Battleplans

December 31, 2012 at 07:00 PM

Share & Print

Coming off of one of the most contentious general elections in recent history, the life and health insurance industry was dealt a series of stinging defeats, most notably in the re-election of President Barack Obama, who goes into his second term with a substantial mandate and, critics fear, little reason to negotiate with Republicans. After all, the Obama administration oversaw the passage into law of the Patient Protection and Affordable Care Act as well as the Dodd-Frank Wall Street Reform and Consumer Protection Act…both fiercely contested initiatives that would carry re-election fallout. Will a second Obama administration be even more eventful than the first? It is too early to tell, but as we go into 2013, however the dreaded "fiscal cliff" is dealt with will speak volumes about the political battlefield between the Democrats and the GOP. It will also set expectations for what may be accomplished—or inflicted in the coming year. Let's take a look at five of the most important issues on the political front-burner for the life and health insurance industry.

DOL Fiduciary Standard

Emboldened by President Obama's re-election, the Department of Labor (DOL) will reintroduce its proposal to amend the definition of fiduciary under ERISA in coming months despite universal industry opposition. The original proposal was withdrawn in September. Phyllis Borzi, assistant DOL secretary and director of the DOL's Employee Benefits Security Administration, said earlier this month that the "reproposal will be better, clearer, more targeted and more reasonably balanced" and reflect the huge number of comments the agency received on the proposal. "We are facing a crisis of confidence and people need help," she said.

SEC Fiduciary Standard

A uniform standard for sale of investment products was mandated under the Dodd-Frank financial services reform law, but the issue has languished under current SEC chairman Mary Schapiro because of strong opposition, mainly from insurance agents, who oppose any change. They argue that they sell only a limited range of products and are captive agents, which could potentially create a conflict. Schapiro left this month, and even strong supporters of a uniform standard are not optimistic that a new chairman will invest much political capital on this project.

Report on Insurance Modernization from the Federal Insurance Office

It had been expected that the report, mandated by Dodd-Frank for completion last January, would be released next month. That now appears unlikely, with signs emerging that the administration will delay release of the report until after a new Treasury secretary is confirmed sometime early next year. Treasury secretary Timothy Geithner has indicated that he is staying on only to help forestall the so-called "fiscal cliff." One reason for the apparent delay is that the administration doesn't want Republicans in Congress to use the report to embarrass the administration through the confirmation process if it contains proposals calling for greater federal regulation, a politically sensitive issue.

Consolidated Regulation of Insurers Which Operate Savings and Loans

Dodd-Frank mandates that the Federal Reserve Board serve as the consolidated regulator of insurers which operate savings and loans as successors to the Office of Thrift Supervision (OTS). However, members of Congress have made clear through recent hearings that they won't support strong oversight of these institutions, despite the fact that lax OTS oversight of AIG was universally blamed as the reason the federal government had to provide hundreds of billions in cash to AIG in order to save it from insolvency. Insolvency could have left all insurers holding the bag for paying claims from AIG policyholders even though state regulatory officials vehemently deny that is the case, and Congress decided not to hold state regulators accountable.

Systemically Important Non-Banks

AIG is expected to be designated as systemically important by the Financial Stability Oversight Council later this week. Other insurers, for example, Prudential Financial and MetLife, are also being scrutinized for such designation, but no decision is likely until next year. However, what metrics will be used to by the Federal Reserve Board to provide consolidated regulation of these institutions is not likely to become clear until the Fed issues additional rules during the first quarter of 2013.

Taxes

Tax rates will certainly go up in 2013, and estate taxes are also likely to be raised beyond current levels. Moreover, Congress will be working next year to limit tax deductions in legislation expected to take effect in 2014. Despite the likelihood that interest rates will continue to be very low for the foreseeable future, that is good news for the insurance industry. The Bush tax cuts, which went into effect in 2002, hurt sales of insurance products. The life industry can expect to pay higher taxes, certainly on earnings, and perhaps with some curtailment in the tax benefits allowed on some products. However, all of that will be offset by increased desire in general for such industry products as annuities, corporate-owned life insurance, and life insurance in general. Indeed, with the certainty likely to be generated by knowledge that the government is coming to terms with the need for increased revenue and lesser expenditures, the stock market is likely to rise, generating even greater demand for a key industry product, variable annuities.

