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Putative class action in the Southern District of New York challenges use of ‘shadow insurance’

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 23 April 2014 complaint — filed by plaintiffs’ counsel Perkins Coie — is the first of its kind and draws heavily from a June 2013 New York Department of Financial Services (NYDFS) report that criticised 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 per cent 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 It is unclear whether putative class members’ policies would also be rescinded and far less clear whether such rescission would actually serve the putative class policyholders’ long-term interests.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 individualised nature of the life insurance sales process…

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