Since the New York State Department of Financial Services ("DFS") began operations in late 2011, the agency appears to have lived up to its billing as an activist regulator of insurers and financial institutions. DFS has taken on several novel issues and will likely continue to do so. Insurers and financial institutions doing business in New York should keep DFS on their radar given the scope of its regulatory mandate and its initial enforcement activities since inception. Institutions outside New York may also want to monitor DFS's initiatives, which may pique the interest of federal or state law enforcement and regulatory agencies in other jurisdictions and lead to similar or parallel initiatives.
DFS's Actions Since Inception
On October 3, 2011, the former New York State Banking and
Insurance Departments were combined to create DFS.1 The
4,400 entities DFS supervises have about $6.2 trillion in assets
and include all insurance companies in New York, all depository
institutions chartered in New York, the majority of United
States-based branches and agencies of foreign banking institutions,
mortgage brokers in New York, and other financial service
providers.2
Since October 2011, DFS has announced several notable enforcement
actions. Most recently, DFS entered into a settlement concerning
the so-called force-placed insurance industry, which DFS began to
investigate in October 2011. Force-placed insurance, also known as
lender-placed insurance, is insurance that a bank, lender, or
mortgage servicer places on a property that does not have the
coverage required by the mortgage.3 Lenders typically
obtain force-placed insurance to replace coverage that the borrower
has allowed to lapse or to supplement coverage the bank or mortgage
servicer determines is insufficient. After its investigation, DFS
claimed that the premiums borrowers pay for force-placed insurance
can be two to 10 times higher than premiums for voluntary insurance
and typically provides less protection. The borrowers pay the costs
of the higher premiums, and investors in residential
mortgage-backed securities may in turn bear the costs if a
foreclosure occurs. In March 2013, DFS settled with the
country's largest force-placed insurer over DFS's claims
that homeowners had been overcharged for force-placed
insurance.4
Shortly after the settlement was announced, the Federal Housing
Finance Agency ("FHFA"), which oversees Fannie Mae and
Freddie Mac, filed a notice prohibiting the payment of fees or
commissions by insurers for force-placed insurance.5 The
notice states that the FHFA considers force-placed insurance to be
"contrary to prudent business practice, to appropriate
administration of Fannie Mae and Freddie Mac [] guaranteed
loans" and exposes Fannie Mae and Freddie Mac to
"potential losses as well as litigation and reputation
risks." A large portion of the costs for unpaid insurance are
passed onto Fannie Mae and Freddie Mac.6
After the announcement of the settlement with the force-placed
insurer, DFS's Superintendent, Benjamin W. Lawsky, sent a
letter to other state insurance commissioners pressing them to
pursue the same investigative and enforcement steps DFS had taken
in the force-placed insurance industry. Recent public remarks by
Superintendent Lawsky indicate that he believes any successful DFS
initiatives can be a model for the investigation and prosecution of
similar issues by other federal and state prosecutors and
regulators. In the Superintendent's words, "[a] dose of
healthy competition among regulators is helpful, and necessary, to
preserve the safety and stability of our financial
sector."7 In Lawsky's view, DFS's work
should be understood in the context of three types of federalism:
(i) "cooperative federalism," (ii) "persuasive
federalism," and (iii) "coercive
federalism."8 As Lawsky frames it, cooperative
federalism occurs when a state regulator works closely and in
collaboration with other federal and state regulators.9
Persuasive federalism arises when state regulators lead by example,
as with the force-placed insurance settlements that DFS
achieved.10 In Lawsky's view, DFS should resort to
coercive federalism when it believes it must take more significant
action before other regulatory agencies.11
DFS's Focus in 2013
DFS Superintendent Lawsky has outlined in recent public statements three new issues that DFS will focus on this year: (i) ownership of insurance companies by private equity firms, (ii) captive insurance companies, and (iii) monitors.12
Ownership of Insurance Companies by Private Equity
Firms. In the coming months, DFS will investigate
investments made by private equity firms in insurance companies,
particularly those that write annuity policies. DFS has found that
ownership of insurers by private equity firms has grown
dramatically over the past year. According to DFS, private
equity's rapid growth in the insurance field may in part be due
to the fact that certain regulations for insurance companies are
not as strict as those for banks. Superintendent Lawsky has
expressed the opinion that private equity firms can be unreasonably
aggressive with risk and use significant leverage to maximize
profits in a relatively short time frame. He believes this approach
is at odds with the long-term outlook of annuity policy holders and
could put them unnecessarily at risk. Moody's Investors Service
also identified this as a potential issue in a recent research
report.13
Captive Insurance Companies. In the typical
captive insurance arrangement, a non-insurance parent company
creates and owns a "captive" to insure the parent's
risk.14 Recently, some insurance companies have created
special purpose vehicles that act as captives for the purposes of
reinsurance, securitization, or reserve financing
purposes.15
DFS began investigating the captive insurance industry in July
2012 when it sent letters to about 80 life insurers requesting
information on their financial arrangements with captive insurance
companies.16 Superintendent Lawsky has said he is
concerned with how insurers are using captive insurance companies
to move billions of dollars in liabilities to offshore
entities—most commonly to Bermuda or the Cayman
Islands—or to states where the insurer is not
based—most commonly Vermont.17 He argues that what
he describes as a "shadow insurance" industry is putting
the greater financial industry at risk. He further asserts that
insurers use the reserves they have moved offshore for other
purposes, even though the parent company may be a guarantor and
therefore liable for any claims on reserves that have been diverted
to other jurisdictions.
