Fed Lays Out Groundbreaking Rules for Insurance Companies

WASHINGTON – The Federal Reserve Friday issued a pair of proposals Friday that would subject insurance firms under its jurisdiction to capital and prudential standards for the first time – a highly anticipated step toward more uniform capital rules.

One plan laid out standards for insurance companies designated as systemically important financial institutions, while an advance notice of proposed rulemaking details how the agency wants to implement capital requirements on both SIFI firms and smaller insurance firms under its purview.

Fed Chair Janet Yellen said that the capital proposal takes pains to distinguish the capital needs of insurance firms from those of more traditional banking institutions.

"The ANPR presents potential capital frameworks that are adapted to the unique nature of the liabilities and risks of companies significantly engaged in insurance activities," Yellen said. "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."

Fed Gov. Daniel Tarullo, who heads the board's Supervisory Committee, said in a prepared statement that the proposal envisions different standards for systemically risky institutions than for firms which only fall under the Fed's umbrella because they have both banking and insurance affiliates. Tarullo said comment from industry at this early stage is encouraged.

"For the current group of a dozen insurance holding companies that we supervise solely because they own a depository institution, the capital requirement would literally build on the requirements placed on the insurance affiliates of the holding company by their insurance regulators," Tarullo said. "However, even for the firms designated as systemically important – where a more conventional consolidated approach to capital is needed and where we would thus create risk categories for assets and liabilities across the holding company – the ANPR contemplates that those risk weights and factors would be designed with insurance activities in mind."

The Fed's authority over the insurance industry is somewhat circuitous. There is no central insurance regulator in the United States – instead the sector is primarily regulated by the individual states. But some insurance firms have banking or thrift affiliates as part of their holding company structure, thus subjecting them to Fed oversight.

Other insurance firms – namely American International Group, Prudential and MetLife – have been designated as SIFIs by the Financial Stability Oversight Council. (MetLife successfully challenged its designation in federal court, but that decision is being appealed.)

Nonbank SIFIs are subject to heightened supervisory and regulatory requirements as determined by the Fed. Insurance companies – both those designated and those not designated – have expressed concern that the Fed would set capital standards akin to those required of banks.

Tarullo laid out the broad strokes of the plan in a speech to the National Association of Insurance Commissioners on May 20, reiterating his position that the risks posed by the traditional insurance industry are very different than those posed by the banking industry. Insurance policies are generally less susceptible to runs or rapid redemptions, which can undermine the capital basis of the firm. But those insurance firms' whose activities make them far more integrated with the financial markets should be closely examined and adequately capitalized, he said.

"It is important that financial regulation be tiered so as to regulate for the kinds of risks various groups of financial institutions actually pose, rather than to regulate in a monolithic fashion," Tarullo said at that meeting. "We should aim … to promote financial stability in a manner that takes account of both the unique form of financial intermediation reflected in the traditional insurance business and the activities by a few firms that are much more closely connected to short-term financial markets and the rest of the financial system."

The proposal outlines enhanced prudential standards for insurance firms designated as SIFIs, and requires insurance SIFIs to have certain governance structures in place, including an enterprisewide risk management "framework," a risk committee at the board level responsible for risk management, as well as a chief risk officer and a chief actuary.

The plan would also require the firm's board and senior management to have certain liquidity provisions and procedures in place. Those include short- and long-term cash flow projections, plans for contingency funding, explicit limits to liquidity risk the firm is willing to take on, and monitoring processes. SIFI firms must also conduct liquidity stress tests on a monthly basis and hold a liquidity buffer capable of covering 90 days of stressed cash flows.

The capital proposal, meanwhile, outlines two tiers of capital: one for SIFI firms and one for non-SIFI firms engaged in insurance activities. For SIFI firms, the plan outlines something called the consolidated approach, which would consider a firm's consolidated assets and liabilities and categorize them into various buckets with an appropriate assignation of risk. The proposal does not elaborate on what those categories might be or how they should be weighted.

For the 12 smaller firms under Fed jurisdiction, the proposal contemplates something called the "building block approach" – or BBA – whereby a firm's affiliates would be required to hold the amount of capital that their legal entity regulator requires, and the consolidated capital requirement would effectively be the sum of those individual capital requirements. Some adjustments will be necessary to standardize accounting languages between jurisdictions, the ANPR says, and to account for intercompany transactions.

"The BBA is relatively low burden, standardized, executable, uses U.S.-based accounting principles, accounts for material insurance risks, strikes a balance between risk-sensitivity and simplicity, and is tailored to the business model and risks of insurance," the board memo said. "However, the draft ANPR invites comments on whether larger or more complex insurance companies that might in the future acquire a depository institution should be subject to a regulatory capital framework other than the BBA."

The Fed will take comment on both proposals through Aug. 2.