New York Department of Financial Services Superintendent Continues Criticism of “Shadow Insurance” Transactions in Letter to U.S. Senate Committee

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New York Department of Financial Services (DFS) Superintendent Benjamin Lawsky continued his attack against the use of so-called “shadow insurance” in an April 27, 2015 letter to the Honorable Sherrod Brown, Ranking Member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs. In the letter, Lawsky called on regulators to initiate measures to address this “textbook example of regulatory arbitrage in order to protect the efficacy of our state-based system of regulation” and hopes to stimulate a national debate on these issues.

Lawsky outlined the mechanics of a “shadow insurance” transaction (set forth in our previous blog post dated April 27, 2015) and emphasized that a 2013 DFS investigation of these transactions had prompted DFS to call for a “national moratorium” on these captive reinsurance arrangements. The letter goes on to state that despite these urgings, the National Association of Insurance Commissioners (NAIC) did not impose such a ban and instead adopted a system of determining reserves known as “principle based reserving.”  Principle-based reserving (PBR) permits insurers to adopt their own company models for reserving, rather than having to use a statutorily mandated formula. Many state regulators believe that PBR’s more liberal approach will eliminate, or at least discourage, the use of captive transactions. Lawsky, who strongly supports the formulaic method used in New York, states that the life insurance industry has maintained that it will continue to use captives even with the advent of PBR.

In his opening statement at a hearing on April 28, 2015 on the State of the Insurance Industry and Insurance Regulation, Senator Sherrod Brown used the 2008 financial crisis that resulted in the passage of Dodd-Frank and the creation of the Federal Insurance Office as a backdrop to a discussion of insurance-related issues, including captive reinsurance. He characterized these transactions as being included in a list of “emerging risks” for state and federal regulators to address and cautioned that the 2008 financial crisis must remind regulators that these types of transactions cannot be ignored.

This latest communication from DFS, combined with Senator Brown’s recent comments, ensure that the topic of “shadow insurance” will continue to dominate the regulatory landscape on both the state and federal level for the months to come.