• Putative Class Action in the Southern District Of New York Challenges Use of "Shadow Insurance"
  • May 2, 2014
  • Law Firm: Dentons Canada LLP - Toronto Office
  • A new putative class action suit filed in the Southern District of New York alleges that the use of so-called "shadow insurance" transactions violates New York Insurance Law Section 4226(a)(4), which prohibits insurers from making "any misleading representation, or any misrepresentation of the financial condition of any such insurer or of the legal reserve system upon which it operates."

    The April 23, 2014 complaint - filed by plaintiffs' counsel Perkins Coie LLP- is the first of its kind and draws heavily from a June 2013 New York Department of Financial Services (NYDFS) report that criticized the use of "shadow insurance" by New York life insurers. Known more formally as "captive reinsurance," the practice involves reinsurance of a subset of an insurer's existing policies through a wholly owned subsidiary rather than through a third party. These subsidiaries are typically located outside of New York in jurisdictions with less stringent reserve and capital requirements. According to the National Association of Insurance Commissioners (NAIC), captive reinsurers underwrite more than 25 percent of reinsurance policies in the US life insurance industry.

    The complaint alleges that the use of captive reinsurance resulted in misrepresentations about the insurer's exposure to the risk of financial loss, its financial condition and its reserve system. Relying on a section of the New York Insurance Law that governs ethical sales practices, the class action plaintiffs seek a statutory penalty in the amount of all premiums paid by class members for life insurance policies in effect during the class period. It is unclear whether putative class members' policies would also be rescinded and far less clear whether such rescission would actually serve the putative class policyholders' long-term interests. It is equally unclear how the class representatives plan to show reliance on a class-wide basis given the individualized nature of the life insurance sales process.

    This lawsuit and the June 2013 NYDFS report highlight growing concerns about the use of captive reinsurance by a number of life insurance companies. At the 2014 NAIC Spring National Meeting, commissioners from New York and California expressed their inclination to impose moratoriums on all captive reinsurance transactions. Other commissioners supported less radical changes, such as new rules to require holding of additional hard assets, approval of the quality of assets used to support reinsurance credit, public disclosure and different risk-based capital calculations.

    The case is pending before the Hon. Jesse M. Furman.