Insurers In Talks Seeking Exemption From Pre-Funding Systemic Risk Fund

A copy of the changes the insurance industry has proposed in the regulatory reform bill that Sen. Dodd introduced last week was obtained National Underwriter.

Sen. Dodd hopes to complete the markup of the bill by March 26, before a scheduled 10-day recess by Congress, and wants a full Senate vote by the end of April. However, Sen. Richard Shelby, R-Ala., cautioned that while the bill as proposed by Sen. Dodd may make it out of the committee on a party-line vote, it is unlikely to pass the full Senate. Sen. Shelby said the "door remains open a crack" for bipartisan legislation.

The changes in language negotiated by life and property and casualty insurance companies were made against the background of congressional testimony by a Federal Reserve Board official last week that insurers and other financial institutions whose failure could pose systemic risks should be regulated under the same plan used for bank and financial holding companies.

In his testimony, Jon Greenlee, the associate director for the Fed's Division of Banking Supervision and Regulation, said "the current financial crisis has clearly demonstrated that risks to the financial system can arise not only in the banking sector, but also from the activities of other financial firms–such as investment banks or insurance companies."

He added that "to close this important gap in our regulatory structure, legislative action is needed that would subject all systemically important financial institutions to the same framework for consolidated prudential supervision that currently applies to bank holding companies and financial holding companies."

He made his comments at a hearing on insurance holding company supervision held by the Capital Markets Subcommittee of the House Financial Services Committee.

Mr. Greenlee said the Fed's customary focus on protecting the bank within a holding company is no longer sufficient because risks can arise outside of a commercial banking unit.

"The crisis has highlighted the financial, managerial, operational and reputational linkages among the bank, securities, commodity, insurance and other units of financial firms," he said.

The language proposed by life and p&c insurers, reportedly accepted by Sen. Dodd and Sen. Warner for inclusion in the bill, clarifies that the language is intended "to exclude insurance companies (including those that are part of non-bank financial holding company structures) from the pre-event assessment."

Specifically, "this provision is only meant to apply to banking holding companies that meet the total consolidated asset threshold and to nonbank financial companies that are determined by a two-thirds majority vote of the Financial Stability Oversight Council, pursuant to section 113, to be subject to prudential supervision by the Board of Governors of the Federal Reserve System because 'material financial distress' at the company 'would pose a threat to the financial stability of the United States.'"

Another industry official, who also insisted on anonymity, was more specific. "Insurers do not want to be the cash cow that provides the federal government with funding to use its resolution authority against banks, hedge funds, securities firms etc.," this official said.

"Just because insurers are big doesn't mean that they present systemic risk and should be subject to federal assessment," this official added. "Insurers already pay for their industry competitors' insolvencies through the state guaranty funds."

This official also noted that the American Council of Life Insurers had at one time suggested that insurers ought to be able to deduct their annual state guaranty fund assessments from any federal assessment.

The concern of both the life and p&c industries, this official explained, is they do not want the financial services reform bill to constitute dual regulation.

"We are concerned that large insurance companies could be subject to federal solvency standards, such as capital and surplus requirements, reserving restrictions by the federal systemic regulator over and above state insurance regulation, or dual and conflicting with state regulation," the official said. "That would be the worst of all worlds."

REACTIONS

Earlier last week, other interested parties responded to additional parts of the bill.

For example, agents in general said they supported the bill, but voiced concern about one of its provisions.

Charles Symington, senior vice president of government affairs for the Independent Insurance Agents and Brokers of America, said while his group may "understand" the desire for an insurance information office at the federal level, "we are concerned that the bill's current language could inadvertently subject insurance agents to mandatory data requests from the federal government."

He added, "We look forward to working with Chairman Dodd and other members of the committee to modify this language to ensure that it does not harm small businesses."

At the same time, two other trade groups are lauding provisions of the bill that will provide state-based modernization and uniformity on regulation of the surplus lines and reinsurance industries–effectively the language in S.B. 1363 and H.R. 2571, better known as the Nonadmitted and Reinsurance Reform Act.

That bill has already passed the House three times–most recently on Sept. 9, 2009–without a single vote against it.

"We are pleased to see the NRRA provisions included in the regulatory reform legislation on which Sen. Dodd and other Senate Banking Committee members so diligently worked," said Marshall Kath, president of the National Association of Professional Surplus Lines Offices. "The NRRA provisions will enable the surplus lines industry to operate more efficiently and effectively."

Nicole Allen, vice president of industry affairs at the Council of Insurance Agents and Brokers, said her group is "very happy and thankful that Senate Banking Chairman Dodd has included surplus lines reform in his financial regulation overhaul legislation."

