Treasury's Proposal for Financial Regulatory Reform: Its Impact on the Insurance Industry

The Department of the Treasury's proposal for systemic financial regulatory reform announced June 17, 2009, http://www.financialstability.gov/docs/regs/FinalReport_web.pdf, is expressly intended to "build a new foundation for financial regulation and supervision that is simpler and more effectively enforced, that protects consumers and investors, that rewards innovation and that is able to adapt and evolve with changes in the financial market." Notably, the proposal ventures into new areas that Treasury has not previously addressed, including insurance regulation. While the proposal does not go so far as to establish a federal charter for insurance companies, it potentially subjects certain insurers to greater federal regulation and leaves the door open for more. In this summary, we briefly highlight what Treasury's regulatory reform proposals could mean for insurers and insurance holding companies, although precise predictions must await actual legislative language.

Except for a few specific references, insurance gets scant express attention in the proposal. In fact, only two of the 88 pages that set forth the reform proposal are dedicated to the insurance industry. However, much of the language of the proposal is broad enough that insurance could be swept into several of the initiatives. In those instances, we will have to await further development of the proposal before we know the exact impact on the insurance industry.

• Systemic Supervision. Treasury seeks to establish strong regulatory oversight of any financial institution that is deemed critical to market functioning. The authority of the Federal Reserve Board (FRB) would be expanded, making it the single point of accountability for supervision of all companies that pose a threat to financial stability, even those that do not own a bank. There are three primary elements of systemic supervision that could impact insurance companies or their holding company systems – the establishment of the Office of National Insurance (ONI), the identification of Tier 1 FHCs and the closure of perceived loopholes in bank regulation.
  • Office of National Insurance. Treasury seeks to create the ONI in order to monitor all aspects of the insurance industry and be responsible for identifying any trends or gaps that could give rise to a future crisis, but does not ascribe any regulatory authority to the ONI. (In fact, the proposal mirrors Congressman Paul Kanjorski's Insurance Information Act of 2009, H.R. 2609, which calls for the establishment of a federal Office of Insurance Information; Kanjorski's bill could provide the basis for future legislation to implement the ONI.) Additionally, the ONI would recommend to the FRB any insurance companies or insurance holding company systems that it believes should be deemed to be Tier 1 FHCs. Further, in the international arena, the ONI would be the single regulatory voice of the U.S. insurance industry, wielding the authority to enter into international agreements.

Treasury's proposal does not suggest displacing the current state-based system of regulation in exchange for a federal regulator. Instead, Treasury will support proposals to "modernize and improve" the current system of insurance regulation that are consistent with six principles:

• • • Effective systemic risk regulation
    • Strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies
    • Meaningful and consistent consumer protection for insurance products and practices
    • Increased national uniformity through either a federal charter or effective action by the states
    • Improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including those affiliates outside of the traditional insurance business
    • International coordination
  • Identification of Tier 1 FHCs. The FRB will directly supervise and regulate each large, interconnected, highly leveraged firm that it deems a potential threat to systemic financial stability, a so-called Tier 1 FHC. Large insurance holding companies will be considered for Tier 1 FHC status. (After all, the AIG meltdown is the primary impetus behind forming a systemic risk regulator.) In order to recommend to the FRB certain firms that should be identified as Tier 1 FHCs, a Financial Services Oversight Council, chaired by Treasury and comprised of the heads of certain financial regulatory agencies, will have authority to require periodic reports from any U.S. financial firm that meets minimum size thresholds yet to be established, including insurers and insurance holding companies. The proposal invites legislation that would set forth specific factors that the FRB must consider in identifying Tier 1 FHCs. A firm deemed to be a Tier 1 FHC will be subject to heightened regulation by the FRB with respect to capital, liquidity and risk management, among other things. The FRB would also have authority to require reports from, conduct examinations of and address systemic risk concerns with respect to all subsidiaries of a Tier 1 FHC, including those that have another primary functional regulator (such as insurance companies).
  • Closure of Bank Regulation Loopholes. Currently, under the Bank Holding Company Act (BHCA), any company that owns a bank must register as a bank holding company and is subject to supervision and regulation by the FRB. However, certain firms, including insurance holding company systems (such as AIG), have taken advantage of perceived loopholes in the BHCA by which certain depository institutions are not deemed to be "banks"; they have, therefore, avoided certain restrictions and regulation under the BHCA. The Treasury proposal seeks to close such loopholes and would bring firms that own a depository institution under greater regulation by the FRB and would give them five years to come into compliance with the nonbanking activity restrictions of the BHCA.
• Consumer Protection. Treasury proposes the formation of an independent agency (the Consumer Financial Protection Agency or CFPA) to regulate firms that provide "consumer financial products and services," without explanation of how broadly this language will be applied. Notably, investment products and services already regulated by the SEC or CFTC are excepted out of CFPA oversight, but no such exception exists for insurance products regulated by the states. Treasury officials have indicated that no decision has been made whether insurance products would be subject to the authority of the CFPA. When asked if the CFPA's authority would extend to the sale of annuities and homeowner's insurance, Treasury Secretary Geithner explained that the administration is "redrawing the boundaries of authority" for consumer protections and that "not all products respect these boundaries neatly."
• Crisis Management. Treasury's proposal contemplates a resolution regime that would allow for the orderly resolution of firms whose failure threatens the stability of the financial system. This resolution authority could be invoked only after consultation with the President and upon written recommendation by two-thirds of the members of the FRB and FDIC Board. If a failing firm includes an insurance company, the ONI would consult with the FRB and FDIC Board on insurance specific matters. Treasury would generally appoint the FDIC as receiver, but the proposal specifically preserves state law consumer protections provided to insurance policyholders.

Obviously, bank and securities issues are sure to be at the heart of the unfolding political debate. But we wanted to highlight the sections of Treasury's 88-page proposal that could have the greatest impact on the insurance industry.