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

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.

Gov’t OIG audit: FIO has been busy, but needs to track work, meet deadlines

The Federal Insurance Office (FIO) should keep records and create a plan for its functions and operations, as well as mid its report deadlines, according to the Office of the Inspector General (OIG).

The audit offered insight into why the reports have been months late, into the focus of FIO to date, and into its apparent shortcomings in tracking its own activities.

Four of the five reports required by the 2010 Dodd-Frank Act were completed well after their due dates, from about 10 to 23 months, and the fifth one, on global reinsurance,  which was due Sept. 30, 2012, has not yet been completed, the report noted.

In addition, FIO hasn’t yet documented a strategy for accomplishing its legislative functions, or developed a comprehensive implementation plan to direct the development of operational processes and ensure critical deliverables are met, the May 14 report stated.

Thus, in the future, FIO will be timely of future reports document its priorities and implementation plan, provide for record keeping, and develop performance measures, according to the audit report’s agreement reached with the Treasury office.

According to FIO management, the reasons that FIO missed the required deadlines vary, the report stated. As expected, the modernization report went through many drafts: “FIO management told us that the insurance industry modernization report was highly anticipated by the insurance industry, and the report underwent an extensive review process to ensure that the information and recommendations contained within the report were not misinterpreted.”

Much of this review process was outside the hands of FIO, some have related. FIO had key drafts done months in advance of their final publishing date, but  reports went through a tough multi-agency vetting process.

FIO officials told the OIG auditor that the global reinsurance report has been delayed while FIO focuses resources on drafting a higher priority report by the President’s Working Group on the availability and affordability of insurance for terrorism risk.

According to Treasury officials, FIO’s primary operational focus to date, the report stated, has been on representing U.S. interests in international insurance matters and working to establish strategic relationships within the insurance industry.

FIO management also were reported to have stated that the delays were due, in large part, to the considerable amount of time required to identify, attract, and hire staff with the knowledge and experience in several areas of insurance regulation needed to perform its work relating to the reports.

Some in Congress have asked McRaith, referencing overdue or late reports, chief among them, the almost two-year overdue report on Financial Modernization, if his office is adequate for the needs of preparing the statutorily-required reports on time.

In this audit report, the OIG was told by an official that the  FIO staff of 15 was determined by using the human capital planning approach which apparently identified the purposes of the office, the skills required for the office, and the skills already available.

However, “FIO was unable to provide us with a copy of this analysis,” the auditor stated.

According to this official, once FIO reaches15 full time employees, an assessment will be made to further evaluate the sufficiency of the staff size, the report said.

The Dodd-Frank Act required FIO to issue five reports, of which two reports are an annual requirement and three reports were a one-time requirement. Four of the required reports, including both initial annual reports, were completed well after their due dates, and the other one has not yet been completed.

The audit report did find that FIO has engaged in numerous activities such as representing U.S. interests related to international insurance matters, worked to establish strategic relationships within the insurance sector, staffed the office, and drafted reports.
Although FIO has worked to develop the European Union- U.S. Insurance Regulatory Dialogue, participated in the U.S.–China Strategic and Economic Dialogue, is building relationships within the domestic insurance sector and has provided a forum for the discussion of insurance topics within the federal government and the insurance sector, the audit found that FIO was unable to provide formal documentation to support the extent of its involvement in such activities.

“We believe that FIO needs to maintain a more complete record of the material activities performed by the office and their results to provide for greater transparency and to conform to Treasury’s record policy,” the OIG report said.

However, the main audit objective was to evaluate the status and effectiveness of Treasury’s process to establish FIO in a way that enables it to perform its functions. Image

In a polite written response, the tone of both the audit report and the letters back, FIO Director Michael McRaith said it agreed with the recommendations and is taking steps to implement them by working to finish the global reinsurance report “with deliberate speed.”

McRaith wrote May 1 in a letter to James Lisle, Jr, the OIG auditor, a CPA, that FIO has built an office of 15 staff and increasingly serves a a resource of insurance expertise not only within Treasury but also for third parties, including the GAO, the Financial Stability Oversight Council (FSOC) and members of Congress.

McRaith wrote that FIO agreed with the recommendations and will document FIO’s priorities and implementation plan, undertake record-keeping and develop performance measures to document the office’s progress.

The auditor also stated that FIO must put the estimated dates for completing corrective actions in the Joint Audit Management Enterprise System (JAMES), Treasury’s audit recommendation tracking system.

Reference for audit: OIG-14-036; Treasury Made Progress to Stand Up the Federal Insurance Office, But Missed Reporting Deadlines

Photo:  A statue of Abraham Alfonse Albert Gallatin, the longest-serving Treasury Secretary (1801-1813) presides over Treasury’s section of Pennsylvania Avenue, NW

Author, Photo: Liz Festa

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