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FIO and NYDFS: A Tale of Two Reports

New York Insurance Commissioner Ben Lawsky's criticism of captive reinsurance deals appears sensationalist in light of the yesterday's FIO report and industry-side statements.

Yesterday New York’s Insurance Commissioner Ben Lawsky was widely quoted as characterizing captive reinsurance deals as “shadow insurance” and likening use of same to the accounting maneuvers that caused the financial crisis of 2008. Coincidentally, the Federal Insurance Office’s (FIO) report on the insurance industry was released yesterday and it included information that goes some distance in explaining why insurers are driven to use captive reinsurance transactions.

Lawsky’s comments accompanied the issue of a report by the New York Department of Financial Services (DFS) which cited the activities of AIG’s Financial Products division as reason for regulators to “remain vigilant about potential threats lurking in unexpected business lines and at more weakly capitalized subsidiaries within a holding company system.” According to a New York Times story, Lawsky reported being “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.”

Mike Nelson, Nelson Levine de Luca & Hamilton
Mike Nelson, Nelson Levine de Luca & Hamilton

Meanwhile, the first of the FIO’s long-awaited reports appeared — the descriptive one about the state of the insurance industry, not the prescriptive one about how it should modernize. The report emphasized, as my colleague Nathan Golia reported yesterday, the systemic impact of low interest rates on insurers.

[Related: 4 Key Issues from Long-Delayed FIO Report .]

The tone of the New York DFS' report contrasted starkly with that of a statement issued by the American Council of Life Insurers (ACLI), which emphasized the normality of captive reinsurance transactions:

Captive reinsurance transactions provide life insurers a means to spread the risks they assume. They also enable life insurers to deploy capital efficiently and, in turn, help them set prices as competitively as possible. Captive reinsurance transactions represent an important and positive element of a competitive life insurance marketplace and are, without exception, reviewed and approved by regulators.

Even many regulators disagree with deeming captive reinsurance transactions as inherently wrong, asserts Mike Nelson, chairman of insurance-focused law firm Nelson Levine de Luca & Hamilton. "Some [of the transactions] are well structured and others need to be looked at carefully -- you can't categorically call them bad," he comments. "Transferring risk to captives has been done forever. It's a [valid] business practice, and when well used, ultimately ends up in a healthy insurance marketplace."

With regard to Commissioner Lawsky's likening of captive reinsurance transactions to the causes of the financial crisis, Nelson says the analogy is lost on him. "I don't see any similarities of any kind," he says.

Perhaps the overblown rhetoric of Commissioner Lawsky was meant as a political shot over life insurers' bows for activities that, while normal for decades, may be creating a genuine vulnerability. Whatever the case, the economic challenges noted by the FIO report must in some degree be driving insurers' recourse to more sophisticated capital allocation and accounting. As one New York Times reader noted:

The credit quality of all insurance companies have deteriorated. They have increase their asset allocations to high yield debt and other "alternatives" in order to fund liability streams that no longer can be met with higher quality assets due to the repressive interest rate regimes imposed by the world's central banks. So much for unintended consequences...

Nelson Levine de Luca & Hamilton chairman Nelson comments that the market challenges raised by the FIO report were hardly new. "Interest rates have stayed down, markets have stayed soft and demographics have clearly changed," he says. "This has been a growing concern for both insurers and regulators."

Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio

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