By Susan T. Stead

After several years of debate and consternation, certain insurance groups have been deemed to be systemically important to the U.S. and global economies. The regulatory oversight of these insurance groups will change. But how? Two different sets of “policy measures” have been developed to help regulators and the companies manage systemic risk, one developed by federal authorities and one by international non-regulatory bodies. The measures are similar in many respects, yet different. One set is more insurance-oriented and the other appears more bank-oriented. Many of the policy measures are not in final form and some will not be implemented for several years.

What is certain is that any U.S.-based insurance company designated as a Systemically Important Financial Institution (SIFI) will be subject to consolidated prudential supervision by the Board of Governors of the Federal Reserve System. This means that all the legal entities in a group that engage in financial activities will be regulated as a group. The insurance companies in the group will remain subject to state regulation as well. The authority for the policy measures that apply to SIFIs is the Dodd-Frank Wall Street Reform & Consumer Protection Act that was enacted in 2010. The Federal Reserve has finalized some regulations but many of the federal policy measures for SIFIs are in proposed regulation that has not yet been finalized.

Some U.S. insurance groups have been designated by the Financial Stability Board (FSB) of the G-20 as a Global Systemically Important Insurer (G-SII). The FSB was established by the G-20 to coordinate the work of national financial authorities and international standard setting bodies and to promote effective regulatory, supervisory and other financial policies in the interest of financial stability. Acting under the purview of the FSB and the G-20, the International Association of Insurance Supervisors (IAIS) developed a set of policy measures for G-SIIs. At the present time, there is no regulator in the U.S. that has authority to implement the global policy measures for U.S. insurance groups designated as G-SIIs.

Both the federal and global policy measures address consolidated group supervision, capital, leverage, risk management, stress testing, recovery and resolution planning, but the details are noticeably different and the two sets of measures are not congruent. One might expect more congruency given that three federal agencies (U.S. Department of the Treasury, Securities and Exchange Commission and the Federal Reserve) participate in the FSB and were presumably involved in the development of Dodd-Frank. In fairness, it should be noted, that Dodd-Frank, the authority for the federal measures, was enacted a full three years before the global policy measures were completed. It is also possible that some of the differences may be attributable to the fact that the global measures were developed by insurance regulators whereas Dodd-Frank incorporates banking principles and terminology.

The federal policy measures provide that an insurance group that has been designated as a SIFI will be subject to leverage requirements and minimum risk-based capital requirements on a consolidated basis. Those measures are based largely on banking principles. In fact, the proposed regulation expressly incorporates sections of U.S. banking laws that deal with capital requirements. Nowhere in the proposed regulation is consideration given to the fact that the insurance companies remain subject to capital and surplus requirements, reserving requirements and other financial requirements and restrictions under state insurance laws.

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In contrast, the global policy measures recognize that traditional insurance does not present the same degree of systemic risk as other “non-traditional non-insurance” (NTNI) activities. The global policy measures include group capital requirements, the amount of which will depend to some extent on the NTNI of the group. The capital requirements may be reduced if there is “effective separation” of NTNI activities from traditional insurance activities within a group.

How SIFIs and G-SIIs are expected to identify and manage risk also varies. Under the global policy measures, a G-SII will be expected to develop a Systemic Risk Management Plan (SRMP) in consultation with its group-wide supervisor and explain how it will manage, mitigate and possibly reduce systemic risk. In contrast, the risk management requirements under the proposed federal regulation are focused on a SIFI’s management of its risks and there is no specific mandate to manage or mitigate systemic risk. Under the regulation, a SIFI will have an enterprise-wide risk committee composed of members of the board of directors that will document, review and approve the company’s enterprise-wide risk management practices.

This is the first time that federal and state regulators will share responsibility for the prudential supervision of any insurance company and it is possible that their respective priorities and authority may not always be in alignment. How state and federal regulators will interact and resolve any differences could present unique challenges for SIFIs. Consider what might happen if the Federal Reserve, responsible for the prudential supervision of the group, directs an insurance company subsidiary to transfer assets to improve the group’s overall financial condition but a transfer would be prohibited by state law or the domiciliary state insurance regulator will not approve the transfer. Neither the federal measures nor state insurance laws directly address such a situation.

A lot of work has been done by many government officials, state and federal, as well as others in the international community, to understand and mitigate possible systemic risk to national and global economies, to strengthen regulation and to provide new regulatory tools. There are many more details yet to be worked out for SIFIs and G-SIIs. The proposed federal regulation may be finalized this year but the IAIS does not expect capital implementation details for the global measures to be worked out until 2015. Nonetheless, some insurance groups are confronted with the reality of a new federal supervisor even if the policy measures are not in final form.

Susan T. Stead is a partner at Nelson Levine de Luca & Hamilton. She counsels insurers on developing compliant business practices, holding company registration and transactions, product innovation, proposed legislative and regulatory changes, obtaining regulatory approvals, implementing electronic transactions and responding to regulators. Susan may be reached at [email protected].

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Advisors Guide to Selling IUL