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Chicago Fed's "Insurance Initiative" Scrutinizing Insurance Industry Risk

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FED WATCH: A glimpse into how the Federal Reserve might view insurance companies’ place in the supervision of the financial services arena in the Dodd-Frank world was provided by a recent presentation by a member of the Chicago Fed Insurance Initiative (yes, there is one.)

The glimpse is important as the parent Federal Reserve in Washington sits on a committee that will help decide which insurance companies, if any are SIFIs, or “systematically important financial institutions.”

Even one such SIFI designation could have future regulatory requirement implications for the regulation and overall supervision of many other companies in the marketplace and federal governments, as state and federal regulators jockey to make sure the companies they supervise are on the right track.

Anna Paulson, vice president and director of financial research in the economic research department at the Federal Reserve Bank of Chicago, spoke March 2, 2012 at the New York University Stern Insurance Conference, but presented her views as that of her own, not the Fed’s, in the typical disclaimer for presentations.

The so-called Chicago Fed Insurance Initiative is designed, it states, to be a source of insurance expertise for the Federal Reserve System, and to understand the role of the industry, both life and property and casualty, motivated by the importance of the insurance industry in the overall economy, as well as the key role the industry plays in households al the way to financial markets.

The Initiative has five members, who appear to be non-insurers, but, like Paulson, Ph.Ds in economics and research professors from prestigious universities and research professors.

Paulson, with a Ph.D in economics from the University of Chicago and on staff with the Fed since November 2001, said in her presentation, “The Risk of Insurance Companies,” that yes, runs on insurance companies do indeed occur, recently, in fact, citing the 1999 case of General American, when “7 day puts” were called in to the tune of over $6 billion–contract holders only needed seven days to call in their money, which they did when the company was downgraded by Moody’s.

As the American Academy of Actuaries pointed out that year, “although General American had the assets, they were not liquid enough, so the company went under state supervision.”

Paulson noted in her report that some insurer liability is very liquid, citing deferred annuities and guaranteed investment contracts (GICs), and other funding agreements. Whole Life. payout annuities and liability insurance are product examples of low to no liquidity. Paulson broke down the liquidity, from none to high liquidity, by percentage, of the industry as a whole, and by top 10 life insurer, by liabilities.

Although she didn’t seem to draw conclusions, the mutuals, Northwestern Mutual and New York Life seemed the most conservative by percentage in moderate to high liquidity, and The Hartford, ING Groep and Lincoln National among the highest, by percentage.

Paulson also noted that increased regulation of insurers –she didn’t say from whom–can “help to internalize externalities that might lead to the build up of systemic risk.”

As an example, she noted that capital surcharges on systemically important financial institutions help to internalize the cost of being too big to fail.

Paulson also countered the general insurance company and insurance commissioners’ claim that “insurers did fine during the crisis, so we don’t need to worry about them,” with citations of not only AIG, but Lincoln National and The Hartford, which both took Troubled Asset Relief Program (TARP) funds, although much later than did the banks.

Paulson also pondered the financial regulatory reform that brings about more safeguards of the rest of the system will make insurance be safer as a result, and how increased regulation might affect the cost and the risk of insurance products to individuals.

The hope is to strike the right balance, Paulson concluded in her slide show presentation.

In other Fed news concerning the insurance sector, MetLife was one of four large financial institutions with bank holding companies found to have failed a “stress test” imposed on large banking institutions by the Federal Reserve Board, a decision roundly criticized by MetLife and insurance analysts. Neither the NAIC nor the New York regulators would offer comment or counterpoint to the Fed’s methodology for insurance holdings, nor publicly come out and defend MetLife’s financial solvency.

MetLife did not return emails sent requesting comment to this reporter on the stress testing.

However, according to Federal Reserve staff notes, four executives of MetLife, including the company Treasurer Marlene Debel, teleconferenced Dec. 27, 2011 with Fed staff, “to discuss the results of the Comprehensive Capital Analysis and Review (CCAR) that the Federal Reserve may publish.”

Involved banks, including MetLife, met by phone with Fed officials to discuss the scope of what the Fed would disclose about the stress test results, but MetLife had not yet submitted its stress test data to the Fed at the time of the December 27 call, and the company did not have knowledge of the results at that time.

“Representatives of the Federal Reserve indicated that the timing of publication of results, the scope of the results, and the level of detail that would be made available are still under consideration. Other topics of discussion included the implications to MetLife of publication of the results…,” the Fed synopsis states.

While the New York Department of Financial Services stayed silent before the public and policyholders, the California’s Department did not, in a press release on March 15, two days after the Fed announced the results, assuring the public that MetLife exceeds financial solvency requirements.

“The methodology utilized for analyzing and stress testing banks is not intended to measure insurance solvency as the business models are quite different. MetLife maintains an A+ rating from AM Best and an AA- rating from Standard & Poor’s….MetLife had a consolidated risk-based capital ratio of 450%, which is a risk-based capital ratio well in excess of regulatory minimums required of life insurance companies,” stated California Insurance Commissioner Dave Jones.

MetLife roughly $200 billion of separate account assets in the denominator of the leverage ratio negatively impacted the ration by as many as 200 basis points, and without their inclusion, Met’s leverage ratio would have been in the mid-5% area, Sterne Agee as analysts pointed out March 13th in a report with the teaser, “Snoopy Gets Slapped…Again.”

In MetLife’s printed reaction to the Fed decision late Tuesday, Steven Kandarian stated that MetLife was penalized for was the holding of funds of variable annuity customers in separate accounts. MetLife, is a major seller of VAs that offer “living benefits” payouts.

“With expectations that Prudential and American International Group will ultimately be designated non-bank SIFIs (as well as MET), we believe these stress results for MET make it incredibly apparent that applying bank capital metrics to life insurance companies (particularly those with significant separate account business) is far more onerous than typical life insurance industry metrics,” Stern Agee analysts wrote.

An earlier version of this report suggested MetLife knew of its stress tests results early-on, during a conference call with the Fed staff Dec. 27, 2011. It did not, as the report, based on selected Fed notes, suggested.


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