What impact will the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, and related international regulatory developments, have on structured settlement annuity providers?
Proposed Amendment to Dodd-Frank
That issue was indirectly spotlighted this week when Senator Susan Collins (R., Maine) announced progress on a bill that would amend Dodd-Frank to permit the Federal Reserve to exempt insurers from new capital rules for banks.
Although the Federal Reserve has not yet published capital rules for insurers, "the Fed maintains it is required to set minimum capital requirements for insurance companies similar to the standards banks face," according to a recent Wall Street Journal (WSJ) article (subscription required).
Enacting legislation to reopen Dodd-Frank will be difficult, the WSJ article states, because many Senate Democrats fear such a bill would include broader changes and the Obama administration has opposed legislation that reopens Dodd-Frank before it has been fully implemented by regulators.
Many insurers believe "bank-centric" capital rules supervised by the Federal Reserve would require them to increase capital and product prices thereby creating a competitive disadvantage. Structured settlement annuity providers MetLife, Prudential, New York Life, and Mutual of Omaha have joined a lobbying coalition of insurers seeking separate capital requirements that take into account their business model, according to various new sources.
A recent LifeHealthPRO article , however, confirms life insurer expectations for increasing federal and international regulatory supervision quoting Gary Hughes, executive vice president and general counsel of the American Council of Life Insurers (ACLI) as stating: “In the very near future, a major segment of the U.S. insurance business will have material aspects of its capital structure dictated or influenced by someone other than a state insurance regulator.”
Hughes added: "life insurance regulation in the U.S. can no longer be viewed as a purely domestic matter” and highlighted the importance of regulatory cooperation, according to the LifeHealthPRO article.
"If the capital standards of the states, the Federal Reserve (FSB), the International Association of Insurance Supervisors (IAIS) and the European Union are not generally consistent," he stated, "the resulting competitive disparities mainly involving the relative cost of capital will significantly disrupt the U.S. and the global life insurance markets.”
BACKGROUND - Insurance Regulation, Capital Requirements and Structured Settlements
The United States insurance industry historically has been regulated by the states whose regulatory responsibility was reaffirmed in 1945 when Congress passed the McCarran-Ferguson Act .
Following the collapse of First Executive Corporation and its two Executive Life subsidiaries in 1991, which had invested heavily in "junk bonds" and had sold a substantial number of structured settlement annuities, the National Association of Insurance Commissioners (NAIC) adopted several model reforms including risk based capital (RBC) requirements. RBC requires insurance companies with higher amounts of risk to retain higher amounts of capital and surplus.
Prior to the Executive Life collapse, state insurance regulators had used fixed capital standards to monitor the financial solvency of insurance companies. Under fixed capital standards, depending upon the state and its line of business, insurance companies were required to maintain the same minimum amount of capital, regardless of the financial condition of the company.
Enacted in response to the 2008 global financial crisis, Dodd-Frank created changes in the United States financial regulatory system that impact all aspects of the financial services industry including insurance.
Among those changes, Dodd-Frank established the U.S. Treasury's Federal Insurance Office (FIO) and "vested FIO with the authority to monitor all aspects of the insurance sector ... and to represent the United States on prudential aspects of international insurance matters, including at the International Association of Insurance Supervisors [IAIS]".
Established in 1994, IAIS is "the international standard setting body responsible for developing and assisting in the implementation of principles, standards and other supporting material for the supervision of the insurance sector", according to its website.
IAIS' mission is "to promote effective and globally consistent supervision of the insurance industry in order to develop and maintain fair, safe and stable insurance markets for the benefit and protection of policyholders and to contribute to global financial stability."
The IAIS, whose members constitute nearly all of the world's insurance supervisors including the FIO and the NAIC, has committed to develop by 2016 and implement by 2019 the first-ever risk based global insurance capital standard (ICS).
The FIO published a report December 12, 2013 about "how to modernize and improve the system of insurance regulation in the United States." The report concludes:
- "[I]n some circumstances, policy goals of uniformity, efficiency, and consumer protection make continued federal involvement necessary to improve insurance regulation."
- However, "insurance regulation in the United States is best viewed in terms of a hybrid model, where state and federal oversight play complementary roles and where the roles are defined in terms of the strengths and opportunities that each brings to improving solvency and market conduct regulation."
Dodd-Frank also requires the Federal Reserve to regulate and establish capital levels for nonbank companies designated as "systemically important". The Financial Stability Board (FSB),an international body that monitors and makes recommendations about the global financial system, published a list of nine insurers on July 18, 2013 that it identified as “global systemically important”. The FSB list includes three United States insurers, AIG, MetLife and Prudential - each of which currently sells structured settlement annuities in the U.S. market.
Although these insurers insist they are nothing like banks in terms of insolvency risks, "regulators are more worried by non-insurance activities carried out by insurance groups than by their core activities", according to a July 27, 2013 article in The Economist titled "Global Systemic Insurers".
"But it is not clear", The Economist article adds, "which activities the FSB considers core and which it thinks are too racy for insurers. Regulators (and others) worry about some annuities, savings-like products which offer guaranteed returns to customers."
Dodd-Frank and Product Suitability Standards
In addition to the insurance regulatory and capital requirement changes discussed above, Dodd-Frank directed the SEC to study the need for a new, uniform fiduciary standard of care for broker-dealers and investment advisers and to apply such a uniform standard if it deemed necessary.
This study is potentially important for structured settlements and personal injury settlement planning because:
- Both of these related markets currently lack uniform product suitability standards.
- By comparison, structured settlement protection acts impose a "best interest" standard on the secondary market.
- Broker-dealers and investment advisers increasingly participate in settlement planning.
- Settlement planning increasing integrates structured settlement annuities with other insurance and financial products ("blended products") in settlement trusts subject to "best interest" fiduciary standards.
Although the SEC published a fiduciary standard study in January 2011, it has not yet published any related regulations. S2KM reviewed settlement planning product suitability standards in a four-part 2012 blog series.