Insurers that own depository institutions (DIs), mainly mutual insurers owning savings and loans (S&Ls), have been waiting since the 2010 adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act for specific administrative guidance on the amount of group capital they will have to hold. The wait is over, in the form of proposed rulemaking on risk-based capital (RBC) from the Board of Governors of the Federal Reserve System (the Fed).

These new rules, if they become final, could impose new capital burdens on insurers, but alternatively could allow them to release or move redundant capital within their groups, or explore new capital management or leverage opportunities that may not have been available or attractive before.

On Sept. 6, the Fed issued and solicited comments on a proposed rulemaking on RBC that would amend the Fed’s existing Regulation Q. Comments may be submitted up to 60 days after the proposal is published in the Federal Register.

The Fed proposed the rule to implement the requirement under Dodd-Frank that minimum capital requirements be imposed on DI holding companies. Such capital requirements must be “no less than” the requirements for the DIs themselves. Up to now, only the individual regulated entities (that is, the insurers, S&Ls, broker-dealers and others within a consolidated group) have had to observe discrete minimum capital requirements under their respective regulatory regimes.

Insurers covered by the proposed rule should consider the following to determine whether their groups have sufficient — or even redundant — capital under the new requirements.

  • The proposed rule establishes a “building block” approach to a group capital standard for insurers and their DI subsidiaries. This approach does not analyze such a group on a consolidated basis. Instead, the Fed will require the reporting company to tabulate the RBC of specified components within its group (e.g., building blocks). These are then aggregated to come up with a group capital ratio. This could require more adjustments for intercompany transactions and balances than a consolidated approach would have. This could also present opportunities for more efficient capital management.
  • The Fed is using the National Association of Insurance Commissioners’ (NAIC) RBC approach rather than some other yardstick. This represents a victory for the NAIC and state insurance regulators. These officials have been vocal in opposing a “bank-centric” capital measurement for insurance companies.
  • Consider a case where a DI in a group is a building block for purposes of the rule. In such a case, the proposed rule prescribes how to convert the DI’s bank-regulatory risk-weighted assets and capital to their NAIC equivalents. This then would be aggregated with the RBC ratios of the insurance building blocks within the group (as adjusted and scaled), and simliar ratios of other regulated building blocks, to establish the group’s ratio. Insurers might perform these calculations to see how they would fare under the rule. The key scalars including the following:
    • The NAIC Authorized Control Level RBC would be determined by multiplying the DI's bank-regulatory risk-weighted assets by 0.106.
    • The NAIC Total Adjusted Capital would be determined by subtracting from its bank-regulatory total capital the product of risk-weighted assets and 0.063.
  • The rule largely follows existing Regulation Q on features that an instrument must have in order to qualify as capital for a building block. These requirements are not squarely aligned with the insurance accounting requirements for surplus under insurance statutory accounting (Statement of Statutory Accounting Practice No. 72). Therefore, an insurer that is a building-block parent will have to consider how to harmonize these. The insurer may also wish to consider how to navigate these requirements for maximum capital efficiency. Under the Fed proposal, a capital instrument must meet the following criteria to qualify as capital:
    • The instrument is issued and paid in.
    • The instrument is subordinated to depositors and general creditors of the building-block parent.
    • The instrument is not secured, guaranteed or otherwise credit-enhanced.
    • The instrument has a minimum original maturity of at least five years. At the beginning of each of the last five years of the life of the instrument, the amount eligible to be included in capital is reduced by 20 percent.
    • The instrument may be called by the building-block parent only after a minimum of five years following issuance. In addition:
      • The top-tier DI holding company within the group must receive the Fed’s prior approval to exercise a call option on the instrument.
      • The building-block parent must not create an expectation that the call option will be exercised.
      • Prior to exercising the call option, or immediately thereafter, the board-regulated institution must either replace the capital or demonstrate to the Fed that remaining capital is adequate.
  • Redemption of the instrument prior to maturity or repurchase requires the prior approval of the Fed.
  • The instrument must meet certain criteria in existing Regulation Q. For instance, the holder must have no right to accelerate except upon default. In addition, the instrument cannot have a rate that fluctuates based on the institution’s credit standing.