FSOC Issues Proposed Rule on Systemically Important Non-Bank Financial Companies

Proposed guidelines for determining whether non-bank financial companies are "systemically important" under Dodd-Frank have been released, and the potential impact on the insurance industry may be less than previously feared.

The Financial Stability Oversight Council ("FSOC") recently released proposed guidelines for determining whether non-bank financial institutions, including insurance companies, should be deemed "systemically important" under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). Despite concerns that FSOC could impose federal regulatory oversight on insurers and other non-bank entities that are traditionally state regulated, the proposed criteria seem to limit the potential impact on insurers.

The proposed criteria seem to limit the potential impact on insurers.

The designation of Non-bank Systemically Important Financial Institutions ("SIFIs") under Dodd- Frank is essentially a three-step process under the proposed FSOC rules.[1]

The trigger for detailed review by FSOC under the proposed rules is an entity that has at least $50 billion in total consolidated assets and that meets or exceeds one or more of the following thresholds:

• $30 billion in gross notional credit default swaps outstanding for which the nonbank financial company is the reference entity;
• $3.5 billion in derivative liabilities;
• $20 billion of outstanding loans borrowed and bonds issued;
• Leverage ratio of total consolidated assets (excluding separate accounts) to total equity of 15 to 1; and
• Short-term debt ratio of debt with a maturity of less than twelve (12) months to total consolidated assets (less separate accounts) of ten percent (10%).

Once a detailed review of a non-bank financial entity by FSOC is triggered, the second step of analysis is a detailed internal review of the entity based on information from public and regulatory sources.[2]

The third phase of the evaluation under the proposed rules involves FSOC requesting additional information directly from the subject non-bank financial company.

If the FSOC determines that a systemically important designation is appropriate, the entity is afforded an opportunity to object.

Finally, if the FSOC determines that a systemically important designation is appropriate, the entity is afforded an opportunity to object to that determination with written reasons. Thereafter, FSOC votes on the systematically important designation. After the vote, the subject company may request a hearing as well as an additional vote of the FSOC after the hearing.[3]

Insurance industry insiders are welcoming the proposed rule, encouraged by the fact that size alone is not the sole factor in determining systematic risk. According to an article by Business Insurance, J. Stephen Zielezienski, senior vice president and general counsel of the American Insurance Association had this to say:

This guidance suggested that while size is a required threshold at Stage 1, it is not the sole factor for that screening process…

I think Stage 1 provides quantifiable metrics that should help all nonbank financial companies determine whether or not they will be screened out of the designation process at Stage 1.

Ben McKay, senior vice president in the Property Casualty Insurers Association of America also welcomed the proposed rules as good news, according to Business Insurance. However, McKay suggested that the proposed rules should also include cyclicality as a criterion, noting that insurance companies tend to have sources of income that are more steady than the rise and fall of the stock market and therefore the economic downturns that can affect other financial institutions may have less impact on the insurance industry. [4]

The proposed rule is available in PDF form here.

1.  United States: FSOC Clarifies SIFI Designation Process; Mondaq; October 16, 2011; Kara Baysinger, Mike Zolandz, John Finston and Jerome Walker.
2.  United States…; Id.
3.  United States…; Id.
4.  Property/casualty insurers may dodge FSOC scrutiny; Business Insurance; October 16, 2011; Mark A. Hofmann.

Pending FIO Insurance Regulatory Modernization Report Still Pending

Already well past the deadline for its insurance regulation modernization report, the FIO faces a looming deadline on its global reinsurance report.

The Federal Insurance Office ("FIO") was authorized by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") in 2010, and the first Director of FIO, former Illinois Insurance Director Michael McRaith, took office in June of 2011.[1]

At the time, proponents of FIO insisted that insurance regulation was not among its responsibilities.

At the time, Deputy Treasury Secretary Neal Wolin said the creation of FIO would correct the "glaring omission" of any federal "institutional capacity to develop and coordinate insurance policy...". Regulation of the insurance industry was not part of FIO's responsibilities, according to Wolin and others who indicated that neither FIO nor the Dodd-Frank Act altered the fact that insurance is primarily regulated by the states.[2]

Under the Dodd-Frank Act, FIO was directed to study and prepare a report to Congress regarding the improvement and modernization of insurance regulation in the United States. This report was initially due in January of 2012.[3]

In February, 2012, FIO was hard at work and expected the report in "the coming weeks."

