Antipasti -- A Tasting Menu of Regulatory Morsels Financial Regulatory Changes Thursday, April 28, :00 a.m. - 11:15 a.m.

Transcription

1 2011 ANNUAL SPRING INVESTMENT FORUM American College of Investment Counsel Chicago, IL Antipasti -- A Tasting Menu of Regulatory Morsels Financial Regulatory Changes Thursday, April 28, :00 a.m. - 11:15 a.m. Paul L. Lee Debevoise & Plimpton LLP (Moderator) Leah Campbell Willkie Farr & Gallagher LLP Yves P. Denizé TIAA-CREF William K. Ding MetLife

2 Dodd-Frank Reforms Insurance Industry Implications ACIC Annual Spring Investment Forum Leah Campbell April 28, 2011 Introduction The Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd- Frank ) addresses gaps and weaknesses in the financial services regulatory systems that became evident during the financial crisis. Dodd-Frank does not result in the federal regulation of insurance, but it may lay the foundation for some form of federal insurance regulation in the future. Financial Stability Oversight Council ( FSOC ) is authorized to designate systemically important companies for supervision by the Board of Governors of the Federal Reserve System ( FRB ), monitor the financial markets, identify gaps in regulation and recommend changes to regulatory priorities and practices. Federal Insurance Office ( FIO ), an office within U.S. Treasury Department, will monitor, advise and report on the insurance industry and liaise with state and international insurance regulators -2-1

3 Financial Stability Oversight Council FSOC is responsible for determining whether a nonbank financial company is systemically important ( Covered Nonbank Company ) and subject to supervision by the FRB. A nonbank financial company is a U.S. or foreign company predominantly engaged in activities that are financial in nature as defined in Section 4(k) of the Bank Holding Company Act. Insuring, guarantying or indemnifying against loss, harm, damage, illness, disability or death, or providing and issuing annuities, and acting as principal, agent or broker for purposes of the foregoing in any state is included in the list of activities that are financial in nature. If a subsidiary, but not the parent, is predominantly engaged in financial activities, the subsidiary may be designated as systemically important. Non-U.S. nonbank financial companies may be designated as systemically important but FSOC must consider specific factors including U.S. assets, liabilities and non-u.s supervision. Financial Stability Oversight Council January 2011 FSOC published a Notice of Proposed Rulemaking regarding the designation of systemically important nonbank financial companies proposing six broad qualitative categories: Three are designed to help FSOC assess the likelihood that a particular financial company s distress would impact the broader financial system or real economy: (i) size; (ii) absence of substitutes for the company s financial services and products; and (iii) interconnectedness or mix of activities with other financial firms. Three are intended to assess the specific financial company s vulnerability to financial distress: (i) leverage; (ii) liquidity risk and maturity mismatch; and (iii) existing regulatory scrutiny. FSOC s proposed rule does not rule out any kinds of financial companies or give a clear view of companies that will be designated. Once FSOC adopts a final rule, it will begin the process of designating systemically important Covered Nonbank Companies

4 FSOC Designation of Insurance Company as Systemically Important Insurance companies could be designated as systemically significant recent reports indicate that the Treasury sees insurance as potentially systemically significant because: A big company s failure could reduce overall investor sentiment. There is a significant interconnectedness between the life insurance industry and the corporate bond sector and between the property/casualty insurance business and the municipal bond market. A sector-wide crisis in insurance could have an adverse macroeconomic effect because of insurance s role in the general conduct of economic activity. FSOC Council Members Current Lack of Insurance Expertise on FSOC Voting Members Ten voting members include the heads of the FRB, Securities and Exchange Commission ( SEC ), Commodity Futures Trading Commission ( CFTC ), Office of the Comptroller of the Currency ( OCC ), Federal Deposit Insurance Corporation ( FDIC ), Department of Treasury, Bureau of Consumer Financial Protection and Federal Housing Finance Agency, and a person with insurance expertise nominated by the President and confirmed by the Senate. The insurance voting member has not yet been nominated by President Obama. Trade associations are seeking delays in FSOC rulemaking and designations until this appointment has been made. Public comments have been made by ACLI, AIA and RAA that the absence of this appointment deprives the insurance industry of input in the federal rulemaking. Bipartisan leaders of House Financial Services Committee have called on FSOC to halt consideration of insurance issues until the insurance appointment is made

