NU Online News Service, May 3, 10:33 a.m.EDT

Insurance companies that own or operate a savings & loanwill face fresh oversight from the Federal Reserve Board, which iscreating a process by which to examine those financial institutionsthat have significant banking assets.

At present, National Underwriter haslearned that theFed has identified at least 20institutions whose holding companies andconstituent thrifts it intends to oversee. These include AmericanInternational Group, State Farm, Nationwide, Prudential,Northwestern Mutual, Massachusetts Mutual and W.R. Berkley. Butthis list of regulated companies is considered a "moving target" byfederal regulators and is subject to change.

[See also: TheFed's Hit List]

The entire process is being overseen on behalf of the Fed byFrank Tarullo, a Fed governor who also serves as the Fedrepresentative to the FinancialStability Oversight Council, the unit created by theDodd-Frank Act to ensure stronger oversight of large financialinstitutions.

According to information provided by the Fed, as well asindustry officials and their outside lawyers, the purpose of thisnew process is broad, designed to increase its own understanding ofthe insurance business and the differences between banking andinsurance. But more importantly, the Fed also intends to overseethrifts operated by financial firms at the holding company level,through authority granted it under the Dodd-Frank Act.

A third purpose, as noted by Federal Reserve Chairman BenBernanke in a recent speech in New York, is to increase federaloversight so that the oversight of large, complex financialservices conglomerates – such as AIG in the run-up to the globalfinancial crisis – does not somehow fall through the cracks.

Moving Targets  Some of the companieson the Fed's list are already either shedding their thriftoperations, or are planing to do so out of a concern of facing anadditional layer of regulation through the Fed. For example,Prudential has announced plans through a securities filing todowngrade its thrift to a trust bank, thereby escaping Fedoversight. As a result, its thrift will be regulated by the Officeof the Comptroller of the Currency (OCC).

According to Prudential spokesman Robert DeFillippo, Prudentialis accomplishing this by divesting itself of all assets insured bythe Federal Deposit Insurance Corporation. That will also allowPrudential to escape regulation underthe Volcker rule, which limits proprietary trading byfinancial firms for their own account.

DeFillippo explained that its trading partners in the commercialmortgage business want Prudential to trade alongside them on thesesecurities, which Prudential believes is appropriate. "We justdon't want to be considered a bank," DeFillippo said. "We are aninsurance company, and that's what we want to remain."

Mass Mutual is taking the same route as Prudential,"de-registering" as a thrift holding company, according to asecurities filing that has been confirmed by company officials. Theofficials said they are awaiting word from the Fed that thedownsizing of their thrift to a trust bank has been approved.

The official said that the actions of the company to downsizetheir savings bank operations stems from a July 21, 2011 memo fromthe Board of Governors, No. S.R. 11-12, outlining their plans to bethe overseer of savings and loans owned by non-banks such asinsurers which take deposits and conduct other banking activities.All insurers have been re-evaluating their business model as aresult of this development, prompted by the Dodd-FrankAct. This act dissolved the Office of ThriftSupervision and shifted its responsibilities to the Office of theComptroller of the Currency as charterer of savings and loans, andthe Fed as overseer of thrift holding companies.

Separately, officials of W.R. Berkley Co. has revealed in asecurities filing that it plans to divest its 80 percent interestin InsurBank, a thrift based in Farmington, Conn. The remaining 20percent is owned by the Independent Insurance Agents and Brokers ofAmerica.

Robert A. Rusbuldt, IIABA president and CEO, acknowledged thatbecause of Dodd-Frank, Berkley is considering divesting itsinterest in the thrift, and a "lot of decisions have to be made,"both by us and them. He said there is no immediate timetable for adecision as to what will happen with the thrift, which will beregulated going forward both by the OCC and the Fed. "[TheDodd-Frank Act] means that thrifts will be regulated in a differentway than before," and that Berkley believes that operating a thriftunder DFA "is very onerous."

Rusbuldt said that "banks are regulated in a different way thaninsurers," and not only Berkley but other companies with thriftsare considering their options because of the different rules underDodd-Frank."

At the same time, Rusbuldt said that "InsurBank is profitable,it is growing, and it has a lot of independent agents ascustomers." According to SNL, InsureBank at the end of 2001 hadtotal assets of $170 million, total deposits of $130 million, andyear-to-year growth rates of 10 percent for assets and 11.53percent for deposits.

Meanwhile, Thrivent Financial for Lutherans, a life insurancecompany, Minneapolis, Minn., has filed an application to turn itsthrift into a credit union in order to escape regulation by theFed.

Other insurers that are winding down bank-type operations areMetLife, which is selling its bank to GE Capital; Allstate, whichis winding down its bank; Pacific Mutual Holding Company, which isselling its College Savings Bank unit; and Western & SouthernMutual Holding Company, which is winding down its Fort WashingtonSavings Co.

