Regulators should halt approvals of life insurance deals that mask risk while watchdogs investigate past deals that allowed companies to shift liabilities, New York’s financial services overseer said in a report today.

Carriers in New York had $48 billion in “shadow insurance,” according to the report from Benjamin Lawsky, superintendent of the New York State Department of Financial Services. Lawsky has been investigating since July transactions that life insurers conduct with subsidiaries, known as captives.

Insurers use the captives to decrease the amount of capital they’re required to hold, Lawsky said in the report. The department said 17 New York-based firms use such transactions, without identifying them. The captives, which are typically based in other jurisdictions, are sometimes capitalized with letters of credit or intra-company guarantees, which can leave the parent responsible for claims if losses mount.

“The fact that certain insurers are inappropriately using shell games to hide risk and loosen reserve requirements is greatly troubling,” Lawsky said in the report. “Shadow insurance allows companies to divert reserves for other purposes besides paying policyholder claims.”

Lawsky said he’s requiring New York-based insurers to disclose more information about their use of the reinsurance arrangements and called on other regulators to do the same. He said the National Association of Insurance Commissioners and state watchdogs should conduct similar investigations, and there should be a moratorium on new captive transactions until those inquiries are completed. The NAIC had no immediate comment.

Riskier Collateral

Some states let insurers use riskier types of collateral to back the reinsurance captives, creating a “regulatory race to the bottom,” Lawsky said. Missouri, Delaware, Iowa, South Carolina, Nebraska and Vermont allow captives to be backed by letters of credit, according to the report.

In the U.S., Vermont had the most captives in 2012, followed by Utah and Delaware, according to the Insurance Information Institute.

The New York Times reported on Lawsky’s report late yesterday and asked SNL Financial to conduct a separate analysis of which insurers are using the arrangements. MetLife Inc. and Prudential Financial Inc., the largest U.S. life insurers, are among companies using the transactions, the newspaper said.

“Prudential uses captive reinsurance companies in our domestic insurance operations to more effectively manage our capital on an economic basis and to enable the aggregation and transfer of risks,” Bob DeFillippo, a spokesman for Newark, New Jersey-based Prudential, said in an e-mailed statement. “Our captives are capitalized to a level consistent with AA financial-strength rating targets.”

MetLife’s View

The contracts are a “cost-effective way of addressing overly conservative reserving requirements,” John Calagna, a spokesman for MetLife, said in an e-mail. “Alternative means of financing such reserves have drawbacks. Using equity could reduce returns to levels below those required by investors and issuing debt could negatively impact credit ratings.”

MetLife said last month it would combine an offshore reinsurer with three U.S. life units, in part to address regulatory concerns. Lawsky said at the time that MetLife’s move was a “step in the right direction as we seek to address the risks created by the shadowy world of ‘captive’ reinsurance.”

“The New York Department of Financial Services’ industry inquiry regarding captives was an important factor in our taking a closer look at our offshore reinsurance subsidiary,” MetLife Chief Executive Officer Steve Kandarian said in a May 21 presentation to investors.

MetLife advanced 1.2 percent to $44.99 at 9:40 a.m. in New York and is up 37 percent since Dec. 31. Prudential climbed 0.9 percent bringing its gain for the year to 34 percent.