NYU prof. sees possible life insurer failure from risky behavior Industry, NAIC, say nonsense

The C.V.Starr Professor of Economics at the New York University Stern School of Business said he sees systemic risk in the life insurance sector as companies deploy more regulatory arbitrage to reduce needed capital, push off liabilities and pursue riskier strategies that banks used to pursue.

Specifically, the professor, Viral V. Acharya, focused on recent research on captive reinsurance, which he termed off balance sheet shadow insurance, search for yields in the corporate bond market and a reduction in capital requirements for mortgage-backed securities. He said insurers seem to be filling the void left by banks who started exiting risky behavior after the crisis.
He specifically raised MetLife, especially, and Prudential Financial as life insurers that can fail if there is a housing market correction and an equity market collapse.

Speaking a part of a panel on global insurance regulation at the Brookings Institution on Oct. 14, he said he was “stunned” at the capital reduction requirements for residential (R) MBS since a 2009 reform by the NAIC reducing RMBS capital required by 67%. This capital relief for large and perhaps distressed – in 2009 insurers amounts to over $15 billion relative to the earlier risk-based system, he charged.
For his suggested failure scenario, Acharya faulted capital calculations based on expected losses.
“What about unexpected losses,?” he asked. A crisis is about unexpected losses not expected losses, he added.
Acharya said he doesn’t expect a run-on-the-bank scenario so much as a collapse in market values which will cause contagion “stop” the intermediation in the market by insurers, who will not be buying RMBS or any MBS and withdraw from bonds.
Later, Acharya explained in an email that raised an audience member’s question about insurance industry surplus (about $672 billion estimated) as a buffer that these surplus calculations “do not account for unexpected losses, I think, and ignore off balance sheet liabilities at captives. It also would be odd to give the firms capital relief for RMBS on one hand and tighten through surplus elsewhere,” he stated.
“The plan was to give capital relief to undercapitalized insurers and allow them to get into the space banks were withdrawing from, by earning fat yields on subIG (investment grade securities) …But even if justified in 2009, why should the relief be permanent?” he said in the email.
Acharya, who covered a chapter of a book he is writing (Chapter 9) with Matt Richardson, entitled Modernizing Insurance Regulation, (Wiley and Sons, Inc.) said it was worrisome that there seems to be insurance risk-taking across an investment grade classes, and fall at the edges of each investment class to the extent they can, and noted insurers have become the buyer of last resort for sub-investment fade RMBS at a time when banks are pulling back.
“There s a huge killing to be made here,” he said, guessing at insurers’ motivation, and there will be a housing crisis in the next 20 years and companies like MetLife could fail, he said.
He wanted to know why the NAIC has made permanent the capital relief it is giving insurers’ investments.
In the preface to the upcoming book, Acharya and Richardson write: “The insurance sector may be a source for systemic risk. In brief, we argue that the insurance industry is no longer traditional in the above sense and instead (i) offers products with non-diversifiable risk, (ii) is more prone to “runs” (iii) insures against macro-wide events and (iv) has expanded its role in financial markets. This can lead to the insurance sector performing particularly poorly in systemic states, that is, when other parts of the financial sector are struggling. We provide evidence using publicly available data on equities and credit default swaps. As an important source for products to the economy (i.e., insurance) and a source for financing (i.e., corporate bonds and commercial mortgages), disintermediation of the insurance sector can have dire consequences.”
In remarks to audience members gathered afterward, Acharya alleged that the company Google, for example, was safe, a certain pharmaceutical company was safe, but MetLife was not “safe.”
Earlier, in his presentation, Acharya, who has been an academic advisor to the Federal Reserve Banks of Cleveland, New York and Philadelphia and teaches credit risk, noted that MetLife owns an affiliated firm that reinsurers MetLife and that the AM Best rating ignores the captives. Its failure would costs state guarantees funds more the $15 billion, he said.
“Regulatory arbitrage” has allowed the insurance sector to free up reserves and increase its size, something over which various federal government offices are also noting.
He suggested insurers put pressure on state regulators to have the investment grade requirements for RMBS be almost the same as the sub-investment grade RMBS.
MetLife and Prudential were not in attendance and did not have a comment.
Acharya’s charts show high capital shortfalls for MetLife and Prudential in the case of a 40% market correction, above that of Bank of American and JP Morgan.
Insurance representatives and others weren’t buying it. Most have heard the warning bells about captive reinsurance before, but did not accept the scenario where the large insurers would fail in a housing crisis. The insurers would continue to buy in the market and people would continue to buy life insurance, one insurance representative noted.
Marty Carus, an industry consultant and former AIG and New York state insurance department official noted that RMBS performance from 2008 to 2010 in terms of cash flow was healthy. During this period, the industry lost minimal cash flows and cash flows are what was important as opposed to unrealized losses due market price decreases that caused write-downs, according to Carus. There is almost “no likelihood” of Prudential or MetLife failing with industry surplus,the long-time insurance regulatory official said.
Even if MetLife’s and Pru’s “RBC hit mandatory control level, they are eminently solvent (that is more assets than liabilities). Moreover, point estimates of required capital levels make little sense. If there is a temporary decline in asset values but no real loss of cash flows, companies can flow in and out of solvency. That is why during the Great Depression, valuations of debt securities (i.e., bonds) went to amortized values. Market values had decreased so markedly during 1930 that industry would be broke nominally but not actually,” Carus said in an email.
Acharya disagreed with arguemtns about this in general. “I think MetLife can fail,” Acharya said, charging that CDS fluctuated a great deal in 2008 and now almost 50% of RMBS are sub investment grade.
NAIC CEO Ben Nelson said on the panel in response to the myriad accusations that the “NAIC is on it,” and noted the NAIC work on principles-based reserving (PBR). Because of NAIC’s implementation of PBR, on will see “less use of the captives,” Nelson said. He reiterated the stance that the state system has worked and that the last crisis was not an insurance failure but an AIG failure.
But the professor warned that, “If we don’t harmonize insurance principles,” there will be problems and said this was a problem for the Financial Stability Oversight Council (FSOC) housed at Treasury. FSOC members and staff were among those in the audience. MetLife filed an appeal early this month to fight its proposed systemically risky financial institution (SIFI) designation by the FSOC. MetLife’s appeal will take place this fall, and if it fails, it could take the matter to court.
Failure would impact policyholders too, he said in a follow-up email.
“The insurance firms have been buying sub-IG tranches….So if losses exceed expected losses, for which they have not reserved and increasingly kept low equity cushion, policyholders and more likely federal taxpayers, will be on the hook,” Acharya said.

