National Underwriter - November 21, 2011

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observes that information that may be material to investors and policyholders, such as amounts ceded to captive reinsurers, and their state of domicile, are listed in the ceding insurers’ audited financial statements, including footnotes of the companies’ annual statements.

He notes, too, that the books and records of both parent and captive insurers are thoroughly scrutinized by regulators in states where the companies are domiciled. The due diligence in most jurisdictions also includes a review of proposals for establishing a captive by an independent actuary recruited by the captive domicile.

That close scrutiny, adds Mead, is reflected in the captive companies’ track records. He notes there are “far fewer failures of captives” than there are insurers. He adds the NAIC has, through requirements established in its Model Captive Reinsurance Act, eliminated a practice that might have led to such failures: insurers setting up, but not funding, reinsurance shell companies.

Critics remain unconvinced by these arguments. W.O. Myrick, a now retired state insurance examiner, sides with Gober in insisting that captives have no business assuming policy liability risks. These, he adds, should remain with the company that had underwritten the policies.

“In my experience, where there is an opportunity to throw
liabilities into a vehicle that is shielded [from the public], then
there is a very high likelihood that the insurer chose to do this
so as to falsify reserves,” says Myrick. “What I fear is that the
captives are being used to hide more and more risk. And when
risk bounces from one entity to another, it often vanishes.”
Shell games aside, critics are asking whether captive rein-
surers are being properly regulated. Memories still linger of
how AIG, in 1987, off-loaded some $1 billion in losses to its
captive Coral Re, and then moved those liabilities to another
captive, Richmond Re, when state regulators objected. Ulti-
mately, the losses returned to AIG’s main balance sheet after
regulators deemed that the captive transaction was little more
than an effort to purge liabilities from AIG’s books by making
them appear to be third-party reinsurance recoverables.

Prompted in part by an article on the industry in a May edition of the New York Times—which was written after Aetna chief financial officer Joseph M. Zubretsky noted how the company had successfully refinanced a book of health insurance through a Vermont captive, saving some $150 million

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in the process—the NAIC’s Executive Com-
mittee authorized its Financial Condition
Committee to “study insurers’ use of
captives and special purpose vehicles
to transfer third-party insurance risk
in relation to existing state laws and
regulations.” Depending on the study’s
findings, an NAIC statement adds, the
committee may recommend “modifica-
tions to existing NAIC model laws and/
or generation of a new model law.”
(The NAIC did not respond to an National
Underwriter request for additional comment on
the study, the XXX and AXXX reserve requirements
and questions raised about oversight of captive reinsurers.)

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EYEING THE STATE REGULATORS

One potential area of concern for the NAIC committee, some observers suggest, is an uneven ability among the 50 states to properly police the captives. The issue is likely to grow, they note, as more insurers seek to domicile captives in the minority of states that are garnering much of the business due to successful captive programs, but may not be appropriately staffed to oversee the companies. Or as critics would put more bluntly: what kind of regulatory shortcomings are likely to develop when the states themselves, with no strong federal oversight, are competing with each other to provide the most insurance-friendly captive domiciles? What captive proponents consider a competitive marketplace for risk, critics see a kind of forum-shopping for insurers looking to enjoy the benefits of lower reserving requirements, thereby skirting the most primary reason for insurance regulation at all—to protect policyholders by enforcing insurers’ ability to pay claims.

Kinion insists that Delaware’s insurance department is up to the task, noting that company’s staff has accrued extensive experience regulating the 135 commercial insurers domiciled in the state; and that the staff applies many of the “lessons learned” regarding these companies to captives also. He adds that he hasn’t “seen anything to substantiate critics’ concerns on this issue” in other states.

Adkisson, for his part, questions whether the captive business ought to be more evenly shared among the states so as: (1) not to overtax those that are attracting a disproportionate number of the companies; and (2) enable better due diligence by limiting oversight of both the ceding and captive insurers to a single insurance department.