13 November 2017News

The fallout from Lava Jato

The Lava Jato money-laundering scandal has caused deep reverberations throughout the insurance industry. Alex Guillamont and Anna Weiss of Kennedys discuss its implications.

What has been the fallout from the scandal and the effect on the insurance industry?

Lava Jato has caused deep reverberations throughout the insurance industry in Brazil, particularly in surety and financial lines. However, the impact of Lava Jato does not end in Brazil, as its effects are being felt throughout Latin America.

The scandal also resulted in the expansion of the powers of the Brazilian administrative authorities, allowing them to impose more severe penalties on companies that are not complying with the relevant regulations; presenting a new risk of exposure that insurers must take into consideration.

Another important effect of Lava Jato was the Brazilian Congress’ approval of the Anticorruption Law, effective on 28 January 2014. The intention of this law is to fill some gaps in the existing law; creating a specific law imposing liability on corporations for corrupt acts committed by their employees or agents. Previously, only individuals could be punished for such violations.

As a consequence of Lava Jato, politicians, and high-level directors of Brazil’s largest companies are being prosecuted and receiving jail sentences for the first time in the country’s history.

One of the biggest questions presented to claims adjusters is whether insurers should pay the defence costs of many directors, officers, and managers implicated in the corruption scandal—information gathered mostly from these plea bargain agreements. Each case will depend on the specific allegations made against the insured, the specific D&O policy wording, and how any admissions by the insured are phrased.

These questions are far from being solved and further complicating the situation are the conflicting positions that come from the complex re/insurance structures backing the majority of large policies.

Thus, more than ever, re/insurers need to review their wording and consider whether specific clauses for the kinds of situations detailed above should be covered.

What has been the effect on the construction industry?

Before Lava Jato, the Brazilian economy enjoyed an accelerated growth in the construction market; it was full of large-scale programmes such as power plants, hydroelectric dams, oil wells, and projects for the World Cup and the Olympics. However, in 2015 a financial crisis gripped Brazil that continues to this day.

In the midst of this crisis, Lava Jato revealed that the company’s biggest contractors were complicit in the largest corruption scheme in the country’s history. Odebrecht admitted it paid US$788 million in bribes to win contracts in 12 countries. This naturally aggravated the impact of the economic crisis on those companies, which had to sell assets, fire many employees, and in some extreme cases, declare bankruptcy. Peru and Colombia have banned Odebrecht from bidding on new contracts.

Several construction companies have been trying to exculpate themselves of Lava Jato by actively collaborating with the investigation and working to create a new business environment, but the outcomes of Lava Jato and the attempts to create this change of mentality to the business culture are forward-looking measures that have yet to produce any immediate results.

In the midst of the political and economic crisis that is gripping Brazil, there has been no discussion on the real necessity to improve infrastructure in all areas of Brazil. It is believed that the government will soon have lucrative opportunities to tender and the expectation is that new players in the construction sector will step into the vacuum left by Lava Jato, especially from China.

What will this mean for insurers in the country?

It is not clear when the government will resume its investment in the different sectors. Until then, construction and engineering insurance will suffer the impact felt by their clients and will have to consider how to reinvent themselves.

However, what represents a loss of opportunity for the pure construction insurance sector, represents a large opportunity for the financial lines and surety sectors. The underwriters that are dealing with these lines of business need to be more active and consider all elements that can affect the risk of their clients.

What do insurers need to be aware of in relation to the scandal?

The takeaway for re/insurers from Lava Jato is that the relationship between the public and private sector needs to be fundamentally redefined and that corruption is a threat that must be combated relentlessly. How companies in Brazil, and in the rest of Latin America, will do that, is not yet clear.

Insurers need to assess their wordings and exclusions in order to avoid indemnifying losses arising out of fraudulent schemes. But perhaps more than that, a more active (as opposed to reactive) solution lies with insurers. Insurers should take steps to be aware of their client’s profile and business culture through a thorough due diligence and more direct interaction with the client.

Alex Guillamont is head of the Latin America and Caribbean practice at Kennedys. He can be contacted at: alex.guillamont@kennedyslaw.com

Anna Weiss is head of construction for Latin America and the Caribbean at Kennedys. She can be contacted at: anna.weiss@kennedyslaw.com

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