Yesterday, I explained how captive insurance companies are supposed to work.  They serve as a means to minimize the risk, but don’t leave policyholders without any recourse- or, in the case of our firms, any potentially harmed folks without any chance to recover damages.  Today, I will explain how this process is being subverted- these captives are being formed to rip off the public.

You don’t believe me?   Let’s consider life insurance companies. State insurance agencies want to be sure that life insurance funds are invested in safe entities- because they need to be able to pay out when their policyholders die. So, the regulators expect the funds to be held in bonds, because they are generally safe, so the benefits can be paid in a timely fashion.

Enter Athene.  A life insurance company with plenty of policy holders.  But, Athene is owned by a conglomerate- Apollo Global Management.  Which also owns some hotels in Las Vegas, including Caesars.  Which is hemorrhaging cash.

So, Apollo goes to the Nevada Gaming Commission, which gives not a hoot about the safety of funds for life insurance policy holders.  It, therefore, lets Apollo put up Athene’s assets to bolster Caesars.  Except Caesars went bankrupt.  Guess who is going to feel the pain?

This is just part of the problem.  Because life insurance companies are now world-wide entities, employing complex instruments that few comprehend.  (Does it remind you of the banking fiasco that led tot he Great Recession?) These companies are also public entities, which means the shareholders feel they are far more important than those who give their cash to the companies for insurance.   (Isn’t that what Athene just did?)

After all, the stockholders wonder why they need all these cash reserves.  They don’t care about the policyholders and the promises they were made.   And, as time goes on, the state regulators are relenting and granting waivers from what has heretofore been called ‘statutory accounting’.   You think that name was developed lightly?  Only if you are a shareholder and not a policyholder.

That’s where these captive reinsurance entities fall.  In those waivers from ‘statutory accounting’.  So, let’s explain what really happens.  It’s NOTHING like the captive insurance company we ran.

Company X sells life insurance policies.  These policies are really long-term obligations.  The insurance company promises to pay the policyholder money at some future date.  Ok, not the policyholder generally, since s/he will be dead- but the children and/or the spouses of the policy holders.

But, company X now coalesces a bunch of these long-term obligations into a wholly-owned subsidiary.  (The captive is called Subsidiary 1 in the above diagram.)  This means the captive has “reinsured” the obligations.  Company X no longer has the obligation to pay anybody anything.  The captive does.  So, company X has no obligation to guarantee the debt of the obligations with the lower yielding bonds.   And, it only transferred 1/2 as much of the assets it was using to secure the life insurance policies as it should have.

And, then Company X forms a second subsidiary.  Which takes in a loan from the newly formed subsidiary and, in turn, provides a loan to the subsidiary for the same amount of money.

You see, the risk really never changed anywhere.  Since the captive is wholly owned by Company X.  And, that loan that Subsidiary 2 gave Subsidiary 1 and vice versa only created paper assets.  No money changed hands, there is no real asset growth to cover the obligations.  All that happened is that the public was fooled.  (Kind of like cleaning your house by sweeping the dirt under the rug.)

And, now Company X can pay dividends to its shareholders, since they have no obligation (lien) on those funds it had to guarantee the life policies.  (Remember, it only transferred half the assets that were necessary [via statutory accounting] to guarantee the life policies it transferred.)

And, now, Company X is free to sell that captive.  Often,  the purchaser typically takes the reserves from the captive to pay Company X for the right to own the subsidiary.  Leaving the captive with even less money.  So, Company Y now owns the captive and has little capital, Company X is swimming in cash with no obligations, and the policy holders are up the creek without a paddle.

(This may sound hypothetical- but Apollo and Athene did just this when they acquired Aviva USA, which was dumped by the British insurance firm, Aviva.)

What is really happening is the insurance company looks really good on paper, because it is backed by IOU’s.  Lots of them.  But, no cash.  Which is what it needs when the policy holders die.

And, you thought the pensions and the banking crises were a mess…