S.D.N.Y. Dismisses Plaintiffs' 'Shadow Insurance' Class Action Claims

On July 21, 2015, a federal judge granted AXA Equitable Life Insurance Company's motion to dismiss claims brought against it by insureds who alleged that AXA violated New York law by engaging in various "shadow insurance" transactions. The Southern District of New York concluded that the plaintiff insureds failed to demonstrate that they had suffered a concrete injury-in-fact and therefore concluded that they could not satisfy the standing requirements of Article III of the Constitution. Thus, without subject-matter jurisdiction, the court dismissed the case. The decision is a positive bellwether for the life insurance industry, which has faced increasing scrutiny in recent months from regulators and the press regarding the propriety of certain captive reinsurance arrangements.

"Shadow Insurance"

The term "shadow insurance" has been used by various regulators, particularly in New York, to refer to the practice of using captive reinsurance companies, often domiciled in jurisdictions with relatively lenient capital reserve requirements, to transfer insurance risk off of the ceding insurer's books and allow the ceding insurer to free up assets for higher-return investments.

For example, suppose that Life Insurer A would like to increase its profitability by increasing its investment returns on its capital assets — i.e., the premiums that it has collected, a portion of which will ultimately be needed to satisfy insureds' claims. Life Insurer A sees that it can obtain greater returns through a certain investment that does not satisfy its state regulator's "admitted assets" rules governing Risk Based Capital ratios. In order to free up assets currently held in reserve, Life Insurer A's parent establishes Captive Reinsurer B in a jurisdiction with low reserve requirements, and the latter reinsures Life Insurer A. Through this captive reinsurance transaction, Life Insurer A reduces its exposure to future claims, allowing it to take a reserve credit toward the amount of assets that Life Insurer A's state regulator requires it to maintain in reserve.

On April 27, 2015, the New York Department of Financial Services (DFS) sent a letter to U.S. Senator Sherrod Brown to draw attention to what the DFS characterized as "shadow insurance" in the life insurance industry. DFS called these types of arrangements "financial alchemy" and "shell games" that do not actually transfer risk away from the ceding insurer because, according to the DFS, in many instances...