State regulation 2013

State insurance regulation will be affected by a few unknown variables in the coming year:

The Federal Insurance Office (FIO) report; the mystery contents of the regulatory modernization report were much awaited by the industry throughout the majority of 2012, even when it appeared it would not be made public until after the Presidential election. While there is plenty to speculate about, only when it is finally issued by the FIO will we have an idea of the FIO's intent towards a more modern regulatory regime, including whether it intends to act purely as a fact-finding body, or if it will lay the groundwork for more substantive action.

A new leader at the NAIC. With the retirement of Terri Vaughan, the NAIC is looking for a replacement CEO, to be chosen for his or her ability in Washington, and in staving off federal regulation, and the manner in which the Federal Reserve regulates some insurers under Dodd-Frank Act strictures. This will not be an easy job at a time when the NAIC is commanding a large budget with an ambitious agenda and no small number of critics.

State regulators will be very engaged internationally as they work toward a cohesive system of global financial stability while trying to preserving U.S. specific approaches. As Europe works out its own uniform standards, European-based insurers are likely to abide by those, which tend to be more strict than what is already present in the United States. The risk of the U.S. losing industry regulatory momentum is quite real.

Reserve, reserve, reserve. Regulators will be shepherding the freshly adopted principles-based reserving methodology manual through their legislatures and building out health care exchanges if their states welcomed the Affordable Care Act. In addition regulators will be looking into the extent to which their life companies' reserves have been siphoned off by special purpose vehicles or captives and figuring out what to do about it.

A brave new world

Insurance groups and CEOs are bristling against the global designation of insurers as Global Systemically Important Insurers (G-SIIs). A decision by the Financial Stability Board (FSB) is expected in or near the first quarter of 2013.

Insurers argue they carry much less systemic risk, even when very large, than any bank, and are different from banks and should not be treated as banks or it could upset the global economy in ways not contemplated by regulators.

Insurers are particularly concerned over the potential introduction of blanket capital requirements. A blanket capital surcharge on large global insurers would reduce the efficiency of risk pooling and lead to more expensive insurance, less risk capacity and, ultimately, greater reliance on state protection, said the Institute of International Finance Inc. (IIF).

"Because the traditional insurance business is not a source of systemic risk, it is important that any additional policy measures are specifically designed to focus only on those non-traditional and non-insurance activities that pose systemic risk," said Steven A. Kandarian, vice chair of the IIF Insurance Regulatory Committee and CEO and chairman of MetLife. "A blanket capital surcharge may raise the cost of offering traditional insurance products and result in reduced availability of products currently meeting social needs."

Proposed targeted capital increases on separated activities also have the potential to generate or aggravate systemic risk, according to major insurers.

The IIF encouraged the International Association of Insurance Supervisors (IAIS) to regard separation and targeted capital surcharges as measures of last resort, only to be considered after a specific assessment and identification of systemic relevant activities, and only after taking into account risk mitigation activities.

"Most non-traditional and non-insurance activities are closely linked to traditional insurance and complement each other without being systemically risky. A separation may eliminate the benefits resulting from such diversification," the IIF stated.

The Property Casualty Insurers Association of America (PCI) told the group of insurance supervisors that reports to the FSB on G-SIIs, that IAIS' proposals for increased regulation could harm G-SIIs and their consumers as they carry out their traditional insurance activities.

Additional capital at the group level as a capital add-on would be harmful to traditional insurance activities, as well as the policyholders they serve, according to the group, which responded to the IAIS December 14.

PCI urged the IAIS to focus its proposed policy measures on systemically-risky activities.

AIG, and more companies than many are comfortable with, have been rounded up in data calls to examine whether they will trigger a G-SII designation.

