On Nov. 27, 2023, the Board of Governors of the Federal Reserve System (the Fed) published a final rule, available here, on risk-based capital (RBC) standards for depository institution holding companies that are significantly engaged in insurance activities. The rule is significant insofar as it represents a rare federal touchpoint with insurance regulation, largely a state-regulated sector. The rule, which is the culmination of a four-year process since the 2019 introduction of the proposed rule, implements Section 171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (enacted in 2010). That provision calls on federal banking agencies to establish, inter alia, minimum RBC requirements on a consolidated basis for depository institution holding companies.

Section 171 was amended in 2014 to permit the Fed, in establishing minimum risk-based and leverage capital requirements on a consolidated basis, to exclude companies engaged in the business of insurance and regulated by a state insurance regulator, such as insurers that are also savings and loan holding companies (SLHCs). In the final rule, the Fed has chosen to include these entities.

Under the final rule, companies must comply with most of the new RBC framework, called the “building block” approach, or BBA, beginning on Jan. 1, 2024. Beginning at that time, companies are expected to hold capital sufficient to comply with the BBA’s minimum requirement. Companies must first report on their capital adequacy under the BBA capital requirement as of Dec. 31, 2024.

The Fed’s BBA framework incorporates legal entity capital requirements such as the RBC requirements prescribed by the National Association of Insurance Commissioners (NAIC), taking into account differences between the business of insurance and banking. The NAIC’s RBC framework requires each insurer to calculate, based on its own investment, underwriting and other business risks, a customized level of required capital in accordance with detailed instructions published by the NAIC.

The BBA expresses capital position as a BBA ratio, which is the ratio of the aggregated available capital to the aggregated required capital of the enterprise. Under the final rule, a supervised insurance organization (SIO), which is generally an insurance company that is also a holding company for a depository institution, must maintain a BBA ratio of at least 250% and a “capital conservation buffer” of 150%, resulting in a total requirement of 400% (the total requirement under the proposed rule would have been 485%).

The final rule contains definitions of “qualifying capital instruments,” “additional tier 1 capital instruments,” “common equity tier 1 capital instruments” and “tier 2 capital instruments,” and it sets quantitative limits for certain types of capital resources. Some of these limits have been relaxed relative to the 2019 proposed rule.

In addition to the changes discussed above, the final rule simplifies the insurance adjustments, eliminates an exception of certain asset managers from being material financial entities and reduces the burden of the proposed form FR Q–1 (the form on which the capital ratio is to be reported).

In addition, the proposed calculation would have allowed an insurance SLHC subject to the generally applicable RBC requirements (i.e., that is not a top-tier insurance underwriting company) to elect not to consolidate the assets and liabilities of all of its subsidiary state-regulated insurers and certain foreign-regulated insurers. The proposal would have provided two alternative approaches if this election is made. Under the first alternative, the holding company could have elected to deduct the aggregate amount of its outstanding equity investment in its subsidiary state-regulated and certain foreign-regulated insurers, including retained earnings, from its common equity tier 1 capital elements. Under the second alternative, the holding company could have included the amount of its investment in its risk-weighted assets and assigned to the investment a 400% risk weight.

In the final rule, firms that elect not to consolidate the assets and liabilities of all of its subsidiary state-regulated insurers and certain foreign-regulated insurers have the option to choose between the proposed treatments.

The final rule also modifies the definition of materiality in response to comments received on the proposed rule, for purposes of defining “material financial entity” (MFE), which is a component of how capital ratios are calculated for a group of entities. The final rule uses a threshold of 5% of equity of the top-tier depository institution’s holding company rather than 1% of its assets.