[Vision2020] New Whores Ready To Be Bailed Out

[Art Deco]

 [image: DealBook - A Financial News Service of The New York
Times]<http://dealbook.nytimes.com/>
  June 11, 2013, 8:50 pm Insurers Inflating Books, New York Regulator Says By
MARY WILLIAMS WALSH<http://dealbook.nytimes.com/author/mary-williams-walsh/>

New York State regulators are calling for a nationwide moratorium on
transactions that life insurers are using to alter their books by billions
of dollars, saying that the deals put policyholders at risk and could lead
to another taxpayer bailout.

Insurers’ use of the secretive transactions has become widespread, nearly
doubling over the last five years. The deals now affect life insurance
policies worth trillions of dollars, according to an analysis done for The
New York Times by SNL Financial, a research and data firm.

These complex private deals allow the companies to describe themselves as
richer and stronger than they otherwise could in their communications with
regulators, stockholders, the ratings agencies and customers, who often
rely on ratings to buy insurance.

Benjamin M. Lawsky, New York’s superintendent of financial services, said
that life insurers based in New York had alone burnished their books by $48
billion, using what he called “shadow insurance,” according to an
investigation conducted by his department. He issued a
report<http://www.dfs.ny.gov/reportpub/shadow_insurance_report_2013.pdf>about
the investigation late Tuesday.

The transactions are so opaque that Mr. Lawsky said it took his team of
investigators nearly a year to follow the paper trail, even though they had
the power to subpoena documents.

Insurance is regulated by the states, and Mr. Lawsky said his investigators
found that life insurers in New York were seeking out states with looser
regulations and setting up shell companies there for the deals. They then
used those states’ tight secrecy laws to avoid scrutiny by the New York
State regulators.

Insurance regulation is based squarely on the concept of solvency — the
idea that future claims can be predicted fairly accurately and that each
insurer should track them and keep enough reserves on hand to pay all of
them. The states have detailed rules for what types of assets reserves can
be invested in. Companies are also expected to keep a little more than they
really expect to need — called their surplus — as a buffer against
unexpected events. State regulators monitor the reserves and surpluses of
companies and make sure none fall short.

Mr. Lawsky said that because the transactions made companies look richer
than they otherwise would, some were diverting reserves to other uses, like
executive compensation or stockholder dividends.

The most frequent use, he said, was to artificially increase companies’
risk-based capital ratios, an important measurement of solvency that was
instituted after a series of life-insurance failures and near misses in the
1980s.

Mr. Lawsky said he was struck by similarities between what the life
insurers were doing now and the issuing of structured mortgage securities
in the run-up to the financial crisis of 2008.

“Those practices were used to water down capital buffers, as well as
temporarily boost quarterly profits and stock prices,” Mr. Lawsky said.
“And ultimately, those practices left those very same companies on the hook
for hundreds of billions of dollars in losses from risks hidden in the
shadows, and led to a multitrillion-dollar taxpayer bailout.”

The transactions at issue are modeled after reinsurance, a business in
which an insurance company pays another company, a reinsurer, to take over
some of its obligations to pay claims. Reinsurance is widely used and is
considered beneficial because it allows insurers to spread their risks and
remain stable as they grow. Conventional reinsurance deals are negotiated
at arm’s length by independent companies; both sides understand the risk
and can agree on a fair price for covering it. The obligations drop off the
original insurer’s books because the reinsurer has picked them up.

Mr. Lawsky’s investigators found, though, that life insurance groups,
including some of the best known, were creating their own shell companies
in other states or countries — outside the regulators’ view — and saying
that these so-called captives were selling them reinsurance. The value of
policies reinsured through all affiliates, including captives, rose to
$5.46 trillion in 2012, from $2.82 trillion in 2007.

The chief problem with captive reinsurance, Mr. Lawsky said, is that the
risk is not being transferred to an independent reinsurer. Also, the deal
is not at arm’s length. And confidentiality rules make it difficult to see
what secures the obligations.

The New York State investigators subpoenaed this information and discovered
that some states were approving deals backed by assets that would not be
allowed in New York; Mr. Lawsky referred to “hollow assets,” “naked
parental guarantees” and “conditional letters of credit.”

“Weaker collateral requirements mean the policyholders are at greater
risk,” he said.

Insurers, unlike banks, have no prepaid fund like the Federal Deposit
Insurance Corporation<http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_deposit_insurance_corp/index.html?inline=nyt-org>to
make customers whole in the event of a collapse. That’s why Mr. Lawsky
said he feared that taxpayers might have to be called to the rescue again.

