The bankruptcy of crypto-currency exchange (FTX) is the latest example of a corporate collapse resulting from governance failure, AM Best has said. AM Best, international rating agency, stated that the series of events leading to the collapse of FTX should warn insurers.
AM Best said they would take a favourable view of insurance company enterprise risk management (ERM) frameworks, which incorporate lessons from recent events and emerging issues.
Equally, they expect insurers with strong governance practices to manage risks. The statement read: “Insurers generally benefit from effective ring-fencing of, and/or reserving for resources to meet obligations to policyholders, underpinned by market discipline and regulation. However, even insurers with healthy balance sheets and sound operating performance may in some instances experience rapid deterioration in their financial strength because of weak internal controls, or poor strategic decisions linked to inadequate governance.”
The collapse of FTX has resulted in losses not just for shareholders, but also for its customers. Similarly, insolvency of an insurance company creates the risk of policyholder claims going unpaid. AM Best’s Financial Strength Ratings are focused on insurers and their ability to meet ongoing insurance contract obligations.
Surprisingly, FTX does not have board of directors. An experienced, informed and independent board is vital for effective governance practice to ensure companies are run and challenged in an appropriate way. AM Best notes that governance rules and best practice guidance vary widely between jurisdictions. For example, there are different requirements for the number of independent directors on a board, and varying definitions of independence itself. 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. To achieve this, the board must combine relevant knowledge and experience with a sufficient level of independence. In order to promote effective oversight of executives, many jurisdictions do not allow the combined Chief Executive Officer/Chairman’s role.
In markets where it is permitted, such as France and the US, pressure from regulators and investors is increasingly pushing insurance companies to split the function.
John Ray III, the CEO appointed to oversee the liquidation of FTX, said: “Never in my career have I seen such a complete absence of trustworthy financial information as occurred here”. Understanding the structure and effectiveness of internal controls is an important part of AM Best’s assessment of ERM.
Management teams with insufficient access to timely financial information lack the ability to make accurate strategic decisions while insurance companies with poor data quality have weaker pricing capability and are at a competitive disadvantage.