Expert Commentary

Captives: A Shadow Insurance Industry?

Recently, an issue has arisen that, while applying to few captives, continues to muddy the captive waters, and a response is in order.

July 2013

New York State Superintendent of Financial Services Benjamin Lawsky has produced a report after 11 months of investigation that declares captives to be a "shadow insurance industry." He has called for a nationwide moratorium on licensing new captives. His report and press release have been picked up by, among others, the New York Times. Many writers have jumped on his bandwagon.

Fortunately, cooler heads are prevailing. James Donelon, the chair of the National Association of Insurance Commissioners (NAIC), has called Mr. Lawsky's comments a "knee-jerk reaction." Other regulators have rejected the call for a moratorium. Many regulators are ignoring him altogether.


By way of explanation and background, Mr. Lawsky was originally looking into the practice of many life insurers of taking excess, redundant reserves, placing them into a captive, and selling the ownership to investors for an increased return. These transactions fall under the NAIC Section XXX and AXXX and are allowed, encouraged, perfectly legal, and aboveboard.

These reserves are seen as redundant by all regulators because, while life insurers are required to reserve for future payouts, it is widely accepted that many policyholders will let their insurance lapse or nonrenew, making reserves for those policies not needed. Actuaries for the life insurers and the NAIC all agree on that point, including the New York Department of Insurance.

Some clever person saw that, since these reserves have value, they could be converted into a commercially saleable asset. So, the idea arose that the reserves could be put into a captive, and the captive, now with secure assets, could sell ownership interests to outside investors. We are talking about hundreds of millions of dollars here. The reserves are invested in assets that produce potentially higher returns than what would be in a traditional captive or sitting flat on the insurer's books.

These captives are so large that, when licensed, they immediately pay the full tax to the maximum limit. This benefits the domicile.

So, what is the issue? Some within the NAIC feel that the redundant reserve problem could be solved another way without a captive. They have formed the inevitable committee to investigate. This is not Mr. Lawsky's investigation. The NAIC may have a point, but so far no evidence has shown a big advantage one way or the other. Of course, the NAIC continues to investigate. That's what it is designed to do.

One can only speculate as to why Mr. Lawsky and his staff, as well as the New York Times and other uninformed commentators, would not be aware of the above explanation.

Mr. Lawsky maintains that the life insurers use captives as a "black box" to hide their transactions. He asserts that, since the captives are not domiciled in New York, they are lightly regulated. He says this about Vermont, Bermuda, Cayman, South Carolina, and Missouri, all of which, it can be argued, are better captive regulators than New York. He makes the "black box" claim even though all of these life insurers are audited, file annual reports with him and all domiciles in which they do business, and are examined by the Securities and Exchange Commission and countless other regulatory bodies. Many are domiciled in New York and file volumes of information with the New York Department quarterly. The captives may not show on the insurers' balance sheets, but they are in the notes. Regulators know about them.

Effect of Accusations

The concern is that this story won't go away and affects all captives. Not a day passes without a comment by an uninformed observer of the industry that gets picked up and blown all over the Internet. If commentators don't understand the XXX/AXXX issue, then they certainly won't understand that a captive owned by an association of bricklayers is completely unlike a life insurer's captive. If they think that Vermont regulates captives lightly, then they will never understand that captives are different from traditional insurers. Captives are not required to file all of the voluminous reports required of traditional insurers because they are a form of self-insurance. Their exposure to loss is their own.

If an institution like the New York Times can mindlessly publish a critical article without, apparently, a smattering of independent research or any understanding (even their parent company owns a captive), then it is not surprising that others give the story credence without any facts or understanding.


As you encounter these stories, please bear in mind that life insurer captives are closely regulated; the reserves invested are redundant and don't threaten policyholder claims; there is no black box or shadow industry. In my opinion, anyone saying otherwise simply doesn't know of what they speak. Beware of what else they may be saying on other subjects as they are so wrong on this one.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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