The New York State Department of Financial Services (NYDFS) recently concluded a year-long investigation into shadow insurance transactions. Shadow insurance, as the term is used by the NYDFS, is the act of shifting risk from a life insurer to one of its subsidiaries. Shadow insurance is similar to captive insurance, where a parent company (that is not an insurance company) is insured by one of its subsidiaries. According to the NYDFS, the result of captive-like transactions at life insurance companies is that risks may be ‘hidden in the shadows’. NYDFS warns that, unbeknownst to regulators and investors, shadow insurance could leave life insurance companies responsible for losses at their more weakly capitalised captives.

The NYDFS investigation, concluded in June 2013, found that there were 17 New York-based life insurers that conducted $48bn of shadow insurance transactions. The NYDFS investigation raised concerns about a lack of transparency and even described shadow insurance transactions as ‘regulatory blind spots’. The NYDFS concluded that many New York-based life insurance companies used shadow insurance to artificially boost their risk based capital (RBC) ratios and either failed to disclose or inadequately disclosed parental guarantees in their annual financial statements.

The NYDFS identified several potential issues with shadow insurance, each of which may present risk to policyholders. For instance, NYDFS warns that life insurers may be making misleading disclosures about its capital. This occurs because a company’s statutory RBC is affected by permitted practices like the usage of captive insurance. The NYDFS observed that shadow insurance boosts RBC figures without actually raising any new capital or reducing risk and that this ‘artificially boosted’ RBC is commonly reported to regulators, investors, customers and creditors.

Jul-Sep 2013 Issue

Berkeley Research Group