Captive Industry Defends Life Reinsurance Deals

By David Dankwa

InsuranceNewsNet

Here's the message the captive insurance industry wants to get across: Life insurance captives are closely regulated and the reserves invested are redundant and do not threaten policyholder claims.

Industry insiders have been saying their piece ever since Benjamin Lawsky, New York's superintendent of financial services, published a report castigating life insurers’ use of captive reinsurers to conduct so-called shadow transactions.

Captive reinsurers are entities created and owned by a parent company for the purpose of reinsuring the risks of its owner. According to the National Association of Insurance Commissioners (NAIC), the vast majority of Fortune 500 companies own and use captives.

The Captive Insurance Companies Association (CICA) has said it fears the traditional captive insurance market from which its members are drawn “will be negatively affected by Mr. Lawsky’s concerns about a very narrow and unconventional form of reinsurance transaction utilized by banks and life insurance companies.”

In a letter to NAIC, CICA wrote that while it acknowledges regulators need more in-depth reviews of those transactions, it objects “to the broad negative characterization of the entire captive insurance industry in Mr. Lawsky’s report.”

Even before the report was published, NAIC had formed a subgroup to study the industry's use of captives and to consider changing existing regulatory requirements as they relate to these vehicles.

In the report Lawsky described so-called “shadow insurance” as a little-known loophole that allows insurance companies to reinsure a block of existing policy claims through a captive insurance subsidiary, essentially a shell company owned by the insurer’s parent.

The New York regulator said the transactions are used to divert reserves set aside to pay policyholders for other purposes, since the reserve and collateral requirements for the captive shell company are typically lower. He said these types of transactions put insurance policyholders and taxpayers at greater risk.

However, David Provost, head of the captive regulatory division for Vermont (the nation’s largest domicile for captive insurers), told InsuranceNewsNet that life insurance companies typically will cede economic reserve on funds-withheld basis through a captive, and also obtain a letter of credit for the redundant reserve.

“That is different from using an affiliated captive as a reinsurer and having a letter of credit as collateral for that reinsurance; it’s almost double collateral because the captive has other assets as well,” Provost said.

Michael Mead, president of M.R. Mead & Co., told InsuranceNewsNet that Lawsky was wrong to assert that captives not domiciled in New York are lightly regulated. “If you have a captive in South Carolina, there is nothing shadowy about it. The South Carolina regulator, who is very good, is regulating it according to NAIC rules.”

In addition, Mead said the life insurers that engage in these types of reinsurance deals are publicly-held companies and as such examined by the Securities and Exchange Commission. “They also have examinations and audits by the state in which they are domiciled, which is sometimes New York. All of this information is in their financial reports.”

Mead, who is president and managing member of the newly formed Constitution Insurance Company of Delaware, a special purpose captive, also argues that offshore captives in popular domiciles like Bermuda and the Cayman Islands are well regulated by people who have lots of experience with captives. “In my view, the regulator in the Caymans is way better than the regulator in New York. He knows a lot more about what he is doing.”

In May, MetLife announced it would merge its offshore captive reinsurer into a U.S.-regulated entity, thereby moving a bulk of variable annuity business. The life insurer added that it was actively addressing regulatory concerns about the use of captive reinsurers.

Lawsky applauded the decision, calling it a step in the right direction. “MetLife has acted wisely in bringing this subsidiary back to the United States where it will be subject to stronger rules and oversight,” he said. “Now is the time to address these troubling vehicles before policyholders and our economy are seriously damaged.”In all, Lawsky estimates New York-based insurers were using $48 billion of shadow insurance to lower their reserves and regulatory capital requirements.

David Dankwa is a longtime business reporter with significant experience writing about the global insurance industry. Contact him at [email protected].

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