Tag Archives: dodd-frank act

The Gristle in Dodd-Frank

I love using the phrase “unintended consequences” when talking about our issues on Capitol Hill. It’s so commonly understood among veteran staffers that legislative actions produce market reactions, some that are unexpected and unintended. Whoops!

Sometimes these unintended consequences are significant, like when Congress passed the behemoth rewrite of financial regulations in the Dodd-Frank Act.

A big unintended consequence of that law gave the Federal Reserve the authority to regulate non-bank “systemically important financial institutions” (SIFI), as designated by the Financial Stability Oversight Council (FSOC), with the same capital standards that they impose on banks. Insurance companies at risk of being regulated by the Federal Reserve, like MetLife, Prudential and AIG, are facing the big threat of being held to an additional layer of capital standards that are bank-centric and threaten their regulatory compliance models and ultimate product safety.

The thing is, the business of insurance is very different from banking, and regulatory capital standards designed to protect consumers should reflect those differences. Property-casualty and life insurance products are underwritten with sophisticated data and predictable global risk-sharing schemes that inherently withstand most market fluctuations. And to protect consumers, different capital standards are imposed on insurance companies for the different models and products they produce. Traditional banks, however, have different economic threats, requiring different standards. There cannot be a run on insurers with claims the way there can be on banks.

The last economic crisis demonstrated that varying insurance capital standards protected the insurance industry throughout the global debacle. Even AIG’s insurance operations were well protected (it was AIG’s non-insurance financial products division that led to the company’s near-demise). Allowing the Fed to regulate insurers with the same standards as banks not only threatens corporate compliance models but also ultimately makes it more expensive for insurers to share risk, increases the cost for the same level of coverage and spikes prices for consumers.

Even the congressional authors of the too-big-to-fail language recognize the issue and are pushing to correct it. Sen. Susan Collins, R-Maine, who originally wrote the Dodd-Frank provision to allow the FSOC to designate insurance companies as SIFIs, recognizes that any capital standards imposed by the Fed should be duly tailored for insurance companies. She said in congressional testimony: “I want to emphasize my belief that the Federal Reserve is able to take into account—and should take into account—the differences between insurance and other financial activities…. While it is essential that insurers subject to Federal Reserve Board oversight be adequately capitalized on a consolidated basis, it would be improper, and not in keeping with Congress’s intent, for federal regulators to supplant prudential state-based insurance regulation with a bank-centric capital regime for insurance activities.”

Fed Chair Janet Yellen, who is responsible for implementing the law, agrees.

So there’s now legislation in the grinder designed to fix the problem by giving the Fed flexibility to tailor capital standards to the unique characteristics of the insurance industry. The bill passed the Senate without opposition but at the time of this writing is stalled in the House and risks being caught in the partisan battle between the House and Senate’s varying legislative vehicles.

It’s rightly frustrating to stakeholders and lawmakers that the fix is held up, but it’s not surprising that another serious unintended consequence is facing our industry. I’ve used the term when discussing the Foreign Account Tax Compliance Act (FATCA), flood reform, and the Affordable Care Act (ACA). I hope we can see the legislative fix to this latest unintended consequence signed into law soon.

This article first appeared in Leader’s Edge magazine.

The FIO Report on Insurance Regulation

The December 2013 issuance of the Federal Insurance Office (FIO) report, How to Modernize and Improve the System of Insurance Regulation in the United States, may in hindsight be regarded as more momentous an occasion for the industry and its regulation than the muted initial reaction might suggest. History’s verdict most likely will depend on the effectiveness of the follow-up to the report by both the executive and legislative branches, but current trends in financial services regulation may serve to increase the importance and influence over time of the FIO even in the face of inaction in Washington.

Insurance regulation has traditionally been the near-exclusive province of the states, a right jealously guarded by the states and secured by Congress in 1945 after the Supreme Court ruled insurance could be regulated by the federal government under the Commerce Clause of the Constitution.

Any fear that the FIO report would call for an end to state regulation proved unfounded, but industry members might be well-advised to prepare for the eventualities that may result as the FIO uses both the soft power of the bully pulpit and the harder power of the federal government to achieve its aims. As the designated U.S. insurance representative in international forums that more and more mold financial services regulation, and as an arbiter of standards that could be imposed on the states, the FIO and this report should not be ignored.

Having met with the FIO’s leadership team, we believe there are concerns that uniformity at the state level cannot be achieved without federal involvement. We further believe the FIO plans to work to translate its potential into an actual impact in the near future, making a clear-eyed understanding of the report and what it may herald for insurers a prudent and necessary step in regulatory risk management.

The concerns

The biggest surprise about the FIO report may well have been that there were no surprises. There were no strident calls for a wholesale revamp of the regulatory system, and praise for the state regulatory system was liberally mingled among the criticisms.

The lack of any real blockbusters in the details of the FIO report may seem to lend implicit support to those who foresee a continuation of the status quo in insurance regulation. But, taken as a whole, this report and the regulatory atmosphere in which it has been released should be considered a subtle warning of changes that may yet come.

