On June 14, 2016, the Federal Reserve Board (“FRB”) published an Advance Notice of Proposed Rulemaking (“ANPRM”) requesting comments on how it should formulate capital standards for insurance companies that own banks that carry federal deposit insurance (“insured banks”). Comments are due on or before August 17, 2016.
Section 171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires the US federal banking agencies to establish consolidated minimum capital requirements for insured banks and their holding companies, and for nonbank financial companies deemed of systemic risk and supervised by the FRB (“SIFIs”). The requirements could not be any lower than what was in effect for insured banks at the time Dodd-Frank was enacted.
The original language of Section 171 did not make any distinctions for the types of companies that might own insured banks and whether they might be subject to another regulatory regime. Insurance companies that owned insured banks argued that they already were subject to capital requirements under applicable state insurance laws. The FRB took the position that Section 171 in its original form did not allow it to make such distinctions
As a result, on December 18, 2014, the President signed S. 2270, the Insurance Capital Standards Clarification Act of 2014 (Pub. Law No. 113-279), to amend section 171 of the Dodd-Frank Act, to clarify capital requirements for insurance companies that own insured banks by specifically providing that in setting the consolidated minimum capital requirements for those companies, the federal banking agencies are not required to include a company that is regulated by an insurance regulator, to the extent that the company is acting in its capacity as a regulated insurance entity.
The ANPRM poses 38 questions for the public to consider in formulating their comments. Currently, there are twelve insurance companies that own insured banks, and two SIFIs that are insurance companies, AIG and Prudential Financial.
The FRB proposes two alternatives for determining the appropriate way to calculate the capital requirements for insurance companies that own insured banks, and discusses the strengths and weaknesses of each approach:
Building Block Approach (BBA): Under the BBA, the insurance company’s capital would be the sum of the capital requirements of each legal entity in the consolidated enterprise. Each regulated insurance company’s capital would be determined in accordance with the applicable capital requirements of the insurance regulators. The other subsidiaries in the enterprise (banks, non-banks that are not insurance companies and holding companies) generally would follow the FRB capital requirements already in place for bank holding companies with any additional adjustments that may be necessary, such as eliminating inter-company transactions and accounting for cross-jurisdictional differences applied by insurance regulators. The BBA consolidated capital ratio then would be the ratio of aggregate qualifying capital to aggregate required capital.
Consolidated Approach (CA): This approach is proposed to be used for the more systemically significant insurance company enterprises that own insured banks, such as the two insurance SIFIs. Instead of calculating capital on an entity by basis, capital would be determined on a fully consolidated basis. Under the CA, insurance liabilities, assets and certain other exposures would be categorized into different risk segments, and risk weights and risk factors would be applied to the amounts in each risk segment that are appropriate to the longer term nature of insurance liabilities. Qualifying capital then would be defined for the consolidated enterprise with a minimum ratio of consolidated qualifying regulatory capital to consolidated risk-weighted assets and insurance liabilities.
The FRB requests comments not only on the two approaches proposed in the ANPRM, but is looking for comments on other possible alternatives. Any capital framework that may ultimately be adopted, however, will require that the parent holding company be able to act as a source of capital strength to the entire enterprise, including the subsidiary insured banks and regulated insurance companies.
On the same day, the FRB also published a proposed rule to impose enhanced prudential safeguards on insurance-focused SIFIs. Section 165 of the Dodd-Frank Act requires the FRB to develop enhanced prudential standards for SIFIs under its jurisdictions. Large bank holding companies already are subject to enhanced prudential safeguards and the proposal uses those standards as the basis for the ones now proposed for the insurance-focused SIFIs, and include provisions dealing with enterprise-wide risk management, corporate governance and liquidity risk. Comments also are due on or before August 17, 2016.