Michael Appleton for The New York TimesBenjamin Lawsky, New York’s financial services overseer, seeks to raise insurers’ asset reserves.Several big life insurers are going to have to set aside a total of at least $4 billion because New York regulators believe they have been manipulating new rules meant to make sure they have adequate reserves to pay out claims.
The development stems from contentions by insurance companies that states’ regulations are forcing them to hold too much money in reserve. Many of them have engaged in secretive transactions to artificially bolster their balance sheets, often through shell companies in other states or countries. Regulators, who want to be sure companies have enough real liquid assets to pay all claims, have struggled to find a solution that all 50 states can agree on, and decided to test a new framework of rules.
On Friday, New York State plans to drop out of that agreement, according to a letter from Benjamin M. Lawsky, the financial services superintendent, to his fellow state insurance regulators. In the letter, which was reviewed by The New York Times, Mr. Lawsky said the test, which started in 2012, showed that the new framework did not work and was, in fact, making the “gamesmanship and abuses” in the industry even worse.
The move appears to be another attempt by Mr. Lawsky to address the much broader potential problem of the life insurance industry’s use of the secretive transactions. He has derided them as “financial alchemy” because they seem to create surplus assets out of thin air. In June, Mr. Lawsky called on other state insurance regulators to join him in blocking any more of these transactions. But other regulators said they wanted instead to keep pursuing a test of the new regulatory framework. The test covers a narrow segment of the life insurance business, but state regulators, through the National Association of Insurance Commissioners, are committed to extending the framework to all parts of the life insurance industry over the next few years.
But the new framework is “so loose as to be practically illusory,” Mr. Lawsky said in his letter. A sample of 16 insurers in the test were expected to increase their reserves by $10 billion, he said, but instead only $668 million was added. And that was at just five of the 16 companies; the others did not report any reserve increase at all and in fact seemed inclined to reduce their reserves by about $4 billion.
“This cannot possibly be the ‘compromise’ that we as insurance regulators had in mind,” he told the other commissioners in his letter.
Starting on Friday, New York will revert to its previous way of calculating reserves, at least for the type of life insurance being tested, requiring insurers that offer it to add a total of $4 billion to their reserves. Known as universal life with secondary guarantees, the insurance offers both death benefits and a cash value to policyholders. Because its design is highly flexible, it has for years been subject to questions about the amount of reserves that should back it. Leading companies that sell such insurance include Lincoln National, Genworth, Principal, John Hancock, U.S. Life and Sun Life. When asked about New York’s move, company officials said they could not comment because they still knew little about it.
It was not clear what portion of the $4 billion each company would have to come up with, or how much time they would have. The total amount could ultimately be higher if regulators in other states decide to join Mr. Lawsky. People briefed on his decision said they did not expect any of the affected insurers to stop doing business in New York State but said they might start charging more for this type of policy in the future.
Mr. Lawsky also said he wanted the other insurance regulators to reconsider their commitment to adopting the new framework in its entirety, given its performance on the current test. Adopting it at this point “represents a potent cocktail that puts policyholders and taxpayers at significant risk,” he said.
Companies have been arguing for years that state insurance regulations are too formulaic, forcing them to hold far more reserves than necessary. The proposed new framework, known as “principle-based reserving,” would free insurance actuaries from having to follow statutory requirements in their calculations, allowing them instead to use their own data and assumptions.
While regulators grappled with the reserve question and one another, a wave of transactions washed through the life insurance industry, sweeping billions of dollars’ worth of business offshore, where reserve requirements are different. The transactions, known as captive reinsurance, often involve the creation of subsidiaries, known as captives, that then sell reinsurance to their parent companies, which removes billions of dollars of policy obligations from the parents’ books.
In recent years, some states have been promoting themselves as good places to set up captives, promising insurers an offshore-style regulatory environment without the need to go offshore.
The transactions allow insurers to do other things with their money besides locking it up to pay future claims. But as they have become widespread, concerns have grown that insurers are lowballing their reserves and adding a large amount of hidden leverage to the life insurance industry.
In August, Moody’s Investors Service estimated that captive reinsurance had artificially bolstered life insurers’ balance sheets by $324 billion. The estimate covered a much wider sector than the one being monitored by New York State and included transactions conducted throughout the life insurance industry, as well as long-term care and disability insurance. Its finding suggests that as much as 85 percent of the sector’s aggregate capital and surplus is being enhanced by reinsurance through affiliated companies. Moody’s noted that the transactions did vary, and that not all of them caused hidden capital shortfalls. Some insurers do not engage in them at all.
The National Association of Insurance Commissioners has reacted to Mr. Lawsky’s June proposal with concern, saying he appeared to be giving the federal government reasons to step into the realm of insurance regulation, something the states generally oppose. The Dodd-Frank financial overhaul law created a body called the Federal Insurance Office within the Treasury Department, which has been studying state insurance regulation and is supposed to report on how current practices could be improved. Its report is more than a year overdue, but at an association meeting in late August, some officials said the report was imminent.