Prudential Insurance has decided not to pursue a legal battle against its federal designation as a systemically important financial institution (SIFI) and will work within the confines of its new status, it said after the market closed today.
The life insurer lost its appeal before the Financial Stability Oversight Council (FSOC) last month, and had 30 days following receipt of notice Sept. 19 to decide if it would stick with the SIFI designation or fight it in U.S. federal court under the Dodd-Frank Act.
Prudential made its decision despite strong positions from the independent insurance expert and the nonvoting insurance regulatory members of the FSOC on the global life insurer's actual ability to cause systemic risk to or within the economy if it started failing and/or was in material financial distress.
However, one insurance lawyer noted the high hurdle Prudential faced.
"The decision is not surprising. The legal standard on appeal is going to be very, very difficult to meet. The standard was arbitrary and capricious. The court would have had to find that the FSOC acted arbitrarily and capriciously,” said Susan T. Stead a partner with the regulatory law firm of Nelson Levine de Luca & Hamilton in Washington. “Whether you agree with it or not, FSOC took a very in-depth review and analysis so the chances of a court saying they are arbitrary and capricious are next to zero."
Prudential had asked for the appeal to the FSOC this summer, following its proposed designation by the Council in June. This suggests it now wants to submit to the system and do its best under it, rather than raise the hackles in Washington, among members of the new supervisory regime.
The New Jersey-based company with more than $1 trillion in assets under management has already been designated a global SIFI by the Financial Stability Board of the G-20, as have AIG and MetLife in the U.S., thereby sealing their fate as SIFIs in the U.S., some would say. One cannot be a G-SII and not be SIFI, and still be subject to Fed oversight.
The designation means that Prudential will now be subject not only to enhanced standards imposed by the Federal Reserve Board, but also to strict minimum capital requirements under Basel III that will apply to all SIFIs and savings and loan holding companies, regardless of their primary insurance business models.
“The company will continue to work with the Board of Governors of the Federal Reserve System and other regulators to develop regulatory standards that take into account the differences between insurance companies and banks, particularly in the use of capital, and that benefit consumers and preserve competition within the insurance industry, the company stated in a release today.
State regulators and industry executives have been concerned that the higher capital requirements coming from federal and international insurance oversight initiatives are more suitable to banks and such application to different levels of the company structure will make insurance more costly in the end to consumers.
Independent member Roy Woodall, as well as Federal Housing Finance Agency (FHFA) Chair Ed DeMarco, voted against the affirmation of the designation in September, as they did initially back on June 3. They joined FSOC nonvoting member and state regulatory insurance representative John Huff, Missouri insurance director, in rejecting the majority's opinion that a life insurance company is subject to runs on the bank and contagion that threaten the financial system. FSOC and Treasury did not immediately respond, but the minutes and the rationale will be justified at some future point.
According to its basis ruling, the FSOC majority believes that the size and the interconnectedness of Prudential, and its hedging and derivatives exposures necessarily strapped to its variable annuity business, could cause macro-economic problems through contagion if there is a run on the company — not to mention to its counterparties.
Huff has said publicly that he does not believe that some members of FSOC understand insurance, pointing to the FSOC analysis used for AIG, which cites runs on the life insurance business, cashing in of policies and the spread of such policyholder panic to other life insurers as cause for market-wide economic instability.
The FSOC by statute starts with the assumption the company is in distress and then follows through with possible outcomes.
There is legislation pending in Congress that would alleviate the Basel III strictures so they are more tailored to the business of insurance, and as late as Monday, Sens. Sherrod Brown, D-Ohio, and Mike Johanns, R-Neb., wrote to their colleagues asking them to join them in "clarifying the law" to prevent the "bank-centric standards from being applied to insurance and causing serious challenges for them and possibly for their policyholders.”
The senators are still looking for broad bi-partisan support for their bill, S. 1369, which will fashion Basel III to the long-term liability matching business of insurance, rather than the short-term debt-funding model of banks.
Fed officials have suggested in testimony that a legislative fix is necessary to address this part of Dodd-Frank, known as Section 171 and the Collins Amendment.
Treasury, seat of the FSOC, declined comment today.
MetLife is now in Stage 3 of the FSOC review process for its potential — and probable, some would say — SIFI designation. MetLife has been vocal in its argument that it is not systemically risky, but has offered alternatives to Basel III, suggesting it expects the same ruling Prudential received.