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How the Federal Reserve Became the De Facto Federal Insurance Regulator

Wednesday, July 30, 2014

It is rumored that the Financial Stability Oversight Council (FSOC) will this week designate MetLife Inc., one of the country’s largest life insurers, as a “systemically important financial institution” (SIFI), making it the fourth non-bank financial company and third insurance company to be designated as a SIFI. Under the Dodd-Frank Act, designated institutions are subject to regulation and supervision by the Federal Reserve Board. Dodd-Frank also transferred regulatory authority over savings and loan holding companies (SLHCs, also sometimes referred to as thrift holding companies) to the Federal Reserve. This affected a large number of insurance companies that are organized as SHLCs. As a result of both changes, over a quarter – and possibly closer to a third, depending on the measurement adopted – of the insurance industry is now subject to examination and regulation by the Federal Reserve. This development will likely have major implications, both for the industry and the traditional state-based model of insurance regulation.

Background

Insurance regulatory reform was not a major part of the debate that preceded the passage of the Dodd-Frank Act. Indeed, Dodd-Frank made relatively minor changes to the existing state-based regulatory framework for life and property and casualty insurers. While it created a new federal voice on insurance issues in the form of the new Federal Insurance Office (FIO), its role is largely international, advisory and research based. In fact, it was made explicitly clear that FIO was not to be a federal regulator. The changes that the Act made to the way certain insurance products are sold across state lines were also relatively minor.1

Neither of these legislative changes fundamentally altered the McCarran-Ferguson Act of 1945, which codified that the business of insurance was largely exempt from federal regulation and supervision. However, Dodd-Frank contained two important provisions that, while little appreciated at the time, have had the effect of transforming the Federal Reserve into an insurance regulator over the past four years.

Insurance-Based SLHCs

The first change concerned SLHCs. Previously, SLHCs had been overseen by the Office of Thrift Supervision (OTS). Dodd-Frank abolished that agency and transferred its supervisory and regulatory authority over such institutions to the Federal Reserve. At of the end of 2013, at least 55 insurers, including major firms such as Nationwide and State Farm, were organized as SLHCs. Estimating the total size of insurance-based SLHCs is difficult since many companies are do not publicly report their data. However, based on the assets of six of the largest insurance-based SLHCs, we know that they account for over 6percent of total industry assets. This figure increases to over 16 percent in the property and casualty (P/C) sector.

Data obtained from SNL Financial. Figures are as of June 2014.

Insurers operate thrifts for a variety of reasons, including to better service clients and easily provide instruments, such as debit cards, to policyholders that have suffered losses. With the exception of USAA, thrifts generally do not comprise a significant portion of the insurance company’s business or assets; for example, Nationwide’s thrift accounted for just 3 percent of the company’s total assets as of December 2011.2 Nevertheless, insurers that are also SLHCs are now subject to consolidated (or company-wide) supervision by the Federal Reserve.

Insurance SIFIs

Dodd-Frank allowed the FSOC to determine, by a two-thirds vote (including an affirmative vote from the Secretary of the Treasury), whether the distress or failure of a nonbank financial company would threaten the financial stability of the United States. Companies found to meet this criterion by FSOC are designated as SIFIs and are subject to examination, supervision, and regulation by the Federal Reserve. Currently, two insurers have been designated as SIFIs: Prudential and AIG. A similar ruling designating MetLife may come this week from the FSOC. While one might expect any SIFI designated insurer to comprise an extremely large share of assets of the industry, none of them individually comprise more than 10% of the assets of the industry in either the life or P/C sectors. However, combined, these three insurers account for over one-in-five insurance industry assets. Measured as a percent of premiums underwritten, those insurers comprised close to one-third of the life insurance market at the end of 2012.3

*On the assumption that MetLife will be designated as a SIFI. Data obtained from SNL Financial. Figures are as of June 2014.

Implications

As a result of these developments, the Federal Reserve currently supervises and regulates close to one-fifth of the insurance industry based on assets. If MetLife is designated, that figure will rise to well over a quarter of the industry. However, these estimates are likely conservative, given the absence of data on many insurance-based SLHCs. In addition, the 2012 figures that we have on direct premiums underwritten suggest that the portion of the insurance industry regulated by the Federal Reserve may well be closer to a third following a designation of MetLife.

*Based on the assets of insurance subsidiaries of companies with reported asset information: Prudential, MetLife, AIG, Nationwide Mutual, New Jersey Manufacturers Insurance Company, Ohio Farmers Insurance Company, Principal Insurance Company, State Farm Mutual, and USAA. Data obtained from SNL Financial.

There are a number of important implications of this development. Most obviously, the Fed is rapidly emerging as the de-facto federal insurance regulator, transforming what was until just a few years ago an exclusively state-based regulatory system. This raises important questions about what role state regulators will have in this new system and how the Federal Reserve will manage its relationship with state insurance regulators. It also begs the question of whether an agency with a long history as a prudential banking regulator will be able to adapt to regulating the business of insurance, which is fundamentally different from the business of banking.

There was little appreciation of these dramatic changes to the structure of insurance regulation prior to the passage of Dodd-Frank. As the Federal Reserve assumes an increasingly important role, it is vital that policymakers engage in that conversation. This debate should directly address exactly what role the federal government should play in the regulation of the insurance industry. An open dialogue between policymakers that recognizes the rapidly changing reality of insurance regulation in this country would be an important first step to ensuring more effective oversight of this critical industry.


1 The Nonadmitted and Reinsurance Reform Act of 2010 made changes to the way surplus or excess lines of insurance were sold across state-lines, and set federal standards relating to surplus premium taxes, insurer eligibility, and commercial purchaser exceptions. Surplus products refers to insurance coverage that is not available from admitted (that is, in-state) companies.

2 Mark R. Thresher, Letter to regulatory agencies on behalf of Nationwide Mutual Company regarding “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action,” October 17, 2012.

3 Federal Insurance Office, “Annual Report on the Insurance Industry,” June 2013, p. 10.

KEYWORDS: DODD-FRANK ACT, FEDERAL RESERVE, FINANCIAL STABILITY OVERSIGHT COUNCIL (FSOC), METLIFE