5 FSOC Council Members Non-Voting Members There are five non-voting members of FSOC including representatives of state banking, securities and insurance regulators. Two of the non-voting members are from the insurance sector. One has been appointed to represent state insurance commissioners Missouri Insurance Director John Huff. The second non-voting member position, that of the Director of FIO, was only recently filled with the appointment of Illinois Insurance Director Michael McRaith. FIO may also make recommendations to FSOC regarding systemically significant insurers. FRB Supervision of Covered Nonbank Companies Systemically important Covered Nonbank Companies will be subject to heightened prudential standards by FRB. Heightened standards for designated companies may be tailored by FRB on an individual company basis or by category in consideration of capital structure, riskiness, complexity, activities, size and other factors. Heightened standards FRB is required to establish: Risk-based capital requirements Leverage limits Liquidity requirements Risk management requirements (risk committee)

6 FRB Supervision of Covered Nonbank Companies Resolution plan or living will Credit exposure Management interlock provision prohibiting a person from serving simultaneously as a director or senior officer of two nonaffiliated Covered Nonbank Companies, Bank Holding Companies, Savings & Loan Holding Companies, or any of their subsidiaries Stress tests Additional standards FRB is authorized to establish: Contingent capital requirement Enhanced public disclosure Short-term debt limits FRB Supervision of Covered Nonbank Companies Supervisory Actions: Examinations Early remediation requirements for Covered Nonbank Companies experiencing increasing financial distress Limits on capital distribution, acquisitions and asset growth Upon further decline, capital restoration plan and capital raising, limitations on transactions with affiliates, management changes, asset sales

7 FSOC Insurance Issues In addition to designating companies as systemically important, FSOC can make recommendations to state regulators regarding new or heightened regulatory standards and safeguards for financial activities or practices that threaten the stability of the markets. FSOC can also collect information from state regulators and coordinate the exchange of information regarding financial services policy development. To support FSOC in fulfilling its duties, an Office of Financial Research was created within Treasury to collect such information. Volcker Rule, Proprietary Trading and Insurance Exception Under the Volcker Rule, with the exception of certain permitted activities, banking entities may not engage in proprietary trading or invest in or sponsor hedge funds or private equity funds, and Covered Nonbank Companies supervised by the FRB that engage in proprietary trading or invest in or sponsor hedge funds or private equity funds will be subject to additional capital requirements and quantitative limits regarding such proprietary trading or investments. Under what circumstances and to what extent may the Volcker Rule prohibitions/restrictions on proprietary trading apply to insurance companies?

8 FSOC Volcker Rule Study and Recommendations FSOC Study & Recommendations on Prohibition on Proprietary Trading and Certain Relationships with Hedge Funds & Private Equity Funds ( FSOC Study ) issued in January As required by Dodd-Frank (Section 619(b)(1)), the FSOC Study makes recommendations to appropriately accommodate the business of insurance within an insurance company subject to regulation in accordance with the relevant insurance company investment laws.... FSOC Study recognizes that insurers invest premiums, which contributes to policyholder surplus and supports underwriting and claim payments. The investment activity of insurers is central to the overall insurance business model and could be unduly disrupted if certain provisions of the Volcker Rule applied. Federal banking agencies, SEC and CFTC are required to adopt rules regarding the Volcker Rule considering the findings of the FSOC Study. Volcker Rule Applicability to Insurance Companies FSOC Study states that the Volcker Rule applies to only two types of insurance companies: Insurance companies that are affiliates of insured banks or thrifts ( insured bank or thrift includes any federally insured depositary institution as defined in the Bank Holding Company Act) Covered Nonbank Companies supervised by the FRB, i.e., any nonbank financial company (including its affiliates) designated as systemically significant by FSOC All other insurers are NOT subject to the Volcker Rule