So Much for SIFI Officials of the BostonFederal Reserve Bank confirmed what the Fed is doing, and said theFed "became responsible for 26 savings and loan holding companiesthat were primarily engaged in insurance operations" through theDodd-Frank Act.

Dodd-Frank transferred all of the powers of the Office of ThriftSupervision to other federal agencies, and as a result, the Fed'sauthority is now "very broad," according to the former top counselof a federal regulatory agency who is now in private practice.

The stronger oversight of the insurance industry by federalregulators also includes plans to designate certaininstitutions systemicallysignificant (SIFI). Only a handful ofinsurers are likely to be so designated, however. Far more insurerswill come under stronger federal oversight through the regulationof their thrifts by the Fed and the OCC, as successor to theOTS.

The former federal regulatory lawyer now in private practice,said the Fed, as overseer of the thrift at the holding companylevel, can examine an insurer, set minimum capital and liquidityrequirements and restrict or prohibition transactions between theholding company and the savings association subsidiary.

The Fed can also establish internal controls, mandate policiesand procedures that must be followed, and can take enforcementactions against officers and directors of the holding company. TheOffice of the Comptroller of Currency has similar broad authority,but only over federal savings association entities and their directsubsidiaries.

Several of the companies involved, from the largest ones to thesmallest ones, have confirmed that the Fed has already talked tothem, and has designated a Fed Bank to examine them.

Another Washington lawyer familiar with the thrift regulationissue acknowledged that a number of institutions are divestingtheir thrift and bank business, or downgrading them to trust banks,underscoring industry concern about having the Fed asregulator.

The lawyer, who asked not to be identified, said that most ofthe remaining institutions are comfortable with the Fed asregulator of its thrifts. He classified the Fed as a "diligentregulator," and that its oversight will be limited to the holdingcompany and not the insurance operating level.

This lawyer noted that insurers are as concerned about theVolcker rule's impact on them as they are about SIFI and regulationof their thrifts, citing the comments by Prudential as reflectiveof the views of many insurers about the potential impact theVolcker rule could have on them. He noted that insurers lobbied"long and hard" to exempt their trading activities, which aredesigned to hedge against interest rate risk on long-term assets,from the Volcker rule during negotiations over the Dodd-FrankAct.

The Fed board in Washington is engaging all the Fed banksoutside of the New York Fed in the enterprise, with the ChicagoFed's economics unit establishing the benchmarks through which Fedexaminers will examine the books of the targeted insurers.

The Boston and Chicago Fed banks are playing a key role,assuming responsibility for overseeing many insurers in the NewYork metropolitan area as well as those based in New England.

"We want to develop a thoughtful and effective supervisoryapproach for savings and loan holding companies that are primarilyengaged in insurance operations," said Judy Quenzel, a vicepresident and head of insurance supervision at the Boston Fed.

"Certainly there are similarities, but also importantdifferences between the banking and insurance industries," Quenzelsaid. "It is incumbent upon us to understand the businessstrategies and risk profiles of these firms and reflect thatawareness in our supervisory approach."

Meanwhile, Anna Paulson, vice president & director ofFinancial Research at the Chicago Fed said that the Fed's goal wasto better understand the role of the insurance industry in the U.S.financial system. "The insurance industry is a large and importantpart of the financial sector, and we anticipate an on-going need tounderstand the industry's role in the financial system," shesaid.

Paulson confirmed that the Fed's insurance initiative personnelhave begun meeting with members of the insurance industry, otherfinancial sector representatives and insurance regulators. "Thequality of our analysis is significantly enhanced through thesediscussions, so we are interested in extending and deepening ourrange of contacts," Paulson said.

However, it is clear the Fed views insurance industry eventsthrough a banking lens.

Paulson, who has a Ph.D in economics from the University ofChicago and has been with the Fed since November 2001, said onMarch 2 at the New York University Stern Insurance Conference inher presentation,"The Risk of Insurance Companies," that runs oninsurance companies do happen. She cited the 1999 case of GeneralAmerican, when "7-day puts" were called in to the tune of over $6billion; contract holders only needed seven days to call in theirmoney, which they did when the company was downgraded byMoody's.

"The reason for including the General American example wassimply to demonstrate that runs on insurance companies can happen,and have happened, in some rare cases," Paulson later noted. "Itshould not be taken as a commentary on the failure or success ofinsurance regulation."

Paulson said in an emailed answer to reporter queries that theFed was interested ultimately in both the impact of the insurancesolvency situation on the markets and  onpolicyholders.

"We would like to better understand how the financial conditionof the insurance sector impacts both financial markets and realeconomic activity," she said. Besides the obvious interest in howfinancial markets affect insurance companies (e.g., throughinterest rates), the Chicago Fed is clearly looking at theindustry's place in society as a provider of financial protectionproducts.

