The Loop Within The Loop: How Danish Banks Use Insurers To Mask Capital Strain

In the world of finance, where optics often compete with fundamentals, few systems embody the illusion of strength as effectively as Denmark’s bancassurance model. Behind a façade of robust capital positions and reliable profitability, some of the country’s most prominent financial groups are leveraging their insurance subsidiaries to obscure underlying strain. This “loop within the loop” — involving reciprocal shareholdings, deferred liabilities, and cross-entity income flows — has created a structural opacity that poses serious questions about financial transparency and regulatory oversight.

As scrutiny from investors and regulators intensifies, Denmark’s bancassurance architecture may soon face demands for reform. But for now, it remains a sophisticated method of managing appearances in an increasingly volatile financial landscape.

A Unique Bancassurance Blueprint

The bancassurance model — whereby banks and insurers collaborate to distribute financial products — is common across Europe. However, the Danish version includes distinct accounting and ownership practices that make it uniquely problematic.

In several major Danish financial groups, banks own controlling stakes in insurance companies, which in turn hold substantial investments back into the banking entity. These cross-holdings are sometimes structured through equity stakes, hybrid capital instruments, or long-term intra-group receivables. The result is a closed-loop of capital that allows banks to present artificially strong equity buffers while maintaining full control over the risks being offloaded.

This interlocking structure has proven particularly effective in allowing institutions to meet regulatory capital thresholds — not by raising new equity or reducing risk, but by shifting liabilities and inflating group-level income.

How the Accounting Loop Operates

The core mechanism is relatively straightforward, though its financial implications are anything but.

1. Circular Ownership: The bank owns the insurer, and the insurer, in turn, holds equity or subordinated debt in the bank. While technically distinct legal entities, the group reports consolidated earnings that benefit from both sides of the loop.

2. Deferred Liabilities: Future profit expectations from insurance operations are often capitalised or used to justify lower risk weightings. This may include fee income from policy sales, assumed persistency of insurance premiums, or expected investment returns from policyholder funds.

3. Synthetic Capital Creation: The bank’s capital position is effectively enhanced through claims on the insurer — which itself depends on the bank’s performance. In economic terms, the risk has not been transferred, only internally cycled.

4. Risk Displacement Without Real Transfer: In several cases, liabilities such as pension obligations, long-dated guarantees, or even impaired loans are shifted into the insurance entity. Although this relieves the bank's balance sheet, the ultimate risk remains within the group.

Spotting the Loop: What the Numbers Reveal

While such structures are often legal and comply with both Danish and EU reporting standards, they create a misleading impression of resilience. Analysts who dig into the footnotes of annual reports often find recurring red flags:

• Unusually High Intra-Group Receivables: These often represent internal capital injections or synthetic instruments treated as equity under local rules.

• Consistent Group Profitability Despite Insurance Losses: Group profits are maintained via transfer pricing or internal revenue recognition, even when insurance operations underperform.

• Opaquely Disclosed Risk Sharing: Complex reinsurance or back-to-back guarantee structures blur the actual economic exposure borne by each entity.

These features are not merely theoretical. Several mid-sized and large Danish financial groups have been observed using these mechanisms, prompting concerns from external credit analysts and institutional investors.

Regulatory Gaps and Oversight Limitations

The Danish Financial Supervisory Authority (Finanstilsynet) maintains that its regulatory framework adheres to the EU’s Capital Requirements Regulation (CRR) and Solvency II. However, critics argue that compliance with the letter of the law may come at the expense of its spirit.

Under Solvency II, insurers are required to hold sufficient capital to back long-term liabilities. Yet when owned by a banking parent that also benefits from insurance income streams, the distinction becomes blurred. Similarly, the CRR allows for partial deduction of intra-group holdings under specific exemptions, enabling circular capital structures to persist.

The European Banking Authority (EBA) and European Insurance and Occupational Pensions Authority (EIOPA) have both raised concerns in recent years about intra-group complexity, but Denmark’s model remains largely unchallenged at the EU level.

Systemic Risks and Broader Implications

There are several reasons this matters.

First, financial stability: in the event of a shock — such as a sharp rise in interest rates or a fall in asset values — the artificial strength portrayed in group balance sheets may unwind quickly, revealing undercapitalisation.

Second, market confidence: investors who believe they are buying into well-capitalised firms may discover the underlying capital is neither liquid nor independent, but tied up in reciprocal exposures.

Third, regulatory consistency: if one member state permits structural opacity, others may follow. The risk is a regulatory race to the bottom that undermines EU-wide prudential standards.

Conclusion: A Structural Time Bomb or Manageable Quirk?

The use of insurers by Danish banks to shift liabilities and enhance capital metrics is not a new practice, but it is one that is becoming increasingly difficult to justify in a post-crisis regulatory climate. While some argue that these structures offer legitimate flexibility in capital planning, others view them as a form of regulatory arbitrage that obscures risk and undermines transparency.

With economic conditions tightening and scrutiny intensifying, Danish regulators may soon face pressure to close the loop — not just in accounting terms, but in the broader sense of aligning form with substance. Until then, the loop within the loop remains a cautionary tale for how complexity in financial architecture can be used to mask fragility rather than manage it.

Author: Brett Hurll