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October 23, 2011 at 08:00 PM
A proposal outlining the factors federal regulators want to use in determining whether an insurer is “systemically significant” has launched a period of great uncertainty for the life insurance industry.
The proposal was published for comment Sept. 11 by the Financial Stability Oversight Council.
It sets out the criteria that will be used by the Financial Stability Oversight Council in determining whether a non-bank is SIFI—a systemically important financial institution—under a provision of the Dodd-Frank financial services reform law.
The proposal was first published in January, but it was re-crafted under pressure from the insurance industry and their supporters in Congress.
The industry contended that the initial proposal did not take into account the differences between banks—the primary concern of the FSOC—and non-bank financial providers such as insurers.
Moreover, the industry and its congressional supporters wanted the regulation to be more specific in disclosing the qualitative and quantitative standards that will be used in determining whether an institution is systemically significant.
Howard Mills, chief advisor for the insurance industry group at Deloitte in New York, said a key first step will be the recommendations made to the FSOC by Michael McRaith, director of the Federal Insurance Office, as to which insurers, if any should be designated as SIFI.
“We are very much in a wait-and-see mode as to which insurers he will recommend to be designated as SIFI,” Mills said.
Mills said that the expectation is that McRaith will make such recommendations in the “near future,” but added that there is no deadline under the Dodd-Frank Act as to when he should do so.
At the moment, industry analysts believe that only two life insurers—MetLife and Prudential—will have to justify to the FSOC they do not merit SIFI classification.
But there is widespread acknowledgement that regulation of the life insurance industry—which has been solely in the hands of the states since the nation’s founding—is entering an entirely new phase.
The initial SIFI screening will cover a host of companies, including any non-bank financial services company with $50 billion in global total consolidated assets. This would include large domestic stock and mutual insurers.
Moreover, as pointed out by George M. Williams, a partner at Dewey & LeBoeuf in New York, it also includes foreign insurers with $50 billion in U.S. assets.
Williams also said that the proposed regulation may be of particular importance to financial companies that have not generally been subject to federal regulation, such as many insurers with no affiliated insured depository institution.
For example, he points out that under the Dodd-Frank Act, the Financial Stability Oversight Council and the Federal Reserve Board have back-up examination powers if they consider the examinations conducted by other agencies to be inadequate for purposes relating to systemic importance.
He said that measures that may be indicative of potential distress for some kinds of insurance companies (to take one example) may not be indicative for others.
Another industry lawyer who asked not to be named described the process as one of “reverse engineering” by “first deciding whom they wanted to regulate.”
He said that once a company is established as meeting the first SIFI criteria, “the rest is subjective.”
“They are free to pick and choose who they want to select as SIFIs,” the lawyer argued. He insists that there is “no standard an insurer or other non-bank can hold the FSOC up to legally.”
He argues that it is “totally up to the FSOC to determine if you are a SIFI once you make the initial cutoff.”
The lawyer said the proposal is 63 pages long, “but I have above given you the answer.”
The lawyer, who is advising insurers as well as hedge funds, broker-dealers and others who would come under the SIFI designation, said that there are some significant questions as to whether the whole process is Constitutional, “but since the 1930s there are no Supreme Court cases addressing this broad delegation of authority to any agency.”
Under the law, if an insurer were to be designated as SIFI, it would be regulated by the Federal Reserve Board, which will establish the “prudential standards” the non-bank SIFIs must adhere to. The SIFI would have to register with the Fed within six months and would be subject to additional capital standards as well as other requirements.
Above all else, it ushers in a brave new world of regulation and scrutiny regardless of how many institutions, if any, are cited as SIFI.
Because, as Williams stated, federal authorities have never had the power to examine the books of insurers or impose any other form of scrutiny…until now.
This was imposed on a de facto basis until 1945, when the McCarran-Ferguson Act specifically reserved to the states the authority to regulate the business of insurance.
The Supreme Court clarified this authority when it said oversight of insurers is strictly allotted to the states unless a federal law or rule specifically related to a particular issue.
It was again confirmed in the 1999 Gramm-Leach-Bliley Act, both in a resolution reserving insurance regulation to the states, and, in a provision that specifically stated that the Federal Reserve Board had no authority to regulate insurance holding companies.
Allowing federal intrusion into insurance oversight, albeit on a limited basis, was provided through the 2010 Dodd-Frank financial services law.
The limited intrusion was allowed, however, during the 2008-2009 world financial crisis, when the federal government sought to provide both cash and guarantees to sustain American International Group.
In return for the authority to borrow up to $120 billion in cash from the Treasury and the Federal Reserve, as well as guarantees and other aid, AIG gave the federal government control of 79.9% of its stock.
The government currently owns a greater percentage of AIG stock in exchange for ending direct financial aid to the company.
Other insurance companies also received federal financial aid during the crisis through the Troubled Asset Relief Program, or TARP, including Hartford Insurance Group and the Lincoln Financial.
Under the proposal, non-bank companies that have at least $50 billion in total consolidated assets and meet or exceed any one of the following thresholds will be evaluated as potential SIFIs and therefore subject to oversight by the Fed as well as the current state regulation. The other thresholds are as follows:
- $30 billion in gross notional credit default swaps outstanding that reference the nonbank financial company’s debt obligations
- $3.5 billion of derivative exposure liability to third parties
- $20 billion of outstanding loans borrowed and bonds issued
- 15-to-1 leverage as measured by total consolidated assets (excluding separate accounts) to total equity
- 10% ratio of short-term debt (maturity of less than 12 months) to total consolidated assets
In addition, according to a legal alert Oct. 17 by Sutherland, Asbill and Brennan, as a fail-safe device for situations where these simple thresholds may not capture a potentially significant company, the FSOC reserves the right to evaluate nonbank financial companies on other “firm-specific qualitative or quantitative factors, such as substitutability and existing regulatory scrutiny.” The companies identified in Stage 1 (the Stage 2 Pool) would be further assessed in Stage 2.
According to Jeff Schuman of Keefe, Bruyette & Woods, only MetLife and Prudential Life as stock life insurers are likely to be subject to the second and third test as SIFI under the new scrutiny.
Schuman also said the proposed regulation is “good news” for most large life insurers.
Colin Devine, an analyst at Citigroup Global Markets, was more circumspect.
He said that current disclosure makes it difficult to assess who may face Stage 2 testing.
He said that under the Stage 1 tests, MetLife, Prudential, Manulife (which owns John Hancock), Hartford, Aflac, Ameriprise, Genworth, Principal, and Sun Life (which owns asset manager MFS) and Unum all meet the criteria of having at least $50 billion in consolidated global assets.
However, he said, only MetLife and Prudential immediately stand out as exceeding the $20 billion test for outstanding debt.
In addition, he said, “we have not been able to fully determine if Hartford, Lincoln or Manulife, each of which utilizes an extensive hedging program in conjunction with their large variable annuity liability risk management programs, might exceed the $3.5 billion derivative liability test.”
Insurers, Devine said in his investment note, generally only report net derivative values whereas the Stage 1 test is based upon the fair value of any derivative contracts in a negative position after taking into account the effects of master netting agreements and cash collateral held with the same counterparty on a net basis.
enough information at the moment,” he said.