Tangled up in Pru

However, this view of FSOC paying homage to an international designation has also been countered as “poorly informed” and “tremendously disrespectful” of the FSOC process to study with great rigor the company before it on its own. 

Woodall, in a lengthy, sharp-tongued and multi-faceted dissent, called the failure hypothesis implausible based on “misplaced assumptions” of a large scale runs on the company at all levels in all accounts, and without giving enough weight to mitigating interventions built into the system. 

The majority view is that these measures would cause further alarm among policyholders and then the general public. And the last thing the country wants is a riot in the streets for cash. 

Could it happen here?

But the “reliance on the lack of a precedent for a failure of an insurance company the size and scale of Prudential begs the question of why there has been no such precedent? It seems inherently unreasonable to make negative inferences about the current state resolution and guaranty systems based on the lack of such precedent, while presuming material financial distress and the failure across all insurance subsidiaries; without a reasonable and complete assessment of the extremely low probability of such a scenario occurring,” Woodall stated in his dissent.

And if there is concern, although unsupported, according to DeMarco, for a run-risk as a key catalyst for a destructive asset liquidation, with spillover into the greater economy and a state system unable to handle such an event, then the Council could instead address those concerns  with other tools, he wrote in his dissent.

Huff agreed with DeMarco and criticized the majority for an overall failure of analysis that does not take into account the very nature of insurance products and insurance consumers but instead treats scenarios as if banking is the business analyzed. Huff also says that the majority also does not adequately analyze actions taken by Prudential’s counterparties, which include several of the largest U.S. banks, or their regulators, to manage the risks arising from transactions with Prudential or other financial counterparties. 

AIG was unanimously designated a SIFI by the FSOC June 3rd and took its designation and accepted it by July, unlike Prudential, which forced the appeal showdown and is still weighing its options to pursue the matter in court. Although a shorthand version of the Prudential rationale was used for AIG’s life business, AIG has property casualty, seen as less systemically risky, and non insurance operations, seen as more risky, but its designation did not provoke an outcry from the company or other FSOC members. Prudential is also a larger life insurer than AIG.

The only way for any regulator to check everything under the lid of the trunk is through consolidated supervision, and only the Fed can now do this, according to a source. The claims that this can be accomplished at the state level through group supervision and supervisory colleges is limited, and would require a 50-state compact, this person said.

Thus, the Fed wants a window into this and other big companies as it monitors major players in the U.S. economy and is on its way to getting it with this latest action mandating consolidated oversight of Prudential, something the states could not offer. 

Too big to fail, er, understand?

However, dissenters argue that all the majority did was prove that Prudential — which has over $1.1 trillion in assets under management and is the fifth-largest life insurer in the world with more than $3.5 billion in life insurance in force, according to BestLife — is a very larger insurance company whose individual exposures would not have a systemic impact.

“In attempting to address the fact that individual exposures would not have a systemic impact, the Basis aggregates exposures and argues that, together, such exposures could pose a threat to the financial system of the United States. In so doing, the basis merely demonstrates that Prudential is a large insurance company,” Huff stated.

There are multiple factors that go into sifting through companies to identify potential SIFIs, and the way the rules are written, size alone is not enough. Exposure, liabilities, interconnectedness, liquidity risk, derivatives activity and many other factors are measured under the SIFI designation rules. 

However, the run on the bank and contagion rationale, anticipated after the AIG rationale on its life insurance exposures, but rejected by the NAIC, the states, the industry in multiple statements and members of the insurance block at FSOC, carried the day. 

“…other insurance companies could be exposed to second-order effects if asset liquidations at Prudential sparked a loss of confidence in the broader insurance industry because of their similar product or balance sheet profiles, potentially leading to policy withdrawals, surrenders, or redemptions at other major insurers. Even if Prudential were able to avoid significant asset liquidations in response to surrender and withdrawal requests by invoking a stay, these requests, once started, could cause market participants to lose confidence in the financial strength of companies with similar product or balance sheet profiles,” the majority said, stressing its concern about the message sent to the economy by policyholders, apparently of all ages, health status and investment levels, trying to get their money out of policies – -then being told they couldn’t or would have to wait.

NAIC President and Louisiana Insurance Commissioner Jim Donelon stated that he was deeply troubled by the implications of the FSOC’s action designating Prudential as a SIFI. 

“The justification for this designation shows fundamental gaps in FSOC’s understanding of the business of insurance or the regulatory regime that governs it. More disturbing is the unknown consequences of such a designation and the potential disruption in the insurance marketplace,” Donelon stated. 

Part of the capital standards the Fed will impose on Prudential include the undeniably strict — and looming — Basel III banking standards for capital, liquidity and leverage for SIFIs and institutions with thrifts. Even the Fed has delayed Basel III strictures for insurers, accepting their point that they really aren’t crafted for the insurance industry, and all are waiting to see if a Congressional fix for the admittedly airtight language, found in Section 171 of the DFA, will make it through the Senate (S. 1369) and the House (HR 2140). Both chambers have a bill lodged now on development of Basel III for insurers. Sec. 171 requires it to use the same capital standards used in regulating banks to insurance companies that operate thrifts.

What would Pru do and is Snoopy next? 

Of course, the FSOC handed Prudential a much more detailed, proprietary-data driven analysis of its rationale, based on the confidential information Prudential supplied in stage three of the SIFI process, but it likely supports the same run-on-the-bank scenario playing out as its premise just as the dissents are likely furnished with more data, as well..

Prudential asked for the appeal of its initial SIFI proposed designation June 3rd, believing it was not systemically risky under the set DFA rules. The appeal occurred July 23. 

And MetLife, which had no comment, despite its place in the final stage of SIFI determination by the FSOC, will likely be watching what Pru does carefully — it is giant domestically and internationally, like Prudential, and has a huge derivatives hedging portfolio for variable annuities, like Prudential. 

MetLife has been busy hawking a Basel III alternative as it prepares for its likely inevitable Federal Reserve oversight (again).