5 Class Action Suits Target ‘Shadow Insurance’

By Arthur D. Postal
InsuranceNewsNet

WASHINGTON – The use of captives as part of the capital underlying life insurance and variable annuity (VA) policies is the subject of five class action lawsuits filed against insurers. This is another sign that the spotlight on insurance capital issues continues to intensify.

Two lawsuits have been filed against MetLife, two against AXA Equitable and another against Lincoln National. Four of the lawsuits have been filed in U.S. District Court in New York state and the fifth was filed in U.S. District Court in New Jersey. But all of the suits are related to policies issued by insurance companies chartered in New York. One named plaintiff is the International Association of Machinists and Aerospace Workers District Lodge 15; the other named plaintiffs are individuals.

All the lawsuits relate to concerns regarding so-called shadow insurance. These concerns have been voiced by the New York Department of Financial Services (DFS) in a June 2013 report, as well as in studies by the Minneapolis and Boston Federal Reserve Banks, the Financial Stability Oversight Council (FSOC) and the Federal Insurance Office (FIO). 

An article, “Risky Moves in the Game of Life Insurance,” published in Sunday’s New York Times business section, described the insurance regulation that led to the lawsuits.

The suit against Lincoln says that the “typical shadow insurance transaction involves the following: A life insurance company decides (1) that the reserve requirements under New York law are too high and (2) that it has better uses for its assets than supporting large reserves.”

For example, the suit says, “rather than preserving assets as required by law to pay life insurance claims, (the carrier) may use some or all that money to pay its executives higher salaries, to help it purchase other life insurance companies, to pay its stockholders higher dividends, or to invest in riskier securities or other investments.”

The Lincoln suit cites the 2012 New York DFS report on “shadow insurance.” That report alleges that some insurers, including Lincoln, took shadow insurance a step further by using a practice the DFS calls “two-step transactions,” which allows New York-based insurers to conceal the existence of certain shadow insurance practices.

In a two-step transaction, the lawsuit continued, the New York-based insurer cedes risk to a non-New York-based affiliate. The affiliate then reinsures again (or “retrocedes”) that risk to a company-affiliated captive reinsurer of the original New York insurer, often collateralizing the retrocession with a parental guarantee. The end result of this complex arrangement is that the New York-based insurer reports no direct transaction between it and a company-affiliated captive reinsurer. This is despite the presence of the parental guarantee backing the letter of credit collateralizing the retrocession.

The DFS report explained that two-step transactions are “particularly problematic,” according to the lawsuit, because the New York-domiciled insurer “is still ultimately on the hook for losses through a parental guarantee,” even though the New York-based insurer reports no direct shadow insurance activity.

“In other words, two-step transactions obscure the risks that (New York-based) insurers are taking on through shadow insurance,” the suit claims.

One suit against AXA relates to life insurance. It alleges that AXA violated New York insurance law by “engaging in various ‘shadow insurance’ transactions in connection with its life insurance business, which were not reported on its mandatory statutory annual statement and not properly disclosed to its principal regulator, to its credit rating agencies, or to its customers.”

“As a result, AXA’s representations concerning its own financial condition were materially misleading,” the suit alleged.

The lawsuit against AXA regarding VAs alleges that when marketing its guaranteed benefits insurance riders and other life insurance products, “AXA touts its credit and insurance ratings, as well as the insurance company’s assurances of financial strength.”

“These marketing efforts and references confirm that AXA’s representations about its financial condition, insurance ratings and overall financial health are material to its business,” the complaint read, but “AXA’s use of shadow insurance constituted a misrepresentation of the financial condition of AXA, and the adequacy of the reserves and reserve system upon which AXA operates.”

The suit dealing with VAs seeks a penalty against AXA in the amount of the premiums received by AXA during the class period in connection with guaranteed benefit riders.

One of the suits against MetLife cites the carrier’s challenge to its designation last fall as a Systemically Important Financial Institution (SIFI) by the FSOC.

In designating MetLife a SIFI, the complaint read, “The FSOC issued an ominous warning: As history has shown, including in 2008, financial crises can be hard to predict and can have consequences that are both far reaching and unanticipated …There may be scenarios in which material financial distress at MetLife would not pose a threat to U.S. financial stability, but there is a range of possible alternatives in which it could do so.”

The complaint went on to read that the lawsuit ultimately is about how MetLife “is engaging in conduct that imperils the financial future of (it’s) policyholders, their beneficiaries, and the public at large.”

If MetLife were domiciled in certain states, the suit alleged, there might be little that its policyholders could do about the company’s conduct.

“Over the past several decades, some states have been in a race to the bottom in terms of regulating insurers,” the complaint read. MetLife, however is domiciled in New York, authorized to sell insurance there, and required to file non-misleading Statutory Annual Statements with the New York DFS.

A MetLife spokesman, citing the company’s securities filing, said, “MetLife intends to defend these actions vigorously.” An AXA spokesman said the company would have no comment, and Lincoln National officials were not available to comment.

The suits were filed over the period Feb. 13 through April 3.

Lawyers at Perkins Coie with offices in Madison, Wis., and New York City, represent plaintiffs in four of the lawsuits. Lawyers at Berger & Montague in Philadelphia, are among the firms representing the plaintiffs in the Lincoln lawsuit.

In addition to the New York DFS, the National Association of Insurance Commissioners (NAIC) is looking into this issue. The NAIC is forming task forces to evaluate the use of captive reinsurance for guaranteed elements in VAs and the hedging risks associated with such products.

At the NAIC’s spring meeting in Phoenix, Joseph Torti III, who chairs the NAIC's Financial Condition Committee, discussed VA captives reinsurance reserve and capital issues in detail. He also named Iowa Commissioner Nick Gerhart to lead a new working group to deal with the issue.

In a Legal Alert last week, Sutherland, Asbill & Brennan said the NAIC’s Variable Annuities Issues Working Group will attempt to reach a better understanding of why insurers use VA captives.

InsuranceNewsNet Washington Bureau Chief Arthur D. Postal has covered regulatory and legislative issues for more than 30 years. He can be reached at [email protected].

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