Fed Gov. Tarullo calls for prudence in G-SII designations

Reserve System member Daniel Tarullo testifying on Capitol Hill, in June 2012. (AP photo/Manuel Balce Ceneta) Reserve System member Daniel Tarullo testifying on Capitol Hill, in June 2012. (AP photo/Manuel Balce Ceneta)

Federal Reserve Gov. Daniel K. Tarullo appeared to urge careful consideration by international regulators on their future actions in designating insurers as non-bank systemically important financial institutions (SIFIs) in remarks Feb. 22 in New York.

“It is important to take the time to evaluate carefully the actual systemic risk associated with these (insurance) companies, and to understand the amount of such risk relative to other financial firms, before fixing on a list of firms and surcharges,” Tarullo stated.

It is unclear if Tarullo was targeting his remarks to the International Association of Insurance Supervisors (IAIS) or the Financial Stability Board (FSB), which makes the final determination on these designations, but the remarks were embraced by insurance interests. 

The sentiment seems sympathetic with the take of big insurers, a representative of which has said they have been sitting in a number of meetings where there’s the various representatives of the FSB and the IAIS considering the methodology to name global firms as systemically important, and the insurance industry reps would argue that insurers are different, and policymakers would be dismissive.

"Ultimately, the evidence should drive policy-making and I think that is what you see reflected in Daniel Tarullo's speech and remarks," said John H. Fitzpatrick, secretary general of the Geneva Association, in a short interview Monday. 

The Basel-based Geneva Association membership comprises a statutory maximum of 90 chief executive officers from the world’s top insurance and reinsurance companies. The U.S. company CEOs involved in this report include those from Prudential, MetLife, New York Life, Liberty Mutual, AIG, RGA and The Hartford, as well as, in Bermuda: Ace, Arch, Axis, Renaissance and XL.

The IAIS should remove traditional insurance activities in determining its methodology for identifying globally systemically important insurers (G-SIIs or G-SIFIs) that may be misclassified, insurers have argued in comments submitted to the IAIS.

See also: MetLife changing U.S. strategy

Traditional insurance features too prominently in the IAIS indicators, creating a situation that could result in non-risky insurers being designated as systemically risky and systemically risky insurers avoiding designation, the Geneva Association has warned.

The Federal Reserve has been more stringent in grouping insurers subject to its regulation and oversight with banks under Dodd-Frank, but Tarullo was commenting in his New York remarks not so much on domestic policy as international.

Tarullo added that “this seems to me a realistic goal over the next six months.” The first of the G-SIFIs, or, more accurately, Global Systemically Important Insurers (G-SIIs). Global SIIs are expected to be named in April, according to the previously stated IAIS timetable.

Tarullo was discussing work on designating non-bank SIFIs [internationally], and noting that, to date, it has “been pursued mostly in the IAIS and thus has concentrated on insurance companies.”

Tarullo, very active on Dodd-Frank Act detail work at the Fed, was speaking at the Cornell International Law Journal Symposium on “International Cooperation in Financial Regulation.”

U.S.-based insurers are alarmed with many of the elements that would be applied to any insurance company designated as a G-SII.

The IAIS financial stability committee had met on Jan. 14 in New Orleans to host a discussion on policy measures that would be applied to G-SIIs, although not much will be known on how the comments are received until the first, if any, G-SIIs are named. This move is expected in April, with annual designations thereafter expected each November, according to the IAIS timeline. Not all the policy measures will be implemented at once. Some measures won't kick in until 2019.

However, Tarullo’s remarks lent credence to the argument by insurers that they are different from banks. The bank regulatory-heavy FSB will ultimately decide on G-SIIs, and most insurers believe that insurers are not by and large systemically risky, especially when compared to the largest banks.

To that end, the global insurance industry think tank and insurer advocate Geneva Association conducted a benchmark study called the Cross-Industry Analysis—28 G-SIBs vs. 28 Insurers, Comparison of systemic risk indicators, which was recently updated to compare the landscape between insurers and three banks removed from the special designation list in November.

