Disclosure of captive exposures to certain long-term and universal life insurance policies has improved among life insurers, but it has also revealed additional problems, according to Moody’s Investors Service.

Although it is helpful to have more information on assets held to support XXX/AXXX reserves, as they are known, there is too little information on the underlying financial arrangements, making risk assessments challenging.

The better disclosure, mandated by the National Association of Insurance Commissioners (NAIC), has revealed sizable industry and company exposures, which are credit negative, Moody’s said.

Laura Bazer, vice president and senior credit officer at Moody’s, said: “About 80 percent of total 2015 reinsured XXX/AXXX reserves went to captives, rather than to third-party reinsurers, improving regulatory capital ratios, even though no risk has left the house.”

At the end of 2015, XXX/AXXX business in captives was highly concentrated, with 10 US insurance groups accounting for 80 percent of the industry’s total reinsurance exposure.

Although regulatory “grandfathering” of all pre-2015 business limits recapture risk, stress event-driven recapture could still put pressure on regulatory capital ratios.

In 2015, 50 percent of ‘grandfathered’ captive XXX/AXXX reserves in the life insurance industry were also economic. This means the other 50 percent were excess or redundant. According to Moody’s, these redundant reserves were financed with soft assets such as letters of credit.

Bazer said: “Economic reserves are those that life insurers deem necessary to cover expected benefit claims under their XXX/AXXX policies.”

According to Moody’s, if economic reserves are set too low, insurers can be exposed to reserve charges, if interest rates, or policyholder behaviour, turn out to be different from what was originally assumed. On top of this, soft assets are typically less available to support claims in stress scenarios.

From 2017, implementation of the NAIC’s principles-based reserving rules for XXX/AXXX captive financing, plus the implementation of new principles-based reserving methodology, could reduce reserve redundancies.

Moody’s suggested this means the need for captives could potentially diminish.

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