Lawsky: Regulators’ Stance on Life Insurers’ Captives Leaves Gaping Problem

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New York’s financial-services regulator told fellow watchdogs they are failing to address a “gaping regulatory problem” that he said allows life insurers to artificially inflate reserves.

There should be tighter rules governing captives, the subsidiaries that some insurers use to offload risk from their main companies, Benjamin Lawsky, superintendent of the state’s Department of Financial Services, said in a letter to other regulators.

“There’s this growing pocket of nontransparent risk being injected into the system that we should all be worried about,” Lawsky said in a phone interview today.

Lawsky last year sought a moratorium on the use of captives by life insurers, dubbing the transactions “shadow insurance.” The National Association of Insurance Commissioners rejected his call and embarked on a study, commissioning a report from Rector & Associates. Lawsky said in his letter to NAIC members that the report, released in February and revised in June, falls short.

“Sadly, the revised and now-defanged report simply permits more of the same,” Lawsky wrote in the Aug. 12 letter. “The NAIC’s initial seriousness and urgency on this issue appears to have been overcome by industry lobbying.”

The American Council of Life Insurers, an industry group, said that captives benefit consumers by allowing companies to charge less for coverage without taking on excessive risk.

The arrangements “are an important tool to help life insurers fulfill their financial obligations under state law and are subject to significant oversight by state regulators and analysis by rating agencies,” the ACLI said in a statement in June, citing a report that month from Scott Harrington, a professor at the University of Pennsylvania’s Wharton School.

‘Significantly Defanged’

The NAIC is holding a meeting starting Aug. 16, and Lawsky said he hopes his letter will draw attention to captives.

“The hope is that this will reinvigorate or renew the debate over captives and cause maybe some commissioners who weren’t focused on the fact that the Rector Report had been significantly defanged to start asking questions,” Lawsky said.

If state regulators fail to address how life insurers use captives, federal overseers may get involved, Lawsky wrote. NAIC members have resisted efforts to expand U.S. oversight of insurance since the Dodd-Frank Act created the Treasury Department’s Federal Insurance Office.

In December, the FIO called for tougher oversight of life insurer captives, citing a report from Lawsky. The FIO, led by former Illinois regulator Michael McRaith, advises the Financial Stability Oversight Council and aids the Treasury secretary on insurance issues.

Lawsky also sent his letter to McRaith, Treasury Secretary Jacob J. Lew, and Mary Miller, Treasury undersecretary for domestic finance. U.S. insurers are primarily overseen by state regulators. The state authorities cooperate via the NAIC, which holds meetings and can propose model regulation