Insurance Sifis face bank-style supervisory regime

Federal Reserve Board proposals on the supervision of systemically important non-banks would subject insurers to a bank-style regime. Insurance risk managers say the rules make no sense for their industry. By Peter Madigan

American International Group (AIG) has a lot to answer for – including, perhaps, forcing some of its peers into a new, tougher regulatory environment. The insurer’s bail-out in September 2008 prompted the Dodd-Frank Act to demand that systemically important non-banks be subject to the oversight of the Federal Reserve Board. Prior to its collapse, the unit of AIG responsible for incurring its losses had been regulated by the now-defunct Office of Thrift Supervision.

Insurers and other large non-bank institutions got their first glimpse of the rules they could be facing when the Fed published its proposals on January 5 – and were alarmed to discover a regime based on bank regulations, complete with minimum capital requirements, liquidity standards and a leverage ratio. The latter concepts are borrowed from the Basel III framework agreed by international bank regulators at the end of 2010, and insurers say they make little sense outside that context.

“If the US imposes a Basel III-type risk-based capital ratio framework directly on to insurance companies, it would be wholly misguided. Insurance is an inherently liability-driven business – we create value for our policyholders by issuing well-underwritten, well-structured and well-priced insurance policies. In contrast, banking is an asset-focused industry that generates earnings by accumulating assets, by accepting credit risk and maturity transformation risk and funding liquidity risk. This proposal would use a screwdriver to drive in a nail,” explains Tom Wilson, chief risk officer at life and general insurer Allianz in Munich.

The most important word there, of course, is if. The Fed acknowledges the proposals have been drawn up with large banks in mind – the rules cover not just big non-banks, but also banks with assets of more than $50 billion – and says it will “take into account differences among bank holding companies and non-bank financial companies supervised by the board”.

That’s enough to reassure Gideon Pell, New York-based chief risk officer at insurer New York Life. “These prudential standards were written with banks largely in mind, and the Federal Reserve even states in the preamble to the proposed rule that the standards may need to be tailored to non-bank financial companies. If we look at the capital standards and the liquidity requirements, it’s clear they’re putting a square peg into a round hole. We would suggest an approach where the Fed establishes basic standards for the various types of non-bank financial companies, then tailors these basic standards to each specific company designated as a systemically important financial institution,” he says.

But it’s not clear how much tailoring there will be. While acknowledging a requirement to consider the business model, capital structure and risk profile of covered companies, the Fed also says some of the bank standards in the proposals are flexible enough to be adopted by non-banks – and the mere suggestion of subjecting insurers to bank prudential rules is enough to spook some in the industry. The comment period for the proposals ends on March 31.

It is also not clear which non-bank companies will be subject to the new rules – that’s up to the Financial Stability Oversight Council (FSOC), which will tip firms into the Fed’s care if it classifies them as systemically important financial institutions (Sifis). The FSOC proposed its Sifi criteria in October last year, the first of which assesses size. A US non-bank would need to hold consolidated assets of at least $50 billion to be subjected to further Sifi tests – a foreign Sifi candidate would need to have that amount of assets in the US – and must also meet one of five other quantitative thresholds, including having at least $30 billion in outstanding credit default swaps  that reference the company.

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