In most of the compared indicators, the three removed banks are still significantly larger than the largest insurers selected for the original study, the updated research showed.

The original study compares the named 28 Global Systemically Important Banks (G-SIBs) and 28 of the world’s largest insurers on indicators of systemic risk.

The benchmark study takes 17 indicators required by the IAIS data calls that are comparable between insurers and banks to provide an analysis of the size of each activity.

This updated comparison demonstrates that along with the G-SIBs, other non-G-SIBs are significantly more dependent on third-party, short-term funding than the largest insurers and thus more exposed to maturity transformation risk, the 2013-updated Geneva benchmark study stated.

“... Insurers are significantly smaller than banks in most of the 17 indicators, and that there are large gaps in measurements along many metrics between the smallest of the 28 identified banks and the largest of the insurers,” the original study stated.

“It should be noted that insurers match assets with liabilities and are thus less exposed than banks to the systemic risk of maturity transformation (borrowing short to lend long) and carry substantially lower positions in derivatives,” the original benchmark study, released in December, stated.

The Geneva Association has argued that the insurance industry does not have the same liquidity issues as banks do, and sparred in January on short-term versus long-term liquidity before the IAIS technical committee led by the Federal Insurance Office (FIO) recently, according to a source.

"Securities lending is one area where regulators have been looking at proper controls – and for the most part, insurance regulators have already taken action to tighten controls over securities lending and believe them to be adequate," Fitzpatrick said in a response to a question on the exchange.

Core insurance business, due to its business model, is not as liquidity dependent as banking, the Association argued in a paper in August 2012.

"Even if you took the highest year from (life policy) surrenders during the crash and increased it by a factor of 10, it still would not be material to financial markets, the general economy and therefore not create or amplify a systemic risk for the world," Fitzpatrick said the paper showed.

“Nevertheless, scenarios of liquidity problems in the insurance sector have been increasingly discussed among the regulatory and supervisory bodies. We hope that our analysis will further guide the discussion to help find the appropriate responses to potential liquidity risk,” said the paper on surrenders in the life industry.

“Insurance companies are nevertheless prepared to deal with the unlikely and have put comprehensive liquidity management routines in place. On a rolling basis, companies regularly check whether they have sufficient liquidity to stand panic surrender scenarios, including testing these scenarios in times of adverse capital market developments,” the monograph stated. Many insurance executives domestically and internationally contributed to the report.

Tarullo spoke about insurance in a section of his remarks dedicated to subjects that he believes should be emphasized in the near term. 

Specifically, Tarullo, stated, “As to the framework for systemically important financial institutions (SIFIs), I would urge that two ongoing initiatives be completed over the next year and two ideas that have been in the discussion stage be developed into concrete proposals.”

The IAIS work and a capital surcharge for banking SIFIs appear under the Basel Committee to be the initiatives the Fed seems to want done in the next year, according to the remarks. 

The longer range initiatives appear to be simplifying capital requirements for credit risk and fashioning standardized capital requirements for market risk to apply standardized capital measures to all internationally active banking firms, and, relating to insurers, completing a proposed requirement proposed for large internationally active financial institutions to have minimum amounts of long-term unsecured debt.

There is a concern by regulators about a short-term funding problem in major international players and Tarullo identified short-term funding vulnerabilities as a priority area in his remarks last week.

Tarullo expressed interest in examining whether there are approaches that might address more directly the vulnerabilities for the financial system created by large non-deposit, short-term funding dependence at major financial institutions. 

At the conclusion, Tarullo said that a “reenergized international agenda for cooperation in international financial regulation” will continue to evolve.

The IAIS  had no comment--there was no response from Treasury/FIO.

For more on what the Federal Reserve thinks of U.S. life insurance liquidity and possible runs on the bank for an insurer see this paper published by the Reserve Bank of Chiciago in September: It agrees that overall, life insurers have less liquid liabilities than banks do, but quantifies liability buckets and as a run on an isnurer the case of Genral American Life Insurance Co. and the calamitous call on its seven-day puts in 1999: http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2012/cflseptember2012_302.pdf  

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