Insurance Companies Shun Clients With Links to FTX Due to High Contagion Risks

FTX founder Sam Bankman-Fried (center) is led away handcuffed by officers of the Royal Bahamas Police Force in Nassau, Bahamas, on Dec. 13, 2022. Mario Duncanson/AFP/Getty Images

Insurance companies are now denying or limiting coverage to any clients who were exposed to FTX, after the cryptocurrency exchange collapsed last month, leaving creditors with more than $3 billion in losses.

This has left many digital currency traders and exchanges uninsured from any losses due to hacks, theft, or lawsuits, as insurers propose new policy exclusions for any claims related to the FTX scandal to protect themselves from further fallout, Reuters reported.

Last week, FTX’s founder and former CEO, Sam Bankman-Fried, was arrested at his home in the Bahamas after being charged with eight criminal allegations by U.S. federal prosecutors.

A federal prosecutor said that Bankman-Fried could face up to 115 years in prison for committing activities such as wire fraud, money laundering, and illegal political campaign contributions, CBS News reported.

Meanwhile, the Securities and Exchange Commission (SEC) is also filing civil charges against the disgraced FTX CEO for his alleged complicity with the illegal practices committed at his firm and for intentionally covering up those acts from investors and the public.

“We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto,” said SEC Chairman Gary Gensler.

At the same time, Bankman-Fried allegedly misused at least $2 billion of his investors’ deposits to purchase luxury properties in the Bahamas, while laundering money into his personal hedge fund, Alameda Research.

Once praised as a visionary and crypto pioneer, Bankman-Fried hobnobbed with former world leaders such as Tony Blair and Bill Clinton and attracted celebrity clients like Tom Brady. One prominent Silicon Valley firm, Sequoia Capital, invested hundreds of millions of dollars in FTX.

Bankman-Fried was supposed to attend a hearing before the House Committee on Financial Services on Dec. 13 before he was arrested by Bahamian authorities.

Creditors and Insurers Take a Loss on FTX Collapse

The failed crypto exchange filed for bankruptcy protection on Nov. 11, after it suddenly collapsed in the cryptocurrency equivalent of a bank run.

FTX allegedly owes its top 50 creditors more than $3 billion, while its top two largest creditors are owed $226 million and $203 million, respectively, CNBC reported.

Insurers have long been reluctant to underwrite asset and directors and officers (D&O) protection policies for crypto firms due to lax market regulation and the high volatility of cryptocurrencies, but this latest scandal has made them even more concerned.

After FTX’s crash in November, “specialists in the Lloyd’s of London and Bermuda insurance markets are requiring more transparency” from crypto firms regarding any potential exposure to the failed crypto exchange, reported Reuters.

Insurers are putting forward broad policy exclusions “for any claims arising from the company’s collapse,” the report noted.

Many firms are now requiring clients to fill out a questionnaire asking whether they invested in FTX, or had assets on the exchange, Kyle Nichols, president of broker Hugh Wood Canada Ltd., told Reuters.

Ben Davis, lead for digital assets at Superscript at Lloyd’s of London, told Reuters, that the brokerage is having clients that did business with FTX fill out a similar questionnaire that reveals the extent of their exposure.

Insurance Companies Raise Standards For Crypto Exchanges Due To Risks

The new exclusions will deny payouts for any claims stemming from the failure of FTX, as part of the insurance policies meant to cover the protection of cryptocurrencies and the personal liabilities of directors and company executives who deal in crypto, reported Reuters.

Several insurance companies have been proposing broad exclusions to policies for anything linked to the FTX crash, according to one of Reuters’ sources.

The addition of such exclusions are meant to improve protection for insurers by making it even more difficult for crypto firms to gain coverage.

The FTX collapse is expected to lead to a rise in insurance rates, especially in the U.S. D&O market, insurers told Reuters.

According to the article, D&O policies, which cover legal costs, do not always pay out in cases of fraud, and the rates are already elevated because of “the perceived risks and lack of historical data on cryptocurrency insurance losses.”

Companies that store crypto assets on platforms not connected to the internet, may get coverage for up to $1 billion, but D&O insurance policyholders are limited to coverage for up to tens of millions of dollars in losses, Joe Ziolkowski, the CEO Bermuda-based crypto insurer Relm, told Reuters.

A crime bond used to protect against losses resulting from losses due to fraud typically costs $30,000–40,000 per $1 million of coverage for a digital assets trader, compared to the $5,000 per $1 million in coverage for a traditional securities trader, said Nichols.

Bankman-Fried was expected to drop his extradition fight after his appearance at a Bahamian courthouse, on Dec. 19, to face charges in the United States on his return.

However, the agreement appears to have stalled after a disagreement over his extradition terms between his attorney and local prosecutors, CNN reported.

He was then returned to the local prison where he has been held at since his arrest last week.

No future court date was set at the hearing.