9 Volcker Rule / Accommodation of the Business of Insurance For regulated insurers subject to the Volcker Rule, investing for the general account of the insurer - is a permitted activity provided that the following conditions are met: The investing activity (purchase, sale, acquisition or disposition) of securities or other specified instruments is conducted in compliance with and subject to the insurance company investment laws of the insurance company s domiciliary state or jurisdiction; and Such investment laws have not been jointly determined by the appropriate federal banking agencies, FSOC, and the relevant state insurance commissioners to be insufficient to protect the safety and soundness of the banking entity, or the financial stability of the United States. Volcker Rule / Accommodation of the Business of Insurance FSOC Study states that although general account is not statutorily defined, it is a fairly well recognized accounting term of art. General account represents all assets of the insurer that are available to satisfy its overall obligations and does not include any separate account assets. Nevertheless, FSOC Study recommends that agencies consider separate accounts and how insurers invest separately on behalf of their customers

10 Volcker Rule / Accommodation of the Business of Insurance FSOC Study recommends that federal agencies, working with state insurance regulators, consider certain terms, including regulated insurance company and business of insurance, to clarify permitted activities excluded from the Volcker Rule. Federal agencies and state insurance agencies should coordinate and enhance the examination of the investment activities of those insurance companies that might otherwise be subject to the Volcker Rule to ensure that they are compliant with state law and regulation. (Volcker Rule permitted activities exception applies only if federal banking agencies, after consultation with FSOC and state insurance regulators, have not jointly determined that such investment rules are insufficient to protect the safety and soundness of the banking entity.) Volcker Rule / Accommodation of the Business of Insurance FSOC Study recommends safe harbor provisions for state investment laws recognizing that a provision deemed insufficient to protect the soundness of a banking entity could have an effect on the investment activity of all regulated insurers domiciled in the affected state. Other Issues Banking entity investment in insurance products Some commenters have expressed concern that some separate account products could be included in the definition of hedge fund or private equity fund because the definition includes funds required to be registered under the Investment Company Act. FSOC Study recommends that agencies examine this carefully so as not to preclude certain insurance products that may not have been intended to be limited by the Volcker Rule

11 Volcker Rule / Accommodation of the Business of Insurance FSOC Study cautions that agencies should monitor fund flows between banking entities and insurance companies to guard against gaming the Volcker Rule whether through innovative products such as bank-owned life insurance or through the use of separate accounts. Agencies should work with state insurance regulators to monitor the activity of bank affiliate insurance companies and captive insurers. Federal Insurance Office What Is It? FIO is the first office established in the federal government focused on insurance. FIO is an office of the U.S. Department of Treasury. The FIO Director is appointed by the Secretary of the Treasury and will be subject to the direction of the Treasury Secretary. FIO does not have a regulatory function it is not a federal regulator of insurance but it will be the federal authority on insurance matters

12 FIO What are Its Functions? Systemic Risk FIO is authorized to recommend that FSOC designate an insurer as systemically significant and subject to Federal Reserve supervision. FIO Director will be a non-voting member of FSOC. FIO may recommend that a systemically significant insurer be subject to resolution. Federal Authority on Insurance Matters FIO is authorized to monitor all aspects of the insurance industry, including identifying gaps in regulation that could lead to systemic crisis in U.S. financial system. FIO Director will advise Treasury Secretary on major prudential insurance policy issues. FIO Director will act in an advisory capacity on FSOC. Federal liaison to states on insurance matters: FIO Director will consult with the states (including state regulators) regarding insurance matters of national importance and prudential insurance matters of international importance. FIO What are Its Functions? Representing the U.S. in the Global Regulatory Arena Coordinating federal efforts and develop federal policy on prudential aspects of international insurance matters Prudential Aspects of Insurance Regulation, i.e., those pertaining to the stability of the regulated entities Assisting the Treasury Secretary and U.S. Trade Representative in negotiating covered agreements Representing the U.S. at the International Association of Insurance Supervisors (IAIS) Limited Preemption Authority related to international agreements discussed below Other Functions Assisting in the administration of the Terrorism Risk Insurance Act Monitoring extent of access to insurance afforded to under-served communities