In February of 2012, a spokesperson for the U.S. Treasury indicated that FIO was "hard at work preparing [its] first report on how to improve and modernize the system of insurance regulation in the U.S." According to the Treasury spokesperson, FIO expected "to send the report to Congress in the coming weeks."[4]

As Insurance Regulatory Law discussed at the time, many in the insurance industry were watching FIO with interest and expecting the modernization report to potentially be a critical indicator of the future of federal involvement in domestic insurance regulation.[5]

In July of 2012, an opinion piece in Business Insurance noted that FIO's insurance modernization report was still overdue.

Those with long memories will recall that the report was supposed to be presented to Congress by the end of January. And those with an understanding of how Washington too often works know that such deadlines often aren't met. We said in March that we weren't “troubled” that the report was a little late.

Well, now it's more than a little late. The insurance industry and its customers—including risk managers—ought to know what FIO has in mind for improving the regulation of insurance.[6]

While the Business Insurance piece did not expect the FIO report to call for significant direct federal involvement in insurance regulation, it did indicate that the report, and FIO itself, could have a major impact on the future of insurance regulation:

Still, the FIO can greatly influence how insurance is regulated. It can prod states to reform and modernize regulatory practices. As the first-ever federal-level insurance authority, the FIO also should play a critical role in presenting U.S. views in international insurance regulatory forums.

The report will give a clear indication of how the FIO plans to approach its job. With elections looming, we hope the report is issued soon, and the sooner the better.[7]

Also as noted by Business Insurance in July, the FIO set its sights "on crafting another report—this one on reinsurance." That report is due to Congress no later than September 30, 2012.[8]

This refers to the report to Congress that the Dodd-Frack Act requires FIO to make regarding the global reinsurance market and the critical role it plays in the U.S. insurance industry.[9]

There are no signs of FIO's reinsurance report yet, but from a political angle, FIO may have an easier time making the reinsurance report deadline than the insurance modernization report deadline.

"Sources with knowledge" allege that the FIO modernization report has been delayed for political reasons.

In April, the Insurance Insider reported that the FIO modernization report could be delayed until after the U.S. presidential elections in November of 2012, citing "sources with knowledge of the situation" that said the "White House is unlikely to risk a confrontation with states and governors over state rights as well as a potential gridlock in Congress at a time when the US legislation process has ground to a halt...".[10]

Missing a federally-legislated deadline by 9 months (and counting) may not have a significant effect on the future of insurance regulation, but it could illustrate a weakness in the arguments of those proponents of increased federal insurance regulation who decry the inefficiencies of the state-based system.

1. The First Director of the Federal Insurance Office Takes the Reins, Insurance Regulatory Law, June 13, 2011.
2. FIO to Develop and Coordinate Insurance Policy at the Federal Level, Insurance Regulatory Law, December 12, 2011.
3. The Dodd-Frank Act, Title V, Subtitle A, Section 502.
4. FIO Still Working on Overdue Modernization of Insurance Regulation Report, Insurance Regulatory Law, February 7, 2012.
5. FIO Still Working..., id.
6. Opinion: Federal Insurance Office regulatory report looks to be MIA, Business Insurance, July 15, 2012.
7. Opinion: Federal Insurance..., id.
8. Opinion: Federal Insurance..., id.
9. The Dodd-Frank Act, Title V, Subtitle A, Section 502.
10. FIO report could be delayed post-US election date, Insurance Insider, April 23, 2012.

LifeHealthPro: AIG on the Verge of Federal Regulation

AIG, because of pending transactions and the Dodd-Frank Act, may soon become the first insurance holding company ever regulated by the federal government.

According to an article by Arthur D. Postal at LifeHealthPro.com, American International Group, better known as AIG, is "on the verge of becoming the first insurance holding company ever regulated by the federal government."

The Treasury Department is launching a public offering of $18 billion of AIG stock.

