What Everyone Got Wrong About MetLife's Breakup

WASHINGTON — MetLife's surprise announcement that it was going to divest itself from several of its business lines is widely seen as a response to its designation in late 2014 as a systemically important financial institution.

MetLife was just the fourth nonbank named by the Financial Stability Oversight Council as a SIFI, and the second to shortly thereafter announce plans to break itself up.

"You've now seen two of the four firms that were designated actively take steps to restructure their business. That to some degree means that Dodd-Frank is working as intended," said Aaron Klein, director of the Bipartisan Policy Center's Financial Regulatory Reform Initiative.

Yet there is evidence that the conventional wisdom is wrong — and that MetLife's breakup may not be a reaction to its SIFI designation at all. Here's why:

The breakup does not necessarily make MetLife small enough to escape SIFI designation

MetLife is a gargantuan firm with more than $880 billion in assets. Even after it divests itself of the companies it says it plans to break off, it will be a $640 billion company. That's smaller than fellow nonbank SIFI insurance firm Prudential but larger than American International Group, the first nonbank to be designated. On size alone, the breakup does not take MetLife out of the orbit of what the FSOC might consider to be a systemically important firm.

The breakup does not divest MetLife of many of the businesses the FSOC was worried about

The breakup does divest MetLife of a few of the riskier business lines that the FSOC was worried about when it designated MetLife in December 2014 — namely, the new company will take with it 60% of its variable annuities business, which the interagency council said was riskier than alternatives like whole or term life insurance because it can be withdrawn by the customer.

But the legacy company will keep a number of other business activities that were cited by the FSOC: its securities issuances, guaranteed investment contracts, derivatives positions and certain capital market products, to name a few. It's probable that selling off a chunk of the variable annuities business would lessen its systemic footprint, but it's not clear it would be enough for the council to de-designate the firm.

"The sale of these life insurance assets should reduce the capital requirements set to be imposed on MET as part of its designation as a non-bank SIFI," Cathy Seifert, a Standard & Poor's equity analyst, said in a market note on Wednesday morning. "We anticipate that the sale of these assets will lessen and not eliminate its burden as a SIFI, however."

The "regulatory environment" cited by the firm might not have meant the FSOC

Part of the reason so many people believe MetLife is splitting itself up due to its SIFI designation is because its chairman and CEO Steven Kandarian mentioned the "economic and regulatory environment" as a reason for the change. But he may have been referring to other regulatory policy matters, such as higher capital requirements. The International Association of Insurance Supervisors — an international regulatory standards group — recommended higher capital standards for variable annuities in a report last fall, which was developed at the direction of the Financial Stability Board, of which the Federal Reserve Board is a key member.

The new business created by the split will take with it 85% of MetLife's U.S. universal life with secondary guarantee business — a line similar to whole life insurance but with an added cash value. Those kinds of business lines are generally highly capital-intensive compared to some of the businesses that will remain in the legacy MetLife.

The Federal Reserve, meanwhile, is still working on its rules to establish capital standards for nonbank SIFIs, but Congress gave it the power to treat insurance companies differently from banks in 2014. The Fed and MetLife declined to comment for this story.

MetLife isn't planning to change direction regarding its lawsuit

At the moment, MetLife has made it clear that it has no plans to ask the FSOC to reconsider its designation or drop the lawsuit it issued last year against the interagency council. It continues to argue that it is not systemically risky, either in its current form or its proposed new one.

The firm has not shied away from criticizing the FSOC in the past, either during its designation process or afterward. If the SIFI designation were the cause of its breakup, it seems likely it would say so directly. So far, it hasn't done so — and doesn't appear likely to.

To be sure, even if MetLife is not pursuing a de-designation or withdrawing its lawsuit, the breakup is still important and has political and regulatory ramifications.

Mark Calabria, director of financial regulation at the Cato Institute, said that the political importance of MetLife's breakup is going to be in the eye of the beholder: an opponent of the FSOC and the Dodd-Frank Act will see it as an example of overzealous regulation causing a profitable firm to make itself less competitive, while a supporter will view it as proof that the system works.

The breakup could also give Republicans in Congress added momentum to push legislation to more clearly articulate the de-designation process.

"This is not going to change a lot of minds," Calabria said. "I don't think it changes the overall political environment, but it does change the momentum toward whether there does need to be some kind of legislation clarifying the de-designation process."

Karen Shaw Petrou, managing partner of Federal Financial Analytics, said that even if MetLife stays a SIFI, the oversight council will probably face greater pressure to define its off-ramps for designation.

"It certainly will require FSOC to take a fresh look at de-designation, which I think it would otherwise not be been prepared to do in next year or two," she said.

For his part, the Bipartisan Policy Center's Klein says that regardless of whether MetLife seeks de-designation, if one believes that the company's actions have reduced its systemic risk, then its actions should be applauded.

But the episode reveals some structural shortcomings of the SIFI designation process — namely that the question of how much systemic risk is too much is a subjective question and the determination is binary. If a company — be it MetLife or some other nonbank SIFI — makes an attempt in the future at reducing its systemic risk but finds its moves rebuffed, "it would indicate a lack of communication and understanding between the FSOC and the companies," Klein said.

"There's now a line forming at the checkout stand of the SIFI Hotel," he added. "We'll find out if it's a Hotel California, or if you can really check out anytime you like."