Life insurers are required by various states’ laws to hold funds in reserve to ensure that the insurer will be able to pay the policies’ beneficiaries should an unexpected event occur. However, insurers have increasingly begun using secretive transactions—what one regulator called “shadow insurance”—to skirt these regulations and make themselves appear to be in better financial positions than they actually are.
The states regulate insurance, which translates to a patchwork quilt; some states’ regulations are far more comprehensive than others, including rules on how insurers can invest their reserves. Many insurers in states with tighter regulations have been circumventing their state’s oversight, however, by setting up and conducting deals through shell companies in a state with looser regulations. The insurer thus escapes the scrutiny of their home state’s regulators, which can lead to placing reserves in riskier investments, artificially increasing its risk-based capital ratios (a measure of solvency), or even increasing its executive compensation or stockholder dividends. In the words of one New York regulator: “Those practices were used to water down capital buffers, as well as temporarily boost quarterly profits and stock prices.” These practices expose insurers and their customers to much more risk, and may be accompanied by the specter or another financial collapse.
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