[Senate Hearing 113-350]
[From the U.S. Government Publishing Office]





                                                        S. Hrg. 113-350


           FINDING THE RIGHT CAPITAL REGULATIONS FOR INSURERS

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
             FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                   ON

FINDING THE RIGHT CAPITAL REGULATIONS FOR INSURANCE COMPANIES UNDER THE 
                             DODD-FRANK ACT

                               __________

                             MARCH 11, 2014

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                       Taylor Reed, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

     Subcommittee on Financial Institutions and Consumer Protection

                     SHERROD BROWN, Ohio, Chairman

       PATRICK J. TOOMEY, Pennsylvania, Ranking Republican Member

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         DAVID VITTER, Louisiana
ROBERT MENENDEZ, New Jersey          MIKE JOHANNS, Nebraska
JON TESTER, Montana                  JERRY MORAN, Kansas
JEFF MERKLEY, Oregon                 DEAN HELLER, Nevada
KAY HAGAN, North Carolina            BOB CORKER, Tennessee
ELIZABETH WARREN, Massachusetts

               Graham Steele, Subcommittee Staff Director

       Tonnie Wybensinger, Republican Subcommittee Staff Director

                                  (ii)





















                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 11, 2014

                                                                   Page

Opening statement of Chairman Brown..............................     1

Opening statements, comments, or prepared statements of:
    Senator Toomey...............................................     2
    Senator Johanns..............................................     3

                               WITNESSES

Susan M. Collins, a United States Senator from the State of Maine     4
Gina Wilson, Executive Vice President & Chief Financial Officer, 
  TIAA-CREF......................................................     7
    Prepared statement...........................................    29
Daniel Schwarcz, Associate Professor and Solly Robins 
  Distinguished Research Fellow, University of Minnesota Law 
  School.........................................................     9
    Prepared statement...........................................    33
H. Rodgin Cohen, Senior Chairman, Sullivan & Cromwell LLP........    11
    Prepared statement...........................................    40
Aaron Klein, Director, Financial Regulatory Reform Initiative, 
  Bipartisan Policy Center.......................................    12
    Prepared statement...........................................    49
Michael W. Mahaffey, Chief Risk Officer, Nationwide Mutual 
  Insurance Company..............................................    14
    Prepared statement...........................................    55

              Additional Material Supplied for the Record

Letter from Senator Susan M. Collins.............................    60
Prepared statement of Sheila C. Bair, former Chair, Federal 
  Deposit Insurance Corporation..................................    62
Letter from the U.S. Chamber of Commerce.........................    68
Prepared statement of William C. Hines, American Academy of 
  Actuaries......................................................    70
Prepared statement of the American Council of Life Insurers 
  (ACLI).........................................................    76
Prepared statement of the American Insurance Association.........    79
Prepared statement of the Property Casualty Insurers Association 
  of America (PCI)...............................................    86
Prepared statement of the Financial Services Roundtable..........    89
Prepared statement of the National Association of Insurance 
  Commissioners (NAIC)...........................................    94
Prepared statement of the National Association of Mutual 
  Insurance Companies (NAMIC)....................................    96

                                 (iii)

 
           FINDING THE RIGHT CAPITAL REGULATIONS FOR INSURERS

                              ----------                              


                        TUESDAY, MARCH 11, 2014

U.S. Senate, Subcommittee on Financial Institutions 
                           and Consumer Protection,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10:07 a.m. in room SD-538, Dirksen 
Senate Office Building, Hon. Sherrod Brown, Chairman of the 
Subcommittee, presiding.

           OPENING STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. The Committee will come to order. Thank you 
for joining us, especially Senator Collins, thank you for your 
leadership on this issue and sharing your ideas for legislation 
and advice for the Fed with the Subcommittee. Thank you for 
that.
    I want to first thank Chairman Johnson for permitting 
Senator Toomey and me to address this important issue on our 
Subcommittee and a number of others over the past 3 years. 
Chairman Johnson has allowed us to examine a number of 
important issues and take a more active role than 
Subcommittees--at least in my understanding Subcommittees over 
the years in Banking have traditionally assumed. And I 
appreciate very much Tim's generosity and certainly his staff's 
work with us.
    I thank Senator Toomey for working with us on this hearing. 
There is across the political spectrum and across party lines 
broad agreement that providing traditional life and property 
and casualty insurance is different from banking. I appreciate 
particularly Senator Johanns' efforts on this Committee with 
Senator Collins and others in fixing what we think is a very 
fixable issue.
    Funding sources are different for insurance and banking. 
Insurers rely on customer premiums and investment proceeds. The 
nature of their investments is different. Insurers must match 
long-term investments with long-term policies, and the risks 
are different. Insurers are concerned with natural disasters 
and life events.
    While I believe that traditional insurance is distinct 
business from banking, institutions often combine regulated 
banking and so-called shadow banking activities. Similarly 
named institutions can engage in a wide range of activities 
from derivatives to repo to securities lending under a range of 
corporate structures. Dodd-Frank Act tried to remedy this 
problem by creating the FSOC, the Financial Stability Oversight 
Council, to identify systemic financial firms and encourage 
regulation of risky activities. If any institution engages in 
activities like securities financing transactions, those 
activities should absolutely--absolutely--be subject to the 
same capital rules as banks.
    But I agree with New York's Banking Commissioner Ben 
Lawsky, who regulates some of the Nation's largest insurers, 
that applying bank capital standards to insurance is like 
trying to, as he said, ``fit a square peg in a round hole.'' 
For that reason, it is important that the Federal Reserve 
delayed applying Basel III and Section 165 prudential standards 
to insurers. The Fed must determine that insurance capital 
rules are appropriate under the Collins amendment. Chairman 
Dodd and Senator Collins anticipated this issue. There is 
nearly universal agreement that this should not require 
legislation.
    In 2011, Senator Johanns and I sent a letter with a group 
of 20 of our colleagues representing large numbers of 
colleagues in both parties agreeing that Dodd-Frank gives 
regulators the flexibility to treat insurance differently. If 
the Fed continues to disagree, I am committed to working with 
both of my colleagues, Senator Collins and Johanns, to find a 
legislative solution.
    We are all concerned about creating another AIG, which 
realized 45 percent of the losses of all insurers in 2008 and 
received 55 percent of the Government's support provided to 
insurers. Dodd-Frank contains a number of provisions to prevent 
that from happening again: one, regulating derivatives to 
address their credit default swap business; second, eliminating 
the Office of Thrift Supervision and moving thrift regulation 
to the Fed; three, creating nonbank systemically important 
financial institution designations, SIFI designations; and, 
last, requiring enhanced capital and leverage rules for nonbank 
SIFIs.
    Legislation would not alter these provisions. It would 
address a narrow, specific element of the Collins amendment, 
allowing the Fed to tailor capital rules to the insurance 
business model. This issue is not whether applying bank 
standards to insurers would require too much capital or too 
little capital. There is general agreement that institutions 
must have enough capital to pay for the cost of their failures. 
Capital rules should, must accurately measure and address the 
risks of the businesses to which they are being applied.
    I look forward to Senator Collins' testimony and to our 
panel. And, Senator Toomey, thank you.

             STATEMENT OF SENATOR PATRICK J. TOOMEY

    Senator Toomey. Thanks very much, Mr. Chairman, and thanks 
for having this hearing. I think it is a very important topic. 
I want to thank you and Senator Johanns for the legislation you 
have introduced which addresses this and which I am a cosponsor 
of.
    I want to thank Senator Collins for joining us today and 
for testifying before the Committee.
    I just want to underscore a couple of points. I agree 
completely that the insurance business model is completely 
different in so many ways from a banking model that it would be 
completely inappropriate to impose a bank-centric, a bank-
designed capital regime on insurance companies.
    I would argue that the same principle applies with asset 
management. That, too, is completely different and very 
dissimilar from the banking business, and, therefore, a banking 
capital regime does not make sense for asset managers either.
    And I would also point out that, in addition to some danger 
that the Fed may be inclined to go down this road of requiring 
a banking type capital on insurance companies, I am concerned 
that there is a danger that the Financial Stability Board might 
also move in the direction of imposing European-style insurance 
capital on an American industry that has evolved in a way that 
is very different from the European model and for which that 
model, I think--that capital model is not appropriate.
    So I think this is extremely timely. You pointed out the 
problems with AIG, and I know you know very well it was not 
their insurance business that caused the problems at AIG. It 
was activities that had nothing to do with insurance. And, in 
fact, for many, many decades, the insurance industry has 
weathered all kinds of storms and volatility and different 
kinds of markets and circumstances and weathered it quite well, 
which I think further suggests that this is an industry that 
has an appropriate set of capital requirements.
    So thanks for having the hearing. I look forward to the 
testimony of our colleague.
    Senator Brown. Thank you, Senator Toomey.
    Senator Johanns.

               STATEMENT OF SENATOR MIKE JOHANNS

    Senator Johanns. What I was going to say has basically been 
said, so I am not going to repeat that. We do know the 
difference between the two industries, the banking and the 
insurance. But I do want to make a very important point today.
    First of all, I want to say thank you to the Chairman for 
his efforts. My point there is that without your engagement, I 
do not think we would be this far along.
    The second point is to Senator Collins. Senator, without 
you grabbing hold of this and trying to wrestle your way 
through these technical, difficulty issues, I think we would be 
stalled, to be very honest with you. I know you feel very 
passionately about getting this right. That is what we want to 
do. We want to make sure that whatever we end up doing with 
capital standards we have got it right--we have got it right 
for the banking industry, we have got it right for the 
insurance industry.
    And I think this is an opportunity with Dodd-Frank to 
reflect upon what was there, is it working, what can we do to 
improve it. And your engagement I think is critical to get us 
to the finish line.
    If we can have a breakthrough on this, then I think this is 
literally a bill we can get passed, we can get done, get to the 
President for his signature. So I just wanted to devote my 
time, Senator, to just say thank you for being here today and 
thank you for engaging on this very, very challenging, 
difficult issue. But I think I see a light at the end of the 
tunnel.
    Thank you.
    Senator Brown. Thank you, Senator Johanns.
    Senator Tester.
    Senator Tester. I am going to break Senate protocol here 
because everything has been said, I just have not said it, and 
I am not going to say it. So I look forward to Senator Collins' 
testimony.
    Senator Brown. Thank you, Jon.
    Senator Collins, the senior Senator from Maine, welcome.

