A Captive Audience

On the front page of today’s New York Times, in the pole position, is an interesting story about captive insurance. It begins by telling readers what anybody with even the tiniest experience with captive insurance already knows about it. But it then moves on to detail how heavy hitters in the life industry, especially Aetna and MetLife have used captives to reduce their own capital requirements and in so doing, free up operating capital for other purposes, such as paying out bigger dividends.

You can read the story here, but basically it starts by describing for the readers what captive insurance companies are, and then it quickly moves into how companies such as Aetna have been using them to reduce their capital requirements. This, in turn, shows how utterly fragmented the state-based regulatory system, championed by the NAIC, really is. According to the Times, the captives industry and the state insurance regulators allow for insurers to pick and choose where they want to be regulated, slipping out of whatever insurers feel are pernicious regulations, and pitting states against each other as companies go forum shopping. The end result is a system of loopholes that allow insurance companies to dodge the very capital requirements that are supposed to keep them in check. It is eerily reminiscient, the Times suggests, of the kinds of procedures – and the regulatory failure to prevent it – that allowed AIG to implode in the way that it did. And that is the real concern. Where might the next AIG be? And might it be found somewhere in the life insurance industry?

Before we get into that last question, let’s take a look not just at what the Times story said, but at how it said it. First things first, they placed the story in the Monday morning edition’s pole position: front page, top of the fold. Why is this important? Consider, for a moment, the newspaper maxim of “if it bleeds, it leads.” Then consider that this story about life insurance and captives displaced to a second spot on the front page a longer, deeper and frankly, more compelling story about how New York social services failed to prevent a four-year-old girl from being neglected to death by her drug-addled family. The death of an innocent girl was trumped by supposed financial shenanigans by the life insurance industry. If that does not show a sign of intent on the part of the media to chase what it thinks is a spectacular villain story in the making, then nothing will. Likewise, if that doesn’t send a chill up your spine, then you are a far cooler cucumber than I am.

Along these lines, the headline for the story is “Seeking Business, States Loosen Insurance Rules.” But on the front page of the Times’ website, wthe header reads, “As States Battle for Cash, Insurance Concerns Grow.” Virtually the same number of characters, yet the second headline immediately tells a more suspicious story on the part of the industry. Hmm.

The guts of the story is really nothing new. Aside from National Underwriter covering Aetna’s tricky financial move (which was reported elsewhere too; the details of the financing were made plain in Aetna’s earnings report), the business of captvie insurance itself is decades old, and is a staple of how much insurance business is done today. Granted, it is less common for insurers to use captives for their own purposes, but what Aetna and every other company listed in this story has done is entirely legal. And that is the point, but on two different fronts.

The first, and a point the story makes is that there is no consistency in insurance regulations in this country. The NAIC and state insurance commissioners like it that way, as it gives them sovereignty and autonomy. Not to mention that every state is utterly addicted to the premium taxes it levies upon its insurers, so none are eager to see into being system that might take that source of funding away from them. This, more than anything, is what I suspect the NAIC and the states are all about. It is not that they are hellbent to protect consumers, or to drive efficiency within the industry. It is because the present arrangement drives a lot of money into the coffers of the NAIC and a lot of power into the hands of those who see a post as insurance commissioner as a stepping stone to bigger and better things. Only a system as hopelessly fragmented as ours could enable such a mess. Small wonder, then, that the NAIC is so dead-set against federal regulation and has been very active in trying to prevent the Federal Insurance Office from wielding any real regulatory power. To this end, the story is a de facto call for federal insurance regulation, and I must agree with this. I said back in November, and I’ll say it again that the golden era of state-based insurance regulation ended in September 2008 when the states’ collective inability to notice or warn that AIG was about to join the ranks of the dodo bird helped to plunge the entire planet into financial chaos.