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September 16
07:50 2016

Initial positive response from insurance sector for “too big to fail” insurers

Officials of the Federal Reserve System proposed new rules governing capital reserves for two classes of insurance enterprises: insurers that own a bank holding company and insurers deemed to be Systemically Important Financial Institutions (SiFi).

Early responses to the proposal from property/casualty insurance interests welcomed the proposals. The Federal Reserve officials announced plans to accept public comments until August 2, 2016.

If adopted, the capital reserve proposal will establish a two-tier system for enhanced oversight from the Federal Reserve System.

The document that presents the proposed rules for public comment provides an explanation of both the importance and complexity of the SiFi initiative.

The Board currently supervises 12 insurance depository institution holding companies and two systemically important insurance companies. Collectively, these firms have approximately  $2 trillion in assets and represent approximately one-quarter of the assets of the U.S. insurance industry. These institutions range in size from approximately $3 billion in total assets to about $700 billion in total assets and engage in a wide variety of insurance and noninsurance activities. Some of the firms operate exclusively in the United States, and some have material international operations. These institutions have a variety of ownership structures, including stock and mutual forms of ownership. Some of these institutions prepare financial statements according to U.S. Generally Accepted Accounting Principles (GAAP), and some do not, preparing financial statements only according to U.S. Statutory Accounting Principles (SAP) filed with the relevant state insurance regulators. The insurance depository institution holding companies tend to have simpler structures, often have an operating company, rather than a holding company, as the top-tier parent, and have a relatively greater U.S. focus in their operations. By contrast, the systemically important insurance companies are relatively larger financial institutions with substantial international operations, comparatively complex organizational structures relative to other insurance companies, and non-insurance as well as insurance activities.

Both the building block approach and the consolidated approach recognize the distinct differences between insurance companies and banks, and would use insurance-focused risk weights and formulas that reflect the appropriate nature of insurance liabilities.

Building blocks

The first tier concerns entities that control bank holding companies for direct banking or thrift operations, which fall under the “supervisory” jurisdiction of the Federal Reserve. As noted above, 12 companies fall into this category.

Federal Reserve officials refer to the framework proposed for the first tier as “The Building Block Approach.” This approach aggregates existing capital requirements across a firm’s various legal entities to arrive at a combined group-level capital requirement, subject to adjustments to reflect the federal supervisory objectives.


The second tier currently consists of two insurers that hold the SiFi designation: American International Group, Inc., and Prudential Financial, Inc. (The latter company continues to litigate its SiFi designation in federal court.

Under a provision of the Dodd-Frank Act of 2010, the Treasury Department’s Financial Stability Oversight Council (FSOC) holds the authority to deem non-bank institutions as systemically important to the economy. This designation clears the way for federal officials to assume regulatory jurisdiction over the interstate commerce of the business of insurance lent to the states by the McCarran-Ferguson Act of 1945.

The Federal Reserve officials refer to the second tier framework as “The Consolidated Approach.” This approach categorizes the entire insurance firm’s assets and insurance liabilities into risk segments, then applies appropriate risk factors to each segment at the consolidated level to arrive at a minimum required capital ratio.

“The frameworks we are considering would address all the risks across an insurance company’s regulated and unregulated subsidiaries,” Federal Reserve Chair Janet L. Yellen said in a written statement. “I believe this proposal is an important step toward capital standards that are both appropriate for our supervised insurance firms and that enhance the resiliency and stability of our financial system,” Yellen continued.

Both the building block approach and the consolidated approach recognize the distinct differences between insurance companies and banks, and would use insurance-focused risk weights and formulas that reflect the appropriate nature of insurance liabilities.

“The dual approach proposed today is another example of our efforts to tailor capital regulation to the different risks posed by financial intermediaries of varying types and complexity,” said Daniel Tarullo, a member of the Federal Reserve Board of Governors.


The statement also explains that the dual tier proposal seeks “to provide ample opportunity for interested parties to comment on the appropriate structure of capital standards to promote financial stability, and to protect depository institutions owned by insurance companies.”

If adopted and applied with robust efficiency, an effort to regulate—not supervise—the risk of financial loss assumed by, but possibly stashed in dark corners of, insurance companies would not only “protect depository institutions.”

After the elimination of the old and highly effective Glass-Steagall Act framework, financial regulators began to realize that some financial firms were too large and complex to “resolve” in the case of financial failure. Traditionally, the resolution of a failed company truncated stockholders’ claims on equity and transferred it to bondholders/lenders. “Too big to resolve” became “too big to fail.” At the same time, it became clear that before these entities were too big to fail, the companies were “too big to regulate.” The political, commercial, and economic power of some of these institutions precluded any public official from standing up to compel the institution to act in the public interest.

Take, for example, the credit default swaps (CDS)—insurance on loan defaults by a misleading name—marketed by AIG, which led ultimately to the collapse of what was then the world’s largest insurer. Insurance regulators ignored these insurance products for years because the company called them by another name and sold them through a thrift subsidiary. Even if an insurance regulator tried to regulate these functional insurance activities—which transferred the risk of financial loss related to bond defaults—under the functional regulation provision of the Gramm-Leach-Bliley Act of 1999 (GLBA), years of litigation would have followed.

By the way, this writer has never found documentary evidence of a state insurance regulator trying to exert his or her regulatory authority under GLBA over the CDS products. In addition, because the jurisdiction over insurance regulation transfers from Congress to the several states through the McCarran-Ferguson Act only “to the extent the business of insurance is regulated by state law,” one could argue that the jurisdiction over CDS products remained at the federal level.

No regulatory agency or office has a good story to tell with regard to the CDS example, which resulted in at least $180 billion in tax dollars being pumped into the AIG financial failure—to protect ancillary commerce.

Will the Federal Reserve System provide the necessary regulation with robust efficiency? There is reason to answer “No.”

The Federal Reserve System brings to a problem a corporate culture that is neither robust nor efficient. The system is notorious for its self-perception as a bank, operated by bankers. Documents produced by the system habitually refer to the voyeuristic phrase “bank supervision.” Too often examiners view their role as friendly advisors or even buddies to “the other bankers.”

That said, state insurance regulators proved unwilling even to try to assert jurisdiction over the business of insurance that transpired under the name CDS. After the collapse of AIG, a then-officer of the National Association of Insurance Commissioners even denied that AIG was an insurance company. The company was too big to regulate before it was too big to fail.


Perhaps the 14 companies that would immediately come under these rules—well, 13 if you don’t include Prudential—feel comfortable that the Federal Reserve will act as a buddy. Most insurance sector responses to the initial proposed rules appear “comfy.”

For example, Leigh Ann Pusey, president and CEO of the American Insurance Association (AIA), issued the following statement on June 3, 2016:

“Today’s issuance of the ANPR outlining the Federal Reserve’s bifurcated approach to group capital for prudently supervised insurance firms is an important next step in the implementation process of the Dodd-Frank Act. It provides additional clarity on the Federal Reserve’s underlying rationale and sets the stage for public input on its intended approach.”

That statement was not exactly a gauntlet thrown down.

As the Federal Reserve receives comments from interested parties, officials will post those comments for public review at

Standards adopted

In addition to the capital reserves proposal, the Federal Reserve officials approved a rule that applies management and governance standards to Sifi entities. As required under the Dodd-Frank Act, these standards apply consistent liquidity, corporate governance, and risk management standards to the firms.

The approved rule also requires SiFi entities to employ both a chief risk officer and a chief actuary. The often submissive people at the Federal Reserve want the new requirements “to help ensure that firm-wide risks are properly managed.” n

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Companies and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.


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