MetLife receives preliminary SIFI designation from FSOC

Washington, Sept. 4 — After more than a year of review, the Financial Stability Oversight Council (FSOC) voted today to preliminarily designate MetLife, the country’s largest life insurer, a nonbank systemically risky financial institution or SIFI, and the insurer said it is weighing its options.
The Council’s vote was unanimous with one member voting present. AIG, when it was designated, had an unanimous vote. Prudential Financial’s final designation vote was 7-2, with an abstention from the new SEC chairwoman.
“MetLife strongly disagrees with the Financial Stability Oversight Council’s preliminary designation of MetLife as a SIFI,” stated after the vote.

“MetLife is not systemically important under the Dodd-Frank Act criteria. In fact, MetLife has served as a source of financial strength and stability during times of economic distress, including the 2008 financial crisis,”MetLife CEO Steven Kandarian continued in a prepared statement this afternoon.
The preliminary designation came in a closed meeting of the FSOC, over which U.S. Treasury Secretary Jacob Lew presides.

Construction of the US Treasury Building, 1857, image courtesy LOC

Construction of the Treasury Building, 1857, courtesy LOC


Kandarian said that MetLife is not ruling out any of the available remedies under Dodd-Frank to contest a SIFI designation.

Prudential Financial appealed the decision last year by the FSOC and lost but did not pursue the matter through the court system.

MetLife now has 30 days to request a hearing before the Council to contest the proposed determination. After any hearing, the Council may make a final determination regarding the company.

FSOC does not intend to publicly announce the name of any nonbank financial company that is under evaluation before a final determination is made.

Instead, MetLife did the talking today: “The current regulatory system oversees a stable industry that pays out more than $500 billion every year. Imposing bank-centric capital rules on life insurance companies will make it more difficult for Americans to buy products that help protect their financial futures. At a time when government social safety nets are under increasing pressure and corporate pensions are disappearing, the goal of public policy should be to preserve and encourage competitively priced financial protection for consumers,” Kandarian stated.
If assets are treated as short-term under accounting or capital rules, then insurers will not be there to buffer the risk they have taken on with huge pension plans, insurers have argued.
When and if New York-based MetLife is formally designated, it would be subject to enhanced prudential supervision from what (again) will be its primary regulatory Federal Reserve Board, with a host of accompanying  holding company oversight and capital standards, a yet to be worked out by the Fed.
The vote by the 10-member Council would not mean a proposed SIFI designation is official until MetLife is given a chance to respond, which may mean it decides to appeal or does nothing and the time-frame to respond elapses.

