By Cyril Tuohy
Bank-centric capital standards would be unsuitable for the nation’s insurers and create an unnecessary regulatory universe for insurers that operate on a very different business model than banks, experts told Congress last week.
At issue is whether Section 171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act gives federal regulators enough latitude to develop risk-based standards applicable to the insurance industry, which is regulated by states.
Dodd-Frank granted the Federal Reserve the authority to regulate non-bank organizations affiliated with savings and loan holding companies or institutions designated as “systemically important financial institutions (SIFIs)” by the Financial Stability Oversight Council (FSOC). Several life insurers fall under these new rules.
The Federal Reserve seems to think it doesn’t have that much discretion when applying different capital standards for banks and for insurers.
Sen. Susan Collins, R-Maine, sponsor of the Section 171 amendment to Dodd-Frank, was frustrated with the Federal Reserve’s interpretation.
“As I have already said, I do not agree that the Fed lacks this authority and find its disregard of my clear intent as the author of Section 171 to be frustrating, to say the least,” she told a Senate Banking, Housing and Urban Affairs subcommittee hearing last week.
Janet Yellen, the new chair of the Federal Reserve, said last month before a Senate panel that Section 171 “does restrict what is possible for the Federal Reserve in designing an appropriate set of rules.”
The Federal Reserve, Yellen also said, would do its “very best to craft an appropriate set of rules subject to that constraint.”
Section 171 specifically intended federal regulators to take into account distinctions between banks and insurance companies when setting capital adequacy, Collins said, and Section 171 is designed to prevent federal regulators from supplanting prudential, state-based insurance regulation.
Legislation sponsored by Sen. Sherrod Brown, D-Ohio, and Sen. Mike Johanns, R-Neb., would give the Federal Reserve more flexibility to establish capital standards properly tailored to insurers. The bill, S-1369, has 23 cosponsors.
In the absence of the Federal Reserve using Section 171 to develop a capital model appropriate for the insurance industry, the American Council of Life Insurers said it would support S-1369 to encourage the development of an insurance-based capital adequacy model.
Insurance-based capital models ensure that insurance companies have enough to pay claims long into the future.
Assets, liabilities and balance sheets of insurers are very different from those of banks, and therefore require unique capital models. Insurers also say their models are regulated by the states and that there’s no need for more federal oversight.
Michael W. Mahaffey, Nationwide’s chief risk officer, said there is no “one size fits all” risk model for banks and insurance. No universally applicable framework exists to determine capital requirements, he said.
But Daniel Schwarcz, an associate professor at the University of Minnesota Law School, said that S-1369 makes for “particularly bad policy.”
Under the bill, bank and thrift holding companies that derive large portions of revenue from insurance operations are exempted from Section 171, he told the Subcommittee on Financial Institutions and Consumer Protection.
Federal oversight of insurance capital models is necessary and the financial crisis proved that. American International Group, which had to be rescued by taxpayers, became the poster child for oversight by federal regulators.
Systematic risk in insurance is felt nationally and internationally, he said. National and international regulatory bodies should play a role in systematically regulating important financial institutions as a result, he also said.
“Capital regimes should be designed not only according to the industry to which they apply, but also to the regulatory goal that they seek to achieve,” he said.
Insurance companies pose “a variety of systematic risks to the larger financial system,” he said, and that warrants broader regulatory oversight than what a patchwork of state-based regulators are designed to control.
Demand for assets that “spread system risks,” affect the marketplace, said Schwarcz. These include mortgage-backed securities, asset fire sales that inject illiquidity into the marketplace, the simultaneous failure of several large insurance carriers, the relationship between insurers and a small group of reinsurers, policyholder runs and under-reserving.
Systematic risk in insurance is a “negative externality,” he said. Since those effects are felt nationally and internationally, national and international regulatory bodies should play a role in systematically regulating important financial institutions, he said.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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