STATEMENT OF SUSAN M. COLLINS, A UNITED STATES SENATOR FROM THE 
                         STATE OF MAINE

    Senator Collins. Thank you very much, Mr. Chairman, Ranking 
Member Toomey, Senator Johanns, Senator Tester. It is a great 
pleasure to join you this morning. I wager that this hearing is 
the most technical hearing that is being held on Capitol Hill 
today, perhaps this week, perhaps this year.
    I do thank you for convening this hearing on insurance 
capital standards and for inviting me to come before you today 
to share my views on this important topic. As a former 
financial regulator myself, I appreciate how complex it is to 
develop proper capital standards. For 5 years I headed Maine's 
Department of Professional and Financial Regulation and oversaw 
the Bureau of Banking, the Bureau of Insurance, the Bureau of 
Consumer Credit Protection, and the Securities Division.
    There are three issues that I would like to touch upon this 
morning.
    First, I would like to describe why I authored what has 
become to be called ``the Collins capital standards 
amendment,'' Section 171 of Dodd-Frank, and why I feel strongly 
that it is so important that nothing be done to diminish or 
weaken it.
    Second, I want to emphasize my belief that the Federal 
Reserve is able to take into account and should take into 
account the differences between insurance and other financial 
activities when consolidating holding company capital under 
Section 171.
    And, third, I will comment on how the Federal Reserve's 
authority on this point can be clarified, if necessary, through 
legislation that I have recently introduced, Senate bill 2102. 
I am also very aware of the legislation that the Chairman, the 
Ranking Member, and Senator Johanns--Senator Tester may be on 
it also--have introduced, and I think we are not that far 
apart. And I hope that we can continue to work to reach 
consensus.
    With regard to my first point, we all recall the 
circumstances we faced 4 years ago as our Nation was emerging 
from the most serious financial crisis since the Great 
Depression. That crisis had many causes, but among the most 
important was the fact that some of our Nation's largest 
financial institutions were dangerously undercapitalized while 
at the same time they held interconnected assets and 
liabilities that could not be disentangled in the midst of a 
crisis.
    I remember the big debate during Dodd-Frank about what 
financial institutions should be allowed to do. Should they be 
involved in the derivative business? Should they be able to 
issue credit default swaps? And I kept thinking, from the 
perspective of the former regulator that I once was, that what 
really was important was how much capital they had if they were 
going to engage in riskier transactions. And when I looked at 
the leverage ratios of, for example, Bear Stearns and found 
that it was 30:1, I once again came to the conclusion that what 
was important was having adequate capital standards.
    The failure of these overleveraged financial institutions 
threatened to bring the American economy to its knees. As a 
consequence, the Federal Government was forced to step in to 
prop up financial institutions that were considered too big to 
fail. Little has angered the American public more than these 
taxpayer-funded bailouts. That is the context in which I 
offered my capital standards proposal as an amendment to the 
Dodd-Frank bill.
    Section 171 is aimed at addressing the too-big-to-fail 
problem at the root of the 2008-09 crisis by requiring large 
financial holding companies to maintain a level of capital at 
least as high as that required for our Nation's community 
banks, equalizing their minimum capital requirements, and 
eliminating the incentives for banks to become too big to fail.
    Incredibly, prior to the passage of the Collins amendment, 
the capital and risk standards for our Nation's largest 
financial institutions were more lax than those that applied to 
smaller depository banks, even though the failure of larger 
institutions was much more likely to trigger the kind of 
cascade of economic harm that we experienced during the 
financial meltdown. Section 171 gave the regulators the tools 
and the direction to fix this problem.
    Let me now turn to my second point, that Section 171 allows 
Federal regulators to take into account the distinctions that 
you have all discussed between banking and insurance and the 
implications of these distinctions for capital adequacy. While 
it is essential that insurers subject to the Federal Reserve 
Board oversight be adequately capitalized on a consolidated 
basis, it would be improper and not in keeping with Congress' 
intent for Federal regulators to supplant the prudential State-
based insurance regulation with a bank-centric capital regime 
for insurance activities.
    Indeed, nothing in Section 171 alters State capital 
requirements for insurance companies under State regulation nor 
the State guarantee funds. Section 171 directs the Federal 
Reserve to establish minimum consolidated capital standards 
with reference to the FDIC's Prompt Corrective Action 
regulations. But as I have publicly and repeatedly stressed, 
Section 171 does not direct the regulators to apply bank-
centric capital standards to insurance entities which are 
already regulated by the States. And having been in that role 
of overseeing insurance regulation plus State banking 
regulation, I am keenly aware of the difference and of the 
regulation at the State level with the requirement for adequate 
reserves and with the guarantee fund.
    I have written to the financial regulators on more than one 
occasion to make this point. For example, in a November 26, 
2012, letter, which I would respectfully request be inserted in 
the record, I stressed to financial regulators that while it is 
essential that insurers subject to the Federal Reserve Board 
oversight be adequately capitalized on a consolidated basis, it 
was not Congress' intent to replace State-based insurance 
regulation with a bank-centric capital regime. For that reason, 
I called upon the Federal regulators to acknowledge the 
distinctions between banking and insurance and to take these 
distinctions into account in the final rules implementing 
Section 171.
    While the Federal Reserve has acknowledged the important 
distinctions between insurance and banking, it has repeatedly 
suggested that it lacks authority to take those distinctions 
into account when implementing the consolidated capital 
standards required by Section 171. As I have already said, as 
the author of Section 171, I do not agree that the Fed lacks 
this authority and find its disregard of my clear intent, as 
the author of Section 171, to be frustrating, to say the least.
    Since I am the author of the Collins amendment, since I am 
Senator Collins, I think I know what I meant.
    [Laughter.]
    Senator Collins. Which brings me to my final point: how the 
Federal Reserve's authority to recognize the distinctions 
between insurance and banking may be clarified through 
legislation that I have recently introduced, Senate bill 2102.
    My legislation would add language to Section 171 to clarify 
that in establishing minimum capital requirements for holding 
companies on a consolidated basis, the Federal Reserve is not 
required to include insurers so long as the insurers are 
engaged in activities regulated as insurance at the State 
level. My legislation also provides a mechanism for the Federal 
Reserve, acting in consultation with the appropriate State 
insurance authority, to provide similar treatment for foreign 
insurance entities within a U.S. holding company where that 
entity does not itself do business in the United States. That 
was a very difficult issue to try to come up with a solution 
to. I would encourage you to take a look at that section of the 
bill that I have introduced. We have tried very hard to deal 
with the situation where there is a foreign insurance entity 
within a U.S. holding company when the entity does not do 
business in the United States. I think we have come up with a 
reasonable approach.
    I should point out that my legislation does not in any way 
modify or supersede any other provision of law upon which the 
Federal Reserve may rely to set appropriate holding company 
capital requirements.
    In closing, I want to thank the Committee for holding this 
hearing. This has been an enormously complex issue to resolve 
in a way that does not undermine the intent of Section 171. I 
want to especially thank you, Chairman Brown and Senator 
Johanns, for your hard work. Your staff has worked night and 
day with my staff over many months to try to craft language 
that clarified the Fed's authority to provide the appropriate 
treatment for insurer capital. I believe that the language that 
I have introduced should give the Fed the clarity it needs to 
address the legitimate concerns raised by insurers that they 
not have a bank-centric capital regime for their insurance 
activities imposed upon them.
    This is an exceptionally complex area of the law, and I 
recognize that some, including Members of this Committee, may 
prefer a different approach than the one that I have taken. I 
am also aware that there is an unusual accounting issue here 
that involves some insurers, not all of them, not those that 
are publicly traded, for example, but on whether there should 
be generally accepted accounting principles or the SAP approach 
that is used by insurers.
    I am, of course, more than willing to continue to work with 
you on a carefully tailored response to address those 
legitimate concerns, but I would ask that we all be mindful of 
the fact that we must not take action that would diminish the 
taxpayer protections that provided the motivation for my 
writing the Collins amendment and that are provided by the 
critical reforms in Section 171.
    Thank you very much for allowing me to testify. I realize I 
went over my 5 minutes, but this is a very complex issue, and I 
appreciate your indulgence.
    Senator Brown. Thank you, Senator Collins, for your 
explanation and your leadership and your hard work on this and 
so much else in the Senate. Your letter, without objection, the 
Collins letter, will be inserted in the record.
    Senator Brown. Thanks for joining us.
    Senator Collins. Thank you very much.
    Senator Brown. We appreciate it.
    Senator Collins said this is the most technical, maybe the 
most technical hearing in the Senate, at least today if not for 
the last few months, and that is why we have five really smart 
people testifying--including Senator Collins, six really smart 
people.
    Senator Collins. I was just going to take a great exception 
to that.
    [Laughter.]
    Senator Collins. Thank you, Mr. Chairman. And good save 
there.
    Senator Brown. If the witnesses would come forward, I will 
begin the introductions.
    [Pause.]
    Senator Brown. Thank you to the five of you for joining us, 
a couple of you on pretty short notice, so thank you for that.
    Gina Wilson is Executive Vice President and Chief Financial 
Officer of TIAA-CREF. Welcome, Ms. Wilson. Thank you for 
joining us.
    Daniel Schwarcz is Associate Professor of Law and Solly 
Robins Distinguished Research Fellow at the University of 
Minnesota Law School. His research primarily focuses on 
consumer protection and regulation and property and casualty 
and health insurance markets. Thank you for joining us.
    Rodgin Cohen is Senior Chairman of the law firm Sullivan & 
Cromwell. The New York Times described him as the ``Dean of 
Wall Street Lawyers.'' Welcome, Mr. Cohen.
    Aaron Klein is no stranger to this Committee room, having 
served on the Banking Committee staff for some 8 years. He is 
now Director of the Bipartisan Policy Center's Financial 
Regulatory Reform Initiative. Welcome back, Mr. Klein.
    And Michael Mahaffey is the Senior Vice President and Chief 
Risk Officer for Nationwide Insurance in Columbus, Ohio.
    Welcome to all of you. Ms. Wilson, would you like to start?

