A Regulator Calls It Like He Sees It

Financial regulators are a lot like umpiring baseball games. It is not easy work and you won’t win many friends if you do it well.

Benjamin Lawsky isn’t a very popular man these days as New York’s Superintendent of Financial Services.

Lawsky is being a very good financial regulator. Being a good financial regulator means being able to anticipate problems before they become calamities. A bad regulator, which there are many, is one that focuses on trivia and follows the bureaucratic crowd. Then, they look for blames when things go wrong.

Lawsky’s counterparts in regulatory jurisdictions across the globe will no doubt view him as a publicity hound. His regulators likely view him as a micromanager with a heavy hand. These assessments may have some truth, but that doesn’t necessarily mean Lawsky isn’t doing his job.

Lawsky recently wrote about how some life insurance companies make themselves appear stronger than they really are. This is a disaster waiting for both the industry and consumers. A promise is all that an insurance policy can be. It cannot be stronger than the company making the promise, and the government structures meant to keep those promises. We will all lose valuable financial planning tools if the public loses trust in the ability of insurers to keep their promises. This will also mean that the industry’s credibility will be shaken up after a century of reliable performance.

Lawsky isn’t the first to make headlines for his bold pursuit of a case involving financial misbehavior. Lawsky took on Standard Chartered PLC in London last summer. He accused them of violating American money laundering laws and engaging with Iran-prohibited transactions. Although such lawbreaking is normally the domain of federal regulators but Standard Chartered’s U.S. operations are headquartered at New York gave Lawsky enough leverage to oversee a settlement. Lawsky also admitted wrongdoing – something that is rare for a financial institution settling with a regulatory body.

Lawsky now focuses on insurance companies. Insurance is not regulated at the federal level like most financial services. New York has been known for being a progressive and strict insurance regulator for decades. This is why I and my Palisades Hudson colleagues consider it a plus when a company submits itself to New York’s scrutiny.

Lawsky conducted a year-long investigation and concluded that some insurance companies are making financial gains by using transactions with their affiliates. Lawsky asserted that captives allow insurers to reduce the capital they need to hold while not transferring any risk. This is something some companies have already admitted to. Lawsky stated that it was troubling that some insurers use shell games to conceal risk and reduce reserve requirements. (1) Lawsky called on the National Association of Insurance Commissioners (and other state regulators) to investigate similar practices in other countries and for a nationwide moratorium regarding captive transactions until more information can be uncovered.

Jim Donelon (president of NAIC) questioned the necessity for a moratorium. He said he thought it was “a knee-jerk […position] before the house is set on fire.” (2) (The logical answer is that safety measures work best when they are implemented before an emergency. A working group was also discussing the use of captives. The NAIC and other state regulators appear to be willing to allow the companies to continue doing the same things they are doing.

Lawsky believes the risk to taxpayers and policyholders is real. There is plenty of evidence to support his belief. Insurers are now faced with a toxic environment, where ultra-low interest rates have made it difficult for them to invest the premiums they collect to make sure that they can pay their claims in decades to come. This environment puts a lot of pressure on insurers to seek yield. However, reaching for yield can backfire when rates invariably rise and the bond markets get pummeled. This has happened already – to a very small extent – in the past two months.

These hazards were not created by insurance companies, nor is it easy for them to navigate. Companies are tempted to reduce their problems by using financial and accounting shortcuts. This is because it can be detrimental for policy sales. Ask the people who purchased low-cost long-term care insurance, and the companies that sold it.

Captive transactions are essentially a way for companies to insure their employees. It’s similar to a person trying to lose weight by going on a diet. Your scale will not believe you, even if you say all you want.

Lawsky and his colleagues are supposed to keep the scale. State regulators will call companies to expose the truth about financial strength and security of investments. Lawsky may be the only one doing this, but that doesn’t make him wrong.