However, the most interesting part of MetLife’s potential designation will be the rationale used by FSOC. For example, for Prudential, last year, the FSOC majority started with the premise of an impaired insurer, with a run on the bank scenario, that many in the insurance industry–and the independent insurance expert, Roy Woodall, thought was implausible, according to his dissent.
Last year, FSOC determined that Prudential’s material financial distress could pose a threat to financial stability focusing on two of the channels: exposure and asset liquidation.
“The Council has based its conclusion solely on what is referred to as the First Determination Standard; namely: ‘material financial distress at the nonbank financial company could pose a threat to the financial stability of the United States,'” Woodall stated in his dissent.
Under Dodd Frank regulations, FSOC can, but does not require, that it begin with the company in distress and make determinations from there.
Passing that up brings the Second Determination Standard, dealing with the activities of an institution, into play.
“Given the questionable and unreasonable basis for the Council’s reliance solely on the First Determination Standard, it is my position that it would have been prudent for the Council also to have considered the Second Determination Standard pertaining to activities,” Woodall stated in the Prudential dissent of September 2013.
The fact that there were no dissents today–a ‘present’ vote is not a dissent–it appears the FSOC COULD have used the second determination route with MetLife.
Reaction from the Hill will certainly come, as some concerned lawmakers there have been attempting to stop FSOC in its tracks and have it reconsider SIFI designations until there is further disclosure on proceedings.
Rep. John K. Delaney, D-Md., a member of the House Committee on Financial Services,stated he had concerns about the process behind the MetLife designation, particularly regarding an alleged lack of communication and transparency.
“I generally support FSOC and its goals, but believe the details can be improved,” said Delaney, who, in July introduced with Rep. Dennis Ross, R-Fla., the FSOC Improvement Act (H.R. 5180) to address concerns about lack of transparency in the SIFI designation process.

MetLife, like its insurance SIFI brethren AIG and Prudential, is already designated as a global systemically important insurer (G-SII) by the Financial Stability Board (FSB) and the International Association of Insurance Supervisors (IAIS), which is expecting to designate any global reinsurers it deems systemically risky this November.
MetLife has been regulated by the Fed before, back when it owned a bank. MetLife debanked in early 2013 in part to get out from under the Fed’s Tier One capital-focused oversight, where it was subject to stress tests it believed befit banks, not insurers.

Insurance trades were having none of what the FSOC delivered today.

The American Council of Life Insurers (ACLI) said it “is extremely disappointed” by the designation today of another life insurance company, MetLife, as a SIFI.

“No single life insurer poses a systemic risk to the U.S.economy,” it simply stated.
For its part, he Property Casualty Insurance Association of America (PCI)’s Robert Gordon, senior vice president, policy development and research, stated that “while a particular combination of facts, including the performance of non-insurance activities, may trigger a determination of systemic risk for an institution, such a determination does not alter the fact that property and casualty and other traditional insurance activities do not give rise to systemic risk.”
Rep. Scott Garrett, R-NJ), chairman of the Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, who once tried to gain entry to a closed FSOC meeting, let loose on the preliminary decision: “Today’s irresponsible and inappropriate designation of another U.S. business as too-big-to-fail only strengthens my resolve to reform the out-of-control FSOC….This designation flies in the face of a unanimous, bipartisan vote in the House of Representatives to postpone any additional designations,” he said.
Garret and others have been engaged in a flurry of letter-writing over the past months to get answers from Lew and FSOC.

Lawmakers to Lew: why treat insurers differently in FSOC risk review?

Two days before the Financial Stability Oversight Council (FSOC) is due to discuss, at minimum, insurance company systemic risk designations, a group of seven Congressmen led by Rep. Scott Garrett, R-N.J., wrote to Secretary Treasury Jacob Lew with concerns that the Council is not giving insurers a fair shake.

 1839 Kollner ink and ink wash landscape of Capitol Hill,  before the dome had been added to the Capitol. Courtesy, LOC.

1839 Kollner ink and ink wash over graphite landscape of Capitol Hill, before the dome had been added to the Capitol itself. Courtesy LOC.


The treatment of the insurance industry didn’t get the public analytical effort that the asset management industry did in the FSOCs “rush” to designate firms as systemically important financial institutions (SIFIs), leading to disparate treatment of insurers, the Congressmen charged in the Sept. 2 letter.

Treasury has said before it does a very through review of the companies it reviews. metLife has been under consideration as a potential SIFI for over a year-the deliberations have not been made public nor has Treasury ever acknowledged that this company was under review.

