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Cuomo Cries Out Against 'Shadow Insurance'

Updated from 3:22 p.m. ET with comment from American Council of Life Insurers spokesman Jack Dolan.

NEW YORK ( TheStreet) -- New York Governor Andrew Cuomo on Wednesday announced that an investigation by the New York Department of Financial Services (DFS) had uncovered "billions of dollars in hidden shadow insurance risk that could potentially threaten policyholder and taxpayer interests."

The yearlong investigation found that life insurers chartered in New York had exploited a loophole to shift "at least $48 billion" in insurance claims to off-balance-sheet entities, some of which were located outside the U.S., according to Cuomo's press release.

According to Cuomo and DFS superintendent Benjamin Lawsky, the insurers had reinsured themselves though the creation of "captive" subsidiaries, which themselves had lower reserve requirements because they were chartered outside of New York.

A typical transaction of this type "diverts the reserves that it had previously set aside to pay policyholders to other purposes," according to the press release. "Those other purposes may include anything from an acquisition of another company to executive compensation to paying dividends to investors."

According to the announcement, the DFS investigation found that "New York-based insurance companies failed to disclose the parental guarantees associated with nearly 80 percent ($38 billion) of that $48 billion in shadow insurance in their statutory, annual financial statements."

MetLife (MET - Get Report) said in a statement that it "holds more than sufficient reserves to pay claims on its policies. We use reinsurance subsidiaries as means of efficiently conducting our hedging activities, and as a cost-effective way of addressing overly conservative reserving requirements."

By citing "overly conservative reserving requirements," MetLife seems to be taking a direct shot at Cuomo, Lawsky and the DFS.

Here's the rest of MetLife's statement:

"Life insurers use reinsurance subsidiaries to finance reserve requirements for term life products and universal life products with secondary guarantees. Alternative means of financing such reserves have drawbacks. Using equity could reduce returns to levels below those required by investors and issuing debt could negatively impact credit ratings. Traditional reinsurance by a third party is either prohibitively expensive or non existent in the marketplace. Access to reinsurance subsidiaries significantly reduces costs to policyholders and in some cases is necessary to enable insurers to continue to offer certain coverage.

"We conduct reinsurance business according to the laws of the states in which we operate with full knowledge of our regulators and significant disclosure in our GAAP financials," MetLife said.

American Council of Life Insurers (ACLI) spokesman Jack Dolan said "captive reinsurance transactions provide life insurers a means to spread the risks they assume. They also enable life insurers to deploy capital efficiently and, in turn, help them set prices as competitively as possible."

Dolan also said that the transactions made through the capitive reinsurance companies "are, without exception, reviewed and approved by regulators."

The ACLI is working with the National Association of Insurance Commissioner (NAIC) "to enhance disclosures that will provide regulators with more access to information about the captive reinsurer transactions," Dolan said, adding that "with greater transparency, concerns about this vital risk-management tool will be addressed."

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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