The Federal Reserve took a step toward imposing tougher capital requirements on insurers tagged for heightened oversight, sketching out proposals that companies can now respond to after years of uncertainty about the process.
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The Fed's proposals, however, leave key details to be determined later, such as specific numerical capital requirements for large insurers Prudential Financial Inc. and American International Group Inc. U.S. regulators have tagged those two companies "systemic," and as such they face tougher rules than other insurers.
The proposals are set for a vote by the central bank's governing board later Friday, after which the industry would have a chance to comment on them.
One proposal, outlining capital rules for insurance firms under the Fed's purview, suggests a tougher set of rules for Prudential and AIG than for 12 insurance companies that own banks, including State Farm Mutual Automobile Insurance Co. and Nationwide Mutual Insurance Co. The Fed is asking for public comment on the capital concept, after which it would publish a draft rule.
Separately, the Fed is also set to propose draft risk-management and liquidity rules for Prudential and AIG, including requiring that they maintain enough safe assets to cover cash flows for 90 days and that they run "stress tests" ensuring they can meet their cash flow needs.
Those standards would likely take effect before the capital rules, but the Fed expects that the firms will be able to meet the new liquidity rules relatively easily, a Fed official told reporters on a conference call, calling them existing best practices for many firms.
"I believe this proposal is an important step toward capital standards that are both appropriate for our supervised insurance firms and that enhance the resiliency and stability of our financial system," Fed Chairwoman Janet Yellen said.
Under the 2010 Dodd-Frank law, the Fed has authority over large insurance firms with assets that represent about a quarter of the U.S. insurance industry, which has mostly been state-regulated over the years. The insurers have been awaiting the Fed's rules since the law was passed, and the industry and its state regulators have been pressing the Fed to tailor rules to reflect differences between the operations of insurance companies and the banks the Fed usually regulates.
The Fed's decision to issue a "concept" of the rules before writing a more specific draft is both good news and a frustrating development for insurers. The good news is that the Fed is being thoughtful in taking on regulation of an industry it hasn't historically overseen and wanting as much feedback as possible before completing the rules. But it means insurance-industry managers will continue making operational moves without knowing all the important details that will apply in the future.
Fed officials said they are taking a "tiered" approach to capital rules. For the 12 insurance companies not labeled systemic, the Fed "would literally build on the requirements placed" on the units by their existing regulators, Fed governor Daniel Tarullo said.
That approach seems to address criticism that the Fed was reinventing the wheel, when state insurance departments already oversee the nation's insurance industry. But the central bank said it could also require additional capital at those 12 firms to address "financial stability" concerns that aren't contemplated by state rules. In general, the Fed said, its rules would impose a lower regulatory burden on those firms compared to Prudential and AIG
For AIG and Prudential, whose "systemically important" label means regulators think they could harm the broader financial system if they were to collapse, the concept is to "create risk categories for assets and liabilities across the holding company" for which additional capital would be required, Mr. Tarullo said. The Fed didn't specify the categories and asked for public input on what they should be.
The rules have been years in the making, and already have had important ramifications.
Earlier this year, AIG gave board seats to a top lieutenant to activist investor Carl Icahn as well as to hedge-fund manager John Paulson, after their calls for a breakup to get out from under Fed regulation. The New York company is in midst of aggressive cost-cutting, and divestitures of some assets or even businesses is expected.
MetLife Inc., which successfully overturned its "systemically important" label in court but could be redesignated if the government wins its appeal, in January said it would jettison a chunk of its life-insurance operations, for both strategic and regulatory reasons.