A few days ago, the United States Treasury Department announced that it is preparing to launch a public offering of $18 billion of AIG stock. At the same time, AIG announced that it plans to purchase up to $5 billion of that stock, according to the LifeHealthPro article.

Assuming the U.S. divests enough stock such that it no longer holds a majority interest in AIG, industry observers speculate that the Federal Reserve Board will step in and regulate AIG as a thrift holding company under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The decline of U.S. ownership below 50 percent would trigger federal regulation, according to a bevy of securities analysts and industry lawyers, some of whom formerly worked at the Federal Reserve Board.[1]

The LifeHealthPro article quotes Ray Schoen of Washington Analysis, a securities analytical firm, as suggesting that "the company is poised to face real regulatory supervision of its non-insurance financial business for the first time in its history."

AIG may face new restrictions on dividend payments, share buybacks, minimum leverage and risk-based capital.

Schoen also indicated that, because of the new federal regulation, AIG may face "a litany of new restrictions... including minimum leverage and risk-based capital requirements, as well as restrictions on dividend payments and share buybacks."

Robert Benmosche, President and CEO of AIG, suggested in early August that it was preparing for federal regulation as well as state regulation moving forward.

According to Benmosche and the analysts, AIG will be subject to federal regulation both because it owns a savings and loan holding company based in Wilton, Conn. now regulated by the Fed, and/or through its designation by the Financial Stability Oversight Council as systemically significant.[2]

Schoen also suggests that AIG may be required to separate its financial activities from its non-financial activities, with new restrictions between the two holding companies.

Read the full article:

AIG on the Verge of Federal RegulationArthur D. Postal | LifeHealthPro.com September 10, 2012

1. AIG on the Verge of Federal Regulation, Arthur D. Postal, LifeHealthPro.com, September 8, 2012.
1. AIG on the Verge..., id.

Top 10 Regulatory States for P&C Insurers

Vermont and Ohio had the best property and casualty insurance regulatory environments in the U.S. in 2010, followed by Illinois, Maine, and Wisconsin, according to a report recently released by the Heartland Institute.

The Heartland Institute, a national nonprofit research and education organization, has issued its 2011 Property and Casualty Insurance Report Card (available in PDF), a state-by-state analysis of insurance regulatory burden.

The report ‘asks fundamental questions about the nation’s property and casualty insurance regulatory environment’ such as the following:

• ‘How free are consumers to choose the property and casualty insurance products they want?’ and


• ‘How free are insurers to provide the property and casualty insurance products consumers say they want?’[1][2]

Vermont and Ohio had the best property and casualty insurance regulatory environments in the U.S. in 2010, followed by Illinois, Maine, and Wisconsin, according to the report.

The report notes that federal regulatory reforms of the financial services industry and health care did not have any major effects on property and casualty insurance, despite the fact that both the Patient Protection and Affordable Care Act (PPACA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act included provisions affecting property and casualty insurance.

Reviewing the data on insurance in 2011, we see once again a modest, uneven, but nonetheless real trend towards more freedom for consumers and businesses in the homeowners’ and automobile insurance realms. Although state-level insurance bureaucracies make it difficult, sometimes impossible, for insurers to offer consumers the products they need, want, and deserve, burdensome regulation shows signs of easing.[3]

State insurance regulation is graded in the report based on a number of factors, including politicization, regulatory clarity, residual insurance markets, market concentration and rate regulation.

For the fourth year in a row, Florida was ranked last on the list with an ‘F’ letter grade.

For the fourth year in a row, Florida was ranked last on the list with a letter grade of ‘F’ and a numerical score of -35. The report is very critical of the Florida regulatory environment, but notes that Florida’s legislature, with bipartisan majorities, did attempt ‘to reduce the size and scope of the state’s extensive insurance market interventions.'

The report also indicates that Florida ‘experienced a wave of insurer insolvencies mostly from over-regulation of the market’ including many insolvencies that ‘the Florida Office of Insurance Regulation kept secret from consumers in the early months of the year [that] ended up sending consumers and regulators scampering to other companies and the state’s residual market, the Florida Citizens Property Insurance Corporation.'