  STATEMENT OF GINA WILSON, EXECUTIVE VICE PRESIDENT & CHIEF 
                  FINANCIAL OFFICER, TIAA-CREF

    Ms. Wilson. Thank you very much, Chairman Brown, Ranking 
Member Toomey, Members of the Subcommittee. Thank you for 
providing TIAA-CREF with the opportunity----
    Senator Brown. Microphone? Either you are not speaking into 
it or it is not on.
    Ms. Wilson. Chairman Brown, thank you, also to Ranking 
Member Toomey, Members of the Subcommittee, thank you for 
providing TIAA-CREF the opportunity to testify on an important 
issue to us and to the clients we serve.
    My testimony today focuses on the final rules governing 
capital standards and the Basel III accords issued by the 
Federal Reserve Board in conjunction with the Office of the 
Comptroller of Currency and the Federal Deposit Insurance 
Corporation, which I will collectively refer to as the 
``agencies.''
    The final rules issued in July contain several changes from 
the proposed rulemaking. Most notably for TIAA-CREF, it 
temporarily exempted savings and loan holding companies, or 
SLHCs, substantially engaged in insurance underwriting or 
commercial activities.
    We are a leading provider of retirement services in the 
academic, research, medical, and cultural fields managing 
retirement assets on behalf of 3.9 million clients with more 
than 15,000 institutions nationwide.
    While we are primarily engaged in the business of 
insurance, we hold a small thrift institution within our 
structure and as a result are registered as an SLHC. This 
thrift provides us the opportunity to offer our clients deposit 
and lending products integrated with our retirement, investment 
management, and life insurance products and enhances our 
ability to offer them the chance to attain lifelong financial 
security.
    Our status as an SLHC places us under the purview of the 
Federal Reserve and consequently subjects us to the proposed 
capital regime the agencies have set forth. TIAA-CREF supports 
strong and appropriate capital standards that consistent with 
SLHCs' operating models and the risks inherent in our 
businesses. To be clear, this includes our support for 
appropriate capital standards for banking organizations, and we 
are not seeking to exempt insurers from the tenets of the Dodd-
Frank Act. We do not object to the Federal Reserve oversight to 
enterprise capital standards. We are very concerned, however, 
about how the final standards will be fully accounting for the 
diverse business models under which different financial service 
organizations operate. In short, we want to make sure that the 
metrics we are measured on appropriately reflect the nature of 
our business. Applying metrics designed for banks to an insurer 
would be inappropriate and could have negative effects for the 
economy, our customers, and insurers.
    Bank-centric standards do not effectively recognize the 
long dated nature of both sides of an insurer's balance sheet 
and would likely encourage insurers to modify certain 
investment practices and strategies that would be detrimental 
to our core activities. A bank's core business is lending and 
maturity transformation while insurers practice risk pooling 
and management. As a result, insurers' investment portfolios 
involve duration matching of assorted longer-term liabilities. 
That is, we match our long-term liabilities with longer-term 
investments. Imposing a capital framework designed to address 
maturity mismatch inherent in banking on an insurer would 
create a challenging insurer investment portfolio consideration 
where none previously existed.
    Under the rules, certain long dated investments, which are 
typically less liquid than shorter-term investments, are 
discouraged. Applying these bank capital standards on insurers 
would also create a disincentive to invest in the very assets 
that promote stability and solvency best.
    The rules set forth by the agencies, if applied to 
insurers, would have a detrimental effect on the ability to 
offer affordable financial products, which in turn could 
trickle down to individuals who utilize insurance products to 
help them build a more secure financial future.
    The rules also could have macroeconomic impact, for 
example, creating disincentives for insurers to invest in asset 
classes that promote the long-term economic growth such as 
long-term corporate bonds, project finance, and infrastructure 
investments, commercial real estate assets, private equity, and 
other alternative asset classes.
    In our comment letter to the Federal Reserve Board and in 
our subsequent conversations with them, we have proposed 
alternative methodologies for measuring an insurer's capital 
that support both the policy concerns of the Federal Reserve 
and ensure a strong capital regime, while also accounting for 
the business of insurance. We hope that they continue to study 
the issue and that they will find a sensible way to integrate a 
capital standard that is appropriately designed for insurers. 
In the meantime, we ask Congress to explicitly give the 
agencies the ability to ensure that capital standards are 
appropriately tailored for our business.
    Thank you again for the opportunity to testify. We 
appreciate the Subcommittee's interest in this issue and 
affording us another venue in which to express our concerns.
    I look forward to answering any questions you may have.
    Senator Brown. Thank you, Ms. Wilson.
    Professor Schwarcz, welcome.

  STATEMENT OF DANIEL SCHWARCZ, ASSOCIATE PROFESSOR AND SOLLY 
 ROBINS DISTINGUISHED RESEARCH FELLOW, UNIVERSITY OF MINNESOTA 
                           LAW SCHOOL

    Mr. Schwarcz. Thank you very much, Chairman Brown, Ranking 
Member Toomey, Members of the Subcommittee. My comments today 
are going to be focused on what I am going to call ``insurance 
SIFIs.'' These are nonbank financial holding companies that 
FSOC designates as ``systemically significant'' and that are 
predominantly engaged in insurance activities. Also, savings 
and loan holding companies that have predominant insurance 
businesses are covered by the Collins amendment. I deal with 
that in my testimony, but I am not going to be talking about 
that today.
    In starting off talking about insurance SIFIs, I want to 
note where I agree with members of this panel and with many of 
you. I agree that bank-centric capital requirements should not 
be applied to insurers. I agree that insurance and banking are 
different and that, as a result of that difference, there must 
be appropriately tailored capital requirements. I agree that 
the Collins amendment gives the Fed the authority, very clearly 
I think--I find the legal analysis of my fellow witness Mr. 
Cohen to be very persuasive that the Fed has the authority to 
implement that.
    Here is where I disagree. There is a tendency in much of 
the writing and much of the rhetoric to say the fact that we 
should not apply bank-centric capital rules to insurers means 
that we should completely defer to the State-based risk-based 
capital requirements. That I do not believe is true.
    I believe that Dodd-Frank requires the Fed to craft 
appropriate capital requirements to apply to insurance SIFIs 
and that those rules should differ from the State risk-based 
capital rules.
    Why is that? What we learned during the crisis is that 
insurance can pose a real systemic risk. I deal with this in my 
written testimony and much more thoroughly in an article that 
is referenced in the written testimony.
    People like to say, ``Oh, well, AIG, the portion of AIG 
that got AIG into trouble was not about insurance.'' Well, that 
is true with respect to its credit default swaps. But a major 
problem at AIG was its securities lending business. Its 
securities lending business involved the lending of insurers' 
assets. So insurers' at AIG were intimately involved in the 
problem.
    Moreover, if you look at FSOC's report designating 
Prudential as a SIFI, you will see that FSOC, after looking at 
the portfolio of Prudential quite carefully, says that they 
are, in fact, potentially susceptible to a run.
    Now, I admit and I want to emphasize this risk is different 
and less substantial than the risk of a run in banking. But at 
the same time, it is real. There, in fact, have been runs on 
insurance companies. Executive Life in 1991 was subject to a 
run wherein policy holders removed from the company $3 billion 
within the course of a single year.
    Why is this significant? It can result in systemic risk not 
because the insurer fails necessarily, but because an insurer 
facing massive liquidity problems can immediately try to dump 
its portfolio, thereby interfering with broader capital 
markets. There is emerging research showing that insurers were 
a big part of the problem in their purchase of mortgage-backed 
securities leading up to the crisis and in triggering a fire 
sale of mortgage-backed securities when they offloaded those 
assets.
    So the point I want to make is this: Insurance is less 
systemically risky than banking, but it can be systemically 
risky. Why then does that lead to the conclusion that we need 
to have distinct capital requirements at the Federal level?
    State risk-based capital requirements are not meant to deal 
with systemic risk. They are meant to deal with consumer 
protection. There is no, absolutely no consolidated capital 
requirement of State-based regulation. Therefore, you do not 
have any sense of whether the aggregated insurance business of 
a company presents capital risk. You are not dealing with the 
possibility of multiple gearing.
    State risk-based capital requirements directly and 
uncritically incorporate rating agencies in terms of assessing 
capital penalties. A core provision of Dodd-Frank says that is 
a mistake, that can cause systemic risk. And yet that is what 
State regulation does, because it is not concerned about 
systemic risk, it is concerned about consumer protection.
    State risk-based capital requirements, remarkably, are 
moving toward a system for reserving where life insurers' 
reserves are going to be determined almost exclusively based on 
insurers' private models--the very private internal risk models 
that got companies in trouble in the years preceding the 
crisis.
    Here then is the point. I am not saying that State risk-
based capital requirements do not work. What I am saying is 
that they are geared toward consumer protection concerns. Yet 
we know that insurers, at least some insurers, raise systemic 
risks. And as such, we need an appropriate risk-based capital 
requirement at the Federal level for those conglomerates to 
protect against that systemic risk.
    Thank you very much.
    Senator Brown. Thank you, Professor Schwarcz.
    Mr. Cohen.

   STATEMENT OF H. RODGIN COHEN, SENIOR CHAIRMAN, SULLIVAN & 
                          CROMWELL LLP

    Mr. Cohen. Chairman Brown, Ranking Member Toomey, and 
distinguished Members of the Subcommittee, I am honored to 
appear before you today to discuss the application of the 
capital standards in Section 171 of the Dodd-Frank Act--the 
Collins Amendment--to insurance companies that are savings and 
loan holding companies or have been designated as 
``systemically important'' by the FSOC. Let me begin by 
commending your leadership on this important issue.
    As far as I know, not a single legislator or regulator has 
expressed the belief that, as a matter of policy, the same 
capital framework should be automatically imposed on two very 
different businesses--banks and insurers. Nor do I know of a 
single Member of Congress who believes that Congress intended 
such a result. This overwhelming agreement on what the right 
answer is, both in terms of sound policy and effecting 
congressional intent, led to Chairman Brown's suggestion that I 
focus my remarks this morning on the legal analysis of whether 
the Fed has the authority under Section 171 to reach this 
answer.
    In my view, the Federal Reserve does have the interpretive 
authority to differentiate between banking organizations and 
insurance companies solely on the basis of the language of 
Section 171. This conclusion becomes compelling when one takes 
into account the statutory framework of which Section 171 is a 
part.
    Section 171 does not require that designated insurers be 
subject to the Bank Capital Framework, but only that the 
capital standards for these entities not be less than bank 
standards. Because Section 171 is not prescriptive as to how 
this compatibility analysis should be conducted, Supreme Court 
precedent makes clear that the Federal Reserve has the 
authority to adopt an interpretation that implements Congress' 
policy objectives.
    Accordingly, even reading Section 171 in isolation, the 
Federal Reserve has the necessary flexibility to apply capital 
requirements to insurance companies that are appropriately 
tailored for business, liability mix, and risk profile. But it 
is also a fundamental canon of statutory interpretation and 
construction that Section 171 must be read in its context. This 
requires us to consider the other provisions of Title I of 
Dodd-Frank, which collectively established the enhanced 
prudential framework for the Federal regulation of both 
systemically important banks and nonbank SIFIs.
    Under the enhanced prudential standards of Section 165, 
Congress required that there be both robust regulation and 
differentiated regulation. These two objectives are not 
inconsistent but mutually reinforcing, because regulation is 
more effective when directed to the actual risk involved.
    Section 165 is replete with congressional instructions that 
the Federal Reserve apply enhanced prudential standards through 
a differentiated approach. This includes a provision in Section 
165 titled ``Tailored Application'' that expressly authorizes 
the Federal Reserve differentiate among companies by category.
    Another provision requires the Federal Reserve to take into 
account differences between bank and nonbank SIFIs, including 
the nature of a company's liability, in particular the reliance 
on short-term funding.
    In addition, in Section 169, Congress directed the Federal 
Reserve to avoid duplicative requirements. Given that insurance 
companies are already subject to a comprehensive risk-based 
capital framework under State law, superimposing the Bank 
Capital Framework would fail to fulfill that mandate.
    Let me close with two points.
    First, as I detail in my written testimony, there is an 
interpretive solution that the Federal Reserve could apply 
without legislation that conforms to the literal language of 
the statute, the intent of Congress, and sound public policy. 
Key to this solution would be the application of the risk-based 
capital framework, as it may be modified, if necessary, to an 
organization's insurance operations while applying bank capital 
standards to the remainder.
    Second, if the Federal Reserve is not prepared to act, I 
would urge that Congress do so to prevent a result that is so 
clearly unwarranted. I recognize the concern that some have 
about opening up Dodd-Frank. But if there were ever to be a 
revision, this is the time and place. An amendment to clarify 
Section 171 could be both surgical and bipartisan; of most 
importance, it is the right result.
    I would be pleased to answer any questions you may have. 
Thank you.
    Senator Brown. Thank you, Mr. Cohen. I have never heard 
``surgical'' and ``bipartisan'' in the same sentence.
    [Laughter.]
    Senator Brown. Mr. Klein, thank you.