The Council has devoted far less effort to empirical analysis, stakeholder outreach, and transparency in its consideration of insurance companies for designation than it has for asset management firms,” the Congressmen alleged.

The preliminary agenda of the Sept. 4 closed FSOC meeting includes a discussion of nonbank financial company designations as well as consideration of the Council’s fiscal year 2015 budget, and discussion of the Council’s work on asset management, according to a notice from the Treasury Department.

Joining Garrett, chairman of the Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises, were GOP Reps. Ed Royce, R-Calif., Sean Duffy, R-Wis., Dennis Ross, R-Fla., Spencer Bachus, R-Ala., Steve Stivers, R-OH, and Mick Mulvaney, R-SC.

They asked Lew for the rationale behind the approaches to the insurance industry in its consideration of potential SIFIs, including MetLife, which may or may not go to a Council vote tomorrow for proposed SIFI designation, depending on how ready Council members are.

The Office of Financial Research (OFR), which provides research for FSOC, published a report on the asset management industry in September 13. Although the quality of the report was roundly criticized by the Congressmen and some in the industry, they used it as a point of comparison in contrast with lack of such a report for the insurance industry. The lawmakers also noted that the FSOC held a public conference on asset management back in May but questioned why a similar exercise was conducted before designating insurers as SIFIs.

Some prominent lawmakers have been busy this year sending letters to Lew and otherwise passing legislation along party line votes through committee to attempt to gain some insight control over the FSOC process, either through efforts to make it more transparent to the public or at least certain Congressional members, or to get concrete feedback on the decision-making process for nonbank SIFIs.

Garrett himself, who introduced the Financial Stability Oversight Council (FSOC) Transparency and Accountability Act (H.R. 4387), was barred from a March 2014 FSOC meting he tried to attend.

Thus far, non bank SIFIS are AIG, GE Capital and Prudential. No asset managers have yet been named. Two insurers are under consideration, MetLife, which underwent Stage 3 analysis and has had its books formally “closed by the FSOC and another company in Stage 2, according to the minutes, which is perhaps Berkshire Hathaway, as a reinsurer, but which could be another big life insurance company, as well.

If  MetLife is designated, it would be subject to enhanced prudential supervision from the Federal Reserve Board, with a host of accompanying  holding company oversight and capital standards, a yet to be worked out by the Fed. A vote by the 10-member Council would not mean a proposed SIFI designation is official until MetLife is given a chance to respond, which may mean it decides to appeal or does nothing until the time-frame to respond elapses.

Yes, the book on MetLife is closed; vote on SIFI desgination next step

The Financial Stability Oversight Council voted Aug. 19 unanimously to close the evidentiary record on a what it says is a nonbank financial company, which we shall refer to as MetLife.
MetLife has been in Stage 3 of the review process for potential designation as a systemically risky financial institution (SIFI) for over a year.
Closing the books is the next step before the FSOC gathers in person or by phone to vote to potentially designate the largest U.S. life insurance company a SIFI, as it has for AIG, GE Capital and Prudential Financial, the second-largest U.S. life insurer. Prudential contested its proposed designation in an appeal, lost its bid and finally accepted it in lieu of a further battle and a higher standard of proof in the courts.
MetLife has long argued that it is not a SIFI, and it will be of interest to many to see whether the vote is unanimous or not.
The vote for Prudential was broken by three dissents, two from voting members Roy Woodall, the appointed independent member with insurance expertise, and Edward DeMarco, then acting chair of the Federal Housing Finance Agency (FHFA), and one from the representative from the state regulators, Missouri Insurance Director John Huff. The Securuties and Exchange Commission (SEC) had abstained in light of the recent Mary Jo White appointment.
When MetLife reached Stage 3 of the FSOC’s designation process in mid-July 2013, CEO Steven Kandarian stated that,
“I do not believe that MetLife is a systemically important financial institution. The Dodd-Frank Act defines a SIFI as a company whose failure ‘could pose a threat to the financial stability of the United States.’ Not only does exposure to MetLife not threaten the financial system, but I cannot think of a single firm that would be threatened by its exposure to MetLife.”

He argued against the scenario that the FSOC in large used that summer to finally designate Prudential, a run on the bank scenario.