The report may quietly help to usher in an acceleration of the current evolution of insurance regulation. The result could be a regulatory climate that offers more consistency and clarity for insurers and reduces the cost of regulation. The result could also be a regulatory climate that offers more stringent regulatory requirements and increases both the cost of compliance and capital requirements. Most likely, the result could be a hybrid of both.

Either way, preparing to influence and cope with any possible changes portended in the report would be preferable to ignoring the portents.

Part of the disconnect between the short-term reception and the long-term impact of this report may be because of the implicit FIO recognition in the report of the lack of political will needed to enforce any real changes in current U.S. insurance regulation, most especially any that would require increased expenditures or personnel at the federal level. In our current economic and political environment, plugging gaps in state regulation by using measures that would require federal dollars may quite reasonably be construed to be off the table.

But the difference between identified problems and feasible solutions may offer an opportunity. States, industry and other stakeholders could act together to bring needed reform to the insurance regulatory system in a way that adds uniform national standards to regulation, reduces the possibility of regulatory arbitrage and maintains the national system of state-based regulation, all while recognizing the industry’s strengths and needs and not burdening the industry with unnecessary, onerous regulation.

There is much to praise in the current state regulatory system. A generally complimentary federal report on the insurance industry and the fiscal crisis of the past decade noted, “The effects of the financial crisis on insurers and policyholders were generally limited, with a few exceptions…The crisis had a generally minor effect on policyholders…Actions by state and federal regulators and the National Association of Insurance Commissioners (NAIC), among other factors, helped limit the effects of the crisis.”

While the financial crisis demonstrated the effectiveness of the current insurance regulation in the U.S., it is also evident that, as in any enterprise, there are areas for improvement. There are niches within the industry – financial guaranty, title and mortgage insurance come to mind – where regulatory standards and practices have proven less than optimal.

There are also national concerns that affect the industry. The lack of consistent disciplinary and enforcement standards across the states for agents, brokers, insurers and reinsurers is one obvious concern. Similarly, the inconsistent use of permitted practices and other solvency-related regulatory options could lead to regulatory arbitrage. At a time when insurance regulators in the U.S. call for a level playing field with rivals internationally, these regulatory differences represent an example of possible unlevel playing fields at home that deserve regulatory attention and correction.

A Bloomberg News story in January 2014, for example, quoted one insurer as planning to switch its legal domicile from one state to another because the change would allow, according to a spokeswoman for the company, a level playing field with rivals related to reserves, accounting and reinsurance rules.

For insurers operating within the national system of state-based regulation, one would hope that that level playing field would cross domiciles, and no insurer would be disadvantaged because of its domicile in any of the 56 jurisdictions.

But perhaps one of the greatest challenges to the state-based system of regulation is the added cost of that regulation, partly engendered by duplicative requests for information and regulatory structures that have not been harmonized among states. How to respond to that may represent the biggest gap in the FIO report. It may also be the biggest opportunity for both insurers and regulators to rationalize the current regulatory system and ensure the future of state-based regulation.

Cost

The FIO report notes that the cost per dollar of premium of the state-based insurance regulatory system “is approximately 6.8 times greater for an insurer operating in the United States than for an insurer operating in the United Kingdom.” It quotes research estimating that our state-based system increases costs for property-casualty insurers by $7.2 billion annually and for life insurers by $5.7 billion annually.

According to the report, “regulation at the federal level would improve uniformity, efficiency and consistency, and it would address concerns with uniform supervision of insurance firms with national and global activities.”

Yet the report does not recommend the replacement of state-based regulation with federal regulation, but with a hybrid system of regulation that may remain primarily state-based, but does include some federal involvement.

At least one rationale for this is clearly admitted in the report. As it says, “establishing a new federal agency to regulate all or part of the $7.3 trillion insurance sector would be a significant undertaking … (that) would, of necessity, require an unequivocal commitment from the legislative and executive branches of the U.S. government.”

The result of that limitation is a significant difference between diagnosis and prescription in the FIO report. Having diagnosed the cost of the state-based regulatory system as an unnecessary $13 billion burden on policyholders, the FIO's policy recommendations may possibly be characterized as, for the most part, the policy equivalent of “take two aspirin and call me in the morning.”

Still, as the Dodd-Frank Act showed, even Congress can muster the will to impose regulatory solutions if a crisis becomes acute enough and broad enough. Unlikely as that may now seem, the threat of federal radical surgery should not be what is required for states to move toward addressing the recommendations of the FIO report.

Indeed, actions of the NAIC over the past few years have addressed much of what is in the FIO report. Now the NAIC, industry and other stakeholders can take the opportunity provided by the report to work to resolve some of the issues identified in it. The possible outcome of an even greater federal reluctance to become involved in insurance regulation would only be a side benefit. The real goal should be a regulatory system that is more streamlined, less duplicative, more responsive, more cost-efficient and more supportive of innovation.

