By Cyril Tuohy
A relatively obscure corner of the insurance industry has lit up in the past 18 months. State insurance commissioners, consultants, lobbyists and powerful insurance carriers have engaged in a vociferous give-and-take.
At issue is how to craft a legal and economic reinsurance framework that will bring states' regulations into uniformity with regard to captive reinsurance transactions that are used to finance insurance company reserves.
Many life and health insurers, as well as property-casualty carriers, reinsure their liabilities through a captive, which acts as an in-house insurance company for a larger insurance carrier. The transaction allows an insurer to take credit for reserves ceded to the captive.
Insurance carriers have found captives useful as a capital management tool as captives have allowed insurers to meet higher regulatory reserve requirements while also allowing underwriters to competitively price life insurance policies. As a result, the use of captives has grown over the past 15 years.
Technical committees with the National Association of Insurance Commissioners (NAIC) are in the midst of refining the framework. NAIC officials said they are confident the “vast majority” of the nation’s insurance commissioners will support the final outcome.
While insurance experts seem to be having a field day with detailed examination of arcane reserving requirements and actuaries are diving into mathematical exactitude extending to five decimal points, the overall process of harmonizing the treatment of life-insurer-owned captives has exposed deep divisions among insurance regulators.
New York State Department of Financial Services Superintendent Benjamin M. Lawsky, in a letter written in August, warned the NAIC to “get its own house in order to devise a better means of policing the use of captive insurance vehicles by life insurers.”
Failure by the NAIC to properly regulate life-insurer-owned captive insurance vehicles will only invite federal authorities to do so, Lawsky said. Nothing raises the hackles of the insurance industry more than to cede state-based control to federal authorities.
In a report issued last year, New York-based insurers were found to be inflating balance sheets by “juicing” capital ratios by 250 percent, enabling carriers to reduce reserves by tens of billions of dollars, Lawsky said.
Since companies based in New York and California produce so much of the insurance premium volume, the voices of regulators from those states often carry farther than commissioners from other states.
When Lawsky, therefore, chided the NAIC for “neutered” revisions to a report proposing improvements to the treatment of life reinsurance transactions, NAIC leadership responded within four days.
The proposed reinsurance framework represents “real and effective regulatory requirements, both in the short term and over time,” commissioners from North Dakota, Montana, Pennsylvania and Kentucky said in their response. “It is not ‘toothless’ nor is it ‘defanged.’ ”
NAIC President Adam Hamm, the North Dakota insurance commissioner; NAIC President-Elect Monica Lindeen, Montana's commissioner of securities and insurance; NAIC Vice President Michael F. Consedine, Pennsylvania's insurance commissioner; and NAIC Secretary-Treasurer Sharon P. Clark, Kentucky's insurance commissioner; appeared to take a harder tone with New York.
“The New York approach is fundamentally flawed, as lower mortality rates become the new valuation standard for all companies in New York, whether they actually have mortality experience that is that low or not,” the NAIC leaders wrote.
The most recent round of discussions surrounding the life reinsurance transactions has garnered support on both sides.
Lawsky in particular has warned of “shadow insurance” arrangements used to circumvent reserve requirements through the use of shell corporations set up in the United States and abroad, where regulatory requirements are less restrictive and disclosure rules more opaque.
Connecticut regulators have even called on many aspects of the reinsurance framework to apply to all transactions involving captives.
Proponents of diverse captive reinsurance transactions maintain these arrangements are an important capital management tool for insurance carriers, leading to lower premiums without taking on excessive risk.
In fact, there’s “no evidence that life reinsurance captive insurers create a systemic risk or there is a particular risk related to a specific captive insurer,” Delaware regulators said.
Besides, captives are already regulated, wrote Scott E. Harrington, a professor in the Health Care Management and Business Economic and Public Policy departments at the Wharton School, in a research document funded by the American Council of Life Insurers.
In addition, rating agencies, which have evaluated reinsurance arrangements for the past decade, have incorporated the risk of captives into the rating models, Harrington said.
Cyril Tuohy 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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