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Does "shadow insurance" lead to dangerous debt deals?

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Yogi Berra probably wasn’t thinking about insurance when he said, “It’s like deja vu all over again.” But he could have been.

In 2008, trillion-dollar insurer American International Group’s (AIG) house of cards collapsed with a thud and -- along with phony mortgages -- helped send the U.S. spiraling into recession.

Now some regulators and consumer advocates are challenging a concept known as “shadow insurance.” It allows life insurers to take massive amounts of debt off their books and transfer it to wholly owned “captives,” which are in reality just units of the company, in return for “parental guarantees” to pay those subsidiaries if they get into financial trouble.

When life insurance policies don't pay

The problem: Those arrangements -- and there are lots of them -- are kept secret. Only the insurer and the insurance department in the state where the deal was worked out know what the terms are.

Steve Weisbart, chief economist for the Insurance Information Institute, which represents and lobbies for the insurance industry, makes no bones about his concern.

“We are worried,” said Weisbart. “These transactions are not publicly inspected. You can’t find the assets. And this secrecy creates anxiety.”

It could also create anxiety for those who have term life insurance policies (which expire after a set number of years) and universal life insurance (which are sometimes used to transfer assets to the next generation), especially if the insurance companies following this practice don’t have enough in assets to pay off their obligations.

Shadow insurance isn’t legal in many states. In New York, where AIG’s crash still lingers, former New York Insurance Regulator Benjamin Lawsky warned in 2013 that shadow insurance amounted to “financial alchemy” and was “reminiscent” of practices that contributed to the 2008 financial crisis.

And Lawsky isn’t alone. Two federal monitoring groups formed after the 2008 crash, the Financial Stability Oversight Council and the Office of Financial Research (OFR), have harshly criticized shadow insurance deals.

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“They can cloud … an insurer’s financial positions and create blind spots in the monitoring of threats to financial stability,” the OFR warned in a report earlier this year.

But this hasn’t stopped other states from adopting the practice, among them Delaware, Georgia, Indiana, Iowa, South Carolina and Vermont. And the reason is very simple: money.

One of America’s largest life insurers, Transamerica, is headquartered in Cedar Rapids, Iowa, and has moved hundreds of employees there from other cities.

This insurer has recently done a lot of transactions with its captives in Iowa, which is so captive-friendly that it changed its law to attract this business. Life insurer Symetra has also “re-domesticated” to Iowa from the state of Washington.

“Captives are safe financial arrangements and provide an important and positive element of a competitive marketplace,” said Gregory Tucker, head of public affairs for Transamerica.

But consumer advocates like Joseph M. Belth, professor emeritus of insurance at Indiana University, are trying to expose these deals. On Sept. 2, Belth filed suit to force the Iowa Insurance Division to disclose documents related to eight shadow insurance transactions Transamerica has done in Iowa, warning that they could “adversely affect the interests of shareholders, policyholders and taxpayers.” No date has been set for a hearing.

“Iowa’s limited-purpose insurer statute and regulation is not in the shadows,” responded Chance McElhaney, communications director of the Iowa Insurance Division. “Adopted in 2010, the legislation established a pragmatic approach to address the nationally recognized problem of excess reserves related exclusively to term insurance and universal life insurance with secondary guarantees.”

“As with all insurers, specific documents are afforded statutory confidential treatment, and this is also true of limited-purpose subsidiaries,” he said, adding that senior staff at the Iowa Insurance Department reviewed all filings.

Shadow insurance makes a life insurer more competitive. A paper published by the Federal Reserve Bank of Minneapolis in May showed that the amount ceded to captives by parent insurers had grown to $364 billion in 2012 from $11 billion a decade ago. The result: Life insurers were able to reduce the price of their policies by 10 percent and, coincidentally, give their executives raises.

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