How should regulators address the risks associated with so-called “shadow insurance?” What about the uptick in private equity activity in the insurance industry, the growing numbers of cyber-attacks on banking institutions, and the emergence of bitcoin and a host of other virtual currencies?
These are just a few of the topics being addressed by Superintendent for the New York State Department of Financial Services (DFS) Benjamin Lawsky. As the regulator who oversees the insurance, banking and money transmission activities in the state of New York, he clearly has an active agenda.
Lawsky was appointed to his post by Gov. Andrew Cuomo after the organization was formed in 2011 by the merger of the New York State Banking Department and the New York State Insurance Department. He is perhaps best known for a $340 million settlement he concluded with Standard Chartered Bank last year related to the U.K. bank’s money laundering activities. More recently, he has garnered headlines for establishing new reinsurance requirements in New York and for launching a probe into the activities of Bitcoin and more than 20 other startup virtual-currency providers including Bitinstant, Coinbase and Coinsetter.
Lawsky’s activist, regulatory stance at DFS tends to elicit differing reactions from the public. Some view him as an assertive and right-minded regulator doing his best to right wrongs and reduce the risks that have emerged in the aftermath of the financial crisis. Others see him as a self-serving publicity seeker outshining the Feds but, to his credit, demanding and winning larger financial settlements for wrongdoing than his counterparts in Washington, D.C. Some have even made comparisons to former New York Gov. and Attorney General Elliot Spitzer, known for his steamrolling management style.
But whatever the point of view, there can be no doubt that Lawsky, a 43-year-old former prosecutor, is shaking up the financial and insurance industry regulatory landscape, both in New York and on a national level.
Shadow Insurance
Take, for example, his recent push to tackle the dangers of what some have referred to as “shadow insurance,” where life insurance firms create subsidiary captive entities—often in another state or abroad—that take reserves originally set aside to pay policyholder claims and divert them for other purposes, such as potentially risky investments. At a public breakfast for the business community in New York this summer, Lawsky described this as an example of insurers “juicing their underlying numbers.”
In June, after a year-long investigation, Lawsky’s office issued a report entitled “Shining a Light on Shadow Insurance,” which showed that 17 life insurance carriers in New York had diverted significant reserves—upwards of $48 billion—for purposes other than paying policyholder claims. Lawsky said this activity “puts the stability of the broader financial system at greater risk.”
He is now requiring New York-based life insurance firms to provide more information about their reinsurance arrangements and is calling for a moratorium on these activities in the state until inquiries are completed. He has also called upon the National Association of Insurance Commissioners to conduct similar investigations.
In response to the DFS report, the American Council of Life Insurers defended the transactions in a statement: “Captive reinsurance transactions provide life insurers a means to spread the risks they assume. They also enable life insurers to deploy capital efficiently and, in turn, help them set prices as competitively as possible. Captive reinsurance transactions represent an important and positive element of a competitive life insurance marketplace and are, without exception, reviewed and approved by regulators.”
Private Equity and Insurance Company Acquisitions
Other risks on Lawsky’s agenda include the growing number of instances where private equity firms are active in the acquisition of annuity and insurance companies. His office has reported that private equity-controlled insurers now account for nearly 30% of the indexed annuity market, up from 7% a year ago, and 15% of the total fixed annuity market, up from 4% a year ago. He is calling for extra scrutiny of the risks that can occur when private equity firms acquire insurers.
Speaking at the breakfast, Lawsky pointed out that private equity firms and their shorter-term strategies for maximum returns have a totally different risk model than those of life insurers that are in the business of making sure that retirement benefits are there for policyholders in the long term. The former are better known for their aggressive risk-taking and high-leverage practices. According to Lawsky, the acquisition trend does not appear to be a good recipe for the protection of policyholder interests.
“We are not saying that such deals can never happen,” Lawsky said. “We are looking at putting guard rails in place and are working closely with a number of these [private equity] firms.” Among the players in this sector are entities such as Apollo Global Management, Goldman Sachs, Guggenheim Partners and Harbinger Group.
