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FIO Calls For Uniform Capital Requirements, More Transparency For Captives



States should develop and adopt “uniform and robust” transparency standards for liabilities insurance companies reinsure through their captives, as well as the assets used to back those very same captives, the Federal Insurance Office (FIO) said.

States should also develop “nationally-consistent” standards for the oversight of the captive industry to include public disclosure of financial statements pertaining to the captives, the FIO also said in a new report on how to modernize the insurance industry.

And finally, states need to develop and adopt “a uniform capital requirement for reinsurance captives, including a prohibition on those types of transactions that do not constitute a legitimate transfer of risk,” the FIO said.

Captives function as “in-house” insurance companies for their parent corporation – a Fortune 500 manufacturer, an insurer or a group of nonprofit organizations – and allow the parent company to reinsure a liability, or potential risk.

Critics claim the captive insurance industry allows companies to hide liabilities from the balance sheets of parent corporations and, in the case of parent insurance companies, allow an insurer to lower capital and reserve requirements against which to pay claims.

Captives have become known in some circles as “shadow insurance,” as many transactions involving captives, sometimes known as “special purpose vehicles,” don’t show up in financial statements.

Earlier this year, the New York Department of Financial Services uncovered a form of what the FIO called “capital arbitrage” among life insurance companies, in which New York-based insurers accounted for as much as $48 billion worth of “shadow insurance’ capital manipulation,” the FIO said.

Requirements under which companies can set up captives run the gamut. Some states supervise the industry closely, while others allow companies to organize a captive cheaply with little legal or financial oversight.

In the U.S., Vermont alone has 1,000 licensed captives, and almost 30 states, the District of Columbia and the U.S. Virgin Islands have captive reinsurance laws on their books. The “quality” of captives domiciled in those jurisdictions also run from pristine to “junk.”

States like Vermont and Utah welcome captives as they represent millions of dollars in revenue to the states’ general treasuries at very little cost. The FIO, however, said many states don’t go far enough in policing the industry.

“In particular, the standards that govern the quality of capital that reinsurance captives must hold are not sufficiently robust,” the FIO report also said.

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The FIO report was required as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which was passed to tighten rules for borrowing, lending and trading practices of banks and financial services companies.

is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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