The Financial Stability Board (FSB), tasked by the G-20 to prevent a future financial crisis, on July 18, 2013, designated nine large insurance groups as Global Systemically Important Insurers (G-SIIs), three from the United States—American International Group, Inc.; MetLife, Inc.; and Prudential Financial, Inc.—along with Allianz (Germany), Assicurazioni Generali (Italy), Aviva (U.K.), AXA (France), Ping An (China) and Prudential plc (U.K.). The G-SII criteria were developed by the International Association of Insurance Supervisors (IAIS) and released the following day. The G-SII designation will immediately result in enhanced supervision and regulation of these companies and, ultimately, may result in significant changes to the capital structure of each company.
The IAIS framework for G-SIIs includes:
Enhanced Supervision. In order to focus on the unique risk profile and possible risk concentrations of G-SIIs and lessen the probability and impact of failure, enhanced supervision generally requires specifically tailored regulation, greater supervisory resources and bolder use of existing supervisory tools. This also means a direct approach to consolidated and group-wide supervision, including the holding company, the development of a Systemic Risk Management Plan (SRMP) and enhanced liquidity planning and management.
Effective Recovery and Resolution. Included in this are elaboration of recovery and resolution plans (RRPs), establishment of Crisis Management Groups (CMGs), the conduct of resolvability assessments and, most significantly, the adoption of institution-specific cross-border cooperation agreements by regulators.
Higher Loss Absorption (HLA). Increased HLA capacity should reduce the probability of distress or failure and also the expected impact of distress or failure by making G-SIIs more resilient to low-probability, high-impact events.
The IAIS believes the potential for systemic risk in insurance becomes relevant when insurers significantly deviate from the traditional insurance business model and particularly when they engage in non-traditional insurance or non-insurance (NTNI) activities or as a result of interconnectedness with other financial firms. Thus, effective recovery and resolution will take into account plans and steps needed for separating non-traditional or non-insurance (NTNI) activities from traditional insurance activities.
Now is the time to implement enhanced supervision measures. Recovery and resolution plans, including liquidity risk management plans, need to be developed and agreed upon by CMGs by the end of 2014. The implementation of the Systemic Risk Management Plans should be completed within 12 months after designation as a G-SII. The implementation of the SRMP should be assessed by national authorities in 2016. Finally, the Higher Loss Absorption capacity will begin to be implemented in 2019 for all G-SIIs designated by 2017.
Although the traditional insurance business did not contribute directly to the financial crisis, AIG and its financial products subsidiary (AIGFP), which engaged in credit default swaps and similar transactions, did. One of the flaws in the regulation of AIG was that no insurance regulator had direct authority over AIGFP, something that the enhanced supervision measures are meant to address.
The FSB's actions raise a number of interesting issues. First, the IAIS, in a paper titled "Global Systemically Important Insurers: Policy Measures," dated July 18, 2013, notes that regulators should have:
Mandates [that are] geared toward active early intervention [that] can facilitate a culture where supervisors have the will to act early. The mandate should convey the point that the group-wide supervisor's (and often the involved supervisor's) view of appropriate risk tolerance for an insurance group will always reflect a higher degree of conservatism and therefore will often be a source of conflict when viewed against the respective risk appetites of senior management, the board and shareholders.
The differing risk appetites of regulators, on the one hand, and management and owners of insurers, on the other, have long led to regulatory arbitrage. The new policy measures for G-SIIs (and eventually for all insurers) are designed to eliminate this arbitrage. The downside would likely result in enhanced costs and potential competitive disadvantages for G-SIIs. Interestingly, the IAIS points out that designation of an insurer as a G-SII could have an unintended benefit, as policyholders and institutional investors may see them as safer—which could result in lower funding costs. At the same time, the G-SII regulatory measures will increase costs through higher capital requirements. The IAIS states that "During implementation of the policy measures for G-SIIs, unintended consequences should be considered and avoided where possible."
The IAIS has characterized variable annuities and life insurance contracts with various guarantees as non-traditional products. Under the new policy measures, such products should be separated from traditional products. U.S. life insurers already use separate subsidiaries for variable business, but will the new policy measures contemplate further separation? At a minimum, non-traditional insurance and non-insurance activities of a G-SII are likely to lead to greater degrees of HLA capacity, in the form of highest-quality capital (permanent capital that is fully available to cover losses). Some insurers have already decided to reduce their exposure to variable annuities, and return more to the protection business. The capital charges for NTNI business may accelerate that process.
U.S. Department of Treasury's Financial Stability Oversight Council Designates Insurers as Non-Bank Systemically Important Financial Institutions (SIFIs)
In June, the Financial Stability Oversight Council (FSOC) voted to designate three non-bank Systemically Important Financial Institutions (SIFIs): AIG, General Electric Company's GE Capital unit and Prudential Financial, Inc.
AIG and GE have accepted SIFI status; but, as is its right, Prudential is currently contesting the designation. On July 16, 2013, MetLife was alerted that it will move to Phase III of the SIFI designation process. The FSB's July designation of MetLife and Prudential as G-SIIs does not resolve whether those companies will be designated as SIFIs in the United States.
Although the G-SII and SIFI designations stem from the same beginnings, the financial crisis of 2008 and 2009, and the FSOC has common interests with the FSB, the SIFI designation process is independent of the G-SII designation. There are as yet open questions as to interrelationship of the G-SII designation and the potential SIFI designation. The enhanced supervision measures contemplate extensive cooperation between international insurance regulators, under the leadership of a group-wide supervisor, although in cooperation with functional supervisors who regulate specific insurers. This will necessitate a high degree of cooperation by U.S. insurance regulators, many of whom have in the past evidenced reluctance to adopt international regulatory standards; non-U.S. insurance regulators; and the controlling regulator under the rules for SIFIs, which ultimately may be regulators with more experience in banking than in insurance.
Designations as a G-SII, and as a SIFI, if that happens, will have ramifications for insurers and the insurance market generally. As pointed out by Steve Kandarian, CEO of MetLife, in a July 16, 2013, statement in response to being told that MetLife was being moved into the third phase of consideration for designation as a SIFI: "If only a handful of large life insurers are named SIFIs and subjected to capital rules designed for banks, our ability to issue guarantees would be constrained. We would have to raise the price of the products we offer, reduce the amount of risk we take on, or stop offering certain products altogether." In other words, the G-SII and SIFI designations could create competitive imbalances or market disruptions.