A brave new era of insurance regulation will likely be launched sometime this month, when the government’s share of American International Group (AIG) is expected to fall below 50 percent and the Federal Reserve Board uses that opportunity to launch fresh oversight of the AIG holding company.
If so, it would be a significant event. Insurance has been regulated primarily at the state level since the founding of the Republic.
Before the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the two most significant pieces of legislation dealing with insurance regulation emphatically supported state oversight of insurers.
The first was the McCarran-Ferguson Act of 1945, which effectively stated that insurance would be state regulated unless federal regulation spoke specifically to a certain issue.
The second was the Gramm-Leach-Bliley Act of 1999 (also known as the Financial Services Modernization Act), which reiterated McCarran-Ferguson in several ways. One of them was to specifically bar federal regulation of insurance holding companies, as well as restating state oversight of insurance operating subsidiaries.
Dodd-Frank changed that somewhat. Although the act leaves the states as regulators of insurance operating companies, it also created the Federal Insurance Office (FIO) as the means by which the Treasury Department could monitor major domestic and international insurance policy issues. And while the FIO has the authority to monitor most aspects of the insurance industry, it has not exercised it yet. Rather, it will first release a long-awaited report to Congress with suggestions for how insurance should be regulated, which will signal to the industry how aggressively the FIO intends to shake up insurance oversight, if at all.
In the meantime, the FIO also has the authority to recommend to the Financial Stability Oversight Council -another agency of the Treasury Department - which insurers should be considered systemically important financial instituions, or SIFI for short. SIFI companies would merit additional oversight to operations that could potentially crash more than themselves if they went insolvent, as was nearly the case with AIG when it nearly collapsed in 2008 due to its excessive exposure to collateralized default swaps.
On a third front, Dodd-Frank also designated the Fed as the regulator of all financial companies which own savings and loan associations, which has spurred many insurers who own thrifts to shed them so they might avoid another layer of regulation.
According to industry lawyers and analysts as well as regulatory filings by AIG, federal oversight of the company once it leaves government ownership could be triggered in two possible ways. One is by AIG remaining a thrift holding company, because the Federal Reserve will become AIG's regulator when the shares of AIG that the Treasury owns drops below 50 percent.
And additionally, that would also occur if the FSOC designates AIG as a SIFI.
In a proposed rule published for comment in June, insurers which operate thrifts would be subject to the same capital standards as banks at the holding company level except for certain unique insurance activities. Under the proposal, special capital treatment for insurers would be only applied to specific activities, such as separate accounts, deferred acquisition costs and insurance underwriting.
Most observers believe that to be consistent, the FSOC will oversee institutions it designates SIFI in the same manner as it regulates thrift holding companies. As a result, whichever way the Fed decides to oversee AIG, it would be subject to rules currently in place only for banks.
Stock markets, industry lobbyists and, privately, even state regulators, are anticipating that scenario.
John Nadel, an analyst at Sterne Agee in New York, said that AIG management continues to indicate that they are preparing for, and expecting to be regulated by the Fed – whether specifically as a non-bank SIFI or otherwise. “But they do point out that it is a working assumption, and they do not yet know for sure whether they will actually be Fed regulated.”
Sue Stead, head of the insurance regulatory practice at Nelson Levine de Luca & Hamilton, based in Columbus, Ohio, said state insurance regulators are aware of the Fed proposals. She also acknowledges that it is “it is unclear how federal and state regulators will coordinate their respective responsibilities."
“A lot of this remains to be seen,” she said. “State regulators have had discussions with federal regulators as to how this will work out.”
They also are working to make sure federal regulators, in proposing new rules, fully take into account that insurers are already highly regulated, with strict standards, on capital, how they invest, and what they invest in, Stead said.
In an investor’s note, Nadel said the Treasury's Aug. 4 IPO of AIG stock reduced the government’s stake in AIG to 53 percent, and that a 30-day “lockup” period ends Sept.4.
He sees AIG using the proceeds from the sale of its remaining 19 percent stake in American International Assurance (its Asian life insurance business, valued at up to $7.5 billion) as an incentive for the Treasury to launch another IPO before the end of September, “when presumably AIG would enter its third quarter quiet period.”
That would allow AIG to retain control of its own destiny by purchasing some of those shares, while at the same time allowing the Treasury to reduce its stake to below the 50 percent threshold.
Robert Benmosche, AIG president and CEO, signaled his acceptance of federal regulation of insurers when he brought up the issue in early August, in AIG's second-quarter conference call with analysts. "In a way, we see it as a big positive," Benmosche said.
AIG has been working hard to bring down the government’s investment as soon as possible, hopefully by the fall, and Benmosche’s comments were consistent with that. “We're often asked about regulation. We really don't know when we will be regulated but we do believe we will be regulated by the Federal Reserve," Bemmosche explained to analysts. "That seems the most likely candidate and we're putting an enormous amount of effort and cost to make sure that we are Fed-ready.”
He has said that AIG has discussed internally the effects the Volcker Rule - a provision of Dodd-Frank that restricts banks from making certain types of speculative investments that would not directly benefit their customers - could have on the company. Benmosche acknowledged that AIG is considering whether it should close the bank it owns, especially since insurance companies and banks invest differently.
But aside from that issue, he said, “this is really about making sure we have a really good process and good controls, especially in the risk management arena, very good controls around how we determine we can handle a bump in the night that happened in 2008, for example.”
He added that the NAIC (which does “a very effective job in the U.S.,” he noted) and international regulators monitor other aspects of the business. The key is that insurance regulators have capital maintenance agreements as to how much capital subsidiaries must have. “The real question becomes the amount of money that we hold at the holding company above all of the regulated entities; and to the extent that we own these regulated entities, what requirements the Fed may have,” Benmosche said.
For example, at AIG we have, as you know, the capital and maintenance agreements, which say that we can contribute money back into the insurance companies if risk-based capital is full.
“We've got to make sure that money is actually there and is available if, in fact, there is a crisis at an insurance company,” Benmosche said.
“And so having the Fed regulate that money and making sure that when we have a liquidity plan - we have one - that's reassuring to the insurance regulators that are looking at AIG's ability to live up to its commitment. So in a way, we see [Fed regulation] as a big positive.”
AIG’s apparent acceptance of federal regulation as the price for federal help is contrary to the position of most other insurers.
Other insurers, both property casualty and life, are also expected to designated SIFI, but they are fighting it tooth and nail, and enlisting the help of members of Congress to support their position.
A number of insurers which operate thrifts are moving to either divest their thrifts or reduce their involvement with them.
These include Prudential Insurance Company, Massachusetts Mutual Insurance Company and W.R. Berkley.
Besides AIG, other insurers which operate thrifts include State Farm, Nationwide and Northwestern Mutual.
Meanwhile, Thrivent Financial for Lutherans, a life insurance company, Minneapolis, Minn., has filed an application to turn its thrift into a credit union in order to escape regulation by the Fed.
Other insurers that are winding down bank-type operations are MetLife, which is selling its bank to GE Capital; Allstate, which is winding down its bank; Pacific Mutual Holding Company, which is selling its College Savings Bank unit; and Western & Southern Mutual Holding Company, which is winding down its Fort Washington Savings Co.