1. 2011 Property and Casualty Insurance Report Card, The Heartland Institute, May 2011.
2. See also the Heartland Institute's article regarding the report, written by Eli Lehrer, Vice President of Heartland.
3. 2011 Property and Casualty Insurance Report Card, The Heartland Institute, May 2011.

Insurance Regulatory Implications of the Federal Orderly Liquidation Authority and Systemic Risk Determinations

The Orderly Liquidation Authority of the Dodd-Frank Act authorizes the FDIC to act as receiver and liquidator for failing financial companies, including insurance companies and their affiliates in certain circumstances, that pose a systematic risk to the financial stability of the United States.

Section 113(a)(1) of the Dodd-Frank Act[1] authorizes the federal Financial Stability Oversight Council (‘FSOC’) to assume supervision of any ‘nonbank financial company’ if it determines that the financial stability of the United States could be threatened by ‘material financial distress’ at the company, or by the ‘nature, scope, size, scale, concentration, interconnectedness or mix of activities’ at the company.

Under the Dodd-Frank Act, federal regulators can assume supervision of certain financial companies, including insurance companies, that are determined to pose a 'systemic risk' to the financial stability of the U.S.

The term nonbank financial company is defined broadly enough under the Dodd-Frank Act to encompass companies that are engaged in activities including ‘[i]nsuring, guaranteeing, 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 the United States.[2]

In other words, the FSOC is authorized under the Dodd-Frank Act to directly regulate specific insurance companies, as well as financial holding company systems involving insurance companies, under certain circumstances.

The stated purpose of Title II of the Dodd-Frank Act, known as the Orderly Liquidation Authority, is to authorize liquidation under federal law for failing financial companies that pose a ‘significant risk to the financial stability of the United States’ and, as receiver, to do so ‘in a manner that mitigates such risk and minimizes moral hazard.’[3] The Orderly Liquidation Authority thus empowers the Federal Deposit Insurance Corporation (the ‘FDIC’) to liquidate failing companies that are determined to pose a systemic risk to the United States financial system.[4]

The FDIC is authorized to act as the receiver for and liquidate impaired or insolvent insurance companies subject to the provisions of the Dodd-Frank Act.

The Dodd-Frank Act expressly directs the FDIC, as the receiver of a failing financial company, to take all steps necessary and appropriate to assure that all parties – including management, directors and third parties – having responsibility for the condition of the financial company will ‘bear losses consistent with their responsibility, including actions for damages, restitution, and recoupment of compensation and other gains not compatible with such responsibility.’[5]

This appears to suggest the prospect of litigation against directors and officers of failing or insolvent insurance companies in federal court under federal law, which could have a significant impact upon the corporate governance of insurance companies across the industry.

But the Dodd-Frank Act also provides that if an insurance company is determined to be subject to the Orderly Liquidation Authority of the FDIC, the liquidation or rehabilitation of that insurance company, and any subsidiary or affiliate thereof that is also an insurance company, is to be conducted as provided under applicable state law.[6] Thus, the potential of direct federal litigation against directors and officers of a failing or insolvent insurance company in liquidation under the Orderly Liquidation Authority of Dodd-Frank seems unlikely.

The liquidation of an insurance company subject to the Orderly Liquidation Authority of the FDIC is to be conducted as provided under applicable state law.

However, the term ‘insurance company’ under the Orderly Liquidation Authority is defined to include any entity that is engaged in the business of insurance, subject to regulation by a state insurance regulator and ‘covered by a state law that is designed to specifically deal with the rehabilitation, liquidation or insolvency of an insurance company.’[7]

Depending on how these provisions are applied in conjunction with specific state laws, the possibility exists that the directors and officers of certain affiliates, such as management companies or service companies, of a failing or insolvent insurance company could, at the very least, find themselves in federal court arguing the applicability of the exceptions to the Orderly Liquidation Authority in order to avoid federal insolvency proceedings and/or litigation.

1. The Dodd–Frank Wall Street Reform and Consumer Protection Act, Pub.L. 111-203, H.R. 4173.
2/ See § 102(a)(4)(B) and (6) of the Dodd-Frank Act; § 4(k)(4)(B) of the Bank Holding Company Act of 1956.
3. § 204(a) of the Dodd-Frank Act.
4. See § 203(b) and § 204(b) of the Dodd-Frank Act.
5. § 204(a)(3) of the Dodd-Frank Act.
6. § 203(e) of the Dodd-Frank Act.
7. § 201(a)(13) of the Dodd-Frank Act.