Concurrently, the Financial Stability Oversight Council (FSOC), chaired by Treasury Secretary Timothy Geithner, is holding off designating AIG as a systemically important financial institution (SIFI), perhaps into next year, according to several sources.

The IIF urged the IAIS to undertake a comprehensive study to assess the potential impact of its proposals on the wider economy, and the ability for insurers to provide their services to the economy, similar to that undertaken by the Basel Committee on Banking Supervision and the BIS at the time of their proposals to address systemic risk in the banking sector.

In a meeting in December, it was anticipated that the FSOC would designate AIG as a SIFI, a domestic designation meaning it would come under the supervision of the Federal Reserve Board and be subject to enhanced capital requirements, liquidity requirements, short-term debt limits and public disclosures as mandated under the Dodd-Frank Act.

It is unclear if the processes for designating G-SII and SIFIs are being coordinated in terms of timing, as once suggested, and if so, to what extent. The criteria take markedly different approaches—all roads lead to more or enhanced capital requirements, but both processes are thought to envelope, at least for now, AIG and perhaps Prudential Financial and MetLife. Certainly they have been engaged in the process so far. Analysts at Washington Analysis have said Prudential will likely join AIG, MetLife and possibly the Hartford among insurance companies the FSOC is considering designating as SIFIs.

The FIO is working with the IAIS on the "criteria, methodology and timing of SIFI designations so no U.S. insurer is disadvantaged through global designation of [SIFIs]," FIO Director Michael McRaith told House Financial Services subcommittee panel on Insurance, Housing and Community Opportunity on May 17.

The IAIS, operating under the direction of the FSB, is developing a methodology for the (G-SIIs). The IAIS concluded this summer that traditional reinsurance is unlikely to create or amplify systemic risk.

What constitutes systemically risky is still being debated, however. Some groups want non-traditional activities, which include variable annuities, removed from the systemically risky category, and only want non-insurance activities subject to heightened supervision.

PCI said that the activities that pose systemic risk should be more carefully defined, and only those activities should be included in the definition.

These measures should be directed at the few non-insurance and non-traditional insurance activities that are actually systemically important, and should aim to reduce the risk of those activities by improving risk management, rather than induce insurance groups not to engage in those activities, PCI said.

The measures should not be applied on a uniform, one-size-fits-all basis, but rather only as needed, based upon an individual G-SII's particular circumstances. PCI wants the measures, as yet not fully known, to be used sparingly and that any additional capital requirements should be applied only to the activities that pose systemic risk.

"There should be a clear link between those activities and the measures designed to reduce their risk, and that definition should provide insurers the certainty needed to decide whether or not to engage in those activities," PCI said.

The Geneva Association, an international insurance think tank made up of insurance CEOs from both life companies, reinsurers and property casualty companies, suggested to the IAIS a three-step process for applying policy measures to insurers in an escalating "ladder of intervention."

The Geneva approach involves identifying non-traditional, non-insurance (NTNI) activities that are systemically relevant and weighing where they can be handled without further intervention, by the company's existing governance system and "developing and promoting effective regulatory, supervisory and other financial sector policies to improve financial stability and address information gaps is vital to ensure the smooth functioning of the global financial sector," said John H. Fitzpatrick, secretary general of The Geneva Association. Fitzpatrick is also on the board of AIG.

The Geneva Association's recent Cross-Industry Benchmarking report sought to quantify and compare the systemic risk of banks versus insurers using comparable criteria required by the IAIS data calls.

It found that, among other things, insurers are significantly smaller than banks in most of the 17 indicators required by IAIS data calls.

The largest insurer would rank 22nd among globally systemically important banks (G-SIBs) , the Geneva Association research found.

With their significantly smaller amounts of short-term funding, insurers are much less interconnected with the financial system than banks, the Geneva Association found.

Insurers match assets with liabilities and are thus less exposed than banks to the systemic risk of maturity transformation (borrowing short to lend long) and carry substantially lower positions in derivatives, the research showed.

This benchmarking study is the first ever comparison between the 28 named G-SIBs and 28 of the largest global insurers.

NOT FOR REPRINT