STATEMENT OF AARON KLEIN, DIRECTOR, FINANCIAL REGULATORY REFORM 
              INITIATIVE, BIPARTISAN POLICY CENTER

    Mr. Klein. Thank you very much, Chairman Brown, thank you, 
Ranking Member Toomey, Members of the Subcommittees, and as you 
mentioned, Chairman Brown, due to my service on the Committee 
staff, allow me to extend a special warm thank you to the staff 
of the Subcommittee and full Committee for all of their 
excellent work.
    Today I serve as the director of the Bipartisan Policy 
Center's Financial Regulatory Reform Initiative, and I would 
like to make four key points in my testimony this morning.
    First, the business of insurance is fundamentally different 
from that of banking and, hence, must be subject to appropriate 
yet different capital standards.
    Second, the Dodd-Frank Act envisions regulators overcoming 
bank centricity and empowers them to do so.
    Third, insurance company regulation is a real test case in 
whether regulators can overcome their bank-centric approach.
    And, finally, fourth, going forward, a better regulatory 
structure would include a Federal insurance regulator and an 
optional Federal charter.
    To understand why it is so important that banks and 
insurance companies be subject to different capital regimes, 
one must first appreciate the differences in their business 
models.
    At its core the business of insurance is about aggregating 
risks, matching a company's liabilities to its assets. 
Aggregating risk, paradoxically, makes insurers less risky by 
avoid adverse selection and protecting themselves against 
statistically unlikely outcomes.
    By contrast, banks are in the business of mitigating risk. 
For example, banks transfer timing risk by allowing depositors 
to instantly access their money while making longer-term loans 
to consumers and businesses. In contrast to insurance 
companies, banks avoid overconcentration of a specific risk. In 
fact, overconcentration is a classic red flag for safety and 
soundness concerns for bank regulators.
    Mixing insurance and banking has generally not worked for 
financial services firms. It remains to be seen whether a 
regulator can effectively regulate both businesses.
    Under Dodd-Frank the Federal Reserve is now the regulator 
for a diverse set of insurance companies. It is unclear how 
broadly appreciated that fact was during consideration of Dodd-
Frank. What is clear is that Dodd-Frank's decision to move 
thrift holding companies along with regulatory responsibility 
for nonbank SIFIs to the Federal Reserve was given along with 
the ability and responsibility for the Fed to develop 
appropriate capital standards, tailored to each entity or 
separate class of institutions it regulates. This requirement 
to tailor capital standards is a key theme throughout Dodd-
Frank.
    Even if the Federal Reserve is unwilling or unable to use a 
tailored approach, the FSOC could solve this problem. Among the 
responsibilities granted to FSOC are to make recommendations to 
the Federal Reserve concerning the establishment of heightened 
prudential standards, including capital standards, for nonbank 
companies supervised by the Board.
    My first preference would be for regulators to follow the 
intent of Congress and tailor capital standards for insurance 
companies. My second preference would be for FSOC to use this 
authority, make recommendations which the Board could then 
adopt. If neither approach is implemented, I would then support 
a legislative solution such as the bipartisan one proposed by 
Chairman Brown and Senator Johanns or possibly the one 
described this morning by Senator Collins.
    This hearing raises the fundamental question of who is best 
positioned to find the right capital regulatory structure for 
insurance companies. BPC's Regulatory Architecture Task Force 
has been examining the entire financial regulatory structure in 
a post Dodd-Frank world. The task force's full report will be 
released this spring and will contain many recommendations for 
how we can improve our current regulatory structure. One 
recommendation will be to create a Federal insurance regulator 
and an optional Federal charter. This is particularly important 
given the ramifications of making a mistake by applying the 
wrong capital standards to a select set of insurers. As Roy 
Woodall, the independent FSOC member appointed specifically for 
his expertise in insurance, stated in his dissent on whether to 
designate an insurance company as a SIFI, FSOC's analysis was, 
and I quote, ``antithetical to a fundamental and seasoned 
understanding of the business of insurance, the insurance 
regulatory environment, and the State insurance resolution and 
guaranty fund systems.''
    In conclusion, BPC's Financial Regulatory Reform Initiative 
has found that Dodd-Frank generally empowered financial 
regulators with substantial authority and flexibility to use 
their tools to improve regulation and achieve better regulatory 
outcomes. Treatment of insurance companies is an early and 
critical test case of financial regulators' ability to adhere 
in practice to the construct created in Dodd-Frank: that 
financial regulators can overcome bank centricity in handling 
their new-found responsibilities for nonbank financial 
companies. I hope that they are up to the test. The stakes are 
simply too high.
    Thank you very much. I look forward to responding to your 
questions.
    Senator Brown. Mr. Klein, thank you.
    Mr. Mahaffey, welcome. Thank you.

