Insurance Captives Threaten Financial Stability, Report Says

By Arthur D. Postal
InsuranceNewsNet

WASHINGTON – The use of captives by life insurance companies is a key reason that risks to the financial stability of the U.S. have increased since last year, according to a new report by the Office of Financial Research (OFR).

The report included a chart saying that MetLife and Prudential are the two largest users of captives to reinsure their life insurance portfolio risk. Among a group of the 21 largest insurers, the largest U.S. insurers who don’t use captives to reinsure their life insurance portfolios were cited in the report as American International Group (AIG), Northwestern Mutual, New York Life, Securian Financial Group and the Hartford Financial Services Group.

The 21 largest insurers that use captives to reinsure their life insurance risk also include AEGON, Voya Financial, Protective, Lincoln National, Manulife Financial, Axa, Sammons Enterprises, Nationwide and Primerica.

A captive is an insurance company created and wholly owned by one or more non-insurance companies to insure the risks of its owner (or owners). Captives are essentially a form of self-insurance whereby the insurer is owned wholly by the insured. They are typically established to meet the risk-management needs of the owners or members. Over the past 30 years, there has been significant growth in the captive market. Today, there are over 5,000 captives globally compared to roughly 1,000 in 1980 according to AM Best Captive Center. Captives can be domiciled and licensed in a wide number of jurisdictions, both in the U.S. and offshore.

The report was released by the OFR, a unit of the Treasury Department. The OFR was created by the Dodd-Frank Financial Services Reform Law to help the U.S. pinpoint risks to financial stability in the wake of the 2007-2010 financial crisis.

The OFR report cites three key reasons the U.S. economy is less stable now than it was a year ago. These reasons include the fact that risk-taking has been “excessive” during the current extended period of low interest rates and low volatility, the increasing vulnerability due to declining market liquidity, and the migration of financial ctivities toward opaque and less resilient areas of the financial system.

The report cites the use of life insurance captives, as well as mortgage servicing rights and single family rental securitizations, as examples of the flight of financial activities to less opaque risks.

MetLife ceded 36.79 percent of the total life insurance it had in force to captive reinsurers, only 2.2 percent to captives based in the U.S., according to the report. Prudential had reinsured 16.29 percent of its life insurance risk to captives, but all of that to captives based in the U.S., the report said. The issue is separate from variable annuities. Last month, MetLife announced that it had completed a merger that repatriated all of its VA risk captives back to the U.S. from the Cayman Islands.

The OFR report notes that the 2013 Federal Insurance Office’s insurance modernization report, as well as state regulators, also voiced concern about the issue.

In a note to investors, Washington Analysis said that “While insurance regulation is largely left to state insurance supervisors and the National Association of Insurance Commissioners, we expect the Federal Reserve to review the use of captive reinsurers by systemically important insurers, as designated by the Financial Stability Oversight Council (FSOC), including MetLife, AIG and Prudential.”

Also cited in the report is a study released earlier this year by the Federal Reserve Bank of Minneapolis, which states that the growing use of captives is among “the rising and poorly-understood risks to the financial system” posed by the U.S. life industry.

The report also singled out for deep concern the trend toward guaranty riders in VAs because of the shift from defined-benefit to defined-contribution plans in retirement plans.

The Minneapolis Fed commissioned the report, which was written by Ralph Koijen, a London Business School professor, and Motohiro Yogo, a monetary advisor to the Minneapolis Fed.

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

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