set up in Bermuda last year with funding from Warburg Pincus.
If the affiliated reinsurance entity is based in Bermuda, it’ s exempt or allowed“ significant deviations” from the U. S. accounting standards that its parent company must abide by, Gober says.
It’ s not just offshore reinsurers that can largely skirt U. S. accounting standards, he says. There are also“ captive” reinsurance companies within the U. S., mostly in Vermont, South Carolina and Delaware. Captive companies are wholly owned subsidiaries or affiliates of the insurance carriers, which may set them up for various reasons, including tax advantages. The parent company can pay premiums to its captive reinsurer and then deduct them. Like their offshore counterparts, captive reinsurers don’ t file publicly available financial statements that other U. S. insurers must. They also don’ t have to strictly abide by the statutory accounting principles( SAP) established by the National Association of Insurance Commissioners( NAIC), says Gober, even though their“ ceding” insurance companies do.
Those accounting principles are designed to safeguard policyholders and certify that the insurer is solvent.“ The lack of transparency with these affiliated reinsurance companies, both captive and offshore, is the single biggest threat to U. S. policyholders and annuitants,” Gober says.
Dick Weber, president of the Ethical Edge, a fee-only insurance and annuity consultant in Pleasant Hill, Calif., adds:“ It’ s a shell game and, in general, the regulators are not paying attention.”
Private Equity
An additional concern is the growing dependence of reinsurers on private equity help, Rybka says. More and more, they get this through off-balance-sheet entities called“ sidecars” that raise capital from and share risk with outside investors.“ They don’ t report to any U. S. securities or insurance regulators,” he says.
He adds that private equity doesn’ t offer the long-term commitment required to support life insurance and annuities. It’ s true that in the property and casualty arenas, private equity backing is wellestablished, since that kind of insurance can require funding infusions for sudden short-term capital needs after, say, a devastating fire or hurricane. But life insurance and annuities function differently.
“ Contrast [ catastrophe insurance ] with the 30- and 40-year need for capital from life insurance or annuity payouts,” Rybka says.“ Private equity is completely incompatible with the long-term capital needed to back lifetime promises.”
Weber adds that combined with the lack of regulatory scrutiny, this growing reliance on private equity is a“ significant threat to the health of the life [ insurance ] and annuity industry, and of course to consumers who put their trust in the promise that their benefits will be there when needed.”
Better Controls Needed
Naturally, improved regulatory oversight would help alleviate the risks. But insurance carriers aren’ t controlled by any federal agency. They are regulated, instead, at the state level. Every state has its own insurance commissioner, overseen by the non-governmental NAIC, a voluntary non-profit organization that supports and sets standards for state insurance regulators.
Consumers are partially protected against insurance defaults by state guaranty associations, which belong to the National Organization of Life and Health Insurance Guaranty Associations. Gober, who used to be an insurance examiner himself, says insurance commissioners are overworked and vastly understaffed.
A recent report by four researchers at the Federal Reserve Bank found yet more reasons to be skeptical of the life insurance and annuity industry’ s financial stability. Economists Sydney Carlino, Nathan Foley-Fisher, Nathan Heinrich and Stéphane Verani wrote that a growing portion of life insurers’ assets are not invested in“ safe” securities such as Treasurys but in risky, below-investment-grade corporate debt.“ Life insurers invest directly in risky firms through high-yield corporate bonds and leveraged loans,” the study said.
In fact, their overall exposure to these debt instruments is the highest since the 2008 financial crisis, the report said. Since 2009, the share of these assets exposed to risky debt“ has roughly doubled,” it continued,“ and now exceeds the industry’ s exposure to subprime residential mortgage-backed securities in late 2007.”
Asset managers affiliated with these life insurance carriers are“ major corporate loan originators,” the Fed study found. It added that these“ partnerships” have in effect created“ complex and arguably opaque structures,” ones that not only shift portfolio allocations toward subprime corporate debt but exploit“ loopholes stemming from rating agency methodologies and accounting standards.”
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