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A Regulator Calls It Like He Sees It

Being a financial regulator is a lot like being a baseball umpire: The job is a lot harder than it looks, and you will not win many friends by doing it well.

New York’s superintendent of financial services, Benjamin Lawsky, is not a popular guy these days.

Lawsky is proving to be a pretty good financial regulator. Doing that particular job well means anticipating problems before they blow up into calamities, while rejecting hollow justifications for questionable behavior. In contrast, a bad regulator - and there are plenty of them - focuses on trivia, follows the bureaucratic crowd, and then searches for scapegoats to blame when things go sour.

Lawsky’s regulatory counterparts in other jurisdictions no doubt see him as a headline-grabbing publicity hound. The institutions he regulates probably view him as a heavy-handed micromanager. There may be some truth in these assessments, but they don’t mean Lawsky isn’t doing his job.

Lawsky recently reported on ways that some life insurance companies are making themselves look stronger than they are. That is a disaster waiting to happen, for the industry as well as for consumers. An insurance policy, after all, is nothing more than a promise. It is no stronger than the company that makes the promise and the government structures that are supposed to ensure those promises are kept. If the public loses faith in insurers’ ability to keep their promises, we will all lose a valuable financial planning tool - and the industry will lose credibility that has taken a century of generally reliable performance to build.

This is not the first time Lawsky made headlines for boldly pursuing a case of financial misbehavior. Last summer, Lawsky went after London-based bank Standard Chartered PLC, which he accused of violating American money-laundering laws and engaging in forbidden transactions with Iran. Though such lawbreaking is usually the domain of federal regulators, the fact that Standard Chartered’s U.S. operations are headquartered in New York gave Lawsky the leverage he needed to successfully oversee a settlement and the bank’s admission of wrongdoing - unusual for a financial institution settling with a regulatory agency.

Now Lawsky has turned his focus to insurance companies. Unlike most financial services, insurance is mainly regulated at the state, rather than federal, level. For decades, New York has had a reputation as one of the strictest and most forward-looking insurance regulators, to the point that I and my colleagues at Palisades Hudson consider it a plus if a company subjects itself to New York’s oversight.

After a year-long investigation, Lawsky concluded that some insurers are using transactions with their own affiliates to make themselves appear financially stronger. He asserts, and some companies have essentially conceded, that the use of so-called captives is enabling insurers to decrease the amount of capital they are required to hold without transferring any of the risk. Lawsky wrote that “The fact that certain insurers are inappropriately using shell games to hide risk and loosen reserve requirements is greatly troubling.” He called for the National Association of Insurance Commissioners and other state regulators to look into similar practices elsewhere, and for a nationwide moratorium on captive transactions until more information is uncovered.

NAIC’s president, Jim Donelon, questioned the need for a moratorium, saying he considered it “a knee-jerk position […] before the house is on fire.” (The logical response is that safety measures usually work best when implemented before an emergency.) He also said that a working group is already reviewing the use of captives. In the meantime, however, the NAIC and most other state regulators seem prepared to let the companies continue doing what they have been doing.

Yet Lawsky thinks the risk to policyholders and taxpayers is real, and there is ample reason to believe he is right. The recent environment of ultra-low interest rates is toxic to insurers, who must conservatively invest premiums they collect today in order to generate the money that will be used to pay claims decades from now. This sort of environment creates considerable pressure to reach for yield. Yet reaching for yield is likely to backfire when rates inevitably rise and the bond market gets pummeled, which is what has already happened - to a relatively small degree - in just the past two months.

Insurance companies did not create these hazards, and they do not have an easy task in trying to navigate them. But companies face a strong temptation to minimize their problems by taking financial and accounting shortcuts, because telling unpleasant economic truths is not good for policy sales. Just ask the people who bought underpriced long-term care insurance and the companies that sold it to them.

The companies engaging in captive transactions are, in essence, trying to insure themselves. That’s like starting a diet and claiming an immediate weight loss. You can say what you like, but your scale won’t believe you.

Lawsky and his peers are supposed to be the scale. If companies fudge the unpleasant truth about their financial strength or the security of their investments, state regulators are the ones who are supposed to call them on it. The fact that Lawsky is the only one doing so doesn’t mean he’s wrong.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book Looking Ahead: Life, Family, Wealth and Business After 55.

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