“The life insurance industry is a source of financial stability. Even during periods of financial stress, the long-term nature of our liabilities insulates us against bank-like ‘runs’ and the need to sell off assets,” Kandarian said July 16, 2013.
“If only a handful of large life insurers are named SIFIs and subjected to capital rules designed for banks, our ability to issue guarantees would be constrained. We would have to raise the price of the products we offer, reduce the amount of risk we take on, or stop offering certain products altogether.”
MetLife is already a global systemically important insurer, as designated by the Financial Stability Board (FSB) after a review by the International Association of Insurance Supervisors (IAIS), as are AIG and Prudential.
The FSOC said in its resolution approving the completion of the record that “the nonbank financial company” has submitted written materials and information to the Council and the Office of Financial Research (OFR) and the staffs of the Council members and their agencies have analyzed such materials and information. The council member agencies are led by the Treasury Secretary or his designee. Including him, there are 10 voting members. They are listed here, by agency: http://www.treasury.gov/initiatives/fsoc/about/council/Pages/default.aspx
The OFR was planning on hiring more insurance expertise at one point, in the spring.

IAIS proposing removing ‘observer’ groups, adding public forum and phone time

UPDATE with NAIC consumer rep comment

July 31, Washington—In a move that had been anticipated by some for awhile, the International Association of Insurance Supervisors (IAIS) told members and observers that it is proposing the elimination of “observer” status. If this proposal becomes policy, it would go into effect January 2015.
Comments on the proposal, which is expected to become public Aug. 4, will be due on Sept. 2.
The IAIS, which did not confirm this action or timeline. It has been developing and weighing new processes for participation by interested parties for some time and will continue to do so.
Some groups have in the past been vocal about their  criticism of the move toward what they feel has been a trend at the IAIS toward less transparency and more closed meetings. Observers say the policy will definitely change the dynamics  of interaction with the IAIS at a critical time.

A global insurance capital standard is in the works by 2016 for globally active insurance groups, with implementation by 2019, alongside the continued development of capital standards for global systemically important insurers (G-SIIs) and possibly for global reinsurers.

The IAIS is also developing basic capital requirements (BCRs), which are planned to be finalized this year for implementation by global systemically important insurers (G-SIIs.) BCRs will serve as the foundation for higher loss absorbency (HLA) requirements for G-SIIs, and it is anticipated that their development and testing will also inform development of the ICS, the IAIS stated last year.

“You are talking about very complex issues here –the idea that  they are decided in closed sessions is absurd….Corporate governance now being thrown out the window–they spend 10 years opening up these meetings, and now with the flick of a switch they are going to close them,” one industry executive noted.  “Why is it that the public that is most effected by this have little time…less than a month… to comment?”

Also, recently, there are some key observers who just got their ‘wings.” The latest inductees into the observer ranks had strongly pushed for inclusion–namely, consumer groups and the independent insurance member of the U.S. Financial Stability Oversight Council (FSOC.)

Peter Kochenburger, one of six National Association of Insurance Commissioners  (NAIC) consumer representatives designated for IAIS observer participation was worried about the effect of any new policy after consumers had just gotten their foot in the door.

Unlike big insurance  companies, the consumer advocates are less well known and could have really benefitted from face-time with their counterparts from different countries as well as from having an audience with international regulators, he noted. He expressed concern that  eliminating observer status will reduce the effectiveness of consumers’ participation although that is not the intent of the new proposal.

Kochenburger, a University of Connecticut law professor and executive director of the law school’s insurance law center, says he thinks communicating only via e-mail, conferences calls and the like does not enhance understanding and developing trust (if not agreement) between the parties.  However, he noted, consumer groups will always be very strapped for paying for travel (despite funding up to a point by NAIC) and always vastly outnumbered by the industry in public live meetings so the proposed this emphasis on written communication/comments could help level the playing field a bit.  He also supported the IAIS intention of setting out specific processes and timelines for stakeholder participation, and welcomed written participation.

 

Roy Woodall, the appointed independent insurance expert and insurance voting member at FSOC, gained observer status this winter after trying for more than a year and half to become part of the proceedings. Woodall had publicly expressed strong concern in Congressional hearings about not having access to important regulatory discussions on financial stability of insurers in the FSOC’s wheelhouse when associates at NGOs and other service-oriented organizations could join the top-level discussions.