     STATEMENT OF MICHAEL W. MAHAFFEY, CHIEF RISK OFFICER, 
              NATIONWIDE MUTUAL INSURANCE COMPANY

    Mr. Mahaffey. Chairman Brown, Ranking Member Toomey, and 
distinguished Members of the Subcommittee, thank you for the 
opportunity to appear before you and testify today.
    My name is Michael Mahaffey, and I am the Chief Risk 
Officer for Nationwide Mutual Insurance Company. I am 
testifying on behalf of Nationwide but will also represent the 
perspective of a diverse group of insurers that fall under 
Federal Reserve supervision.
    As Nationwide's Chief Risk Officer, I am responsible for 
overseeing the company's approach to managing its risk profile. 
A critical part of my role is to ensure that Nationwide meets 
its internal and external capital requirements so the company 
is always well positioned to honor its promises to our policy 
holders. As such, I believe I can offer a helpful perspective 
on appropriate capital regimes for insurers.
    Nationwide is a Fortune 100 mutual insurance company based 
in Columbus, Ohio. Roughly half of Nationwide's revenue is 
derived from our property and casualty businesses, and half is 
derived from our life insurance and related businesses. 
Nationwide also provides banking products and services through 
Nationwide Bank, a Federal savings bank insured by the FDIC. 
While Nationwide bank is critical to our customers and business 
strategy, it represents less than 3 percent the total assets of 
the combined organization.
    Nationwide is subject to the Collins amendment by virtue of 
being a savings and loan holding company, or SLHC. Nationwide 
Bank is also independently subject to the minimum capital 
standards in the Collins amendment. We support the application 
of the Basel banking capital standards to Nationwide Bank. 
Furthermore, we are not seeking to lower capital standards for 
Nationwide Mutual, and we do not oppose utilization of a group-
wide capital framework. Capital strength is core to our 
business proposition, providing our policy holders financial 
protection when they need it most. We only seek to ensure that 
any capital standards established by the Federal Reserve are 
tailored to the business of insurance; we believe this is 
consistent with congressional intent.
    The Federal Reserve has maintained an interpretation of the 
Collins amendment that constrains their ability to tailor these 
capital rules. We respectfully disagree with this 
interpretation, and we support Congress passing legislation to 
clarify that the Federal Reserve can and should establish a 
separate tailored capital framework for insurers that 
appropriately reflects the industry's unique business model, 
risk profile, and asset-liability management practices.
    Specifically, we support S. 1369, legislation that would 
clarify that the Federal Reserve can appropriately tailor those 
capital rules for insurers, but continue to apply banking 
capital standards to depository institutions owned by insurers.
    I would now like to turn to the problems with imposing a 
bank-centric capital regime on insurers. The Basel III capital 
regime was designed specifically for banks. This framework is 
focused on the asset side of a company's balance sheet, 
including the predominant banking risks of credit, market, 
counterparty, and liquidity risks.
    Given this risk profile, systemic economic events can 
subject banks to destabilizing runs and force them to quickly 
sell assets at a loss to meet their demand deposit obligations 
and funding needs.
    Conversely, the primary risks facing insurers, found on the 
liability side of the balance sheet, are generally not as 
sensitive to the same systemic economic risks. These liability 
risks include, for example, weather, mortality, morbidity, and 
longevity risks, which are not as highly correlated with 
macroeconomic cycles.
    One example of the problem this framework poses for 
insurers is the 100-percent risk weight imposed on corporate 
bonds, an approach which fails to distinguish bonds based on 
the credit quality of the borrower. This charge overstates the 
risk associated with high-quality assets, particularly when 
compared to riskier commercial and industrial loans, which 
receive the same 100-percent risk weight. As of year-end 2012, 
corporate bonds comprised about 48 percent of insurer general 
account assets as compared to around 6 percent for banks. Thus, 
overstating the risk on such a substantial portion of an 
insurer's investment portfolio will likely have a significant 
impact.
    Insurers subject to this regime could decide to take on 
additional credit risk by shifting their investment portfolios 
to higher yielding, lower-quality corporate bonds that receive 
the same 100-percent risk weight. This additional risk taking 
would appropriately require increased capital under the State 
RBC framework, but would be ignored under Basel III as 
proposed.
    In addition, to the issue of corporate credit risk, the 
Basel framework's treatment of insurers' separate account 
assets is problematic. These separate account assets would 
potentially receive capital charges for risks not borne by the 
insurer, resulting in a substantial and unreasonable capital 
cost.
    In summary, the risk weights applied to insurers in the 
Basel regime would overcharge for some risks, entirely ignore 
others, and thereby potentially incent poor risk-taking 
behavior, contribute to a contraction in credit, and/or 
negatively affect availability and affordability of important 
insurance products.
    In conclusion, I would like to reiterate a few important 
points.
    First, we are not objecting to group supervision by the 
Federal Reserve.
    Second, we are not objecting to the concept of a 
comprehensive group capital requirement for SLHCs or SIFIs.
    Third, we are not objecting to utilization of a Basel 
framework for our bank.
    And, finally, we are not seeking lower capital standards. 
Indeed, we support strong capitalization as part of our core 
business proposition. We are simply advocating that there is no 
one-size-fits-all model for assessing risk and by extension no 
universally applicable framework for determining capital 
requirements. We believe strongly that the Federal Reserve 
should have the latitude to utilize any tool, or combination of 
tools, necessary to effectively assess the risk profile and 
capital requirements of a holding company, taking into account 
material differences in their business models.
    We appreciate the leadership of Senators Brown, Johanns, 
and Collins on this important issue, and thank the Subcommittee 
for the opportunity to comment.
    Senator Brown. Thank you, Mr. Mahaffey, and thank you all 
for staying very close to the 5 minutes.
    I am going to ask a series of questions which I would ask 
of each of you. I would like to ask for brief answers, if 
possible yes or no. At 11:30 there will be a series of votes on 
the floor, so I want everybody on the panel to get a chance to 
ask questions. So just go work from left to right. Ms. Wilson, 
do you agree that the insurance business has a different model 
from banking and presents different risks? Just yes or no from 
each on the panel.
    Ms. Wilson. Yes.
    Mr. Schwarcz. Yes.
    Mr. Cohen. Yes.
    Mr. Klein. Yes.
    Mr. Mahaffey. Yes.
    Senator Brown. OK. Do you think, as suggested by Ms. 
Wilson, that applying Basel III to insurers would or could have 
a negative impact on the safety and soundness of these 
institutions? Probably not yes or no there, but brief answers, 
if you could. Ms. Wilson?
    Ms. Wilson. Yes, I think it could, at least in part because 
it could sway the way that insurers make investment decisions 
for its investment portfolio.
    Senator Brown. Professor Schwarcz?
    Mr. Schwarcz. Yes, I agree that applying mechanistically 
bank capital rules to insurers would not be appropriate.
    Mr. Cohen. Yes, I would agree. Basel III is not directed to 
insurers but to banks.
    Mr. Klein. Yes.
    Mr. Mahaffey. Yes, I would agree. Anytime you have a system 
that under- or over-charges for risks and does not account for 
the nuances of a business model, you run that risk.
    Senator Brown. Thank you. Third question. Do each of you 
agree that we could address this by regulation without actually 
going the legislative route? Ms. Wilson?
    Ms. Wilson. My lawyers have assured me that their 
interpretation of the Collins amendment suggests the Federal 
Reserve does have the authority to make accommodations for the 
other businesses that are incorporated in an insurance holding 
company.
    Senator Brown. Mr. Schwarcz?
    Mr. Schwarcz. I would frankly just refer you to Mr. Cohen's 
legal analysis, which I think is superb and I, you know, 
independently agree with. I think that the language is pretty 
clear in context that regulation can solve the problem.
    Senator Brown. Mr. Cohen, would you like to respond to Mr. 
Schwarcz's assessment of your brilliant legal mind?
    [Laughter.]
    Mr. Cohen. Solely to thank Professor Schwarcz for his 
accolade.
    Senator Brown. Mr. Klein?
    Mr. Klein. Yes, I think the Federal Reserve can fix the 
problem. I also point out that I think that FSOC could direct 
the Fed to fix the problem as well.
    Senator Brown. OK.
    Mr. Mahaffey. And I would say yes, small asterisk, that I 
think ultimately if the interpretation remains different by the 
Fed, then I think that there has to be the possibility of 
another legislative action.
    Senator Brown. Thank you. And understanding that the 
solution that we ask for, whether it is legislative or the Fed, 
to tailor capital rules for SIFI insurers, would the Fed still 
have ample tools to regulate these institutions in other ways?
    Ms. Wilson. The Fed absolutely has authority to supervise 
the entirety of the consolidated group, and so we think that 
they would be well positioned to carry out their 
responsibilities.
    Mr. Schwarcz. I am not sure I totally understand the 
question.
    Senator Brown. If we move forward on legislation or the Fed 
makes this--follows the suggestions of this panel, would they 
still have the ample tools to regulate institutions in other 
ways?
    Mr. Schwarcz. Well, I guess I would answer as follows: I 
think that one important element of what the Fed should do and 
needs to do under Dodd-Frank is to craft their own capital 
rules for insurance SIFIs. Those rules should not just be bank 
rules, but nor should they just be as, frankly, some of the 
legislation. And here is where I will disagree with Mr. Cohen. 
Some of his suggestions suggest that we should not just 
completely defer to State risk-based capital rules with respect 
to insurers. And here I would say that is actually quite 
important that, for entities that have been labeled as 
``systemically risky,'' we have capital requirements that are 
on a consolidated basis, including insurers, that take into 
account the specific systemic risks that are identified by FSOC 
that insurers pose.
    So while I would agree that we need different capital 
rules, I would--I think actually it would hinder the Fed's 
ability to regulate insurance SIFIs if we mandated, as some of 
this legislation does, I believe, that they completely defer to 
the State risk-based capital rules with respect to the 
insurance entities.
    Senator Brown. Mr. Cohen?
    Mr. Cohen. I actually would not disagree with Professor 
Schwarcz, because I do believe that the Federal Reserve has 
substantial authority, both under Section 165 and for the S&L 
holding companies under the Bank Holding Company Act, to 
incorporate whatever additional requirements it would deem 
appropriate for an insurer.
    Senator Brown. Mr. Klein?
    Mr. Klein. Yes, the Fed does have the authority. Whether 
they have the expertise, capability, and understanding of the 
differences of insurance companies through the regional bank 
system and the Reserve Board is an open question.
    Senator Brown. Mr. Mahaffey?
    Mr. Mahaffey. As to the question of whether they have the 
appropriate tools, I actually think that S. 1369 actually 
broadens the possible set of tools that they could use at their 
disposal. I think it is their current interpretation of Collins 
that, in effect, limits the toolkit that they are asserting 
they can use for this. So I would actually suggest that this in 
no way shape or form--at least 1369 would not limit them from 
continuing to, if they chose to do so, and I think all 
panelists would agree that would be a bad idea.
    If they chose to continue to use Basel III as a 
consolidated framework, even under that bill they could choose 
to still do so. They are simply not required to as they 
interpret Collins to instruct them today.
    Senator Brown. One last question. I am sorry to go over my 
time a bit. For Mr. Cohen specifically, the Fed has taken 
regulatory steps, as you know, to address unintended 
consequences presented by the text of Dodd-Frank. For example, 
the text of the Volcker rule exempts insurance from the 
proprietary trading prohibition but does not exempt their 
general account investments from the covered funds prohibition. 
Regulators, including the Fed, have extended this exemption.
    Section 716, the swaps pushout provision, applies to 
insured depository institutions, but the Fed extended its 
transition period in temporary relief to uninsured branches and 
branches of foreign banks based upon, among other things, 
legislative history.
    My question is: Do you believe the Fed has the flexibility 
under Collins to deal with any issues that arise? And how do 
these past actions compare to the issue that we are dealing 
with here? Do they strengthen the case for the Fed to act?
    Mr. Cohen. I think those are, in fact, perfect analogies, 
Senator. They show that the Fed has the capacity to act in 
statutory schemes, which are very complex and very technical, 
as Senator Collins testified, to deal with getting to the right 
solution, even if there is ambiguity in the statute. And, 
frankly, with respect to 171, I do not think there is that much 
ambiguity as to the Fed's ability to act.
    Senator Brown. Thank you.
    Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman.
    Well, I think that our witnesses today made a pretty 
bulletproof case that the nature of the insurance industry is 
sufficiently different from the nature of banking to merit a 
different capital regime. I completely agree.
    Mr. Cohen, I know this is not central to the discussion of 
the hearing, and it is not included in your testimony, but I 
wonder if you would comment on this, which is it strikes me 
that the asset management business is also fundamentally 
different from banking in a variety of very important ways. And 
given that it, too, is different from banking, do you see 
problems in trying to apply bank-centric regulations to the 
asset management business as well?
    Mr. Cohen. I would, Senator Toomey, and I think your 
analysis is correct. And, moreover, Congress explicitly 
notified the Federal Reserve and FSOC that asset managers were 
to be treated differently. There are two specific references in 
Section 165 itself to asset managers in the context of 
differentiation.
    Senator Toomey. Thank you.
    Does anybody disagree with Mr. Cohen's assessment there?
    [No response.]
    Senator Toomey. Great. Thank you.
    A second question also for Mr. Cohen, and I think this 
would--I will ask anyone else to comment as well. But if an 
insurer is not designated as a SIFI, does everybody agree that 
it is the intent of Dodd-Frank that the insurer would then, 
therefore, be subject only to the various States--the State 
capital regimes? Mr. Cohen first.
    Mr. Cohen. Yes, Senator, assuming that it is not a savings 
and loan holding company, you are exactly right. It would be 
just the State insurance regulations.
    Senator Toomey. OK. Thank you.
    Yes, go ahead.
    Mr. Schwarcz. You just asked if anyone disagreed.
    Senator Toomey. Sure.
    Mr. Schwarcz. I just want to clarify. I think that it is a 
more--there is a difficult issue with respect to savings and 
loan holding companies and bank holding companies that are 
predominantly engaged in insurance and regulated by the Fed. 
And I do not think it is actually clear that Dodd-Frank would 
say, well, there is no role for the Fed to play there on a 
consolidated basis, because those entities are both insurance 
companies, but they are also bank holding companies or savings 
and loan holding companies. They are both.
    And so I think that it is actually relatively clear from 
the text of Dodd-Frank that we need a capital regime that is 
appropriate to their insurance side of their business, but we 
also need a capital regime that is appropriate to the fact that 
they are a bank holding company or savings and loan holding 
company. And I guess that gives the analogy, if I am a lawyer, 
I am not an insurance agent; but if I wanted to become an 
