The superintendent of New York State’s Department of financial Services Benjamin M. Lawsky has issued a report “Shining a Light on Shadow Insurance” describing practices derided as “financial alchemy”.
In a typical shadow insurance transaction, an insurance company creates a “captive” insurance subsidiary, which is essentially a shell company owned by the insurer’s parent. The company then “reinsures” a block of existing policy claims through the shell company — and diverts the reserves that it had previously set aside to pay policyholders to other purposes, since the reserve and collateral requirements for the captive shell company are typically lower. Sometimes the parent company even effectively pays a commission to itself from the shell company when the transaction is complete.
Some commentators to this report weren’t overly concerned about the practice. The financial crisis of 2008, the role of insurer AIG, the complicit enabling by the ratings agencies, the lack of accountability to the perpetrators, the absence of reform does not engender trust to insurance companies that paper over risk in opaque shells to boost quarterly profits. Policy holders have to rely on their life carrier’s ability to pay claims for a very long period of time.
Consumers shopping for life insurance should be aware of the distinction between publicly-traded life insurance companies, answerable to their stock holders, and those mutual or privately held, and to what extent a company has reinsurance is ceded to affiliated captives.