Monday, May 11, 2015

No. 100: Shadow Insurance—A Chronology of What May Become the Worst Financial Scandal in the History of the Life Insurance Business

"Shadow insurance" usually refers to reinsurance used to weaken (reduce) life insurance reserves, which are liabilities that measure a company's obligations to policyholders. Shadow insurance also involves questionable financial instruments such as parental guarantees, letters of credit, and contingent notes. The details of such instruments are shrouded in secrecy, and the reasons for the secrecy have not been explained.

Shadow insurance may become the worst financial scandal in the history of the life insurance business. The chronology presented here may be useful for those interested in the welfare of the life insurance business, including those who depend on life insurance protection.

Elizur Wright, later called "The Father of Life Insurance," is appointed insurance commissioner of Massachusetts, thereby becoming the first insurance regulator in the U.S., and begins his campaign to require life insurance companies to establish adequate reserves.

August Zillmer, a German actuary, publishes article explaining a method (used in the U.S. beginning about 40 years later) by which to weaken life insurance reserves.

State insurance regulators allow life insurance companies to use, in financial statements for the end of 1932, asset values as of June 30, 1931.

Universal life insurance is introduced.

April 1993
Prudential Insurance Company of America, to save $100 million in federal income taxes, issues $300 million of surplus notes through a confidential private offering to qualified investors.

National Association of Insurance Commissioners (NAIC) begins to require "Triple-X" reserves designed to offset efforts by companies to weaken reserves through clever policy designs.

February 1994
Article entitled "The Recent Flurry of Controversial Surplus Notes" appears in The Insurance Forum.

March 2004
Article entitled "Secondary Guarantees, Marketers, Actuaries, Regulators, and a Potential Financial Disaster for the Life Insurance Business" appears in The Insurance Forum.

NAIC adopts model law that includes reference to so-called principles based reserves designed to allow actuaries to use judgment in establishing reserves rather than using formulas in insurance statutes.

February 2009
Article entitled "Capital Infusions into Life Insurance Companies by Weakening Statutory Accounting Rules" appears in The Insurance Forum.

March 2011
Frederick Andersen, a New York Department of Financial Services (NYDFS) actuary, sends a letter to NAIC concerning what NYDFS perceives as inadequate reserves for universal life policies with secondary guarantees.

February 2012
Article entitled "The Controversy over Reserves for Universal Life Policies with Secondary Guarantees" appears in The Insurance Forum.

July 2012
NYDFS begins investigation of shadow insurance.

March 2013
Article entitled "A Review of More Than a Century of Efforts to Weaken Life Insurance Reserves" appears in The Insurance Forum.

April 18, 2013
NYDFS Superintendent Benjamin Lawsky, in a speech, discloses the existence of NYDFS investigation of shadow insurance.

June 11, 2013
Article by Mary Williams Walsh entitled "Insurers Inflating Books, New York Regulator Says" appears in The New York Times.

June 12, 2013
NYDFS issues report entitled "Shining a Light on Shadow Insurance: A Little Known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk."

August 2013
Moody's Investors Service issues report entitled "The Captive Triangle: Where Life Insurers' Reserves and Capital Requirements Disappear."

September 30, 2013
Article by Alistair Gray entitled "Shadow Insurance Schemes Multiply to $360 Billion" appears in Financial Times.

February 2014
Rector & Associates, consulting firm retained by NAIC, submits report to NAIC concerning shadow insurance.

April 1, 2014
Paper by Ralph Koijen and Motohiro Yogo entitled "Shadow Insurance" is published by Federal Reserve Bank of Minneapolis.

April 22, 2014
Joseph M. Belth blog post No. 44 discusses certain notes to 2013 statutory financial statement filed by Iowa-domiciled Transamerica Life Insurance Company concerning a massive increase in surplus resulting from use of accounting practices permitted in Iowa.

April 23, 2014
Class action lawsuit is filed against AXA Equitable Life Insurance Company following NYDFS report on shadow insurance. (See Yale v. AXA Equitable, U.S. District Court, Southern District of New York, No. 1:14-cv-2904.)

June 2014
Rector submits to NAIC a modified report which, according to Superintendent Lawsky, "essentially defanged" the February 2014 report.

August 12, 2014
Superintendent Lawsky sends letter to his fellow insurance commissioners deploring weak response of NAIC to problems of shadow insurance and improper use of captive reinsurance companies.

August 17, 2014
NAIC Executive Committee issues recommendations based on modified report submitted by Rector.

November 6, 12, 19, 2014
Belth blog post Nos. 71, 72, and 73 discuss frightening accounting rules promulgated in Iowa.

December 18, 2014
Article by Mary Williams Walsh entitled "Regulators Deem MetLife 'Too Big to Fail' Institution" appears in The New York Times and discusses MetLife's designation as "systemically important financial institution" by Financial Stability Oversight Council.

April 12, 2015
Article by Mary Williams Walsh entitled "Risky Moves in the Game of Life Insurance" appears in The New York Times.

May 6, 2015
Belth blog post No. 99 discusses report released by American Academy of Actuaries on April 27, 2015 entitled "Key Ethical Concerns Facing the Actuarial Profession," in which by far the most serious ethical concern expressed by Academy members in 2012 survey was "responding to pressure from principals and/or management to select inappropriate assumptions used in pricing or reserving."

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