Wednesday, June 12, 2013

Life Insurance Companies May Be Inflating Their Books

Insurance companies are regulated by the states.  The regulator in the New York raised concerns about a common practice among life insurers that may put them at risk.  Many large, publically traded life insurers, seem to be engaging in regulatory arbitrage.  They have opened up shell companies in states with weak regulations in order to have them act a reinsurers.  They then sell policies to them which takes risk off of their books.  The shell companies are not required to hold the same quality of reserves against potential claims as they would have to hold in New York.  This increases their profits and it enables them to raise executive compensation and pay dividends to shareholders.  There appears to be a race to the bottom among states to weaken their regulations to attract shell reinsurers to their states. 

These practices among publically held life insurers is a lot like we observed with publically held banks.  The banks created special purpose entities which held the mortgage backed securities originated by the banks.  That improved the quality of their balance sheets and it inflated bank profits and executive compensation.

The insurance companies deny that they are misusing the captive reinsurers that they created.  However, there are many reinsurance companies that are in business to absorb risks that other insurers would like to offload.  If they sold some of their risk to them they would be offloading risk.  The risk is not offloaded when it is held by a subsidiary of the insurance company.  Its primary function is to improve the insurers balance sheet and inflate profits.

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