The 2008 financial crisis brought to light issues relating to so-called “too big to fail” financial institutions and spurred regulators into developing new standards for supervising large, globally active entities, including groups with insurance entity affiliates. However, various regulatory bodies have been concurrently developing standards that may be applicable to insurance groups of varying size, causing uncertainty both in the U.S. and abroad. This article will discuss some emerging developments associated with these parallel regulatory efforts.
The Financial Stability Board (“FSB”), a creation of the G-20, works with the International Association of Insurance Supervisors (“IAIS”) to identify and develop standards for Global Systemically Important Financial Institutions (“G-SIFIs”) and Global Systemically Important Insurers (“G-SIIs”). IAIS, which is comprised of approximately 190 countries, is also working on the Common Framework (“ComFrame”) for the Supervision of Internationally Active Insurance Groups (“IAIGs”). Under ComFrame, IAIS will develop standards and guidance for the regulation of IAIGs, with the intent that these standards will be rolled out to the member countries, including the United States, and implemented in a collaborative and consistent manner. The European Union has also been developing for years its own set of standards as part of its Solvency II Directive, which is currently set to be implemented in 2016.
In the United States, the Federal Reserve and the Financial Stability Oversight Council (“FSOC”), a product of the Dodd-Frank Act, are developing standards for Systemically Important Financial Institutions (“SIFIs”). Entities designated SIFIs by FSOC will be subject to enhanced supervision by the Federal Reserve. Concurrently, the states have been active through the National Association of Insurance Commissioners (“NAIC”) with the development of its Solvency Modernization Initiative (“SMI”) and a wide variety of state implementation initiatives. SMI, which includes revisions to NAIC model laws covering holding companies, capital requirements, and regulatory examinations, among others, will continue to have a major impact on insurance groups subject to U.S. jurisdiction, including internationally domiciled organizations.
The standards under development by these regulatory bodies will each have direct effect on the subject insurers and their groups. However, of particular interest is the possible overlap and contradictory mandates of these developing standards. Three evolving areas illustrate some of these issues; group supervision issues, including reporting of affiliate transactions and non-insurance operations; possible new capital requirements for insurers and other large financial groups; and, recovery and resolution requirements.
Supervisory colleges are forums for the various regulators of an insurance group to improve coordination and cooperation in their regulatory efforts. IAIS has articulated guidance for supervisory colleges of G-SIIs, and has provided that the group-wide supervisor, which is the body that leads the supervisory college, should have direct power over holding companies to ensure that direct group-wide supervision can be implemented. Furthermore, group-wide supervisors should take steps to better monitor a G-SII’s Non-Traditional and Non-Insurance (“NTNI”) activities, such as credit guarantees and other liabilities correlated with financial market outcomes. This would be accomplished through a G-SII’s submission of Systemic Risk Management Plans (“SRMPs”) to the group-wide supervisor. SRMPs describe how the G-SII will manage, mitigate, and reduce its systemic risk, and should be created and implemented in consultation with the group-wide supervisor. Monitoring NTNI and understanding SRMPs would require insurance regulators to work with non-insurance regulators and may require them to analyze business matters outside of their traditional areas of expertise.
The NAIC SMI addresses many of the same issues IAIS has identified in its group supervision guidance. The NAIC's Financial Analysis Handbook includes principles of group supervision, and the 2010 amendments to the holding company model laws specifically authorize state regulators to examine an insurer’s affiliates, including entities that do not transact insurance. The holding company model laws also require an insurer's ultimate controlling party to file a Form F Enterprise Risk Report, which describes a company’s risk management efforts. Similarly, the NAIC's Risk Management and Own Risk and Solvency Assessment Model Act (“RMORSA”) requires certain insurers to file at least on an annual basis an ORSA Summary Report, which identifies the material risks facing the insurer. Both filings require the assessment of risks posed by the insurer's non-insurance affiliates. Like the IAIS NTNI standards, these initiatives will require U.S. state regulators to work with non-insurance regulators and entities to fully understand the risks facing the insurers.
Capital standards for large insurers are another area of parallel regulatory activity. The IAIS, the EU, and the U.S. federal government are all developing standards applicable to certain large insurers and insurance groups. IAIS is finalizing Basic Capital Requirements (“BCR”) for G-SIIs, which the G-20 may adopt at its November, 2014 meeting. BCR will be followed by additional requirements for both G-SIIs and IAIGs. Each of these sets of standards will likely require higher reserves for large insurance groups.
