Insurance regulation: A big ship now in motion

The regulation of American International Group (AIG) and Prudential Financial by the Federal Reserve Board as systemically important financial institutions (SIFIs), along with the government’s ongoing examination of whether other insurance companies should also be designated as SIFIs, constitutes a major turning point for an industry whose oversight has been the exclusive domain of states since the nation’s founding.

The SIFI designation issue is just one ripple in a tide of events that speak to significant changes in how the business of insurance is regulated — as well as to how the industry does business.

SIFI: Implications now and beyond

For SIFIs, designation means that these companies under the oversight of the Federal Reserve System, which will provide regulatory oversight in addition to the current state insurance regulatory framework for the insurers, according to officials at Moody’s Investors Services.

Related story: SIFI impact to be ongoing

“In general, any company designated SIFI can be said to be entering a new reality of dual regulation,” said Howard Mills, a former New York insurance superintendent and now a consultant at Deloitte.

Mills said such a designation “does nothing to change the fact that they will still be regulated by states. Whatever state they are domiciled in, that regulator will continue to be the primary regulator, but there will also be a federal regulator.”

This type of federal regulation will bring much higher capital requirements and additional oversight on everything from consumer protection to market conduct. “It will simply become a more challenging regulatory environment with more opportunities to have regulatory problems,” Mills said.

“Some have argued that this gives a company a marketing advantage because the consumer gets a perception that the federal government will not let that company ‘go away.’ That can’t be proven yet, but it is an interesting counterpoint,” Mills said.

Additionally, as Moody’s has noted, if being a SIFI provides access to the Fed window for liquidity, these issuers could benefit from funds for unanticipated needs in a severe stress scenario.

Michael Nelson, chairman of insurance law firm Nelson Levine, raises another interesting point about the competitive issue. “It’s the ultimate question, obviously, because some of the concern about being designated is higher capital requirements and higher regulatory costs. Companies that don’t have that designation, are they in a superior position?”

Nelson notes that as time goes on and more and more companies are potentially exposed to the designation, the balance might change, and, as time develops, “you will get a better sense of what it means to be regulated as SIFI.”

In other words, the impact of whether a SIFI designation is a burden or a competitive disadvantage remains to be determined, according to Nelson.

Robert Benmosche, president and CEO of AIG, explained that, at the end of 2014 or early 2015, AIG will be under that same capital review umbrella as the banks are.

“And that’s not only what our capital ratio numbers are, but it’s the quality of the systems that produce the numbers,” said Benmosche. “So it’s a very different game we’re going to play in 2014 and beyond, once we’re a part of the Comprehensive Capital Analysis and Review (CCAR) test, so then the Federal Reserve will have a lot to say about what we ultimately do and their satisfaction with what the numbers are.”

Benmosche believes it is in AIG’s best interests to be regulated by the Federal Reserve, however. He applauds the fact that his company has “an outstanding team from the Federal Reserve now at AIG,” he said. “They are digging through everything we have, verifying everything we have, checking our policies, checking our procedures.”

He notes that being under CCAR and being a SIFI will be a different level of regulation then what they are accustomed to, but that they need to run the company the right way. “And so that’s what I think we are going to continue to do, and we’re going to make sure whatever we do, we do not do anything to risk our credit ratings or to make our clients feel we’re not able to live up to our guarantees,” he said.

Prudential is seen as risky because of its holdings of, among other things, synthetic Guaranteed Investment Contracts (GICS), which make some on the FSOC nervous, according to sources who have worked with the FSOC staff.

For its part, Prudential has argued that, while they can’t divulge the nature of their discussions with FSOC, they have said previously that their GICS contracts “contain manageable risks.”

NARAB: A point positive

A major positive for the industry was the strong support voiced in the House last month for legislation creating a clearinghouse for licensing of insurance agents through the National Association of Registered Agents and Brokers (NARAB). Even though the idea has been around for more than a decade, this new support represents a major breakthrough. Passage of legislation creating such a clearinghouse by a strong majority in the House, as well as signs it has strong support in the Senate, also has major implications for how insurance is regulated and how its players conduct business. A passage by the House constitutes a major positive development.

NARAB, as envisioned by the legislation, would create a non-profit, independent board that would allow multistate licensing for insurance producers. Under the bill, insurance agents will be able to apply for NARAB membership and become licensed to sell insurance in multiple states, but states will maintain their full authority in regulating the business of insurance.

States would retain their regulatory jurisdiction over consumer protection, market conduct and unfair trade practices, and would retain their rights over licensing, supervision, disciplining and the setting of licensing fees for insurance producers, according to Ken Crerar, president/CEO of the Council of Insurance Agents and Brokers (CIAB).

Joel Wood, CIAB senior vice president for government affairs, said he has been walking the halls of Congress on NARAB in its various iterations for more than 20 years. The most frequently asked question he hears is whether it undermines state regulation or enhances it. “This thing would have gotten done years ago if it wasn’t caught for so long in the crossfire of that ideological debate,” he said. “Some wish for it to be the camel’s nose under the tent that foretells greater federal involvement. Others see it as a protection of state governance that diminishes some sort of a federal invasion.”

In practice, however, Wood views NARAB as simply an administrative mechanism to solve a series of regulatory problems that have been around for decades. He points to the intriguing politics on the matter, noting that “the congressional leadership on this has been truly bipartisan, at a time when Congress doesn’t agree on much of anything,” he said.

Wood is also impressed by the The National Association of Insurance Commissioners’ (NAIC) support for the measure. “It’s always easier to beat something than to pass something in Congress, and we have a couple remaining hurdles,” Wood admits. “But for the first time, I believe we really can envision solving the bulk of the bureaucratic problems associated with nonresident producer licensure, and in a way that works for all the stakeholders regardless of their position on the spectrum of federal-versus-state regulation.”  

Rob Smith, president of the National Association of Insurance and Financial Advisors (NAIFA) agrees that NARAB would solve some long-plaguing issues regarding licensing. “Nearly 80 percent of NAIFA members have lost clients who moved to states in which they were not licensed, and 12 percent report that they have lost more than 50 clients this way,” said Smith. “NARAB II would offer a common-sense solution to this problem,” Smith said.

Mills believes that there has been a lot of interest in getting greater uniformity amongst the states, which he believes the industry will certainly welcome. “Similar standards for product approvals will obviously benefit the industry and consumers by enabling products to be brought to market faster,” said Mills. “This is something that industry has long sought.”

He believes that creation of the system will be a lengthy process since most everything in the insurance regulatory world is. “But, it is a good beginning,” Mills said.

According to Nelson, from the agent perspective, “they are going to be thrilled with the prospect of more uniform licensing and greater reciprocity.”

Nelson said companies still have to go through the process of appointing producers, including NARAB members, and it will be somewhat of a state-by-state approach by insurers. “I do think it is going to take off pretty quickly,” he said. “A lot of agents want to participate in local markets and this is going to make it easier for them to do it.”

Nelson said he believes that the latest initiative on capital by Benjamin Lawsky, superintendent of the New York Department of Financial Services (DFS), will have “serious implications” for the other insurance commissioners.