Kevin Bingham has shared this article on behalf of the authors of the white paper on which it is based: Gary Shaw, George Hanley, Howard Mills, Richard Godfrey, Steve Foster, Tim Cercelle, Andrew N. Mais and David Sherwood. They can reached through him. The white paper can be downloaded here

US Insurers Must Contend With Federal Overseers

Since 1851, when the first state insurance regulator was established, the US insurance industry has had to comply only with the laws of a regulatory system that is state-based. However, that changed when the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) passed into law on July 21, 2010. The Dodd-Frank Act, which is the US Federal Government’s response to the 2007-2008 financial crisis, created several entities including the Federal Insurance Office (FIO) and the Financial Stability Oversight Council (FSOC). Both of these entities are authorized to be involved in the insurance regulatory system, albeit with different degrees of authority and oversight.

Ovum’s recently published report 2013 US Insurance Regulatory Landscape discusses the strengthening presence of the federal government in US insurance regulation, four interdependent initiatives that US insurers need to implement to comply with regulations, and the expanding role that technology can play in supporting US insurers as they prepare for regulatory compliance.

Federal Presence In The US Insurance Regulatory System Has Strengthened
State-based insurance regulators can be forgiven for believing that the regulatory system they have in place, and are continually reshaping to align with market realities, has continued to prove worthy to both consumers and insurance companies. Be that as it may, the Dodd-Frank Act is now law and the FSOC and the FIO are now active participants in the US insurance regulatory system. Both entities have authority and responsibilities that could transform the US insurance system. Only time will tell whether their existence is a net positive for insurance companies domiciled in the US and international insurers conducting business in the US.

Insurers should familiarize themselves with the roles and responsibilities of the FSOC and FIO. The FSOC will identify and respond to threats to the financial stability of the US and promote market discipline. The FIO has a number of responsibilities, including: recommending to the FSOC when an insurer (and its affiliates) should be designated a “systemically important financial institution” (SIFI), thus making it subject to additional capital requirements set by the Federal Reserve; representing the US in matters relating to international insurance regulation; monitoring the extent to which traditionally underserved communities, consumers, minorities, and those of low-to-moderate income can access affordable insurance products; and assisting the Secretary of the Treasury and other officials in administering the Terrorism Risk Insurance Program.

Insurers Must Implement Four Interdependent Initiatives To Enable Readiness To Comply With State And, Potentially, Federal Regulations
Insurers should create and continue to strengthen four interdependent initiatives to ensure their readiness to comply with regulation, which encompass monitoring, management, analysis, and reporting.

  • Monitoring initiatives include monitoring and capturing: any legislative bills available for public comment; discussions from the insurance legislators in each state, the NAIC, the FIO, the FSOC, the various influencer groups, and online trade press articles and commentary concerning legislative issues impacting the insurance industry; and existing regulations and proposed and actual changes to these regulations for each state in which the company conducts and wants to conduct business.
  • Management initiatives include storing, cleaning, tagging, and otherwise preparing the primarily unstructured content captured above, for analysis and preliminary preparation of regulatory compliance initiatives.
  • Analysis initiatives include analyzing the captured content’s potential impact on existing company regulatory compliance initiatives or the resources needed to create new initiatives. The analysis is likely to encompass financial analysis and modeling if the regulatory discussion impacts the amount of capital reserves the insurance company will need, or alters the investments it can make or the mix of risks it can insure. It also includes the creation of interactive dashboards that enable insurance executives and legal, compliance, and other insurance departments to track compliance with state and, where necessary, federal regulations.
  • Reporting initiatives include creating reports for internal insurance company use, for each state insurance commissioner’s office for the states in which the company conducts business, and, where necessary, for the FIO and the FSOC.

Technology Has A Growing Role To Play In Enabling Insurers To Comply With Regulations
To remain knowledgeable about what is happening, be prepared for any changes to requirements, and comply with existing regulations, insurers should use:

  • Text data mining/semantic technology to create a tagged and searchable repository of existing and pending regulations.
  • Master data management (MDM) applications to establish, maintain, and update a repository of existing and proposed industry regulations.
  • Analytics, including predictive analytics, to measure the company’s capital adequacy and ensure it complies with state and, where necessary, FIO and FSOC requirements, and to model and project the company’s current and projected density of risk (i.e. total exposure across all insurance lines of business that the insurer is selling for all or specific geographies).
  • Data visualization to create dashboards to track the company’s alignment with regulatory deadlines and capital requirements, and its progress toward adopting insurance regulatory initiatives (e.g. uniform producer licensing).
  • Database technologies to create, store, and manage producer demographic, insurance experience, training, and licensing information for every insurance company producer (i.e. agent/broker/financial advisor) for each insurance line of business, for every state (or jurisdiction) in which the agent is legally authorized to sell insurance.
  • Collaboration and communications technologies within the insurance company, including the agent/broker/financial advisor intermediaries, to discuss progress toward regulatory compliance including concerns or problems and potential solutions if the company believes it is non-compliant on certain issues.
  • Reporting capabilities to create compliance reports and send them to internal insurance departments, to each state insurance commissioner’s office for each state in which the company conducts business, and, where necessary, to the FIO and the FSOC.