The First Director of the Federal Insurance Office Takes the Reins

Former Illinois Insurance Director Michael McRaith takes the reins as the first Director of the Federal Insurance Office.

Michael McRaith, former Illinois Insurance Director, takes office as the first Director of the newly created Federal Insurance Office (‘FIO’) today, June 13, 2011.

The FIO was established under Subtitle A of Title V of the Dodd–Frank Wall Street Reform and Consumer Protection Act (the ‘Dodd-Frank Act’).[1] Subtitle A, also known as the Federal Insurance Office Act of 2010, authorizes the FIO to, among other things:

• Monitor all aspects of the insurance industry and identify gaps in the regulation of insurers that could contribute to a systematic crisis in the industry or the U.S. financial system as a whole;

Among other things, the Federal Insurance Office is authorized to monitor all aspects of the insurance industry and identify potential gaps in insurance regulation.

• Monitor the extent to which traditionally underserved communities and consumers, minorities, and low to moderate-income persons have access to affordable insurance products;
• Assist in administering the Terrorism Insurance Program of the U.S. Treasury Department;
• Coordinate federal efforts and develop federal policy on aspects of international insurance matters;
• Consult with the states and state insurance regulators regarding insurance matters of national importance and prudential insurance matters of international importance; and
• Perform such other related duties and authorities as may be assigned to the Office by the Treasury Secretary.[2]

The FIO Director is also an advisory member of the Treasury’s Financial Stability Oversight Council established under the Financial Stability Act of 2010.

The FIO’s mandate to identify 'gaps' in the state-based insurance regulatory system opens the door to more federal regulation of insurance.

While the Federal Insurance Office Act of 2010 states that it is not intended to establish or provide the FIO or the Treasury Department with general supervisory or regulatory authority over the business of insurance, the FIO’s mandate to monitor the insurance industry and identify 'gaps' in the current state-based system opens the door to additional federal regulation of the business of insurance.[3]

Although the FIO is still in the formative stages, the Treasury Department created the Federal Advisory Committee on Insurance in May as one in a series of steps it is taking to establish the new Federal Insurance Office created by the Dodd-Frank Act.

According to Deputy Treasury Secretary Neal Wolin, the staff of the new FIO has already begun work. In written testimony before the Senate Banking Committee on May 12, 2011, Wolin indicated that the FIO staff 'has served an important consultative role in advising on several Dodd-Frank studies, rule writing processes and ongoing responsibilities' as well as 'providing expert advice on the Volcker Rule study and rule writing, Orderly Liquidation Authority rule writing and participating in the FSOC insurance working group.'[4]

1. Dodd-Frank Wall Street Reform and Consumer Protection Act; Pub.L. 111-203, H.R. 4173.
2. Federal Insurance Office Act of 2010, Sec. 503; 31 USC 313(c).
3. Federal Insurance Office Act of 2010, Sec. 503; 31 USC 313(k).
4. Deputy Secretary Neal S. Wolin Written Testimony Before the Senate Committee on Banking, Housing, and Urban Affairs, May 12, 2011.

Although Insurance Regulation Remains a Top Concern of Industry, Federal Rule-Making Progress is Slow

A heightened focus on insurance regulation is a top concern for insurance executives, but deadlines for federal rule-making continue to pass with only slow progress.

The Insurance Journal is reporting that a "heightened focus on insurance regulation as well as exposures related to reputational risk are top concerns for insurance executives today," according to "a survey conducted by Lloyd's at the recent annual Risk and Insurance Management (RIMS) conference" held in Philadelphia.[1]

Excessive regulation is a pressing concern of business leaders globally.