"One way that the insurance sector might impact real economicactivity is through the cost and availability of insuranceproducts. For example, the pace of new business formation might bestronger when property and casualty insurers have experienced lowlosses and are insurance products are cheaper and more available,"Paulson said.

Bernanke vs. the ShadowBankers  The basis of the Fedapproach was outlined April 13th by Chairman Ben Bernake in aspeech at a conference on "Rethinking Finance" sponsored by theRussell Sage Foundation and The Century Foundation. The speechdealt with the causes and effects of the 2007-2009 financialcrisis.

In his address, Bernanke characterized American InternationalGroup as part of the world "shadow banking" system that played akey role in the catastrophic economic downturn.

He said AIG'sproblems in the fall of 2008 "exposedweaknesses in the statutory and regulatory framework" for theshadow banking sector, and "meant that in practice, they wereinadequately regulated and supervised."

He put AIG in the same category as Bear Stearns and LehmanBrothers, both of which had severe financial problems, and saidtheir problems "severely damaged the financial system."

He also said that the shadow banking system played a far greaterrole than the subprime housing market in making the 2007-2009global economic crisis.

Federal oversight of insurers associated with thrifts isunlikely to stir the controversy generated by the process used toestablishing the standards that will be used to designateSIFIs.

The insurance industry enlisted its allies in Congress to argueits case against SIFI designation, and put federal officialsthrough their paces on the issue.

For example, a subcommittee of the House Financial ServicesCommittee has scheduled a hearing May 16th on SIFI, where MetLifeis expected to testify.

MetLife is concerned because the Fed determined in early Aprilthat it had faileda SIFI stress test administered to largefinancial institutions. The test was designed to determine whetherlarge financial institutions had the capital and management inplace to deal with financial market volatility.

As a result, the Fed barred MetLife from increasing its dividendand buying back stock, which MetLife management contended wasunwarranted.

However, there has been bipartisan acknowledgment that the OTSwas supposed to oversee the AIG Financial Products' operation thatcaused AIG such grief.

Bernanke touched on it in his speech.

"The insurance operations of AIG were supervised and regulatedby various state and international insurance regulators, and theOTS had authority to supervise AIG as a thrift holding company,"Bernanke said.

"However, oversight of AIG Financial Products, which housed thederivatives activities that imposed major losses on the firm, wasextremely limited in practice," Bernanke said.

The Fed's Hit List Below is a list of insurerscurrently targeted by the Fed for additional oversight because theyoperate a thrift. While some of the companies on this list areseeking to shed their thrifts to avoid addtional federalregulation, others are willing to live with additional federaloversight.

According to federal regulators, the list of companies underscrutiny by the Fed is a "moving target," and it is subject tochange.

Insurer: AIGThrift: AIG FSB (Wilton, CN)

Insurer: AmeripriseThrift: Ameriprise Bank FSB (Minneapolis,MN

Insurer: Auto Club InsuranceAssociation Thrift: Auto Club Trust BankFSB (Dearborn, MI)

Insurer: CICO HoldingThrift: Colonial Savings Bank (FortWorth, TX) Note: The thrift andColonial Life and Colonial Mortgage Insurance Co. are under commonownership, though the insurance companies do not directly own thethrift.

Insurer: Country FinancialThrift: Country Trust Bank (Bloomington,IL)

Insurer: Donegal MutualThrift: Union Comm Bank FSB (Marietta,PA)

Insurer: First AmericanThrift: First American Trust FSB (SantaAna, CA)

Insurer: MassMutualThrift: MassMutual Trust Co. FSB(Springfield, MA)

Insurer: N.J ManufacturersThrift: N.J.M Bank FSB (West Trenton,NJ)

Insurer: Northwestern MutualThrift: NW Mutual Wealth Management Co.(Milwaukee, WI)

Insurer: Ohio FarmersThrift: Westfield Bank FSB (WestfieldCenter, OH)

Insurer: Polish National Alliance ofthe U.S. Thrift: PNA Bank (Chicago,IL)

Insurer: Prudential FinancialThrift: Prudential Bank and Trust FSB(Philadelphia, PA) Note: Prudential is inthe process of selling off deposits and converting its thrift to atrust bank.

Insurer: Shelter MutualThrift: Shelter Financial Bank(Nashville, TN)

Insurer: State FarmThrift: State Farm Bank FSB (Bloomington,IL)

Insurer: TIAA-CREFThrift: TIAA-CREF Trust Co. FSB (St.Louis, MO)

Insurer: UNIFI MHCThrift: Acacia FSB (Falls Church, VA)

Insurer: USAAThrift: USAA FSB (San Antonion, TX)

Insurer: WPS HealthThrift: WPS Comm Bank FSB (Madison,WI)

Insurer: W.R. BerkleyThrift: InsurBanc (Farmington, CN)

Source: National Underwriter, SNL Financial