IOWA CITY, Iowa – For cash-strapped life insurance companies, the deal sounds almost too good to be true: A state law allows them to create complex financial instruments to transfer liabilities to new subsidiaries, instantly wiping huge debts off their balance sheets.
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So-called "shadow insurance" agreements have exploded over the last decade, but a growing number of critics, including economists and consumer advocates, say the practice threatens the solvency of insurers and puts policyholders and taxpayers at risk.
In 2013, then-New York insurance regulator Benjamin Lawsky warned that the arrangements amounted to "financial alchemy" and were reminiscent of practices that contributed to the 2008 financial meltdown.
But these opaque instruments are not being concocted on Wall Street. They emerged in places like Cedar Rapids, Iowa, at the headquarters of TransAmerica Life, a subsidiary of the Netherlands-based Aegon NV, which was deemed one of nine too-big-to-fail insurers in the world by a global standards board last year.
"I think that the industry is headed for serious trouble with this," said Joseph M. Belth, a professor emeritus of insurance at Indiana University, who calls the practice "a shell game."
Belth has been seeking to force the Iowa Insurance Division to release documents related to eight shadow insurance subsidiaries that have been set up by TransAmerica and other companies under a 2010 state law that has encouraged the practice.
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Insurers say the arrangements — which they call captive reinsurance — are not risky but simply free them from 2001 accounting rules mandating that they hold excess cash reserves.
Some state insurance regulators have agreed with that argument and reject Lawsky's warnings, saying it is a responsible practice when done appropriately. The National Association of Insurance Commissioners has been working with members to oversee the deals and limit the risks.
TransAmerica spokesman Greg Tucker noted that group declined to ban such arrangements in 2014 after "careful consideration" and made few changes to the rules governing them.
Life insurers have been seeking more flexibility at a time when they are struggling to cover financial promises made to beneficiaries decades ago, when interest rates were far higher.
The system works like this: Insurers create wholly owned subsidiaries on paper that assume some of the company's liabilities. Those debts are transferred off the parent company's books, lowering the amount of capital reserves they are required to hold to pay off policies. That frees up cash that companies can use instead to pay dividends, make acquisitions and increase executive pay, all while shaving their federal tax bills.
The parent companies retain the risks because they grant their subsidiaries "guarantees" or "notes" promising to pay their debts. The details of those agreements are largely secret, making them impossible to analyze.
Iowa and a handful of other states have taken the lead in permitting the practice.
A paper published by the Federal Reserve Bank of Minneapolis in May found that U.S. life insurance and annuity liabilities ceded to shadow insurers grew to $364 billion in 2012 from $11 billion a decade earlier — or 25 cents of every dollar for companies that use them. The authors, Ralph Koijen and Motohiro Yogo, said the practice may reduce the price of life insurance policies by about 10 percent on average but also increases the risk of default.
The Office of Financial Research — an arm of the U.S. Treasury created after the 2008 financial collapse to analyze risks — called in a report earlier this year for more disclosure of the arrangements and additional requirements that they be backed by quality assets.
Belth is author of a consumer's guide to life insurance and former 40-year editor of The Insurance Forum, a monthly journal that ceased publication in 2013. He has been seeking copies of the promises that insurers made to their Iowa subsidiaries and other documents under the open records law. He says the records would show just how risky they are, saying the information should be available to policyholders, shareholders and taxpayers.
Iowa Insurance Commissioner Nick Gerhart has denied his requests, saying the documents are part of insurers' "plans of operation," which are confidential under Iowa law. Gerhart has argued that his staff routinely examines the transactions to ensure they are sound, and that Iowa has been more transparent than other states by releasing the subsidiaries' financial statements online every year.
After reviewing those statements, Koijen and Yogo found that six of the eight subsidiaries created in Iowa "have significant negative equity under statutory accounting" — meaning their assets are worth less than their liabilities under traditional insurance industry standards.
Belth said he got interested in Iowa's practices two years ago, when Bellevue, Washington-based Symetra Life Insurance Company announced it was moving its legal headquarters to Iowa "to take advantage of the state-of-the-art statutes and regulations governing the life insurance industry in Iowa." Symetra has since set up one of the shadow insurers in the state, but its size pales in comparison to those created by TransAmerica.
TransAmerica has set up one subsidiary that carries a "parental guarantee" of more than $2 billion and a second that has a "credit linked note" worth $924 million. Under traditional accounting rules for the industry, insurers could not count those as assets but Iowa has permitted them.
Belth said that he's trying to shine a light on a practice that should not be confidential.
"What's the secret? They don't want this discussed. I think that is the bottom line," he said.