For good or ill, the events of the summer of 2011 will be remembered as hugely consequential in determining the extent and manner in which insurers are regulated for decades to come. When President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) on July 21, 2010, it marked the beginning rather than the end of a process of immense import to insurers. The consensus at the time was that insurers fared well in the legislative process as the bill largely bypassed them to focus instead on reworking regulatory oversight of commercial and investment banks. "The insurance industry was the envy of all other financial services when it came to Dodd-Frank," says Jimi Grande, SVP, Federal and Political Affairs for the National Association of Mutual Insurance Companies. "The banks felt like they were hit over the head with a bar stool."
Nonetheless, as the all-important rule-making phase of the DFA now unfolds, the concern for insurers is the possibility that they may suffer collateral damage as regulators look to fix the oversights and excesses that led to the financial crisis. For example, large insurers may yet fall under the purview of new regulators, such as the Federal Reserve, or be deemed a systemic risk by the newly created Financial Stability Oversight Council (FSOC) and thus be subject to a new set of capital and reserve standards.
In this light, last year's legislative victories seems tenuous and reversible. Even if the final the rule-making phase closes largely to the insurance industry's liking, the uncertainty surrounding how the DFA would be implemented already has impacted the insurance industry in observable ways. Faced with an extended period during which they won't know what will be expected of them in terms of compliance demands and costs, or even whether they can remain viable in certain markets, some insurers have opted to restructure. Notably, insurance companies that own a thrift may have good reason to question whether the new resolution's authority granted to the Federal Deposit Insurance Corp. will enable it to reach into an insurance company to retrieve money for a failed bank operating within the same holding company.
This seemed to be the case in February when Allstate announced it was getting out of the baking business. "Allstate Financial has refocused on insurance, retirement and investment products," Matthew Winter, president and CEO of Allstate Financial, said at the time. "That, combined with the changing regulatory environment, led us to the determination that operating Allstate Bank is no longer core to our long-term strategy."
The DFA may already be distorting the insurance market in other ways. Howard Mills, director & chief advisor, Insurance Industry Group, Deloitte LLP, speculates that fear of compliance risk is blunting M&A activity. "There are many big companies with a lot capital that are looking at acquisitions, but they haven't pulled the trigger," he says. "One of the reasons is that they don't know what type of regulatory risk they are incurring if they take that on. You now have more opportunity to get into more regulatory trouble."
No Seat At The Table
Conceived as a supergroup of regulators, the FSOC is intended to identify and oversee firms that may present a systemic risk to the financial system. In total, the FSOC is made up of 10 voting members and five non-voting members. The voting members consist of nine people from federal financial regulatory agencies as well an independent member with insurance expertise. The non-voting members include the head of the newly minted Federal Insurance Office (FIO), and a state insurance commissioner selected by the National Association of Insurance Commissioners (NAIC).
While the two non-voting members are known-future Federal Insurance Office Director Michael McRaith and Missouri Director of Insurance John Huff-the identity of the FSOC's voting member with insurance expertise remains a mystery. "As far I know, there hasn't been any name put forth by the White House," says Ben McKay, SVP of federal government relations of the Property Casualty Insurers Association of America.
The absence of a voting insurance expert on the FSOC is especially troublesome, McKay says, as the FSOC has already begun work on rules that have the potential to significantly impact the insurance industry. "The reality is you don't need to be promulgating all these rules because all the proper pieces are not in place."
Mills notes that since the NAIC is considered a trade association and not a regulator, Huff has not been allowed to share information discussed at the FSOC meetings he has attended with other state regulators. "It seems ironic that so much of the impetus for DFA was about transparency and openness, but the FSOC is telling Huff he can't communicate," he says.
Huff voiced his frustration with the lack of insurance industry representation on the FSOC in April testimony before the House Financial Services Committee. "While FSOC engages in work that could impact insurers, two of our three insurance representatives are absent from the table, and I have been prohibited from utilizing available state regulatory resources, including engaging other state regulators, some of whom are active in very similar work in the international arena," Huff testified.