The Federal Reserve Board, also an FSOC member, was approved for membership –more than observer status-in the fall of 2013. The Federal Insurance Office is also a member.
Observers pay a flat fee of $19,000 Swiss Frances (CHF). A 2013 IAIS list denotes 144 observers for a possible total of 2.736 million CHF which is over $3 million US dollars.
Members pay quite a bit more. Total such fees for 2013 were 3,848,900 CHF or $4.237 million converted today. The NAIC pays a hefty 317,000 CHF, or almost $350,000, dwarfing the fees of any other member. They also bring more people to the table.
The Federal Insurance Office fee is $14,100 CHF and the UK, Canada, the Netherlands and Bermuda have a membership fee of 67,000 CHF, the top fee among most other global jurisdictions.
It is thought that the Financial Stability Board (FSB) could help fund the difference if and when Observers are dropped from membership, although no one is publicly discussing options.
IAIS observers include in the United States as of 2013:  ACE, INA Holdings Inc .,  ACORD
AFLAC, AM Best, American Council of Life Insurers (ACLI,) American Insurance Association(AIA), AIG, Assured Guaranty Municipal Corp., Barnert Global Ltd., Cigna International Corp. CNA Insurance, Deloitte LLP, DLA Piper, LLP, Duane Morris LLP, Examination Resources LLC, Genworth Financial, Liberty Mutual Group, MassMutual Financial Group, MetLife, New York Life International, Northwestern Mutual, Promontory Financial Group, LLC, Property Casualty Insurers Association of America (PCI), Prudential Financial Inc, Reinsurance Association of America USA, Starr International USA Inc., The Chubb Corp., Transatlantic Reinsurance Co., Travelers Companies, Inc., Treliant Risk Advisers, United Health Group and XL Group.

The NAIC consumer representatives, as noted,  and international organizations such as the International Actuarial Association, the World Federation of Insurance Intermediaries and Insurance Europe are also observers.

Late summer, fall harvest of non-bank SIFIs, G-SIRs (global reinsurers)?

SIR? G-SIR?
It should come as no surprise when MetLife receives a proposed systemically risky financial institution(SIFI) designation when the Financial Stability Oversight Council (FSOC) meets July 31 in a closed session –if the decision is ready, whether or not people agree with it.
At least one other institution in consideration for a nonbank SIFI designation will also be discussed at the scheduled meeting, it appears from the FSOC notice.
There was a nonbank SIFI in Stage 2 (out of 3 stages before a designation is proposed) in late March, which could be a reinsurer like the behemoth Berkshire Hathaway, or an asset manager, like BlackRock, which also early on (2011) argued against its sector’s consideration by the FSOC. Yet, because the FSOC minutes show that the deputy director for financial stability in the Federal Insurance Office (FIO) provided an update on the status of the ongoing analysis of this nonbank financial company in Stage 2, a insurer or reinsurer could be under the microscope–although it could be an asset manager that owns an annuity company. Berkshire is expected by some to be named, along with other global reinsurers, a global systemically important reinsurer (G-SIR) in November by the Financial Stability Board. (FSB.)
For its part, MetLife has been meeting with Federal Reserve Board officials for at least two years as they have noted in presentations and filings, regulators and lawmakers have requested input on capital adequacy frameworks for insurers as an alternative to the Basel framework prescribed under the US Basel III final rule. met has been under consideration as a SIFI in stage 3 analysis for more than a year by the FSOC, where it came under review when it divested its bank holding company status. As such, it has been very familiar with Federal Reserve oversight and the onus of stress tests. Insurance-applicable capital standards have yet to be developed. All SIFIs will be subject to Basel III, and insurers are hoping for some insurance-centric adaptation.
What will be interesting, once the MetLife decision is released, will be the rationale used for determining MetLife’s proposed SIFI-hood, and the language of the dissent or dissents which could follow.

If a run on the bank scenario is not used as the starting culprit in the FSOC analysis, MetLife would still have to be shown to cause systemic risk in a failure if it were a SIFI. Its global position and leveraging, and enormous third party asset management arm, MetLife Investment Management, could conceivably be argued to cause  any systemic risk problem more than the insurance operations. According to a snapshot profile, it it manages 12 accounts totaling an estimated $12.3 billion of assets under management with approximately 11 to 25 clients. It purchases commercial real estate. Asset managers are already being explored for their systemic risk. 

There is a strong and lively camp that resolutely believes insurers are just not systemically risky. There are bills in the House, two approved by a panel, that would curtail FSOC’s SIFI designation process pending a review, allow certain members Congress and other agency officials to sit in on closed meetings,  and new efforts  this week to reform FSOC and the Office of Financial lResearch  introduced by U.S. Rep. Dennis Ross, R-Fla., Rep. John Delaney, D-Md, Spencer Bachus, R-AL., Kyrsten Sinema, D-Az.,  and Patrick Murphy, D-Fla.,

“Dodd-Frank turned four this week,” Ross stated.  Unfortunately, it has become increasingly evident that aspects of the law are not working as promised. FSOC and OFR are agencies that were established to identify potential risks to our nation’s financial stability but they have been broadly criticized for their lack of transparency, flawed research, and inadequate designation process. …. In many cases, the SIFI designation can lead to a large cost increase for consumers.” Ross and fellow concerned House members  wrote a letter to Secretary  of the Treasury Jacob Lew in April detailing concerns with judging asset managers as risky and suggesting the need for specific ways in how they pose risk.

