Israeli AI Startup Vesttoo Sparks a Global Insurance Scandal

A hot Israeli startup promised to use artificial intelligence to spread the risk of insurance policies. Now, Vesttoo is embroiled in scandal thanks to an old-fashioned problem: an alleged multi-billion-dollar fraud involving faked letters of credit.

Source: WSJ | Published on August 4, 2023

Vesttoo fraudulent LOCs

A hot Israeli startup promised to use artificial intelligence to spread the risk of insurance policies. Now, Vesttoo is embroiled in scandal thanks to an old-fashioned problem: an alleged multi-billion-dollar fraud involving faked letters of credit.

Vesttoo’s platform acts as a kind of dating service connecting insurers, brokers and big investors. Problems emerged when a policyholder made a substantial intellectual-property claim. The policy had supposedly been sold to investors via Vesttoo, according to people familiar with the matter. It couldn’t be determined who sold the policy or who made the claim.

The insurance company called on the letter of credit backing the deal—a form of guarantee from a bank that the investor has the money. China Construction Bank, whose name was on the letter of credit, denied all knowledge of the document, the people added.

The Federal Bureau of Investigation, several state insurance commissioners and the Bermuda Monetary Authority are among those trying to figure out what happened, according to company statements and people familiar with the matter. More than $2 billion of the alleged fraud occurred in the U.S., according to one of the people familiar with the matter.

The alleged fraud affects a multitude of insurance players, including global brokerages and several U.S. insurers. Investigators are following a trail that winds from insurers in North Carolina and other southern states to Vesttoo’s Tel Aviv headquarters, and includes Bermuda-based brokers, London insurance syndicates and the giant Chinese bank. State-owned China Construction Bank didn’t respond to requests for comment.

Vesttoo said Thursday that its board is considering the removal of two of its co-founders, Chief Executive Yaniv Bertele and Chief Financial Engineer Alon Lifshitz, who have both been put on paid leave.

Bertele said a continuing outside investigation has found “no suspicion against any members of the company’s management.” Lifshitz didn’t respond to a request for comment.

“We want to emphasize that there are no plans to liquidate the company,” Vesttoo added.

Vesttoo had previously attracted top-tier backers, including Goldman Sachs, with its promise of shaking up the reinsurance market. The five-year-old firm was valued at $1 billion in October in its last round of fundraising.

Goldman, which invested in the October fundraising round, no longer owns equity in Vesttoo, a person close to the bank said.

Insurance broker Aon was one of a chain of firms involved in the allegedly fraudulent deal, according to people familiar with the matter. Aon said it is facing potential legal action from clients and counterparties over its role in certain Vesttoo deals. “Aon believes that it has meritorious defenses and intends to vigorously defend itself against these claims,” the company said in a filing.

Beyond Vesttoo, the faked letter of credit caused alarm bells to ring throughout the industry. An attorney acting for a U.S. insurer said he went to China Construction Bank’s New York branch last month to verify a letter of credit for a different Vesttoo deal. The bank’s security staff threw him out, according to the lawyer, who didn’t want to be named.

The scandal also has roiled the $38 billion market for insurance-linked securities, where financial engineering converts policies into bundled-up packages of risk that are sold to investors such as hedge funds and large asset managers, analysts said.

“This has shaken the confidence of investors,” said Marcos Alvarez, global head of insurance at credit-rating firm DBRS Morningstar. Much as the financial crisis led to tougher rules on mortgage deals, he added, “you’re going to see increased scrutiny and tightening of controls on this section of the market.”

Vesttoo specializes in risks that aren’t related to natural disasters, covering everything from copyright theft to bad drivers and long-haul trucking. That contrasts with the catastrophe bonds that dominate the insurance-linked securities market, where investors promise to pay out in the event of hurricanes or other natural disasters, according to the National Association of Insurance Commissioners.

Vesttoo deals include policies written by so-called fronting insurers, a fast-growing sector of the insurance industry that typically pays a group of reinsurers to back their policies. Premiums for a group of 19 fronting insurers rated by AM Best more than doubled in two years, from $4.8 billion in 2020 to $10.6 billion last year. Some of that reinsurance involves securitized deals arranged by Vesttoo and sold to investors.

The Vesttoo blowup has prompted U.S. state insurance commissioners to scrutinize whether the fronting model of selling on risks could leave policyholders exposed, people close to the regulators said.

“We are looking closely at [Vesttoo’s] relationship with our…insurers and how those entities may be impacted,” a spokesman for the North Carolina Department of Insurance said.

North Carolina fronting insurer Clear Blue Insurance Group last year announced a “$1 billion partnership” with Vesttoo. Rating firm AM Best last month put Clear Blue’s “excellent” rating “under review with negative implications.”

Clear Blue said in a statement it has already replaced half the reinsurance affected by Vesttoo. It added that it has retained premiums related to the Vesttoo deals, which are “more than sufficient to pay all claims on the affected programs.”

One question echoing through the reinsurance world is why none of the lawyers, auditors and other professionals paid handsomely to vet the transactions apparently thought to call China Construction Bank to check if the letter of credit was genuine.

Insurer Clear Blue said its Vesttoo business was done through a Bermuda reinsurance unit of Aon called White Rock. Under Bermuda law, White Rock is required to provide appropriate collateral—such as letters of credit—to complete each reinsurance transaction, Clear Blue said. It added that it “strongly disagrees with any assertion that Aon did not have a legal responsibility to receive and verify collateral prior to effecting reinsurance.”

Aon takes a different view. A spokesman for White Rock said the responsibility to conduct the due diligence rested with the beneficiaries of the letters of credit—the insurers—and whoever arranged the collateral. White Rock doesn’t fall into either camp, the statement said.

Vesttoo CEO Bertele blamed his potential ouster on investors trying to grab his company by spreading false information. “Parties with vested interests have decided to exploit the temporary crisis the company is facing, aiming to facilitate a hostile takeover,” he said.