J. Stephen Zielezienski, SVP & general counsel for the American Insurance Association, says the restrictions placed on Huff, along with the lack of a voting member, are engendering unease among insurers. "We really do not know what's going on at the FSOC," he says. Like McKay, Zielezienski is not optimistic about seeing a voting member on the FSOC anytime soon, noting the nominee must clear the often arduous Senate conformation process. "Even if that person is non-controversial, this is going to take time," he says.
SECTION 113
For the insurance industry and FSOC, the nub of the issue is Section 113 of the DFA, which concerns the formula the FSOC will create to determine which companies qualify as a "systemically important financial institution (SIFI)." While the law was intended to target the institutions that comprise the shadow banking system, until the rule is promulgated, insurers will not know if they meet this designation.
Zielezienski says property/casualty insurers were successful in convincing lawmakers during the drafting of the DFA that they already were heavily regulated as a function of their business models, and did not engage in activities that were systemically risky. He notes that while Congress made a specific decision to apply heightened prudential supervision to banks that exceed $50 billion in combined assets, they expressly did not make that decision with respect to "non-bank" financial services firms. Instead, lawmakers opted for a more deliberative process to determine the formula for calculating the systemic risk potential for "non-banks" during the rule-making phase.
Yet, without the resident insurance expertise on the FSOC, insurers may have a harder time getting this message across during the rule-making process. Thus, the worry is that if an insurance company is of a certain size, it still runs the risk of being tagged as a SIFI, even if it meets none of the other threshold requirements for being systemically risky. "Our concern is not only that we don't have a voting member on the panel, but the fact that the rules don't say anything more than the statute," Zielezienski says. "All we have to go on is the proposed rule and the preamble of Dodd-Frank, so the watch word here is 'vigilance.'"
Grande agrees that until the criteria used to make the SIFI designation are made explicit, large insurance companies will have cause for concern. "It's the secret black box," he says. "They won't tell anybody the formula they will use to evaluate the companies."
McKay says that even after the FSOC comes up with its rules regarding which companies are deemed systemically risky, uncertainty will persist, as it will take a while for the financial services industry to determine whether a SIFI determination will hinder a company in the marketplace, or give it a competitive advantage for being perceived too big to fail. "We still don't know whether the SIFI designation be the 'scarlett letter' or the 'seal of approval,'" McKay says.
BIG CHALLENGES
Given the breadth of changes underway, McKay says he is sympathetic to all the pressures regulators are facing. "The Treasury Department is saddled with writing hundreds of rules and staffing up," he says. "The delays are not for lack of caring or trying, they are just overwhelmed."
For example, he notes that the Office of Financial Research (OFR), which was created as the source of information for the FSOC is yet to come into being. "The OFR is at least two years away from being operational," he says. "They haven't bought their first computer. They still have to find a building and hire people."
In addition to turning the lights on, McRaith will face similar challenges when he takes over FIO in June. "Right now the FIO is an office on paper," Mills says. They don't have any staff, so it's going to take them a while to get up to speed." One daunting task facing the incoming FIO director is that the office is mandated to produce a report for the Treasury Secretary on the effectiveness of the state-based system by the end of the year. "To prepare a report on something as consequential as that is a tall order, and [McRaith] has months to get this done."
Nonetheless, Mills says the industry can take some solace in the choice of McRaith. "Mike has the reputation of being a very reasonable person, he knows the state regulatory system and he knows the industry. The worst thing you can have is a regulator who doesn't understand what they are supposed to be regulating."
McKay agrees. "He comes with good Hill experience and good state experience, which is essential for the job," he says. "He has regulated insurers and fits the bill."
Despite McRaith's positive reviews from the industry, a degree of concern still exists over what compliance with the FIO will entail for insurers. Many note that because the existing state regulatory structure has not been weakened, there is an inherent risk for duplicative layers of regulation. "Depending on how muscular the FIO becomes, even smaller companies with no chance of a systemic designation are facing the real potential of dual regulation," Mills says. "That is something no company desires."
