The Financial Stability Oversight Council struck a blow on behalf of common sense at its most recent meeting when it exempted the asset management industry from facing the label of "too big to fail." The FSOC should now take the same sensible approach with the life insurance industry.
In the wake of the financial crisis, the Dodd-Frank Act created the FSOC to "respond to emerging threats to the stability of the U.S. financial system." One of the FSOC's primary tools is its ability to designate nonbank companies as systemically important financial institutions, or SIFIs. All companies labeled as SIFIs will be regulated by the Federal Reserve and face higher capital requirements potentially much higher than their non-SIFI competitors.
To date, the FSOC has named three nonbank companies as SIFIs: GE Capital, American International Group and Prudential Financial. A fourth company, MetLife, is in the final stage of consideration for SIFI designation. Critically, Dodd-Frank gave FSOC another tool as well: the ability to regulate activities. Rather than single out a few companies in an industry for SIFI designation, FSOC can "provide for more stringent regulation of a financial activity."
This is the path FSOC is following with the asset managers. At its July 31 meeting, FSOC told its staff to "undertake a more focused analysis of industry-wide products and activities to assess potential risks associated with the asset management industry," according to a Treasury Department news release.
This came as a surprise to the life insurance industry. After all, life insurers have been arguing for more than two years that the best way to deal with systemic risk is to target potentially systemic activities. Life insurers also have been saying that their traditional activities issuing life, long-term care and disability insurance and annuities, and using capital to make the long-term investments that support these products pose no risk to the financial system. The FSOC has given no explanation as to why it is willing to embrace an activities-based approach for asset managers but not for life insurers.
Focusing on activities is the right approach to capture systemic risk, regardless of the size of the firm. Moreover, an activities-based approach would avoid the competitive distortions that SIFI designations can create. Should a life insurer be incorrectly designated as a SIFI subject to higher prudential standards than its peers, it likely would lead to competitive disadvantages.
Imposing new, unnecessary and unreasonable capital requirements on life insurers will directly affect the products that life insurers provide. To respond to the pressure on capital, consumer benefits may be reduced, prices may be increased, and some products may no longer be available. At a time when government social safety nets are under pressure and corporate pensions are disappearing, public policy should preserve not undermine competitively priced financial and retirement protection for consumers.
The importance of a strong regulatory system for life insurance companies is a given. Not only does regulation protect policyholders, it protects the insurers themselves, who are financially responsible for one another's liabilities through the state-based guaranty fund system. What is not acceptable is a regulatory system that creates an uneven playing field and ultimately harms consumers. Yet that is what the FSOC risks doing by singling out a handful of insurance companies for SIFI designation.
If an activities-based approach to systemic risk will work for asset managers, it will work for life insurers as well. The FSOC should halt further designations and rescind existing designations of life insurers until the merits of an activities-based approach can be fully explored for all nonbanks, not just asset managers.
Dirk A. Kempthorne is president and chief executive of the Washington, D.C.-based American Council of Life Insurers. He served as the 49th U.S. Secretary of the Interior and as Idaho's governor, U.S. Senator and mayor of Boise.