The Obama administration’s financial services regulatory overhaul – effects on the insurance industry
The Obama administration released a white paper on June 18, 2009 outlining its recommendations for US financial services regulatory reform. The document addresses insurance regulation, identifies areas of weakness in the current framework and proposes a structure for wide-ranging changes to the regulation of the insurance sector.
Needless to say, this is an early stage in the process and there will be many changes along the way. Most likely, Congress will lead the effort to come up with more concrete proposals. Given the magnitude of the proposed reforms, insurers need to be aware of the implications that the evolving regulations will have for their business. Below is a summary of the main proposals and how we believe they may affect the insurance sector. Ernst & Young will continue to monitor events and provide updates on future developments.
Six key principles detailed in the paper
The administration recommends the following for the oversight of the insurance industry:
Our legislation will propose the establishment of the Office of National Insurance within Treasury to gather information, develop expertise, negotiate international agreements, and coordinate policy in the insurance sector. Treasury will support proposals to modernize and improve our system of insurance regulation in accordance with the following six principles outlined in the body of the report:
1. Effective systemic risk regulation with respect to insurance;
2. Strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies;
3. Meaningful and consistent consumer protection for insurance products and practices;
4. Increased national uniformity through either a federal charter or effective action by the states;
5. Improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including those affiliates outside of the traditional insurance business; and
6. International coordination.
Ernst &Young’s perspective on key themes
Federal versus state regulation: The white paper refers to the current insurance regulatory system as “highly fragmented, inconsistent, and inefficient.” It is critical of the current state regulatory system, but stops short of mandating a federal regulator, leaving the ultimate structure to the House and Senate. However, it is clear that to achieve the goal of consistency around the regulatory treatment of insurance (e.g. regulatory accounting practices, product filings and illustration requirements) and consumer protection (e.g. registration of agents, sales suitability and sales practices), the white paper encourages state insurance regulators to create a consistent framework if they wish to retain regulatory authority.
Consumer Financial Protection Agency: The white paper calls for the creation of a new federal agency for consumer protection: “We propose to create a single primary federal consumer protection supervisor to protect consumers of credit, savings, payment, and other consumer financial products and services, and to regulate providers of such products and services.”
- The CFPA would oversee consumer protection for a wide variety of financial products, introducing reforms to consumer protection laws based on four guiding principles: transparency, simplicity, fairness and access. The extent to which consumer protection of insurance will fall under the jurisdiction of the CFPA was not explicitly stated in the white paper, though it does mention savings and payment products which include many insurance products.
- This proposal could have a material impact on product design, disclosure regulations, suitability requirements, marketing practices and licensing requirements.
Office of National Insurance: The white paper recommends the creation of the “Office of National Insurance,” which will be located within Treasury: “The ONI should be responsible for monitoring all aspects of the insurance industry. It should gather information and be responsible for identifying the emergence of any problems or gaps in regulation that could contribute to a future crisis.” Without being defined as the “regulatory body”, the ONI would be charged with monitoring the industry at a federal level, thus providing a foundation for possible federal regulation of the insurance industry. It remains to be seen what the role of the National Association of Insurance Commissioners (NAIC) will be going forward.
Financial Services Oversight Council: “We propose the creation of a Financial Services Oversight Council to facilitate information sharing and coordination, identify emerging risks, advise the federal Reserve on the identification of firms whose failure could pose a threat to financial stability due to their combination of size, leverage, and interconnectedness (hereafter referred to as a Tier 1 Financial Holding Companies or FHCs), and provide a forum for resolving jurisdictional disputes between regulators”.
- It should be noted that, as proposed, there will be no insurance representation on the Financial Services Oversight Council.
Capital requirements: The white paper emphasizes the need for stronger capital standards and appropriate risk management for insurers and financial institutions. The NAIC is currently driving the development of a principles-based framework for both reserves and capital. Combined with a stronger focus on risk management practices that is part of the risk-based exam process, the NAIC has made progress in this critical area of possible reform. Whether it accomplishes the broad goals of the reform proposals, including achieving greater consistency of regulation on a global basis remains to be seen.
Tier 1 Financial Holding Companies: Another important theme throughout the White Paper is the threat posed by systemically significant financial institutions (potentially including insurance enterprises) and the need to regulate them by taking a macro approach and evaluating their relevance to the entire financial system: “Any financial firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed (Tier 1 FHC) should be subject to robust consolidated supervision and regulation, regardless of whether the firm owns an insured depository institution.”
- The Federal Reserve Board would have responsibility for regulation of such institutions, with the ONI recommending to the Federal Reserve Board which insurance firms should be classified as Tier 1 FHCs. At this stage, the criteria that will govern the process and the extent to which Federal Reserve Board regulations for Tier 1 FHCs will be more stringent than for other bank and financial holding companies have not been determined.
Ownership of depository institutions: Insurance companies that own a bank or thrift will be regulated at the federal level: "All companies that control an insured depository institution, however organized, should be subject to robust consolidated supervision and regulation at the federal level by the Federal Reserve and should be subject to the nonbanking activity restrictions of the BHC Act. The policy of separating banking from commerce should be re-affirmed and strengthened. We must close loopholes in the BHC Act for thrift holding companies, industrial loan companies, credit card banks, trust companies, and grandfathered “nonbank” banks”. With the number of insurers now having banks and/or thrifts in their organization, this would result in potential dramatically increased federal regulatory scrutiny if the depository institution were to remain in the organization structure.
Capital standards for Tier 1 FHCs: The white paper specifically states that Tier 1 FHCs will be subject to more stringent requirements than other firms: “The prudential standards for Tier 1 FHCs - including capital, liquidity and risk management standards - should be stricter and more conservative than those applicable to other financial firms to account for the greater risks that their potential failure would impose on the financial system.” This would imply that there could be a competitive disadvantage to receiving this classification. This is somewhat contrary to the Solvency II framework in Europe where large highly diversified firms could gain a competitive advantage by way of a diversification benefit and therefore, favorable capital requirements. The implications of being named a Tier 1 FHC are still unknown, but large financial services institutions that may potentially be designated as Tier 1 FHCs will need to carefully monitor developments and determine appropriate strategies to cope with the increased regulatory scrutiny.
Regulatory treatment of affiliates: The white paper calls for reform of regulations dealing with consolidation of insurance companies and affiliates: “any new regulatory regime must address the current gaps in insurance holding company regulation.” This could have an impact on current capital management strategies that use onshore and offshore captives and special purpose vehicles.
For more information on the details of this extensive White Paper and its impact on the insurance industry, please see page 39, Section H: Financial Regulatory Reform.