Because New York has standing to investigate only life insurers based in
the state, the administration of Gov. Andrew M.
Cuomo<http://topics.nytimes.com/top/reference/timestopics/people/c/andrew_m_cuomo/index.html?inline=nyt-per>is
calling for other states, or the federal government, to “conduct
similar
investigations, to document a more complete picture of the full extent of
shadow insurance written nationwide.”

Until then, Mr. Lawsky said, the deals should not be permitted. New York
State has already stopped approving them, but other states have not.

The National Association of Insurance Commissioners has been examining the
same type of transactions, but its members are sharply divided about their
potential risk and what, if anything, to do about it. The group’s proposals
must be adopted by 42 state legislatures to become effective. That seems
unlikely; many states have recently passed laws allowing the formation of
captives. Gov. Rick
Perry<http://topics.nytimes.com/top/reference/timestopics/people/p/rick_perry/index.html?inline=nyt-per>made
Texas the latest contender for the business when he signed such a law
this month.

A new federal entity created under the Dodd-Frank financial reform law, the
Federal Insurance Office, has also been monitoring the trend and is
scheduled to discuss possible federal responses at an advisory committee
meeting on Wednesday. Any federal action would be fought hard by the
states, which have regulated insurance for more than 150 years.

New York’s investigators could not disclose which companies are the biggest
users of reinsurance through captives because of the secrecy laws of other
states. Their report did describe some of the transactions in detail, but
with the names of the companies removed.

The separate analysis by SNL Financial, by contrast, was based on public
regulatory filings. It did identify the life insurance companies that are
the biggest users of the transactions, both in and out of New York. They
include Transamerica,
MetLife<http://dealbook.on.nytimes.com/public/overview?symbol=MET&inline=nyt-org>,
Prudential, Hartford, Genworth, John Hancock, ReliaStar and Lincoln
National<http://dealbook.on.nytimes.com/public/overview?symbol=LNC&inline=nyt-org>,
among others. Another insurer,
Allstate<http://dealbook.on.nytimes.com/public/overview?symbol=ALL&inline=nyt-org>,
turned up in the sample even though its primary business is property and
casualty, because it owns some life insurers.

The big users generally appear to be publicly traded companies, which have
to meet Wall Street’s expectations for earnings growth and returns on
capital. Life insurers that are owned by their policyholders, called mutual
companies, do not have that pressure, and some, like State Farm, Guardian
and New York Life, appear not to be reinsuring through captives at all.

MetLife said in a statement Tuesday that it “holds more than sufficient
reserves to pay claims on its policies” and added that it used reinsurance
subsidiaries “as a cost-effective way of addressing overly conservative
reserving requirements” for certain insurance products. If it had to set
aside that level of reserves more conventionally, it said, it would either
have to borrow — putting its credit rating at risk — or raise the money by
selling stock, dragging its returns below the level its stockholders
require.

“Access to reinsurance subsidiaries significantly reduces costs to
policyholders and in some cases is necessary to enable insurers to continue
to offer certain coverage,” MetLife said.

Prudential said in a statement, “Our captives are capitalized to a level
consistent with ‘AA’ financial strength rating targets of our issuing
insurance entities.” It said that many of its captive reinsurance
transactions were done in Prudential’s own home state, New Jersey, so the
same regulators could see both ends of the deals.

In other cases, Prudential said it reinsured obligations through a captive
entity in Arizona, Pruco Re, whose reserves were “subject to asset adequacy
testing by our actuaries.” The company said these practices were disclosed
to investors.

Other companies using this type of reinsurance said their transactions had
been reviewed and approved by regulators, and helped them use capital
efficiently. They also said the practice allowed them to charge lower
prices, and in some cases made it possible to keep selling types of
insurance that would otherwise have been discontinued. They also said it
was appropriate to support their captives with contingent letters of credit
in cases where the likelihood of big payouts was remote.

The Hartford said that it had sold its life insurance business to
Prudential, and was no longer in the business of writing new life policies
and reinsuring them.

Allstate said that captives and special-purpose vehicles were “a minor part
of Allstate’s reinsurance business.”

SNL Financial’s data also made it possible to see which states are courting
the transactions most eagerly — Vermont, South Carolina, Arizona, Hawaii,
Iowa and Missouri.

“If we let our guard down and ignore this regulatory race to the bottom,
taxpayers and insurance policyholders are the ones who could get left
holding the bag,” Mr. Lawsky said in his report.


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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