The DFA envisioned a limited role for the FIO, essentially as an adviser to the Treasury Secretary on insurance, and a negotiator for the United States during international insurance negotiations. However, since insurance is a global product and a federal negotiator needs access to data in order to be an effective negotiator, the law does endow the FIO with the authority to collect data from insurers. The amount of data flowing to the FIO may challenge insurer and regulator alike.
"There is a lot of concern about the still-murky power the FIO has to request data," Mills says. "The insurance industry has traditionally lagged in its ability to deal with voluminous data requests. It's a huge IT challenge that may require a significant investment."
McKay agrees that insurers need to gird themselves for the reality that of a federal regulator that collects copious amounts of data.
"The wording in the statute that says FIO is not a regulator, but they are going to be doing things that seem regulatory."
The Flood Insurance Follies
No issue demonstrates the complex interrelation between the insurance industry and the government as vividly the National Flood Insurance Program (NFIP).
Established by the National Flood Insurance Act of 1968, the National Flood Insurance Program (NFIP) is administered by the Federal Emergency Management Agency (FEMA) and currently covers some 5.6 million Americans. Over the past three years, the program has struggled, lapsing three times limping along with temporary extensions. With the one-year extension signed last year by President Obama set to expire at the end of September, lawmakers are again struggling to craft a lasting fix to the cash-strapped program.
H.R.1309, the Flood Insurance Reform Act of 2011, is a five-year extension of the program that is currently under consideration by the House Committee on Financial Services. Sponsored Judy Biggert (R - IL), the bill enjoys bipartisan support, and seeks to address some of the program's most pressing issues by phasing in higher premiums, and creating a Technical Mapping Advisory Council to help provide more accurate maps of flood plains. Nonetheless, the bill's fate in the House and beyond is an open question.
"I don't think it's going to be completely smooth sailing in the House, but I do think we will get the bill out in some form," says Ben McKay, SVP of federal government relations for the Property Casualty Insurers Association of America. "However, if the troubles from last year are instructive, a five year extension may not acceptable to the Senate."
Likewise, Jimi Grande, SVP Federal and Political Affairs for the National Association of Mutual Insurance Companies. questions whether the Senate would even take up a bill before the NFIP's funding expires at the end of September. "The House has done everything it can to get it started early," he says. "I wish I could tell you I was more optimistic that the Senate is going to act."
While the bill's uncertain fate in the Senate is largely due to the glacial pace at which the upper chamber takes up legislation, there also is simmering ideological resentment to the NFIP among proponents of limited government. Opponents of the NFIP argue that the program should be privatized, and contend that by subsidizing artificially low insurance premiums, the NFIP disincentives homeowners to avoid or mitigate flood risk. "There's a few senators who don't like the idea of a flood insurance program at all," Grande acknowledges.
Indeed, in this era of newfound fiscal rectitude, the financial situation surrounding the NFIP is especially burdensome. The program is estimated to be about $17.5 billion in debt-expenses largely incurred in the wake of Hurricanes Katrina and Rita. With the NFIP paying interest on its debt to the U.S. Treasury, many argue that the debt must be forgiven in order for the program to retain long-term solvency.
While H.R.1309 does mention the need for actuarially sound rates, it does not address the NFIP's long-term debt. This may be a political liability, McKay predicts. "The conservative caucus has put holds on bills in past," he says. "Their view is that any bill that does not address the program's long-term debt should not be a long-term bill."
Moreover, while "actuarially sound" rates may appeal to actuaries, they may not be politically viable. Some studies indicate that rates would be at least twice as high as they are today to even help the program get anywhere near to breaking even. After years of paying artificially suppressed rates for flood insurance, homeowners would likely impart an earful to their congressional representatives if forced to suddenly find coverage in the private market. "Someone paying premiums in a flood plain that hasn't flooded in 80 years is not going to stand for rate increases," McKay says. "Quadruple their monthly payment and congressional phones will start ringing."
McKay got a sense of this indignation first hand in April when he discussed the NFIP on C-Span's "Washington Journal" in April. "Having spent 40 minutes on the air answering caller questions, I can tell you that folks are not happy with the premiums they are paying now," he says. "If they do privatize the NFIP, I won't be going on any more call in shows again."