insurance agent, I would need to be licensed as a lawyer and 
licensed as an insurance agent.
    And so sort of the same thing. If you are doing two things, 
you need to comply with the appropriate regulatory rules with 
respect to both of those regimes.
    Senator Toomey. OK. But you are focusing on exclusively 
those that have another charter, another--you know, in this 
case a savings and loan?
    Mr. Schwarcz. Correct.
    Senator Toomey. OK. Mr. Klein, a quick question for you, 
and this goes to the point I made in my opening comments. One 
of the things I have a concern about is the Financial Stability 
Board importing what is essentially a European or international 
capital approach to the American insurance industry, and I am 
concerned about this in part because it seems to me that the 
European insurance model is typically quite different from the 
American model in many ways, and so a capital regime that may 
be suitable over there may not be suitable here. And, in 
addition, the Europeans might very well view the role of 
capital differently than we have historically viewed it here.
    Do you share this concern as well?
    Mr. Klein. I do, Senator. In my written testimony, I make 
reference to the fact that one of the things Dodd-Frank did is 
try to create a unified international voice for insurance, 
which we were lacking, frankly, going into the crisis in a pre-
Dodd-Frank world. And it created the Federal Insurance Office, 
or FIO, and actually specifically empowered FIO with that 
objective and a seat on the proper international board.
    Subsequently, the Federal Reserve has now, to my 
understanding, applied for a similar seat on that board, which 
makes some amount of sense given the fact that the Fed has 
these responsibilities. On the other hand, it needs to be 
clarified--and I urge in my written testimony that the 
regulators do so--that FIO is the international voice for the 
United States on insurance matters, as made clear in Dodd-
Frank.
    Senator Toomey. Thank you very much.
    Thanks, Mr. Chairman.
    Senator Brown. Thank you, Senator Toomey.
    Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
thank you, panel, for excellent presentations.
    Mr. Cohen, are you aware of any published memoranda by the 
Federal Reserve basically defending their position?
    Mr. Cohen. No, Senator, I am not. This all seems to be in 
testimony by Governors.
    Senator Reed. So it is sort of colloquial, ``We do not 
think we have it,'' but there is no official documentation you 
have seen?
    Mr. Cohen. Not that I am aware of, Senator.
    Senator Reed. OK. One aspect, I think, that we have dwelled 
on is the difference and the distinct difference between the 
balance sheets and the operations of an insurance company and a 
bank holding company. But there are activities that could be in 
common, particularly on a consolidated basis, and I think 
Professor Schwarcz suggested this, that on a consolidated basis 
there is probably the issue of systemic risk; and, second, the 
obligation of the Fed to sort of control that risk. And your 
suggestion is it not be done through Basel III, which I think 
makes a great deal of sense, but it has to be done. Is that a 
fair approximation?
    Mr. Schwarcz. That is exactly right, Senator. The point is 
that we now know that nonbank holding companies that are 
predominantly engaged in insurance can be systemically risky. 
We need to apply group capital requirements to them, and 
crucially, we cannot just carve out the insurers and say that 
our group capital requirements only apply to the part of the 
business that is not regulated by States. Because if you look 
at AIG, one of the big problems there was with the interactions 
among the different components of the company. The insurance 
companies were really used by other portions of the company for 
the securities lending problems. And there are also just many 
other systemic risks associated with insurance particularly.
    Now, again, those are lesser than banks. We need to have a 
tailored regime for those. But where my concern is is that 
there is slippage. When we all agree--and we all agree in this 
room, I think--that we should not have bank capital 
requirements applied to insurers, there is slippage then to the 
conclusion that that means that the Federal Reserve should not 
apply its consolidated capital requirements to the portions of 
the insurance SIFI that are insurance companies.
    Senator Reed. Well, let me ask you all to comment on sort 
of a procedural approach, which seems to make sense to me, that 
if this was to be done, then it typically would be done through 
a proposal of a rule by the Federal Reserve allowing the 
industry to comment in detail about the specific application 
and also any general points they want to make. And that the 
rule would then be adopted going forward.
    Is that a sensible approach that could be undertaken right 
now by the Federal Reserve? We will start with Ms. Wilson.
    Ms. Wilson. It certainly could be, and I think many of the 
companies that are represented on this panel and in previous 
hearings have actually spent quite a bit of time with the 
agencies to try to help advance discussion about how 
regulations could be proposed.
    Senator Reed. Thank you.
    Professor?
    Mr. Schwarcz. Yes, absolutely, I think that the Fed can and 
should under its existing authority do what many of us are 
suggesting.
    Senator Reed. Mr. Cohen?
    Mr. Cohen. Yes, Senator, I think they could do it, and it 
makes good sense to do it.
    Senator Reed. Thank you.
    Mr. Klein. Yes, Senator, that is a wise and prudent course.
    Senator Reed. OK.
    Mr. Mahaffey. I would concur.
    Senator Reed. Thank you very much. I know when to stop. 
Thank you very much.
    [Laughter.]
    Senator Brown. Senator Johanns.
    Senator Johanns. Thank you all for being here.
    Just listening to your testimony, one of the things that 
occurs to me is how much agreement there is, and, you know, 
there are different viewpoints on this panel on probably many 
things, but it does strike me how much agreement there is.
    One thing, though, I would like to explore a little further 
is this whole issue of how much authority the Fed has, because 
here is the problem I have as a lawmaker. In every possible way 
you can think of, we have asked the Fed if they have this 
authority. When Chairman Yellen was going through the 
confirmation process, tons of questions were sent her way, you 
know: Do you have the authority? Very consistently, the Fed has 
passed. They have said, ``No, we do not.''
    And so we are kind of in this situation where we know the 
easy pathway would be for the Fed just to issue regulations 
that recognize the difference between insurance and banking. 
But it does not look like that is going to happen.
    Under those circumstances would you agree with me--and I 
will just go down the line here--that legislative language is 
necessary then to give the Fed clear direction on this issue?
    Ms. Wilson. I think the legislative approach would 
definitely make it clear that the authority exists in the 
Federal Reserve to do what is needed.
    Senator Johanns. Professor?
    Mr. Schwarcz. An appropriate legislative course would be 
wise, if that came to fruition.
    Mr. Cohen. Senator, although one would hope that the Fed 
may be willing to reconsider after the unanimity expressed 
today to which you referred is so clear, in the absence of 
prompt action by the Federal Reserve, I fully agree that 
legislation is the only recourse.
    Mr. Klein. Senator, as I mentioned before, I think in 
addition to the Fed having the opportunity to do the right 
thing, there is a role that FSOC could play in helping direct 
the Fed to do the right thing. Absent those two positions, then 
I would agree that legislation becomes necessary to avoid a 
problematic policy outcome, and that to some degree would be a 
little bit disappointing as this is one of the first areas 
where regulators are attempting to overcome their bank-centric 
nature in history to extend the provision of Dodd-Frank into a 
nonbank world.
    Mr. Mahaffey. And I would agree. I think this has been the 
classic stumbling block, as we have all approached the Fed. I 
think if this issue does not get resolved, it is one thing for 
all of us to be unified in our opinion that the Fed has this 
discretion and current authority. But if this is not resolved, 
I think the only prudent path is to actually make clear through 
a legislative solution that they do have this authority. And, 
again, I think that actually broadens the toolkit they have at 
their discretion, and it does not remove anything that they 
have at their discretion today in the Collins amendment. So I 
think that might be the path that needs to take place.
    Senator Johanns. Let me stay with you a second. One of the 
things that has occurred to me about the potential that bank-
centric rules would be applied to insurance companies is that 
you could actually increase the risk that insurance companies 
are exposing their customers to, if you will. Do you agree with 
that analysis on my part?
    Mr. Mahaffey. I think generally, yes. Anytime you apply a 
model that attempts to assess risk, and if that model ignores 
risks, underprices risks, or overprices risks relative to the 
model of the company you are trying to measure, then you can 
unintentionally create incentives for them to move the risk 
portfolio to comport with that model. So whenever you try and 
impose a capital charge that does not actually get to the 
economics underlying the business model, whether that is on the 
assets or liabilities, the answer is yes, you can actually have 
perverse incentives for them to take more risk rather than less 
risk.
    Senator Johanns. Exactly. Let me just move down the line. I 
would like comments by others, just very brief comments about 
that.
    Mr. Klein. Absolutely, Senator. The hallmark of every 
financial crisis is the mispricing of risk at its core, mixed 
with leverage. And it would seem to me that if one of the 
defenses against a financial crisis is appropriate risk-based 
capital, then applying inappropriate risk-based capital would 
exacerbate the possibility of a financial crisis.
    Senator Johanns. Mr. Cohen?
    Mr. Cohen. Senator, when you overprice risk, there is then 
a threat to the consumer as well, because that threatens to 
drive the insurer or any financial institution out of the 
product or service for which risk has been overpriced.
    Senator Johanns. Professor?
    Mr. Schwarcz. Let me just make one point. We are talking 
about two different sets of entities: insurance SIFIs and then 
savings and loan holding companies and bank holding companies 
that engage in insurance.
    I actually think we need to disaggregate the analysis. I 
agree completely with respect to insurance SIFIs. With respect 
to savings and loan holding companies and bank holding 
companies that have insurance, they are bank holding companies, 
they are thrift holding companies. And so the question of 
whether or not they should get a special exemption from the 
rules that normally there is actually, I think, much more 
difficult.
    So I think that it is true that you need absolutely an 
appropriate capital regime for the business you are dealing 
with, but recognize that bank holding companies and thrift 
holding companies that predominantly engage in insurance are 
bank holding companies and thrift holding companies, and we 
should regulate them as such.
    Senator Johanns. If you can be very quick, because I am out 
of time, Ms. Wilson. I would like to hear your reaction to 
that.
    Ms. Wilson. I would like to just echo Mr. Cohen's comment. 
The mis-assignment of risk to capital and requiring insurers to 
carry more capital than would otherwise be necessary is 
actually a disadvantage for our policy holders. They would get 
less attractive returns on their retirement funds with us if we 
were forced to go to a different part of the investment 
universe to deploy our resources.
    Senator Johanns. Thank you.
    Thank you, Mr. Chairman.
    Senator Brown. Thank you, Senator Johanns.
    Senator Tester.
    Senator Tester. Thank you, Mr. Chairman.
    This is a question for Ms. Wilson and Mr. Mahaffey. 
Assuming that Basel capital standards would be applied to your 
businesses--and I do not think anybody thinks that should be 
the case, but assuming they would be, could you tell us about 
the impact that would have on your ability to manage your 
assets and liabilities? You can go first, Ms. Wilson.
    Ms. Wilson. Thank you for the question. We have a fairly 
sophisticated investment allocation algorithm, and if the risk 
capital charges are different than they currently are, we could 
potentially change the portfolio mix that we use to deliver on 
decade-long commitments to our policy holders. And that, as I 
think I just said to Senator Johanns, might reduce the amount 
of investment income that they would have to provide for their 
retirement security.
    Mr. Mahaffey. Yes, and I would echo those comments. I would 
also add that it would force you to look at the total capital 
position. Nationwide holds substantially more capital than 
would be imposed upon us by Basel III, so, again, this is not 
about aggregate capital. But as you subdivide the organization 
and you get down to certain products, you would now be forced 
to sort of triangulate between an internal economic view of the 
risk we are taking when we write a product, the current State-
based regulatory requirements for the risk we are taking in a 
product, rating agency views, and now you would layer in 
another view, all of those views likely resulting in very 
different answers as to how much capital.
    And so back to the point of if you have the wrong model 
that does not take into account the real risks of the products 
and the assets that you are putting behind those products, then 
we would be forced to probably make modifications either to the 
price of the products or the lines of business that we choose 
to be in.
    Senator Tester. OK. Impact on the economy, you talked about 
the impact on potential retired folks. Any other impacts that 
come to mind? Go ahead.
    Ms. Wilson. If I might, one of the important sources of 
strength for the economy during the economic downturn were 
large insurance companies that actually invested in 
infrastructure, long dated assets, because we did, in fact, 
have the capital strength to make long-term investments. Even 
when the market was sort of on its heels, we had net inflows in 
many cases. And so we were seen as a source of strength to the 
economy. We make very long term investments in things like 
bridges and highways and support municipal projects that need 
funding across the United States right now. And so it is not 
just the investment returns for our participants, it is also 
the macroeconomic impact that many of our investment portfolios 
support.
    Senator Tester. OK. This is a question for any witness or 
all witnesses that want to respond to it. It goes back to 
Senator Toomey's question on international efforts. Share your 
concerns about potential inconsistencies in coordination 
between international regulations and domestic, if you might.
    Mr. Cohen. I would be glad to start, Senator.
    Senator Tester. Sure.
    Mr. Cohen. I think that this is one of the most significant 
issues confronting the financial system, because we are a 
global system today, and the more we can do to have concerted 
action and collaborative action, the better off I think the 
financial institutions in the United States will be and the 
financial institutions outside the United States will be. There 
is a lot left to be done.
    Senator Tester. Anybody else want to respond?
    [No response.]
    Senator Tester. Mr. Cohen, I will stay with you then. What 
can the Federal regulators do to ensure that the international 
negotiations do not disadvantage American insurers?
    Mr. Cohen. I think it is extremely important that they not 
sacrifice what is the right solution for consensus. Sometimes 
there is a feeling that in the rush to get to consensus, the 
desire--which is certainly a key objective--that the best 
interests of the U.S. financial institutions are sacrificed, 
not in the sense of competitive best interests but just in what 
makes sense.
    Senator Tester. Go ahead, Mr. Klein.
    Mr. Klein. I would add that it is very important when you 
are engaged in an international negotiation that you are able 
to speak with one unified voice, and Dodd-Frank clearly gave 
that voice to the Director of FIO in the Treasury Department, 
and that he should continue to serve that role, and the Fed and 
NAIC should make clear that that is his role in an 
international context.
    Senator Tester. OK. Anybody else?
    [No response.]
    Senator Tester. One last question. This goes back to Ms. 
