On March 10, 2014, Sen. Susan Collins (R-Maine) introduced a bill1 that would allow Federal banking regulators to distinguish between banks and insurers when setting capital requirements for certain diversified financial groups. The legislation is intended to clarify, and correct a possible interpretation of, a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act2 that raises the specter of imposing banking-style capital requirements on insurers.
By way of background, historically U.S. insurers have been subject to “risk-based capital” (RBC) standards imposed by state insurance regulators. Under the RBC regime, each insurer must determine and report to state regulators its own distinct level of required capital based on its profile of risks, assets and liabilities. Actual capital is then measured against this determined threshold. These calculations are performed pursuant to certain instructions and forms prescribed by the National Association of Insurance Commissioners. RBC standards are applied at the entity level, i.e., each insurer must determine its capital level separately even when multiple insurers are affiliated within a single control group.
Banks in the U.S., on the other hand, have historically been subject to capital and leverage requirements imposed by state and Federal financial regulators, including the Federal Deposit Insurance Corporation and others. In an effort to toughen and harmonize these standards, and to align them with the requirements of Dodd-Frank, last July the Board of Governors of the Federal Reserve System and the Office of Comptroller of the Currency adopted the standards of the Basel Committee on Banking Supervision (“Basel III”) for many types of U.S. banks and similar financial institutions.3 Basel III focuses on, inter alia, the “loss absorbency” characteristics of bank capital instruments as well as the “risk weighting” of assets on bank balance sheets.
Ambiguities within Dodd-Frank have prompted concerns that some financial firms could become subject to both capital regimes (that is, the one for insurers and the one for banks) concurrently or at different tiers in the corporate structure, producing impractical, redundant or even nonsensical results. Specifically, Dodd-Frank authorizes the Federal government to designate certain non-bank financial firms (including insurers) as so-called “systemically important financial institutions,” or “SIFIs.” SIFIs are subject to heightened financial regulation by the Board of Governors. Section 171 of Dodd-Frank, known as the Collins Amendment after its drafter, Senator Collins, specified further that SIFIs as well as holding companies of depository institutions (both of which categories include insurers and their affiliates) must be subject to capital standards that are “not less than” those applicable to the depository institutions themselves. Under one reading of Section 171, such holding companies and SIFIs would be required, in effect, to hold capital as though they were banks. Although other provisions of DoddFrank (most notably Section 165) allow the Fed to distinguish between insurers and banks more generally, Section 171 introduced the possibility of insurers being subjected to inappropriate Basel-type standards.
In light of the numerous differences between banks’ and insurers’ business models, liquidity needs, risk profile and roles in the financial system – not to mention the numerous technical differences between the two quantitative capital regimes – many contended that the application of bank-centric standards to insurers would be an undesirable and unintended consequence of Dodd-Frank. Senator Collins herself has indicated publicly that this was not her intent in crafting Section 1714 and that her proposed legislation is intended to correct this anomaly.5 The Board of Governors has suggested that no single, uniform capital regime would be applied to all financial institutions6 while also questioning its own authority under Section 171 to impose mutually exclusive bank and insurer standards.7 Bills introduced in the House and Senate during 20138 to address this issue have struggled to gain momentum.
The new bill introduced by Senator Collins would amend Section 171 (as codified at 12 U.S.C. 5371) by providing that, in establishing capital standards for depository institution holding companies and SIFIs, bank regulators “shall not be required to include” an insurer subject to insurance regulation.9 Insurers may specifically be excluded even for purposes of determining consolidation in the first place.10