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New York Regulators Probe Captives for Life Insurers

Source: WSJ - Leslie Scism

Posted on 06 Aug 2012 by Neilson

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New YorkNew York's top financial-industry regulator is investigating whether life insurers are potentially masking their financial health through dealings with related companies, according to people familiar with the probe.

The state's Department of Financial Services in mid-July sent letters to about 80 life insurers, including large companies like MetLife Inc., seeking details about their financial arrangements with affiliated entities known as captive insurance companies, the people said.

Many of these entities are incorporated offshore or in other states and were set up specifically to take on responsibility for certain types of policyholder claims from their parent companies.

New York regulators, led by Benjamin Lawsky, superintendent of the New York State Department of Financial Services, are looking for potential risks in these "reinsurance" transactions, the people said.

New York's probe is part of a broader state effort to resist any potential watering down of insurance-industry solvency standards. Mr. Lawsky last month questioned the wisdom of a plan supported by many state regulators to revise rules on how life insurers set up reserves, because it would rely more on insurers' own modeling.

In this instance, the New York regulators are concerned that some insurers may be shifting significant liabilities off their balance sheets onto these entities, which have laxer funding requirements than New York-regulated companies.

The nightmare scenario is a repeat of the 2008-09 financial crisis, or a severe worsening of the economy, that would leave the insurers short of the money they need to make good on claims.

The life insurers face a Wednesday deadline for providing the information, according to the people. MetLife and Lincoln National Corp. are among the users of such related entities, according to securities filings.

In a statement, MetLife said that it, "like many life-insurance companies," uses captive reinsurers to help satisfy certain reserve requirements related to universal-life and term-life insurance policies. The arrangements "meet regulatory requirements," MetLife said. Lincoln declined to comment.

In general, states require life insurers to conservatively estimate future claims obligations and to have bonds and other assets on hand to pay those claims. State insurance regulators note that few life insurers got into serious trouble during the 2008-09 economic meltdown, even as scores of banks collapsed.

Many insurers contend the current formula-based reserve requirements result in claims reserves that are far bigger than necessary. Many state regulators allow insurers to establish captives or other entities into which they transfer some of their liabilities.

In these states, the entities are allowed to use letters of credit from a list of qualified banks, or in some instances even the guarantee of the parent company, to pump in more money if necessary at some later date, for a portion of the entity's financial structure.

To deal with the insurers' concerns about the reserve requirements, the new modeling-based approach to reserve calculation is under debate at the National Association of Insurance Commissioners, an organization of state officials that sets solvency standards for adoption in many states. New York often has stricter rules than other states.

The NAIC also is reviewing the captive issue. It launched a study early this year to address "potential concern that a shadow insurance industry is emerging, with less regulation and more potential exposure than policyholders may be aware of," according to the group's website.

Typical of the arrangements is one in place at MetLife since 2008. Its Vermont-based captive obtained a 30-year letter of credit from Deutsche Bank AG,  which is committed to providing $2.4 billion, according to securities filings and people familiar with the transaction.

The cost to MetLife was significantly less than the cost of issuing debt or selling stock, and the bank arrangement enables it to stay within leverage ratios used by credit-ratings firms.

MetLife doesn't expect the letter of credit to be drawn upon, saying it supports "noneconomic reserves," referring to the portion of reserves required by regulation but above the company's estimate of needed reserves.

If the letter is drawn on, Deutsche can demand repayment from MetLife, the people familiar with the transaction said. If the parent company is unable to reimburse the bank, Deutsche could declare MetLife in default of its obligations, which could trigger payouts on credit-default swaps tied to MetLife's debt, these people said.

Such a possible outcome, while highly unlikely, concerns some regulators because of the potentially destabilizing impact on a company's insurance subsidiaries.

The MetLife spokesman said any such debt default "would have no impact on policyholders" because its insurance units are properly capitalized.

"I absolutely think policyholders can sleep soundly at night," said David Provost, a deputy commissioner in Vermont, speaking generally about captives in that state.

Other insurers, including Lincoln, have captives that use bank letters of credit. In 2010, for instance, Lincoln said certain of its subsidiaries had entered into a $550 million, 10-year letter of credit from Credit Suisse AG to support regulatory capital requirements for its life business.

In Iowa, insurers setting up captives are required to hire an independent actuary to review their modeling of reserves, and the state hires its own actuary, to protect policyholders, said senior insurance regulator Jim Armstrong.

"The last thing" the state wants "is a troubled company in Iowa," Mr. Armstrong said.