Indeed, in August, the Athene Holding unit of Apollo reached a deal with DFS to implement heightened capital standards as part of its $1.8 billion purchase of Aviva’s U.S. life and annuity business. Athene agreed to set up a fund with $35 million to cover the Aviva unit’s financial obligations in New York. It will also seek written approval for any changes in dividends or reinsurance. The agreement “will help better protect retirees and others receiving annuity payments,” Lawsky said in a statement.
Similarly, in July, Lawsky approved the sale of Sun Life Financial’s annuities unit for $1.35 billion to a firm associated with private equity firm Guggenheim Partners only after certain steps were taken. In response to DFS concerns, Guggenheim agreed to heightened capital standards, enhanced regulatory scrutiny and the creation of a “backstop” trust account designed to safeguard policyholder claims.
Cybersecurity Concerns
Growing instances of cyberattacks on U.S. banks also appear to be on Lawsky’s radar. In the past year, hackers have blocked or slowed down access to the websites of major banks on more than one occasion. In response, 50 financial institutions participated in a simulated cyberattack in July to improve their response capabilities.
DFS is actively working to protect customers of banks and insurance companies from the larger system threats caused by cyberterrorism and computer hacking. One critical development is the establishment of the Cyber Security Advisory Board for New York, designed to advise the state government on cybersecurity issues. The board is co-chaired by Lawsky and Elizabeth Glazer, deputy secretary to the governor for public safety. The board also includes Richard Clarke, who has served the last three presidents as a senior White House advisor on cybersecurity issues; Shawn Henry, who previously oversaw the FBI’s criminal and cyber programs and worldwide investigations; and Will Pelgrin, former director and chief cybersecurity officer of the New York State Office of Cybersecurity and Critical Infrastructure Coordination.
Lawsky has said that, while large banks are addressing the issue of cyberattacks, smaller banks and insurance institutions are often the ones most at risk. Therefore, he is reportedly considering creating a structure for larger banks to help smaller ones block cyberattacks and disruptions.
The upside to all this is the “huge boom” in the cybersecurity field, with growing numbers basing their operations in New York. “We think it would be great for cybersecurity firms to form a hub here in New York,” Lawsky said.
Virtual Currency Protection
In August, Lawsky’s office issued subpoenas and launched a probe of 22 virtual currency providers, including Bitcoin, the best known of the many players in the fast-growing sector. In light of DFS’ responsibility as a licenser of money transmission firms in New York, the investigation will look into whether or not these new types of money-transmission firms are facilitating money laundering and what, if any, consumer protection measures need to be taken.
“We are trying to upgrade DFS to bank regulation 2.0,” Lawsky said. He added that “we are acting quickly” in an effort to keep up with all forms of financial innovation.
But how does Lawsky justify his recent regulatory efforts, which sometimes overshadow the federal government’s activities? As he explained in an April presentation at the Ford Foundation in New York at the 22nd Annual Hyman P. Minsky Conference, in the wake of the financial crisis, regulators and others are building the new architecture of a reformed Wall Street. And while regulators in Washington have made important progress implementing critical reforms, the rules of the road are not yet fully written.
As a result, there will remain “a constant push and pull between regulators and the financial industry as market participants adjust,” Lawsky said.
According to the superintendent, the public can expect “healthy competition in financial regulation,” with newer regulators such as DFS collaborating with their federal partners—the U.S. Treasury Department, the FDIC and the Federal Reserve—but also aiming to be nimble, agile and fresh in their look at issues across the financial industry.
“We’re the new regulator on the block,” Lawsky said. “DFS isn’t necessarily wedded to existing ways of doing business. Sometimes this means DFS may be out in the lead on a particular issue.”
But his goal is that the department’s efforts will result in better regulation, greater confidence in the integrity of banks and insurers, and more business for the state of New York.