14 May 2015USA analysis

Life insurers' captives are ‘black boxes’ claims S&P

One of the biggest mysteries when deciphering life insurers’ statutory balance sheets is often their  use of captives, rating agency Standard & Poor's has said in a report.

The report, entitled ‘ Peeking  Inside The Black Boxes: Why North American Life Insurers Are Using Captives  And Why It Matters’, notes that while statutory reserves are often very conservative – double the necessary amounts for some products – some insurers have resorted to using captives to hold more economic levels of liabilities.

"The use of statutory accounting on its own creates challenges because of how conservative the assumptions are and how much this varies across products," said Standard & Poor's credit analyst Matthew Walker. "These challenges are multiplied with the increasing deployment of special-purpose vehicles known as captives. Insurers can, in effect, sidestep accounting for liabilities by transferring conservatively valued ones to these entities to help them realize profits and improve capital metrics.

“By using a jurisdiction that allows more economic accounting, they are able to improve their statutory filings by presenting less on the liability side in the same way that they can sell assets carried below market value to realize gains. This effectively solves their statutory presentation problem."

As insurers pursue this risk transfer, one question that the report discusses is whether investors and users of statutory financial statements are receiving adequate disclosures in transactions ceded to the captives.

“Often the devil is in the fine-print details, which may have significant consequences. This is further confounded by the varied use of captives by different insurers, with some not using them at all and others using them to optimize regulatory solvency ratios. This inconsistent usage and lack of transparency means investors can gain some knowledge of reserve levels and the amount of reserves transferred to captives, but not enough to entirely trust its accuracy and effectively compare life insurers' statutory data,” the report said.