Wilson and Mr. Mahaffey. Nationwide has a bank, TIAA-CREF has a 
thrift. Can you describe what services your bank and thrift 
provide and why it is important to your ability to serve your 
policy holders and why you would not want to eliminate these 
offerings? You can go ahead and go first, Ms. Wilson.
    Ms. Wilson. We have, as I mentioned in my opening 
statement, 3.9 million clients whose retirement funds are 
deposited with us. We believe that we can be much more helpful 
to them in building a life of financial stability if we can 
offer additional services like life insurance, savings 
accounts, mortgage loans, potentially car loans, things that 
are really retail nature but really speak to the needs of the 
average employee on our institutional clients' sort of 
workforces.
    Senator Tester. Good. Mr. Mahaffey, would you like to add 
to that?
    Mr. Mahaffey. Sure, I will echo those comments, but I will 
also just give another example on the property/casualty side. 
So our bank, while it is small, it is critically important to 
our other policy holders. An example would be in the wake of a 
disaster we have the ability to issue rather than a bank draft, 
because of our bank we can issue a Nationwide bank debit card 
that gives our customers immediate relief and access to use 
those funds anywhere a credit card would be served. So we try 
and integrate it with our product portfolio. Our desire is not 
to build a big stand-alone bank but to use it as a way to serve 
our existing policy holders better.
    Senator Tester. I appreciate that, and I also appreciate 
all the testimony by all the folks on the panel today. This 
probably is not televised, Mr. Chairman, but it would have been 
nice if they could have seen----
    Senator Brown. It is in Billings.
    Senator Tester. It is in Billings?
    [Laughter.]
    Senator Tester. Thank you.
    Senator Brown. I made special arrangements because I knew 
you were going to be here.
    Senator Tester. Thank you very much. But it would have been 
nice to have the Fed, and hopefully they will take a look at 
the testimony that you guys put forth, because I think it was 
very good. Thank you.
    Senator Brown. Thank you, Senator Tester.
    There is a series of votes to be called around 11:30, so I 
will ask another couple of questions, and perhaps Senator 
Johanns if he wants, and we will see.
    A follow-up, Mr. Mahaffey, on Senator Tester's question. 
Either Ms. Howe or somebody from Nationwide told us about what 
happened in Joplin, Missouri. If you could sort of illustrate 
more graphically your answer to Senator Tester's question about 
what that only $6 billion out of $180 billion--you are a $180 
billion institution, $6 billion in your bank, how that plays 
out for your policy holders?
    Mr. Mahaffey. Sure. And as you mentioned, we were an 
insurer that was able to help in the wake of the Joplin 
disaster. We happened to have a number of insureds that were 
there, and that was a good example of the use of this claims 
card, we call it, which allows our claims agents to be able to 
issue these pre-loaded debit cards on the spot for someone who 
suffered a loss in the wake of a disaster like Joplin. And that 
can be very helpful, rather than attempting to get a bank draft 
when your bank may not actually still be standing.
    We have had a phenomenal response and feedback on that 
program, so it is just another example of a way in which we can 
provide a very value-added service, be there for our members 
when they need us most, and we view that as our model for the 
bank being integrated with the rest of our insurance 
organizations, not necessarily as a stand-alone bank.
    Senator Brown. Thank you. Last question. Professor Schwarcz 
raised concerns about systemic risk from insurers. His article 
highlights two specific activities that AIG engaged in: 
derivatives dealing and securities lending. Dodd-Frank imposes 
new regulations on derivatives. The CFTC is, as we know, 
implementing those for securities lending. Dodd-Frank gives 
FSOC the authority to regulate both entities, and activities--
activity-based regulation is still in its early stages. 
Governor Tarullo of the Fed has proposed applying universal 
margin requirements to all securities financing transactions.
    So, Mr. Cohen and Mr. Klein and Professor Schwarcz, if you 
would just answer a couple of questions. Does FSOC have the 
tools to address the issues that Professor Schwarcz raised? 
And, second, do you agree with Governor Tarullo's proposal as 
far as it goes now? And start with Mr. Cohen, then Mr. Klein, 
then Mr. Schwarcz, if you would.
    Mr. Cohen. Senator, I do believe that the tools exist, 
through FSOC, through the Federal Reserve, to regulate on an 
activity or product basis. Whether or not this should take the 
form of increased margin requirements, which really is a 
macroeconomic approach rather than a micro, institution-
specific approach, I think we just need to see what the Federal 
Reserve is going to propose here.
    Senator Brown. Mr. Klein?
    Mr. Klein. I think, Mr. Chairman, the FSOC does have the 
tools to address it. It is critically important that they do. 
Activities-based regulatory authority was one of the major 
advancements, in my opinion, in Dodd-Frank. There has been a 
lot of focus spent on regulating institutions. It is what 
regulators know to do. But activities is fundamentally where 
problems tend to arise before they end up in institutions. And 
so I think they do have the tools. I think they ought to use 
them more.
    I also think Professor Schwarcz was right to point out with 
AIG, during my time looking into their secured lending 
facility, there were significant problems there. It did 
highlight a weakness in the State-based insurance regulatory 
system, one of the reasons an optional Federal charter may make 
sense.
    With regard to the point on Governor Tarullo on the margin 
requirements, I think it is still a little bit too early to 
tell if that is the right approach, but I think he and the Fed 
ought to be commended for pushing FSOC and going down the 
activities-based regulatory approach.
    Senator Brown. Professor Schwarcz, your last word.
    Mr. Schwarcz. Sure. Two things.
    The first is I think that the Fed does have the appropriate 
authority with respect to insurers that are designated as 
``systemically risky.'' I actually believe that there is 
systemic risk in the insurance industry that may not be 
captured by that. So, for instance, the recent report of the 
FIO pointed out mortgage insurers, and to me it does not make 
sense that mortgage insurers are regulated by States.
    I also tend to think that it is true that we need a 
stronger, more robust Federal presence with respect to other 
systemic risks in the industry. I do not think the designation 
power is enough, and I go through that in the article.
    The final thing I just want to say is I am wary--and I just 
want to emphasize this again. We have been conflating the SIFI 
issue and the issue of bank holding companies and savings and 
loan holding companies. Those are bank holding companies and 
savings and loan holding companies. And I do have concern with 
some of the legislative solutions that it could create 
regulatory arbitrage by saying certain bank holding companies 
or savings and loan holding companies can avoid the regulation 
intended for bank holding companies and savings and loan 
holding companies if they engage in insurance. That could 
encourage them to increase their insurance business, encourage 
them to create an uneven playing field among different types of 
bank holding companies and savings and loan holding companies.
    So while my testimony for the most part was focused on 
insurance SIFIs, I just want to be clear, I think the issues 
are different for bank holding companies and savings and loan 
holding companies. And I think that some of the legislation, 
frankly, does not deal with that issue as well as I would like 
it to.
    Senator Brown. Well, thank you, Professor Schwarcz. Thanks 
to all five of you. If Members of the Subcommittee have 
questions they submit in writing, please answer them within 7 
days, get them back; or if you want to do any addenda to your 
testimony or your comments, we would appreciate that.
    I have statements submitted from the Property Casualty 
Insurers Association, the American Council of Life Insurers, 
the National Association of Mutual Insurance Companies, the 
American Insurance Association, the United States Chamber of 
Commerce, the National Association of Insurance Commissioners, 
a statement by the Financial Services Roundtable, and a letter 
from former Federal Deposit Insurance Corporation Chair, Sheila 
Bair, and I ask unanimous consent that they be entered into the 
record.
    I thank all of you, Senator Johanns, especially thank all 
of you for joining us today.
    The hearing is adjourned.
    [Whereupon, at 11:34 a.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow]:
                   PREPARED STATEMENT OF GINA WILSON
           Executive Vice President & Chief Financial Officer
                               TIAA-CREF
                             March 11, 2014
I. Introduction
    Chairman Brown and Ranking Member Toomey, Members of the 
Subcommittee, thank you for providing TIAA-CREF with the opportunity to 
testify on a very important issue to both TIAA-CREF and the clients we 
serve.
    Our testimony today focuses on the final rules governing capital 
standards and the Basel III accords issued by the Federal Reserve Board 
(``FRB'') in conjunction with the Office of the Comptroller of Currency 
(``OCC''), and the Federal Deposit Insurance Corporation (``FDIC'') 
(collectively the ``Agencies'').\1\ The final rule contained a number 
of changes from the proposed rulemaking, most notably it temporarily 
exempted bank holding companies subject to the FRB's Small Bank Holding 
Company Policy Statement and Savings and Loan Holding Companies 
(``SLHCs'') substantially engaged in insurance underwriting or 
commercial activities. In statements accompanying the final rule, the 
FRB indicated that the temporary exemption for insurance SLHCs was 
provided in recognition of policy concerns expressed regarding the 
imposition of bank capital rules on insurance companies.
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    \1\ 12 CFR Parts 208, 217, and 225. Regulatory Capital Rules: 
Regulatory Capital, Implementation of Basel II, Capital Adequacy, 
Transition Provisions, Prompt Corrective Action, Standardized Approach 
for Risk-Weighted Assets, Market Discipline and Disclosure 
Requirements, Advanced Approaches Risk-Based Capital Rule, and Market 
Risk Capital Rule; Final Rule.
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    We appreciate the temporary exemption and its acknowledgment that 
the insurance business model is quite different from the banking model. 
However, given the FRB's public statements regarding their current 
interpretation of the Collins Amendment, we are concerned that any 
final rule will impose Basel III on insurance companies with only 
modest and incomplete adjustments from the proposed rule.
II. Background
    TIAA-CREF is a leading provider of retirement services in the 
academic, research, medical and cultural fields managing retirement 
assets on behalf of 3.9 million clients at more than 15,000 
institutions nationwide.\2\ The mission of TIAA-CREF is ``to aid and 
strengthen'' the institutions we serve by providing financial products 
that best meet the needs of these organizations and help their 
employees attain financial well-being. Our retirement plans offer a 
range of options to help individuals and institutions meet their 
retirement plan administration and savings goals as well as income and 
wealth protection needs.
---------------------------------------------------------------------------
    \2\ As of December 31, 2013.
---------------------------------------------------------------------------
    TIAA-CREF is comprised of several distinct corporate entities. 
Teachers Insurance and Annuity Association of America (``TIAA''), 
founded in 1918, is a life insurance company domiciled in the State of 
New York operating on a nonprofit basis with net admitted general 
account assets of $232 billion.\3\ TIAA is a wholly owned subsidiary of 
the TIAA Board of Overseers, a special purpose New York not-for-profit 
corporation. The College Retirement Equities Fund (``CREF'') issues 
variable annuities and is an investment company registered with the 
Securities and Exchange Commission (``SEC'') under the Investment 
Company Act of 1940. TIAA-CREF also sponsors a family of equity and 
fixed-income mutual funds.
---------------------------------------------------------------------------
    \3\ As of January 31, 2014.
---------------------------------------------------------------------------
    While we are primarily engaged in the business of insurance, TIAA 
and the Board of Overseers hold a small thrift institution within their 
structure and as a result are registered as SLHCs. This thrift provides 
TIAA-CREF with the ability to offer our clients deposit and lending 
products integrated with our retirement, investment management and life 
insurance products and enhances our ability to help them attain 
lifelong financial well-being.
    Our status as a SLHC places us under the purview of the FRB and 
consequently subjects us to the proposed regulatory capital regime the 
Agencies have set forth. TIAA-CREF supports ongoing progressive 
financial regulation, including strong and appropriate capital 
standards that are consistent with SLHCs' operating models and the 
risks inherent in their business. It is equally important, however, to 
ensure the standards ultimately implemented by the Agencies fully 
account for the diverse business models under which different financial 
services organizations operate. In our analysis of the rules through 
the prism of a firm predominantly engaged in insurance, we have found 
the Agencies have taken a bank-centric approach with the final rule. 
Consequently, this approach does not account for the significant 
differences between insurers who hold thrifts, but maintain the 
overwhelming majority of their business in insurance products 
(``insurance-centric SLHCs''), and those firms that are primarily 
banking entities.
    To be clear, we support appropriate capital regulations for banking 
organizations and are not seeking to exempt insurers from the tenets of 
the Dodd-Frank Act (``DFA''). Nevertheless, applying metrics designed 
for banks to an insurer would be inappropriate and could have a number 
of negative effects for insurers, customers, and the economy as a 
whole. TIAA-CREF is particularly concerned about the effects of the 
rule on our ability to continue providing our clients with a full menu 
of appropriate and reasonably priced financial services products.
    The FRB can use the flexibility permitted by the DFA to tailor 
capital standards for the insurers that they oversee, which is key to 
resolving most of the potential negative repercussions that may result 
from imposing a bank-focused capital regime on insurance companies.
    The FRB has taken the position that Section 171 of DFA (the 
``Collins Amendment''), which requires regulators to establish risk-
based capital standards for banking organizations, prohibits the FRB 
from treating insurance assets differently from banking assets. We, as 
well as many of our peers, do not share this legal interpretation and 
instead believe the Collins Amendment provides banking regulators with 
the necessary flexibility to account for and integrate the existing 
U.S. insurance regulatory capital regime when developing their new 
model.\4\
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    \4\ Comment letter on Regulatory Capital Rules: 1 77 F.R. 52792 
(Aug. 30, 2012); 77 F.R. 52888 (Aug. 30, 2012); 77 F.R. 52978 (Aug. 30, 
2012), Submitted by Chief Financial Officers of Country Financial, 
Mutual of Omaha, Nationwide Mutual Insurance Company, Principal 
Financial Group, Prudential, TIAA-CREF, USAA, Westfield Group, October 
22, 2012.
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III. Congressional Intent and the Collins Amendment
    Congress clearly demonstrated throughout the DFA legislative 
process, and in the text of various provisions within DFA, its intent 
to allow insurance-centric SLHCs to continue to own thrifts and offer 
their customers banking products and services. During consideration of 
the DFA, Congress affirmed the importance of the SLHC structure by 
maintaining the thrift charter, ensuring SLHCs would not need to become 
Bank Holding Companies (``BHCs''), and maintaining the Gramm-Leach-
Bliley (``GLB'') grandfather provisions for nonbank activities of 
certain SLHCs and the qualified thrift lender (``QTL'') test for SLHCs. 
Congress went so far as to instruct the FRB to:

