The New York Department of Financial Services (“DFS”) continues to attack use of so-called “shadow insurance” transactions. In an April 27, 2015 letter to the Honorable Sherrod Brown (D-OH), ranking member of the U.S. Senate Committee on Banking, Housing and Urban Affairs, New York DFS Superintendent Benjamin Lawsky asked 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.” Lawsky’s letter is viewed as an effort to stimulate a national debate on these issues.

Lawsky alleges that the June 2013 DFS investigation of so-called “shadow insurance” transactions had prompted DFS to call for a “national moratorium” on these captive reinsurance arrangements; however, the NAIC did not impose such a ban and instead adopted a system of determining reserves known as “principle based reserving” (“PBR”). PBR allows insurers to adopt their own company models for reserving rather than having to use formulaic principles set forth in existing state insurance law. The NAIC and many state regulators believe that PBR will eliminate if not effectively undercut the use of captive transactions. New York supports the traditional formulaic reserve methodology and believes that the life insurance industry will continue to use captives even in the face of PBR.

At the April 28 hearing, Senator Brown used the 2008 financial crisis that resulted in the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203, H.R. 4173) and creation of the Federal Insurance Office as an introduction to a discussion of insurance-related issues, including captive reinsurance financing transactions. Brown characterized these transactions as one of the “emerging risks for state and federal regulators to address.” However, Brown also questioned how state and federal regulators were tracking insurance industry investments in private equity hedge funds, commercial mortgages, mid-size business loans and securitized credit with some outsourcing to third-party asset managers, which demonstrates that it is not only a life insurer’s captive financing transactions which he believes could undermine the industry’s credibility.

To view the Shadow Insurance Report, click here.