Federal Reserve Unveils New Proposed Capital Rules for Large Insurers

By | June 5, 2016

American International Group Inc. and Prudential Financial Inc.’s new capital rules should reflect the insurance business’s differences from Wall Street banking, the Federal Reserve said in a proposal to limit the chance that the companies could threaten the financial system.

The Fed’s plan would subject AIG and Newark, New Jersey-based Prudential to a narrow set of categories by which they would have to measure the riskiness of their assets, the central bank said in a statement. While the proposal approved Friday makes clear that the companies will be treated in a way that’s “appropriate for the longer-term nature of most insurance liabilities,” the Fed didn’t detail how it will determine the minimum capital the firms must maintain against their assets.

“This proposal is an important step toward capital standards that are both appropriate for our supervised insurance firms and that enhance the resiliency and stability of our financial system,” Fed Chair Janet Yellen said at the Friday board meeting, at which agency staff noted that the more stable funding backing the insurance industry means its risks could be addressed with a lower capital requirement than banks.

The Dodd-Frank Act of 2010 required the Fed to come up with standards for insurers that are deemed so big and complex that they could threaten the economy should they fail. New York-based AIG and Prudential are currently the only companies affected after the Financial

Janet Yellen
Janet Yellen

Stability Oversight Council declared them systemically important financial institutions. MetLife Inc. successfully sued the government to avoid the risk label, and the U.S. is appealing.

Public Comments

The Fed’s rule-writing process is at an early stage that’s meant to draw public comments to help the regulators craft a more formal plan. The agency will accept feedback on the capital plan for 60 days. But with a few steps still to go before the standards become a final rule, the process may be difficult to finish this year.

Also Friday, the Fed approved a formal proposal for how the designated insurers must govern themselves and manage their risks — including a new demand for a 90-day liquidity buffer that would allow the companies to keep operating in periods of stress. The cushion, new internal stress tests and other prudential standards similar to what banks operate under were also based on a Dodd-Frank mandate. Like the capital plan, these standards are also tailored for the insurance industry, the Fed said.

Derivative Bets

Banks rely heavily on funding from deposits, which are subject to immediate withdrawal, and the biggest companies in the industry have long been overseen by federal agencies. On some insurance contracts, however, companies collect periodic premiums over a period of years, and only have to make payments if a policyholder dies or becomes disabled.

Still AIG’s near collapse in the financial crisis highlighted the risks in the insurance industry, which is traditionally overseen by state watchdogs. AIG needed a U.S. bailout after losses on mortgage-related derivative bets beyond the purview of those watchdogs. That rescue, which swelled to $182.3 billion, led to calls for a greater federal role monitoring the industry’s largest companies.

AIG slipped 58 cents to $57.26 at 4:15 p.m. in New York, extending its decline for the year to 7.6 percent. Prudential dropped $2.61 to $76.12 and is down 6.5 percent since Dec. 31. Insurers that aren’t subject to Fed oversight also fell Friday, as disappointing U.S. jobs data led to bets that the central bank will delay an increase in interest rates.

‘Positive Step’

The American Council of Life Insurers, an industry group, said it was “encouraged” by the proposal for the largest companies. Jennifer Hendricks Sullivan, a spokeswoman for AIG, declined to comment on the proposal.

“We view this as a positive step forward that recognizes the underlying economics of our businesses,” Scot Hoffman, a spokesman for Prudential, said in a statement. “We are evaluating the proposals and look forward to continuing to participate in the ongoing dialogue.”

MetLife has been embroiled in a legal battle with the U.S. government. Because a judge reversed MetLife’s designation as systemically important, it may dodge the new rules.

MetLife’s Cloud

Chief Executive Officer Steve Kandarian said this week that as long as FSOC exists, a future version of the panel could later redesignate MetLife, so a “cloud still hangs over the company for the foreseeable future.”

The Fed also proposed a capital plan Friday for the 12 insurers it oversees because they own banks, including State Farm Mutual Automobile Insurance Co., TIAA and Nationwide Mutual Insurance Co. The proposal for those companies largely defers to the capital requirements already imposed on insurance firms by existing regulators — often state agencies.

[Robert Gordon, senior vice president, policy development and research at the Property Casualty Insurers Association of America (PCI), called the Federal Reserve’s proposals a “major step forward in developing a group capital approach for domestic insurance holding companies subject to the Fed’s supervision.” Gordon said PCI believes it is important to get the rules right because “the Fed’s approach to capital standards may set a precedent for the state-based U.S. regulatory system and may also impact the international deliberations.]

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