13 FIO What are the Limitations on Its Functions? Lines of Business FIO s authority extends to all lines of insurance except health, long-term care and crop insurance. Savings Provision FIO law does not preempt state insurance measures that: Govern rates, premiums, underwriting or sales practices Impose coverage requirements for insurance Apply the antitrust laws of any state to business of insurance Set forth capital or solvency requirements (except to the extent that such measures result in less favorable treatment of non-u.s. insurers) Retention of Existing State Regulatory Authority FIO does not have general supervisory or regulatory authority over the business of insurance. FIO Data Collection Authority Data Collection in Service of FIO Functions We described several FIO functions monitoring the insurance business, identifying systemically significant insurers, international representation of U.S. on insurance matters. In order to carry out those functions, FIO is authorized to collect data on and from the insurance industry. Data Collection FIO may require an insurer or its affiliate to submit data, including financial data, but only if the information is not available from other regulators or public sources. Subpoena Power FIO Director has subpoena power but only upon a written finding that the information is required to carry out FIO s functions and that it has exhausted efforts to obtain the information from other agencies and sources Information Sharing FIO may share information it collects with state insurance regulators through information sharing agreements

14 4/19/2011 International Agreements and FIO Preemption Authority FIO s preemption authority relates only to a new concept created under Dodd-Frank known as a covered agreement. Covered Agreement What is a covered agreement: A bilateral or multilateral agreement between the U.S. and a foreign country regarding the recognition of prudential measures with respect to the business of insurance or reinsurance. Covered Agreement is taken to refer to a form of mutual recognition agreement the kind that would allow the U.S. to recognize another country s supervision of insurance and establish grounds to achieve collateral waivers for reinsurance from that country. International Agreements and FIO Preemption Authority How does the U.S. become a party to a covered agreement? The Treasury Secretary and U.S. Trade Representative may jointly negotiate and enter into covered agreements after consultation with Congress and non-disapproval by Congress of the covered agreement. FIO Preemption Authority FIO is authorized to preempt state laws that result in less favorable treatment of a non-u.s. insurer that is subject to a covered agreement. The preemption process requires FIO to notify and consult with state regulators and the U.S. Trade Representative and provide parties an opportunity to comment. Any preemption of state law must be limited to the subject of the covered agreement and must achieve the same level of protection for insurance consumers as that provided in state law

15 4/19/2011 Reports to Congress FIO is required to submit four types listed below of reports to Congress: Annual reports on (i) the insurance industry and (ii) any preemption decisions beginning on September 30, 2011 A report on the significance of international reinsurance on U.S. insurance markets 9/30/2012 A report describing the impact of Dodd-Frank on the ability of state regulators to access reinsurance information for regulated companies in their jurisdictions 1/1/2013 A study and report on how to modernize and improve the U.S. system of insurance regulation which necessarily implies that modernization and improvement are required 1/21/12 Specific focus on systemic risk regulation; uniformity of state regulation; costs and benefits of federal regulation of insurance; feasibility of regulating only certain lines of insurance at the federal level; potential for a federal regulator to provide robust consumer protection and international coordination of insurance regulation FIO Significance FIO provisions establish the foundation for a change in U.S. system of insurance regulation. Global insurance regulation sets a framework for mutual recognition of systems of insurance regulation covered agreements concept is a first step for the U.S. as well as FIO Director s representation of the U.S. on a global stage. Political environment, financial events and global insurance changes all will affect FIO recommendations to Congress and potential changes to U.S. regulatory framework

16 Attorney Information Leah Campbell Partner Willkie Farr & Gallagher LLP 787 Seventh Avenue New York, NY