insurance companies, although high premium growth may not always be a danger sign, rapid growth can be an indication that an insurance company has underpriced business to gain market share or has expanded into an unfamiliar product line – both of which may lead to underwriting losses. Such high growth can be a result of poor strategic decisions associated with weak corporate governance.
Ultimately, the commentary states, FTX suffered from a concentration of power in the hands of a single individual, combined with a lack of experience amongst its senior management team. A lack of transparency with external parties in terms of financial reporting or making misleading public statements is a powerful indicator of poor corporate governance and can precede a substantial decline in a company’s financial strength.
AM Best incorporates an assessment of regulatory environment into credit rating analysis, particularly through the assessment of country risk, and believes that well-developed and effective regulatory regimes put a strong focus on effective corporate governance.