She added that her association was "also encouraged" that Sen. Richard Shelby, R-Ala., the ranking Republican on the Banking Committee, had indicated his desire to reach a bipartisan agreement on broad regulatory reform. "We hope that committee members will agree on these provisions," she said.

"It's taken five years of work to build a consensus among the major stakeholders, including commercial consumers, regulators and industry, that this should be enacted," according to Ms. Allen. "We're very optimistic that we'll finally have the opportunity to get this legislation to the finish line.

Meanwhile, officials of the Consumer Federation of America said they supported provisions in the bill strengthening government regulation of rating agencies.

Barbara Roper, CFA director of investor protection, said that by "slapping Triple-A ratings on mortgage-backed securities whose risks they did not understand and could not calculate, credit rating agencies were central enablers of the unsound mortgage lending at the root of the financial crisis."

She said the CFA supports reforms to simultaneously strengthen SEC regulatory oversight of rating agencies, increase accountability for the firms by making them liable for conducting adequate investigations to support a reliable rating, enhance transparency of ratings and–perhaps most important of all–reduce regulatory reliance on ratings.

"While we have yet to delve into the details, we are pleased to see that is the general approach taken in the revised bill introduced today by Chairman Dodd," she said, adding that "with regard to reducing regulatory reliance on ratings, the bill has been significantly strengthened during the bipartisan negotiations."

BILL'S PROVISIONS

The Dodd bill would allow the president to appoint an insurance regulator to a Financial Stability Oversight Council, composed of a variety of regulators, whose job it will be to monitor the financial system for companies that have become so large or interconnected that their failure could threaten the economy.

However, "there is no detail as to the qualifications required for the insurance appointee" to the council, according to a confidential analysis for insurance industry parties obtained by the National Underwriter, on the condition that the firm not be identified.

The bill, similar to one proposed by Sen. Dodd in December, would create a federal Office of National Insurance, and includes provisions modernizing and streamlining regulation of the surplus lines and reinsurance industries under state regulation.

There are safeguards built into the proposed system. Specifically, a two-thirds vote of the Financial Stability Oversight Council would be needed to approve a decision by the Federal Reserve Board to require a large, complex company to divest some of its holdings if it is found to pose a grave threat to the nation's financial stability. However, this could occur "only as a last resort," according to a summary of the bill released by Sen. Dodd.

Besides an insurance regulator, voting members of the council would include the Treasury secretary (who would serve as chair), along with the chair of the Federal Reserve and the Comptroller of the Currency. Also included would be the chairs of the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Federal Deposit Insurance Corp., as well as the directors of the Federal Housing Financing Agency and the proposed Bureau of Consumer Financial Protection.

The Council is authorized to give formal recommendations to primary financial regulators–including, apparently, state insurance regulators–according to the legal analysis of the bill obtained by National Underwriter, including recommendations that an existing regulator adopt stricter standards to reduce systemic risks.

The bill establishes a framework for the agencies to notify the Council of the steps taken in response, or the reason it has failed to respond to the request. The Council is required to report to Congress with respect to compliance by primary regulators with this provision.

The bill also gives the FDIC resolution authority over systemically important financial companies that are in default or in danger of default.

Although insurers could fall under FDIC authority, the bill includes provisions that significantly reduce that likelihood, according to the legal analysis obtained by National Underwriter.

First, the bill specifically provides for the liquidation or rehabilitation of an insurance company deemed to be a "covered financial company" (or its insurance subsidiary) as provided under state law–so a troubled insurer will go through state runoff proceedings under the supervision of state insurance regulators.

In addition, insurance holding company subsidiaries are specifically excluded from FDIC authority.

At the same time, the insurer exclusion is not guaranteed, the legal analysis warns.

The bill provides the FDIC with backup authority to take over the resolution of an insurer if the applicable state insurance regulator fails to act within 60 days following a determination that resolution is necessary. If this occurs, the FDIC is required to follow the state resolution process, the analysis says.

The bill also calls for strengthened regulation of executive compensation and governance of public companies by providing shareholders with a "say on pay" and other corporate affairs with a nonbinding vote on executive compensation.

In another break with current law, the new Council will have the ability to require nonbank financial companies that pose a risk to the financial stability of the United States to submit to supervision by the Federal Reserve.

The language dealing with creation of an Office of National Insurance would give it the authority to "monitor the insurance industry" and "coordinate international insurance issues." It also requires a study "on ways to modernize insurance regulation and provide Congress with recommendations."

In addition, along with the U.S. Trade Representative, the Treasury is authorized to negotiate and enter into "international agreements on prudential measures" on behalf of the United States, presumably including global deals on insurance.