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In the shadows of life insurance

By Jay MacDonald · Bankrate.com
Friday, June 21, 2013
Posted: 6 am ET

What's the main reason that life insurance doesn't sell? Simply put, many of us don't trust life insurance companies to carry through on their end of the bargain once we've kicked the bucket.

Life insurers know this, of course, and so go to great lengths to show that they're financially solid and above reproach.

But reproach was very much the order of business in Albany, N.Y., last week, where an unnamed 17 New York-based life insurance companies were taken to task by state Department of Financial Services officials for allegedly foisting off $48 billion in claims risk to shell companies offshore or in other states where reserve and collateral requirements are more relaxed.

Risky funny business?

"Claims risk" is industry-speak for the money your life insurer will owe to your beneficiaries when you bite the dust. Good regulators require life insurers to maintain sufficient reserves (think "cash") and collateral (think "assets") to make sure the dough is there once you're not.

But through a murky loophole known as "shadow insurance," these 17 life insurers reportedly shuffled billions of dollars in risk to their own shell companies, thereby buffing their books for investors and diverting policyholder reserves to other purposes. What other purposes, you ask? Acquisitions, investor dividends and executive compensation, to name three.

Don't confuse shadow insurance with "reinsurance," a routine practice in which insurance companies share claim risk by essentially buying insurance on their policies. With shadow insurance and the offloading of risk to their own subsidiaries, insurers keep shareholders, policyholders and regulators in the dark as to their true financial status.

Shining a light on shadow insurance

The New York regulators, who investigated 80 life insurers during their year-long probe, say they ceased approving shadow insurance arrangements in October 2011. New York Gov. Andrew Cuomo urged other states to do the same.

"Shadow insurance undermines transparency and accountability in the financial and insurance industries, which is critical to our economy," Cuomo said in a statement. "Our investigation shows that this is a problem all across the nation, so I encourage other state governments -- as well as our federal officials -- to look into these questionable transactions immediately to protect all consumers."

In response, the Life Insurance Council of New York, a state trade group, said life insurers have used shadow insurance for years "to responsibly and appropriately manage risk." MetLife told The New York Times that it holds plenty in reserve to pay claims and uses shadow insurance only to offset "overly conservative reserve requirements" for some types of insurance.

Whether you call it a business necessity, a loophole or a long-standing practice, shadow insurance may not help sell life insurance.

Follow me on Twitter: @omnisaurus

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Jay MacDonald is a Bankrate contributing editor and co-author of "Future Millionaires' Guidebook," an e-book by Bankrate editors and reporters.

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