MetLife Inc. and Prudential Financial Inc. have been joined by state regulators challenging the Federal Reserve on how to oversee the biggest insurers under the Dodd-Frank law.
The insurers and watchdogs are pressuring the Fed to avoid bank-like capital rules for firms that may eventually fall under central bank oversight. The Fed has said it can be flexible with the standards.
“No amount of ‘tailoring’ will ever make bank capital standards fit a life insurer’s balance sheet,” MetLife Chief Executive Officer Steven Kandarian said in a speech in Washington. “There is a better way.”
MetLife, the largest U.S. life insurer, proposed to the Fed an alternative that it said is more appropriate for insurers deemed systemically important financial institutions, or SIFIs. No. 2 Prudential also met with the Fed to discuss capital standards. Both companies say they aren’t systemically risky.
Tighter capital rules could lead to higher prices for consumers and put the company at a disadvantage against smaller rivals, Kandarian said in the speech on April 10. Fed oversight could also limit companies’ flexibility in buying back shares, New York-based MetLife has said.
“What’s at stake for them is huge,” said Howard Mills, chief adviser of Deloitte LLP’s insurance-industry group and a former New York State insurance regulator. “You just cannot take banking regulation and apply it to insurance.
Bailout Prevention
The Dodd-Frank Act of 2010 empowered a council of regulators to declare non-bank financial institutions as potential threats to financial stability because of their scope, size or interconnectedness, placing them under Fed supervision. Lawmakers have sought to avoid a repeat of the 2008 rescues that propped up companies considered too big to fail.
While most bailout recipients were lenders, and the largest banks automatically qualify for added oversight under Dodd- Frank, the rescue of American International Group Inc. helped convince regulators that more supervision is needed for non-bank firms.
The Financial Stability Oversight Council in June declared AIG, Prudential and a General Electric Co. finance unit as systemically important, putting them closer to tougher U.S. oversight. MetLife has said it may face the same designation. AIG, which last year finished repaying a bailout that swelled to $182.3 billion, has said it won’t contest the SIFI label.
AIG almost failed in 2008 amid losses at the Financial Products unit, which wasn’t overseen by state watchdogs. The Office of Thrift Supervision, the company’s overseer at the time, “fell short” monitoring the unit and overlooked liquidity risk tied to AIG’s derivative bets on mortgages, the regulator later said.
‘SIFI Standards’
Tighter supervision could strengthen the industry, without benefiting MetLife’s rivals, Wells Fargo & Co. analysts led by John Hall said in a June 4 research note.
“We don’t see either Met or Pru being placed at a competitive disadvantage if they are required to hold incrementally more capital,” they wrote. “Other life insurance companies will face competitive pressures in the marketplace to bring their capital up to stronger SIFI standards rather than compete with less strong balance sheets.”
The latest version of rules for bank oversight, released today by the Fed, says the central bank’s board will further consider the requirements for insurers with banking units. Savings and loan holding companies “substantially engaged” in insurance won’t be covered by the rules during the review, according to the document, tied to the implementation of the Basel III international banking standards.
State Regulators
MetLife’s Kandarian is working to shape the rules for non- bank SIFIs. MetLife designed an alternative framework for insurers with consulting firm Oliver Wyman and Promontory Financial Group LLC, and presented it to the Fed in May, according to a document on the Fed’s website.
The National Association of Insurance Commissioners, a group of state watchdogs, was also briefed, according to two people familiar with the meeting. The NAIC has also pushed to avoid applying bank rules to insurers. Insurers in the U.S. are primarily overseen by regulators at the state level.
“We are having a dialogue with the Federal Reserve,” Ben Nelson, CEO of the NAIC and a former U.S. senator, said in an interview. “As to what will happen with the Federal Reserve, I don’t think we know. My sense is that progress is being made.”
The Fed is writing rules under Dodd-Frank that will describe heightened capital and risk-management standards for the largest firms. Michael Gibson, the director of the Fed’s Division of Banking Supervision and Regulation, said in testimony last year the Fed can tailor standards to fit the business models of non-bank firms.
‘Inappropriate Application’
Fed spokeswoman Barbara Hagenbaugh declined to comment on whether the Fed is considering alternative frameworks. She pointed to the Fed’s proposed rule for the enhanced capital standards, which says that the Board of Governors may adjust application of the standards to non-bank financial companies.
Prudential has also proposed a method of determining capital adequacy, based on the state regulatory system, according to a letter it sent to federal officials. The Newark, New Jersey-based insurer has said it’s weighing whether to challenge the SIFI designation. Companies were told they had 30 days to appeal, a deadline that expires tomorrow.
“We’re being heard with respect to the concerns that Prudential, as well as others in the industry, are expressing about the inappropriate application of bank-centric capital models,” Prudential Vice Chairman Mark Grier said on a May 2 conference call.
MetLife’s system would be superior to using Basel III bank rules because it takes into account the long-term nature of insurer’s liabilities and how the companies invest to back obligations, the company said in its document.
Bond Holdings
A life insurance policy might be backed by a long-duration bond, for example. That’s different from banks, which make loans using deposits that typically can be readily withdrawn.
MetLife said insurer funding levels should be based on the amount of capital required at each subsidiary using local regulatory rules, according to the presentation from May. For instance, risk-based capital would be used for a U.S. insurance division and solvency margin ratio for a Japanese unit.
Insurers that own banks would only have their deposit- taking units subjected to bank rules. Adjustments could be made for holding company leverage and assets, and surcharges could be added for non-traditional insurance, such as contracts that guarantee investment appreciation.
House Legislation
U.S. Representative Gary Miller, a California Republican, introduced legislation that would amend Dodd-Frank to let the Fed board tailor capital requirements to insurers. Joining the push, a group of lawyers for insurers sent a letter to the Fed saying it has flexibility to design rules suited to insurers.
The March 20 letter was signed by attorneys including Eric Dinallo, the former New York insurance regulator now at Debevoise & Plimpton LLP, and V. Gerard Comizio, the former deputy general counsel at the OTS, now with Paul Hastings LLP.
MetLife’s capital plans have been stymied by the Fed before. The company was regulated as a bank-holding company because it owned a deposit-taking institution, and it was restricted from raising its dividend or repurchasing shares until exiting that status in February after selling deposits.
Bernanke’s Anger
Fed Chairman Ben S. Bernanke told lawmakers in March 2009 that saving AIG made him “more angry” than any other measure the government undertook to counter the financial crisis.
“AIG exploited a huge gap in the regulatory system, there was no oversight of the financial-products division,” Bernanke said. “This was a hedge fund basically that was attached to a large and stable insurance company.”
The AIG bailout was repaid last year by Robert Benmosche, who became CEO later in 2009. Benmosche has said that while the company has been simplified and reduced risk, AIG understands why it was a candidate for SIFI status.
“All large financial services and insurance companies should have well regulated holding companies,” he said in a Nov. 1 letter to the Treasury. “We welcome supervision by the Federal Reserve.”
Editors: Dan Kraut, Kevin Costelloe