All of this concern, FSOC hand-wringing and legislation will come too late for MetLife, at least.

The rationale used for the case to create Prudential Financial’s SIFI designation was pummeled by many, including the insurance contingent on the FSOC, excepting Treasury official and FIO Director Michael McRaith, a nonvoting member. The run-on-the-bank scenario was held as improbable, and FSOC insurance expertise member Roy Woodall also worried about how the insurer could possibly ever exit from SIFI-hood under the scenario offered. FSOC began its examination from an assumption that Prudential was in distress from a run on the bank.  Woodall dissented on Prudential’s SIFI designation, but not on AIG‘s.

“The Basis does not establish that any individual counterparty would be materially impaired because of losses resulting from exposure to Prudential. Instead, the Basis relies on broader market effects and aggregates the relatively small individual exposures to conclude that exposures across multiple markets and financial products are significant enough that material financial distress at Prudential could contribute to a material impairment in the functioning of key financial markets,” Woodall stated in his dissent.

Treasury officials were concerned about Prudential’s extensive derivatives portfolio and activities for hedging and otherwise.

The majority FSOC rationale offered for MetLife is likely to be a bit different, but invite still find criticism.
Prudential was officially designated by the FSOC on Sept. 19, 2013 after an appeal failed, and as such is subject to enhanced supervision by the FRB pursuant to Dodd-Frank.
Prudential states outright in its resolution plan filed with the Fed “the failure of the Company would not have serious adverse effects on the financial stability of the United States.”
Prudential is also subject to regulation as an insurance holding company in the states where Prudential’s U.S. insurance company material legal entities are domiciled, which currently include New Jersey, Arizona and Connecticut.
There are no capital or enhanced standards or Basel 3 adaptations worked out yet for Prudential, which is being overseen by the Boston Fed. The company says it will continue to work with the regulators to develop policies and standards that are appropriate for the insurance industry.
Its first order of business was filing a resolution plan, which it did just before the July 1 deadline. AIG also had to do one, and MetLife will have to do one as well.
The Resolution Plan describes potential sales and dispositions of material assets, business lines, and legal entities, and/or the run-off of certain businesses that could occur, as necessary, during the hypothetical resolution scenario.
Pru’s resolution plan describes potential asset or business sales that could occur during this hypothetical resolution of Prudential and its material legal entities as the result of the hypothetical stress event.
Prudential says that Under the hypothetical resolution scenario, each of Prudential Financial, Prudential Asset Management Holding Co., the holding company of Prudential’s asset management business, and (Prudential Global Funding (PGF, its central derivatives conduit) would voluntarily commence a bankruptcy proceeding under Chapter 11 of the Bankruptcy Code in the applicable federal court.
Once the Chapter 11 proceeding began, PFI and PAMHC would likely sell certain businesses and reorganize around the businesses each elects to retain.
PGF, Prudential’s central derivatives conduit, would quickly liquidate what limited assets would remain and settle any other liabilities following the termination and closing out of its derivatives positions, Pru’s resolution plan states.
Under the hypothetical resolution scenario, each of the primary insurance regulators for the insurance subsidiaries would file uncontested orders to start rehabilitation proceedings against the relevant insurer material legal entities in their respective states of domicile.
MetLife, which has more extensive global businesses than Prudential, which concentrates its overseas business in Japan, would have to include these in a resolution plan.
MetLife would have 30 days to request a hearing, which then must happen in another 30 days, once it is notified of FSOC’s initial decision. Without a request, a final determination is made by FSOC within 10 days.

S&P questions G-SII merits while acknowledging uncertainty in outcome of designation

Standard & Poor’s  is asking whether the global systemically important  insurers (G-SIIs) designation’s costs outweighs it benefits and appears in its analysis to be sliding toward the answer of yes, at least for some.

Of course, the effects of the designation have not played out at all, yet, so anyone who analyses any effects couches their prognosis in terms of uncertainty.

“The merits of the G-SII designation for global financial stability are not clear, in our view, and may not outweigh its costs for insurers and their regulators,” stated Standard & Poor’s (S&P) Financial Services LLC in a June 3rd report on its global credit portal.

