The growing use of captives is among "the rising and poorly-understood risks to the financial system" posed by the U.S. life industry, according to a new study commissioned by the Federal Reserve Bank of Minneapolis.
The report also singled out deep concern for the trend toward guaranty riders in variable annuities because of the shift from defined-benefit to defined-contribution plans.
Ironically, the study by Ralph Koijen, a London Business School professor, and Motohiro Yogo, a monetary advisor to the Minneapolis Fed, was released the same week as Benjamin Lawsky, superintendent of the New York Department of Financial Services, sent a letter to the National Association of Insurance Commissioners (NAIC) in advance of its spring meeting in Orlando that criticizes a plan proposed by the NAIC to strengthen oversight of captives.
Similar concerns voiced recently by Michael McRaith, director of the Federal Office of Insurance, prompted Ben Nelson, NAIC CEO, to tell McRaith to "stay in lane," and butt out of life insurance industry solvency issues.
And, the Federal Reserve in Washington recently came under fire at a Senate hearing for seeking to use "bank-centric" rules to oversee insurers it now oversees through provisions of the Dodd-Frank financial services law.
The reason insurers pose a growing risk is that, "Although these risks have been growing rapidly over the past 15 years, they have received relatively little attention from academics and regulators," the Minneapolis Fed report said.
"If unaddressed, these risks could cause severe problems," the report said, because insurance is "a large share of the financial sector." For example, U.S. life insurance liabilities amounted to $4.1 trillion in 2012, compared to $7 trillion in U.S. savings deposits, the report said. "Moreover, as the largest institutional investors in the corporate bond market, insurance companies serve an important role in real investment and economic activity,' the report said.
The authors said that U.S. life insurance liabilities totaled $4.1 trillion in 2012, compared with total savings deposits of $7 trillion.
The report said that captives pose a particular danger. "By moving liabilities from operating companies that sell policies to captives, a holding company as a whole can reduce its required capital and increase leverage," the authors say.