The 2011 Risk Index, another study by Lloyd's that is a survey of 500 executives across various countries in different industries, reflects that excessive regulation and reputational risk are among the top ten most pressing concerns of business executives, generally.[2]

The 2011 Risk Index found that losing customers and struggling to find talented workers are the top two risks facing business leaders across the world. These top two concerns were followed by concerns about reputational risk; currency fluctuation; changing legislation; cost and availability of credit; price of material inputs; inflation; corporate liability, and excessively strict regulation, which rounded out the top 10. Rapid technological changes and cyber attacks were 11th and 12th. At the bottom of the 2011 Risk Index list were windstorms – hurricanes, typhoons and cyclones; drought; threats to biodiversity; impact of space weather (e.g. solar flares), and volcanic eruptions (ash clouds].[3]

Meanwhile, Elizabeth Fiesta at LifeHealthPro is reporting on the slow pace that the federal government is taking with respect to issuing final rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act.[4]

As of May 1, 2012, a total of 221 Dodd-Frank rule making requirement deadlines have passed. Of these 221 passed deadlines, 148 or 67% have missed their deadlines, according to a new report from Davis Polk & Wardwell LLP.

Almost one-third or 73 requirements have been met with finalized rules, according to the report, which goes out monthly as the Davis Polk Dodd-Frank Progress Report. It is based on empirical data. In addition, 108 or 27.1% of the 398 total Dodd-Frank required rule makings have been finalized, Davis Polk states.

This includes all agencies, from bank regulators to the Securities and Exchange Commission and the Commodities Futures Trading Commission. There are still 144 rule making requirements that have not yet been proposed, Davis Polk notes. There are actually two other reports besides the high profile “FIO Report” required under the Dodd-Frank Act which are overdue to Congress just from the FIO itself. [5]

1. Regulation, Reputational Risk Top Concerns of Risk Managers: Lloyd’s, April 20, 2012, Insurance Journal.
2. Regulation, Reputational Risk..., id.
3. Regulation, Reputational Risk..., id.
4. 'The FIO Report' isn't the Only One Overdue While D.C. Hands Guess at Reasons for Delay, May 2, 2012, Elizabeth Fiesta, LifeHealthPro.
5. 'The FIO Report' isn'the One One...", id.

FSOC Issues Final Rule on Nonbank SIFI Designation But Questions, Concerns Remain

The Financial Stability Oversight Council (FSOC) has issued a final rule regarding how it will evaluate nonbank financial institutions for designation as Systematically Important Financial Institutions (SIFIs) subject to further federal regulation under the Dodd-Frank Act; nevertheless, questions and concerns about the designation process remain.

The Financial Stability Oversight Council (FSOC or the Council) has published a final rule laying out the three-step process by which it determines those nonbank financial institutions that pose a "systematic risk" to the national economy such that they are subject to heightened regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Dodd-Frank opened the door for the Treasury to oversee "systemically risky" nonbank financial companies.

The Dodd-Frank Act "opened the door for the U.S. Treasury to oversee nonbank financial companies that presented a systemic risk to the U.S. financial system." The final rule, which takes effect May 11 of this year, is another step towards regulating nonbank financial companies, such as insurance companies, deemed to be systemically risky.[1]

The Financial Stability Oversight Council ("the Council") today took another key step toward increasing oversight and addressing risks to U.S. financial stability by issuing the final rule and guidance that details the analysis and process the Council intends to use when determining which nonbank financial companies should be subject to enhanced prudential standards and to supervision by the Board of Governors of the Federal Reserve System.[2]

The FSOC rule identifies certain initial financial thresholds that will serve as the first step of the three-stage process to designate a nonbank company as a Systemically Important Financial Institution (SIFI).

Stage 1 includes a financial threshold of $50 billion of total consolidated assets.

A Nonbank financial institution will be subject to further analysis for SIFI designation if the company has at least $50 billion of total consolidated assets, and it meets or exceeds any one of the following thresholds:

• $30 billion in gross notional credit default swaps outstanding for which the nonbank financial company is the reference entity;
• $3.5 billion in derivative liabilities;
• $20 billion of total debt outstanding;
• 15-to-1 leverage ratio, as measured by total consolidated assets (excluding separate accounts) to total equity; or
• 10% ratio of short-term debt (having a remaining maturity of less than 12 months) to total consolidated assets.[3]

FSOC has indicated that, with respect to foreign nonbank financial companies, the Council intends to calculate these "Stage 1 thresholds" based solely on the United States "assets, liabilities and operations of the foreign nonbank financial company and its subsidiaries."[4]

