Federal regulators are gearing up to designate some U.S. insurers as “systemically important,” despite lingering uncertainty surrounding the magnitude of unintended, industry-wide ripple effects.
Starting this year, the Financial Stability Oversight Council (FSOC) created under the Dodd-Frank legislation is slated to begin naming the non-bank companies that are deemed “systemically important.” FSOC, chaired by the Treasury Secretary, is tasked with identifying and monitoring risks to the U.S. financial system.
Generally speaking, critics say the designation could lead to heightened government oversight that could prove harmful to companies. Others have expressed concerns that naming companies “systemically important” would make them seem “too big to fail,” setting up the expectation of a bailout in a crisis.
What Designation Means
Insurance companies that receive the designation are likely to be involved in activities or transactions that deviate from the industry’s traditional business model. The FSOC and the Federal Reserve remain vague on the exact definition of non-traditional business activities. But the International Association of Insurance Supervisors, which is working collaboratively with U.S. financial regulators, said “examples of non-traditional and non-insurance activities include financial guarantee insurance, capital markets activities such as credit default swaps, transactions for non-hedging purposes, derivatives trading or leveraging assets to enhance investment returns.”
So far, FSOC is known to be studying American International Group Inc. (AIG), Prudential Financial Inc. and MetLife Inc. for possible designation. Credit Suisse analysts said in a December research note titled “Takeaways From Our DC Trip” that they expect both Prudential and MetLife to receive a designation later this year.
Designated companies, in addition to being directly regulated by the Fed, could face increased capital requirements and be required to develop a “living will,” among other restraints similar to those applied to major financial firms and auto companies that needed taxpayer assistance to stay afloat.
The move to characterize certain insurance companies as systemically important stems from the government’s attempts to prevent a future crisis similar to what transpired in 2008 around the bankruptcy of Lehman Brothers Holding Inc. and the government takeover of AIG.
The American Council of Life Insurers (ACLI), an industry trade group, declined to comment on potential industry impacts.
But in March 2012, ACLI President Dirk Kempthorne told a financial roundtable that life insurers do not pose systemic risk to the economy because they are “very well-capitalized and closely regulated by the states.” The Property Casualty Insurers Association of America (PCI) and The National Association of Mutual Insurance Companies have echoed ACLI’s sentiment.
“We must show Congress and the administration that tampering with our companies and our products is not just bad public policy, but undermines efforts to help people maintain their financial security, dignity and independence throughout their entire lives,” Kempthorne’s remarks read.
PCI said most insurance companies are not involved in the sorts of activities that helped cause AIG’s 2008 liquidity crisis.
In 2010, research by Temple University professors J. David Cummins and Mary A. Weiss determined that insurers’ traditional business activities do not carry risk, but that “non-core activities such as derivatives trading have the potential to cause systemic risk, and most global insurance organizations have exposure to derivatives markets. To reduce systemic risk from non-core activities, regulators need to develop better mechanisms for insurance group supervision.”
Credit Suisse analysts wrote in their December note that “state regulators are likely to feel more pressure to protect their turf and become more conservative in their practices,” and further expect them to adopt some of the same measures as the U.S. Federal Reserve.
“This may make it more difficult to garner regulatory benefits from things such as permitted practices, use of captive reinsurance, and other forms of regulatory capital arbitrage,” the Credit Suisse analysts added in the note.
While FSOC, chaired by the U.S. Treasury Secretary, is tasked with identifying systemically important insurers, the capital rules and annual stress testing fall under the Fed’s purview.
“We would expect the ‘tailoring’ for insurers to include a negative adjustment for property and casualty businesses … while it’s unclear what adjustments might be made for separate accounts and variable annuities,” the Credit Suisse analysts said in the December note.
At a recent meeting of the Association of Insurance and Finance Analysts, Bill Wheeler, president of the Americas division at MetLife, indicated that insurance companies could restructure if the “systemically important” designation proves harmful, Credit Suisse analyst Thomas Gallagher said in a March 6 note titled “US Life Insurance: AIFA Conference Takeaways.”
“(Wheeler) noted that he hopes the rules do not put MET at a disadvantage as to cause the company to exit certain businesses,” Gallagher added in the note.