DFS is not the only agency investigating how reserves are being stored in captives. The National Association of Insurance Commissioners and the Federal Insurance Office are also examining the issue.18
Monitors. Monitors or consultants are
periodically placed in a bank or insurer to ensure that the entity
is complying with a regulatory or prosecutorial order or agreement.
Because such monitors are hired and paid by the entities they are
charged with monitoring, Superintendent Lawsky sees potential
conflicts of interest. He believes that regulators should more
actively manage monitors and that communications between monitors
and regulators should improve.
Conclusion
Given DFS's aggressive posture, its willingness to examine new
issues, and its desire to establish precedents for other regulators
and prosecutors to follow, banks, insurers, and other financial
institutions—both in and outside New York—should keep
DFS and its activities in view. In particular, given the particular
subjects Superintendent Lawsky has stated will be a focus for DFS
this year, private equity firms with certain insurance investments
should be prepared to respond to DFS regulatory inquiries
concerning whether their investment objectives are consistent with
the interests of policy holders. In addition, banks and other
financial institutions should be prepared to answer inquiries about
the independence of any monitors or similar consultants affiliated
with their organizations.
Footnotes
1.For a fuller discussion of the creation of DFS and its powers, please see our December 2011 Jones Day Commentary, "The Department of Financial Services: New York's Newest Financial Regulator" (available at http://www.jonesday.com/department_of_financial_services/.
2.DFS web site, http://www.dfs.ny.gov/about/staff_bios/blawsky.htm (last visited May 8, 2013).
3.Press Release, DFS, Mar. 21, 2013.
4.Id.
5.Lender Placed Insurance, Terms and Conditions, 78 Fed. Reg. 19263-64 (Mar. 29, 2013).
6.Alan Zibel and Leslie Scism, "U.S. Cracks Down on 'Forced' Insurance," Wall St. J. (Mar. 26, 2013).
7.Evan Weinberger, "New York Bank Regulator To Examine Compliance Consultants," Law360 (Apr. 18, 2013).
8.Elizabeth D. Festa, "NY doubles down on captives, private equity firm scrutiny," LifeHealthPro (Apr. 18, 2013) (available at http://m.lifehealthpro.com/2013/04/18/ny-doubles-down-on-captives-private-equity-firm-sc).
9.Id.; Benjamin M. Lawsky, "Regulating in an Evolving Financial Landscape," The A.A. Sommer, Jr. Lecture at Fordham Law School, Apr. 18, 2103.
10.Id.
11.Id.
12.Lawsky, supra note 9.
13.Darla Mercado, "Private-equity jumping into annuities could be bad news for insurers," InvestmentNews, Jan. 29, 2013 (available at http://www.investmentnews.com/article/20130129/FREE/130129941#).
14.National Association of Insurance Commissioners web site, Captive Insurance Companies, http://www.naic.org/cipr_topics/topic_captives.htm (last updated Dec. 19, 2012).
15.NAIC Captives and Special Purpose Vehicle Use Subgroup of the Financial Condition Committee, Captives and Special Purpose Vehicles, NAIC Draft White Paper, Mar. 14, 2013, at 8 (available at http://www.naic.org/committees_e_cspv_sg.htm).
16.Leslie Scism and Serena Ng, "Regulators Probe 'Captives'," Wall St. J. (Aug. 5, 2012).
17.Lawsky, supra note 9; National Association of Insurance Commissioners web site, supra note 14.
18.Elizabeth Festa, "Leonardi critical of FIO's new captives task force," LifeHealthPro, Mar. 17, 2013 (available at http://www.lifehealthpro.com/2013/03/17/leonardi-critical-of-fios-new-captives-task-force).
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