In addition, the Council may consider any nonbank financial company for a determination if the Council believes the company could pose a threat to U.S. financial stability.[5]

The fact that a company meets the Stage 1 thresholds and therefore comes under additional scrutiny by FSOC through this process does not mean that the company will necessarily be subject to a final designation as a SIFI by the Council.[6]

At Stage 2 of the process under the final rule, FSOIC will analyze those companies passing the Stage 1 thresholds using "a broad range of information available to the Council primarily through existing public and regulatory sources."[7]

Stage 3 involves direct contact between FSOC and companies under SIFI designation analysis.

The final step of the process, Stage 3, involves direct contact by FSOC with each nonbank financial institution that has passed through Stages 1 and 2 of the SIFI designation analysis. FSOIC will notify the company that it is under consideration for SIFI designation, and the Council will request additional information directly from the company. The company will also have "an opportunity to submit written materials related to the Council’s consideration of the company for a proposed determination."[8]

At the end of Stage 3, based on the results of the analyses conducted during each stage of review, the Council may, by a vote of at least two-thirds of the Council’s voting members then serving, including an affirmative vote by the Chairperson of the Council, make a proposed determination regarding the company. If a proposed determination is made, the Council will provide the nonbank company with a written explanation of the basis of the proposed determination. The company may request a hearing to contest the proposed determination. In order to make a final determination, the Council must again vote by a two-thirds majority, including an affirmative vote by the Chairperson.[9]

While the thresholds relating to Stage 1 are clearly defined, many parts of the rules remain unclear. For example, the final rule lists eleven (11) considerations that FSOC will consider in making a SIFI determination, including the extent of the leverage of the target company and its subsidiaries, the nature and extent of the off-balance-sheet exposures of the target company and its subsidiaries, and the importance of the target company and its subsidiaries as a source of liquidity for the U.S. financial system.[10]

Details of the application of these considerations to the SIFI designation analysis include, without limitation:

• How will leverage be measured?
• How will the nature and extent of off-balance-sheet exposures be quantified?
• What metrics will be employed to determine the quantitative or qualitative importance of a company as a source of liquidity for the U.S. financial system?

Thus, although FSOC suggests that the final rule has provided important clarifications of issues raised during the rule-making process, many questions and concerns still remain with respect to the SIFI designation process.

1. FSOC Rule Begins Definition of Insurers Posing Systemic Risk, Anthony O'Donnell, Insurance & Technology, April 12, 2012.
2. Financial Stability Oversight Council Approves Rule To Designate Nonbank Financial Companies For Enhanced Oversight, Help Prevent Future Financial Crises, U.S. Department of the Treasury, April 4, 2012.
3. Nonbank Financial Company Designations Final Rule and Interpretive Guidance Fact Sheet, U.S. Department of the Treasury.
4. Nonbank Financial Company Designations Final Rule…, id.
5. Nonbank Financial Company Designations Final Rule…, id.
6. Nonbank Financial Company Designations Final Rule…, id.
7. Nonbank Financial Company Designations Final Rule…, id.
8. Nonbank Financial Company Designations Final Rule…, id.
9. Nonbank Financial Company Designations Final Rule…, id.
10. Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies, 12 CFR § 1310.11(a).

Insurance Regulation 2012: Reading the Tea Leaves

Insurance industry auguries expect insurance regulation to be a significant issue in the coming year.

Insurance industry insiders predict that insurance regulation will take center stage in governmental affairs in 2012, and expect that insurance regulatory issues will have an increasing effect on business in the new year.

Mark A. Hofmann of Business Insurance, for instance, expects that regulators will dominate government affairs during 2012 as lawmakers focus on election-year politics with limited risk management and insurance issues on the congressional agenda. He points to the new Federal Insurance Office's report on insurance regulation modernization, due to Congress this month, as the "first major item on the regulatory agenda."[1]

Other regulatory issues include ongoing implementation of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. And although almost certain to be focused on election-year politics, Congress nonetheless will have a role to play in the National Flood Insurance Program.[2]

Regulators will be "dominating the governmental affairs scene."