S&P said it concluded after some analysis that “ultimately, the net impact of the designation may be negative for some G-SIIs and positive for others. The picture will become clearer as the new regime takes shape and the G-SIIs take management actions to respond.”

S&P analysts considered the positive and the negative and did find potential for both, but ultimately questioned whether insurers pose a systemic risk like some of  the large banks have been found to do.

This sentiment, and the question analysts posed, whether naming certain insurers as G-SIIs enhances financial stability and warrants the resulting costs to insurers and their regulators, colored the report’s analysis.

In fact, the analysis suggest that the creation of G-SIIs could possibly destabilize parts of the industry itself if there is too much  regulatory focus on these largest, most interconnected global insurers while the rest of the industry goes its own way, in a way, less scrutinized.  “We further believe that the creation of G-SIIs could divert regulatory resources toward these entities while more risk accumulates at the non-G-SIIs,” the analysts said.

The analysts do suggest there is a place for a systemic risk scrutiny domestically, though: “We believe that systemic risk was more evident in insurance at a national, rather than global, level during the financial crisis, when U.S. bond and mortgage insurance and trade credit insurance in some European markets posed systemic concerns.

It may be that the FSB [G-20 Financial Stability Board]  would never have pursued the G-SII regime were it not for AIG’s failure, S&P analysts stated. It was “a failure that resulted, in our view, from its shadow banking activities, which other insurers largely avoided,” S& P said.

Potential identification of systemically risky/important  global reinsurers by the International Association of Insurance Supervisors (IAIS)  in concert with the FSB, is expected in November.

“The FSB has postponed the announcement of reinsurer G-SIIs twice, which may be indicative of differing views on the potential candidates,” S&P stated.

The IAIS is expected to deliver the basic capital requirement (BCR) n November, but S&P  believes significant later modifications are likely as work continues on the other elements,  including the higher loss absorbency for G-SIIs (by 2015). IAIS said that ComFrame field testing is progressing well, with many meetings taking place over the next month to analyze data and prepare for the next BCR consultation in July.

S&P says that although basic capital requirement, higher loss absorbency, and advocated global insurance capital standard won’t be “hard” capital tests that require insurers to act on deficiencies until 2019, it expects the development of these myriad capital standards to influence regulatory supervision before then.

The ratings agency questioned also this need for capital loadings for G-SIIs.

“It’s understandable for banks, where recent empirical evidence has shown what a failure can cost taxpayers…While insurers, including some large insurers, have failed in the past, their resolutions have generally come at limited cost to taxpayers, in our view…. In light of the lack of data on the cost of these resolutions in general and for taxpayers, it’s unclear to us how the IAIS will calibrate the G-SIIs’ capital loadings,” they stated.

S&P has taken no rating actions on insurers thus far as a direct consequence of a G-SII designation so far.

However, insurers should not expect a ratings boon from S&P for their global designations, at least:

“We anticipate that governments would play a role in resolving failing G-SIIs (and D-SIIs), but don’t see the same incentive for governments to provide capital support to the insurance sector. Accordingly, we factor no government support into insurers’ ratings unless they are government-owned,” S&P stated.

“In our view, the G-SIIs generally aren’t too big to be allowed to fail because we believe it’s possible to resolve their liabilities post-failure without disrupting the financial system and without the injection of taxpayers’ money. Capital injections generally aren’t necessary when resolving insurers because, relative to banks, they have low financial leverage, lower liquidity risk, low interdependency, and extensive use of subsidiaries (rather than branches). The infrequency of insurer bailouts historically bears this out,” the S&P analysts team stated in the research report.

Policy measures under consideration for G-SIIs include heightened oversight, resolution plans, and capital loadings to absorb potential losses.

The U.S. G-SIIs are Prudential Financial, AIG and  MetLife.

Domestic systemically important insurers (SIFIs), as designated by the Financial Stability Oversight Council (FSOC)  are expected to match up with these, according to S&P, with a MetLife designation coming down the pike. MetLife has been in Stage 3 of the FSOC review process for months.

S&P states that  heightened oversight is already a reality: AIG’s lead supervisor, the Fed, has already allocated a dedicated staff of nine to the task–and “colleges” of most of the G-SIIs’ main supervisors are already in place, S&P points out.

Insurers must submit detailed resolution plans to their group supervisor by July, for example.

The primary analyst for this S&P research report, which looks at the nine G-SIIs globally, is in London, with a team in New York, Frankfurt and Singapore.

Under Standard & Poor’s policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action).

What do you think the overall effect will be on G-SIIs, or for that matter, U.S. insurance SIFIs?
AUthor: Liz Festa, June 5, 2014