Life Insurer Use Of Captives Is Growing

By Arthur Postal

WASHINGTON — Life insurers’ use of captives and affiliates to cede their reinsurance risks is growing despite heavy criticism, especially from federal regulators.

In a report issued last week, SNL Financial said that in 2014 U.S. life insurers ceded 51.42 percent of the business they reinsured based on industry data reported to the National Association of Insurance Commissioners (NAIC).

The entities that accepted the risk included captives and special purpose vehicles (SPVs), the SNL report said.

SNL said its analysis indicates that this is up from 50.87 percent in 2013 and 49.07 percent in 2009. Specifically, SNL said, the industry passed 27.86 percent of its reinsurance load to captives and 23.57 percent to affiliates other than captives.

The report said that among the larger insurers, those with more than $2 billion in direct premiums written in 2014, MetLife, Prudential and AIG ceded more than half of the premium risk they reinsured to their own affiliates.

Large mutual insurers, in most cases, were far more conservative in ceding their reinsurance risk.

For example, New York Life said it had no captive insurance structures, and that the affiliated reinsurance reported in its statutory statements relates to reinsurance ceded from life insurer subsidiaries to the parent mutual insurer, New York Life Insurance Co.

“New York Life Insurance Co. is our operating mutual insurer, domiciled in New York, and is most definitely not a captive insurer,” a spokesman said.

According to the SNL data, MetLife increased its use of affiliates to cede risk to 77.32 percent from 76.43 percent in 2013 and 69.38 percent in 2009. SNL said MetLife ceded 65.39 percent of its reinsurance load to captives, mostly to non-U.S. captives.

AIG ceded 83.39 percent to affiliates in 2014, with an insignificant amount to captives.

Prudential's affiliate use has declined but, at 51.12 percent, still accounts for more than half of its total reinsurance offloaded, the SNL report said.

The MetLife issue is important because MetLife is challenging in court its designation by the Financial Stability Oversight Council (FSOC) as a systemically important financial institution (SIFI).

The same day as the SNL story appeared, the NAIC’s Financial Regulation Standards and Accreditation (F) Committee said it unanimously adopted proposed revisions to its new rule requiring disclosure of captives businesses and adding certain captive insurers and SPVs into the accreditation program.

The approval was done by conference call. The next step is approval by the full NAIC. Last week’s action cleared the way for that to occur at the NAIC’s summer meeting, scheduled to occur in August in Chicago.

The new revisions would include regulation of those captives and SPVs that assume XXX or AXXX business, variable annuities (VAs) and long-term care business. Currently, regulation of these types of companies is not included in the program's scope.

“This is a critical step forward in the NAIC's work related to the transparency of information and consistency of treatment for these types of captive insurers,” said NAIC president-elect and Missouri Insurance Director John M. Huff, who also serves as the chairman of the F Committee. “I look forward to continuing our work to strengthen the accreditation program.”

The accreditation program is Actuarial Guideline 48. It was adopted last December and went into effect in January.

According to lawyers at Mayer Brown, the “meat and potatoes” is the regulation of the primary security, or the collateral that shores up the deal. This also is called the “economic reserve layer” of the portfolio policies to be financed.

The Mayer Brown lawyers said that financing will now be restricted to cash and SVO- listed securities, but excludes any synthetic letter of credit, contingent note, credit-linked note or other similar security that operates in a manner similar to a letter of credit.

The NAIC is acting under pressure from federal regulators. The NAIC had been working on AG48 for some time. But a report last fall by economists at the Federal Reserve Bank of Boston put the states under additional pressure because it highlighted increased use of contingent assets to back captive reserves since the economic crisis in 2009. This was especially true with the top five issuers of VAs with guarantees.

Besides the Fed, the Treasury Department and the FSOC, as the well as the Treasury Office of Financial Research (OFR), have issued a number of reports pointing out problems with use of captive financing.

Standard & Poor’s joined the chorus earlier this month, calling life insurer balance sheets “black boxes.”

“When it comes to gaining an accurate view of capitalization, deciphering a life insurer's statutory balance sheet seems a bit like solving a riddle, wrapped in a mystery inside an enigma,” the report said.

The S&P report said that, generally, statutory reserves are very conservative, double the necessary amounts for some products, and insurers have resorted to using captives to hold more economic levels of liabilities.

"The use of statutory accounting on its own creates challenges because of how conservative the assumptions are and how much this varies across products," said Matthew Walker, an S&P credit analyst.

"These challenges are multiplied with the increasing deployment of captives,” Walker said.

He said that, through captives, insurers can, in effect, “sidestep accounting for liabilities by transferring conservatively valued ones to these entities to help them realize profits and improve capital metrics.”

He explained that by using a jurisdiction that allows more economic accounting, “they are able to improve their statutory filings by presenting less on the liability side in the same way that they can sell assets carried below market value to realize gains.”

This, Walker said, “effectively solves their statutory presentation problem."

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].

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].