Penn Mutual Calls For Improved Captives Transparency
June 27, 2013 by Thomas Harman
The insurance industry must look to improve transparency in captive insurer transactions and provide consumers with confidence about the quality of industry reserves, said David O’Malley, chief operating officer of the Penn Mutual Life Insurance Co.
O’Malley’s comments to BestWeek follow a recent call for a national moratorium on captive transactions by New York Department of Financial Services’ Superintendent Benjamin Lawsky.
O’Malley said the captives issue is an old one that most likely concerns both those companies who have formed them as well as those who haven’t. Companies who have formed them and have been operating them for years don’t relish the prospect of having their captives re-examined, he said. If the New York captives alone were removed, it would take$48 billion out of surplus into reserve lines, he said.
A move toward a more principles-based approach to reserving, or ensuring that companies have a level playing field that provides consistent reserving practices across states and across products, should be developed going forward, O’Malley said. “I do believe the industry needs to move carefully and methodically in addressing this properly,” he said.
A consistent set of reserving rules would give consumers and regulators confidence in the reserves that are listed on insurers’ balance sheets, he said.
He said Penn Mutual supports calls by the American Council of Life Insurers to ensure proper disclosure and transparency for captives. ”We need to get into an environment where we have transparency, we have that disclosure,” he said.
The DFS’ investigation into captive insurers showed that state-based insurers and affiliates made$48 billion in transactions that typically involve captives located out of state and offshore. In these transactions, companies use a loophole in insurance law allowing them to artificially enhance balance sheets in order to divert reserves elsewhere, New York officials said (Best’s News Service, June 12, 2013).
The DFS said companies forming captives shift blocks of policy claims to entities outside the state or in offshore destinations such as the Cayman Islands to take advantage of less-restrictive reserve and regulatory requirements. Insurers conducting what New York called “shadow transactions” typically create a captive subsidiary. The company reinsures a block of policy claims and then moves freed-up reserves previously set aside to pay policyholders for other purposes. DFS alleged that when out-of-state captives are formed, newly freed reserves were used to boost risk-based capital buffers reported to regulators, investors and the public without actually raising any new capital or cutting risk.
DFS officials urged that regulators nationwide — including the National Association of Insurance Commissioners and the Federal Insurance Office — conduct investigations similar to DFS’s to have a complete picture of the extent to which such transactions are used nationwide. Groups such as the ACLI defended captives as a way to spread risk and manage prices (Best’s News Service, June 12, 2013).
Penn Mutual has no captives, despite the possibility of benefiting from forming them, O’Malley said. Penn Mutual sells universal life no-lapse products that are among the products that have attracted concerns raised by regulators and others concerned about captives. To address some of those concerns, the National Association of Insurance Commissioners last year passed updates to Actuarial Guideline 38, which was sent to states for ratification.
O’Malley said addressing the captives issue will be complicated because it touches on the ability of companies who hold less reserves to leverage their business in a way that companies who choose not to form captives cannot. He said New York’s concerns raise questions about the adequacy of reserving.
Lawsky voted against principles-based reserving when NAIC voted narrowly to send the issue of using principles-based reserving for life insurers to state lawmakers. Lawsky has since voiced his opposition to principles-based reserving, which he said would prove ineffective at least in the short-term, since captive use is likely to continue (Best’s News Service, April 6, 2013).
Tennessee Insurance Commissioner Julie Mix McPeak told Best’s News Service during the NAIC’s Spring Meeting in Houston that her new NAIC task force would address the reserves and special purpose vehicles that some principles-based reserving backers said it would remove from the reserving process. She said the XXX and AXXX captives may be inappropriate, but that improvements in transparency might make regulators more comfortable (Best’s News Service, April 6, 2013).
The Penn Mutual Life Insurance Co. currently has a Best’s Financial Strength Rating of A+ (Superior).