To those who think the 2012 elections and congressional gridlock will keep the government occupied, both Jimi Grande, senior vice-president of the National Association of Mutual Insurance Companies, and Joel Wood, senior vice-president of the Council of Insurance Agents & Brokers in Washington, disagree. Wood says regulators will be "dominating the governmental affairs scene" in the insurance industry in 2012, and Grande suggests that the regulatory part of the federal government "will be working feverishly" despite the election year or legislative gridlock.[3]

The FIO's report could be a critical event for the insurance industry.

The FIO's insurance regulation modernization report could be a critical event for the insurance industry, potentially setting the stage for "interaction among the FIO, the National Assn. of Insurance Commissioners and the states for years to come," according to Wood, as reported by Business Insurance.[4]

Tom Litjen, vice-president of the Property Casualty Insurers Association of America, agrees that the report will provide significant insight into "the direction the FIO is setting for itself."[5]

Risk management issues are expected to be important points on many state government agendas, as well, including risk assessments and natural catastrophe-related matters, according to another recent Business Insurance article.[6] Those points include:

• A push to create a New York state Office of Risk Assessment to "integrate comprehensive risk management into the state's operations";
• The possibility of legislation involving Florida's hurricane catastrophe fund and/or the Florida Citizens Property Insurance Corporation;
• Ongoing regulatory implementation regarding the Texas Windstorm Insurance Association;
• The possibility that regulators may look to increase the relatively small market penetration of California's Earthquake Authority; and
• The potential for further legislation in the risk management area related to last year's Hurricane Irene and the Virginia earthquake.[7]

Future insurance regulation will not only address catastrophe concerns and risk assessments, but regulatory developments are expected to have an increasing impact on businesses, particularly small business, in 2012.

The insurance industry has seen four states recently pass legislation defining construction defect claims as occurrences under commercial liability policies—a trend likely to continue in some places, experts say.[8]

In the same vein, Insurance Regulatory Law expects to see more states moving to adopt the recent amendments to the National Association of Insurance Commmissioners model act and regulation relative to insurance holding companies, especially as the NAIC appears to be moving forward with incorporating those amendments into its state accreditation standards. The NAIC has also been moving forward with initiatives on suitability in annuity transactions as well as reinsurance credit.

Paychex, a leading provider of payroll, human resources and employee benefit services, suggests that regulatory issues could require small business owners to change the way they operate.[9]

Health care reform has already begun to fundamentally change the health care and health insurance industries.

Among those changes are the potential legislative and regulatory impacts of the Affordable Care Act. Even though the Supreme Court has recently agreed to hear challenges to the implementing legislation, health care reform has already begun to fundamentally change the health care and health insurance industries, and many state and federal agencies are continuing implementation, all of which will impact businesses going forward.[10]

The NAIC, for example, recently adopted three (3) new white papers to assist state regulators with the implementation of the Affordable Care Act's health insurance exchange, including white papers on governance, adverse selection and the role of navigators/producers.

In 2012, "several states will be enacting stricter legislation to more heavily fine companies for misclassified workers," which could impact both workers' compensation insurance coverage and premiums. [11]

Changes in security and privacy laws, financial reform and employment law regulations could also affect small businesses and the insurance industry in indirect ways.[12]

1. Insurance regulation takes center stage, Mark A. Hofmann, Business Insurance, January 1, 2012.
2. Insurance regulation…, Id.
3. Insurance regulation…, Id.
4. Insurance regulation…, Id.
5. Insurance regulation…, Id.FN3
6.  Risk management concerns on state agendas for 2012, Mike Tsikoudakis andRodd Zolkos, Business Insurance, January 1, 2012.
7.  Risk management concerns…, Id.
8.  Risk management concerns…, Id.
9. 12 Laws That Will Affect Your Business in 2012, David Mielach, BusinessNewsDaily, December 28, 2011.
10. Supreme Court Agrees to Hear Health Care Reform Challenges, But Health Care Reform Already Fundamentally Changing the Health Care and Health Insurance Industries, Van R. Mayhall, III, Insurance Regulatory Law, November 15, 2011.
11. 12 Laws…, Id.
12. 12 Laws…, Id.