Separately, the Federal Reserve promulgated capital standards for bank SIFIs in February 2014, and is in the process of developing standards applicable to nonbank SIFIs, including some insurance groups. While it is analyzing nonbank SIFIs to determine appropriate standards, there are concerns that the Federal Reserve will adopt a bank-centric approach to regulating insurers. Some critics have also asserted that the Federal Reserve will ultimately impose the standards developed by FSB and IAIS contrary to what they believe Congress intended in passing the Dodd-Frank Act.
Another Federal Reserve action that has caused some controversy is the agency’s interpretation of the “Collins Amendment,” or section 171 of the Dodd-Frank Act, named after Senator Susan Collins (R-ME). The Federal Reserve currently interprets this section to require insurers within holding companies subject to Federal Reserve oversight to prepare financial statements according to Generally Accepted Accounting Principles (“GAAP”), instead of Statutory Accounting Principles. Many industry stakeholders believe that this requirement is unnecessarily burdensome and that GAAP standards do not reflect the financial realities of insurers’ business model. The controversy is such that Congress is now weighing clarification of the Collins Amendment. In early June, the Senate passed a bill that clarifies that the Federal Reserve may not require insurers to maintain GAAP books, and the House is considering its own version of this legislation.
A significant issue for U.S. insurance stakeholders is the EU Solvency II Directive, which will include new capital requirements for large insurance groups operating within the EU and the three members of the European Economic Area. The regulatory framework of a covered insurer’s home jurisdiction must be deemed equivalent to the Solvency II standards for that insurer to be authorized to transact insurance within the EU. Because the U.S. state-based insurance regulatory system is very different from the EU system, U.S. stakeholders are concerned that the states will not be deemed equivalent, thus imposing serious burdens on U.S. insurers.
Recovery and resolution planning requirements are another major area subject to concurrent regulatory efforts. Previously, the FSB released a paper providing guidance for G-SIFIs titled “Key Attributes of Effective Resolution Regimes for Financial Institutions.” The resolution planning guidance of this paper focuses primarily on banks. IAIS has determined that the guidance in the FSB paper will be applicable to G-SIIs, which, like the Federal Reserve’s activities regarding capital standards, is raising concerns about the prospect of bank-centric regulatory standards for insurers. However, IAIS acknowledges this issue, and is working with FSB to develop insurer-specific provisions to include within the paper.
At the same time, some U.S. insurers have already begun developing and filing with the federal government plans for orderly resolution. The Dodd-Frank Act requires SIFIs to file with the Federal Reserve and the Federal Deposit Insurance Corporation (“FDIC”) plans for the orderly resolution of the affairs of the SIFI under the Bankruptcy Code. SIFIs must include in their plans detailed descriptions of the assets and liabilities of certain affiliates. The three designated non-bank SIFIs (AIG, GE Capital Corp., and Prudential Financial) have all submitted resolution plans. To date, the Federal Reserve and FDIC have not issued public comments on them. However, on August 5, 2014, the agencies released comments on the resolution plans of eleven bank SIFIs. The comments were generally critical and the agencies believed that the plans were not sufficiently realistic. This may signal that the agencies will take a tough stance on resolution planning requirements, which may affect capital sufficiency and other ongoing operational issues for some of the entities in these groups.
The NAIC Receivership and Insolvency (E) Task Force (“RITF”) has also been considering resolution and recovery requirements. RITF is currently evaluating the costs and benefits of such requirements for large insurance groups. For evaluation purposes, RITF is defining “large insurance group” the same way IAIS defines IAIGs, but there is some concern this definition may be broadened. RITF will determine whether recovery and resolution planning requirements are necessary based on the results of its evaluation. According to the draft memorandum it will present to the Financial Condition (E) Committee, RITF does not believe that the time is yet ripe to propose resolution planning requirements for large insurance groups.
These aforementioned issues continue to evolve as different regulatory bodies react to each other’s activities and proposals. While the precise outcomes are uncertain, it is clear that large insurers, and possibly all insurers, will be significantly affected by national and international standards, as development of these guidelines continues.