Race to the Bottom in Insurance Regulation
If you liked the bankster strategy of persuading weak states to reduce regulation, and blackmailing strong states into following suit, you’ll love the version currently being played by giant insurance companies. At least the banksters had the Federal Reserve Board as a backstop. There is no real backstop for insurance companies.
One important goal for the race to the bottom is to reduce the reserves insurance companies are required to maintain. All states have rules requiring insurance companies to hold reserves calculated on a conservative basis so that policy holders can be confident that the company can pay off when the holder dies, gets sick, or has property damage from a car crash or a fire. Most states have adopted a standard method of calculating reserves, so that insurance companies can’t play one state off against another. Of course, this reduces the ability of management and shareholders to loot the company.
Vermont, one of the contestants in the race to the bottom, allows companies to evade reserve requirements by creating something called a “captive insurance company.” A captive insurance company has a restricted market. It either insures the company that set it up, or the customers of that company.
Think about Exxon. It is an enormous company, with thousands of employees and plants and equipment all over the world, and revenues bigger than most countries. It is like a little universe all to itself. It can self-insure. It sets up a captive insurance company to cover its risks of loss from property damage, explosions and so on. The captive insurance company figures out the premiums for normal losses, and Exxon pays those. The captive may make arrangements with an independent insurance company that will cover extraordinary losses.
The captive is located in a nation that doesn’t regulate much, one with puny reserve requirements, low or no taxes on income from investments, and low record-keeping requirements, like, for example, the Bahamas. This makes it possible for Exxon to lower its costs of insurance. Of course, with its revenue and its ability to tap financial markets for more money, the potential failure of the captive is not a serious concern.
That isn’t true of every company. The New York Times explains how the giant health insurance company Aetna, is using its Vermont captive:
Aetna recently used a subsidiary in Vermont to refinance a block of health insurance policies, reaping $150 million in savings, according to its chief financial officer, Joseph M. Zubretsky. The main reason is that the insurer did not need to maintain conventional reserves at the same level as would have been required by insurance regulators in Aetna’s home state of Connecticut.
That’s right, in Vermont, captive insurance companies have low reserve requirements. When they explain how to evade the reserve requirements, the useful idiot lawyers and PR people always come up with this kind of rationalization: the conservative stance of regulators can “… significantly restrict capital that otherwise would be available for such companies to engage in new business generation and diversification and consolidation transactions.” I’m sure the authors of that quote, from the law firm of Stroock & Stroock & Lavin, never considered another possible use of the money:
Three weeks after Aetna’s deal closed, the company announced it was increasing its dividend fifteenfold.
Aetna is betting that policyholders won’t care if it reduces reserves, increases dividends, and buys back its stock at the rate of $1.75 billion per year. (2010 10-K Item 5, p. 13). Policyholders are insured by a subsidiary, not by the parent company, Aetna, Inc. Each insurance subsidiary has to pay its policyholders out of its assets. Money can’t be easily moved between subsidiaries. Suppose one of Aetna’s subs evades the reserve requirements, guesses wrong in the financial markets, gets an unexpectedly large group of claims, and needs money to pay them. The only source of money will be the parent company.
As a holding company, Aetna, Inc. has little in the way of assets other than its ownership interest in its insurance and other subsidiaries. According to the 2010 10-K of Aetna, Inc., at 12/31/10, the current assets of the parent company totaled $723 million, and the current liabilities were $1.2 billion. The parent can’t meet its own obligations without sucking money out of its subs, let alone cover losses incurred by a sub.
There is no reason to think these insurance company executives know what they are doing, any more than the banksters did. As a nation, we did quite nicely for decades with conservative rules about insurance company finances, but what the hell, let’s throw the money away and hope for the best. It worked so well for the banksters.