It’s not often that the life insurance industry is prominent in the news, but it was on June 11, 2013 when the New York Times reported how New York State regulators are calling for an end to tricky financial transactions used by life insurers to inflate their assets by billions of dollars.
By making secret and dubious transactions that make them look richer than they are in reality, insurers are putting life insurance policies at risk because there may not be sufficient reserves to cover them.
Think of how in the run-up to the 2008 financial crisis the banks were engaged in fraudulent practices that ultimately boiled over and almost wrecked the entire financial system. Well, it’s pretty much the same concept that’s at work here–companies making bigger and larger bets without sufficient capital to pay them off when they go bad.
We don’t know if it will happen with the life insurance industry, but it appears that insurers’ widespread practices, especially among publicly-traded companies who are under more pressure to increase profits, raise the risk of danger.
According to New York Superintendent of Financial Services, Ben Lawsky, it took his team of investigators nearly a year to follow the paper trail left by insurers. He said that New York-based life insurers inflated their books to the tune of $48 billion.
One technique used is for insurers to create shell companies and then utilize them as reinsurance vehicles for risk accumulated by the insurer. Reinsurance involves spreading insurance risks to other entities. But that does not occur when reinsurance is done through a shell company created by the same insurer, as opposed to a reinsurance transaction through an independent entity that is responsible for the risk and performing its own underwriting. The risk remains with the insurer. When the appearance is that valid reinsurance arrangements are in place, however, that is a problem.
Read the article for more details. You’ll see what I’m talking about in more detail. Be forewarned, however, that reading about financial transactions made by insurance companies is not exactly the most exciting reading out there. It ain’t John Grisham or David Baldacci. Beforehand, you may want to have a strong cup of coffee.
An overarching problem with the insurance industry is that it is regulated by the 50 states and not the federal government. Consequently, insurers can flock to states with the most favorable laws (and New York is a pro-insurance state) and also more easily evade regulation because, naturally, the regulators are more diffuse, than if there was a single, centralized agency performing monitoring and oversight.
We’ll see what happens. Hopefully, it won’t be 2008 redux.