         . . . take into account the regulatory accounting practices 
        and procedures applicable to, and capital structure of, holding 
        companies that are insurance companies (including mutuals and 
        fraternals), or have subsidiaries that are insurance 
        companies'' in determining SLHC capital standards.\5\

    \5\ Senate Report 111-176 at footnote 161 (April30, 2010)--
discussion of Section 616 amending HOLA to clarify the FRB's authority 
to issue capital regulations for SLHCs where the Committee specifically 
notes:

    It is the intent of the Committee that in issuing regulations 
relating to capital requirements of bank holding companies and savings 
and loan holding companies under this section, the Federal Reserve 
should take into account the regulatory accounting practices and 
procedures applicable to, and capital structure of, holding companies 
that are insurance companies (including mutuals and fraternals), or 
have subsidiaries that are insurance companies.'' [emphasis added].

    Indeed, as demonstrated by the original Volcker Rule provisions in 
the DFA that created a number of insurance exemptions, Congress 
expected insurance companies to continue to own thrifts.\6\ By taking 
these steps, Congress also confirmed that the public is entitled to 
more, not less, competition in the banking industry. Unfortunately, the 
application of the Basel III Capital Rules would make continued 
ownership of thrifts by insurance organizations economically 
prohibitive, effectively accomplishing through regulation what Congress 
not only did not intend to do by statute,\7\ but what Congress 
specifically directed the FRB to avoid doing.
---------------------------------------------------------------------------
    \6\  Section 619(d)(1)(F) of the DFA.
    \7\ ``Dodd-Frank Amps Insurers for Banking Exit,'' SNL Financial 
(July 11, 2012).
---------------------------------------------------------------------------
    The Collins Amendment requires banking regulators to establish 
minimum risk-based and leverage capital requirements on a consolidated 
basis for insured depository institutions, depository institution 
holding companies and nonbank financial companies supervised by the FRB 
(collectively, ``Covered Companies''). However, nowhere in the language 
of the Collins Amendment is there a directive to ignore the differences 
between insurance companies and banks. Rather, the language only 
requires that the risk-based and leverage capital requirements 
applicable to covered companies shall not be:

  1)  Less than the generally applicable risk-based capital and 
        leverage capital requirements, which shall serve as a floor for 
        any capital requirements that the Agencies may require (``Bank 
        Standard''); or

  2)  Quantitatively lower than the generally applicable risk-based 
        capital and leverage capital requirements that were in effect 
        for insured depository institutions as of the date of enactment 
        of the DFA (``2010 Regulations'').\8\
---------------------------------------------------------------------------
    \8\ Section 171(b)(1) of the DFA.

    The Collins Amendment did not intend for banking regulators to 
ignore the differences between banks and insurance companies in 
formulating the capital standards for banking entities, nor for the 
standards applicable to other Covered Companies. In a letter to the 
Agencies on the proposed rules implementing capital standards, Senator 
Susan Collins (R-ME) stated, ``it was not Congress's intent that 
Federal regulators supplant prudential State-based insurance regulation 
with a bank-centric capital regime.''\9\ Rather, the Bank Standard 
outlined in Section 171(a)(2) of the Collins Amendment, which sets a 
floor for SLHC risk-based capital standards, allows the FRB to 
specifically address insurance activities. The requirement of Section 
171(b)(2) sets the ``generally applicable risk-based capital 
requirements'' floor and does not require an asset-by-asset testing of 
risk-weights.\10\ Instead, the requirement speaks to a ``numerator'' of 
capital, a ``denominator'' of risk-weighted assets and a ratio of the 
two. The Collins Amendment also does not require asset-by-asset or 
exposure-by-exposure minimum requirements, but instead calls for 
holistic floors. The second requirement that the standards not be 
quantitatively lower than the 2010 Regulations can be satisfied by 
either following the terms of the 2010 Regulations or through a 
holistic quantitative analysis of equivalence with appropriate capital 
standards, which would meet the ``not less than'' language of the 
statute.
---------------------------------------------------------------------------
    \9\ Letter to Agencies regarding proposed rulemaking for capital 
standards from Senator Susan Collins (R-ME), November 26, 2012.
    \10\ U.S. Senate Committee on Banking, Housing and Urban Affairs, 
``Oversight of Basel III: Impact of Proposed Capital Rules,'' Statement 
of Michael S. Gibson, Director, Division of Banking Supervision and 
Regulation, Board of Governors of the Federal Reserve System, November 
14, 2012.
---------------------------------------------------------------------------
    The FRB has stated publicly before the Committee and others that 
the business of insurance is different than that of banking, but the 
Collins Amendment ties their hands in addressing these differences. 
They believe the language imposes a consistent set of asset specific 
risk-weights for all covered companies. We have expressed to the FRB, 
both in person and in our comment letter (see Appendix A),\11\ our view 
that the language of the Collins Amendment provides adequate 
flexibility to interpret the statute in a way that permits them to 
account for the differences between banking and insurance. This point 
of view is validated by nine leading law firms, which sent a letter to 
the Agencies concurring with our interpretation of the Collins 
Amendment (see Appendix B).\12\
---------------------------------------------------------------------------
    \11\ See Appendix A. Comment letter to Agencies on Regulatory 
Capital Rules, Brandon Becker, Executive Vice President and Chief Legal 
Officer, TIAA-CREF, October 22, 2012.
    \12\ See Appendix B. Comment Letter and Cover to Agencies on 
Regulatory Capital Rules, Signed by attorneys specializing in 
regulatory advice to insurance companies from Arnold & Porter LLP, 
Gibson, Dunn & Crutcher, Venable, Wachtell, Lipton, Rosen & Katz, 
Winston & Strawn LLP, Shearman & Sterling, LLP, Dechert LLP, Debevoise 
& Plimpton LLP, and Paul Hasting LLP, March 20, 2013.
---------------------------------------------------------------------------
    Consequently, we support and applaud the efforts of Senators 
Sherrod Brown (D-OH) and Mike Johanns (R-NE) in introducing S. 1369 
(Brown-Johanns), legislation to address the potential imposition of 
banking capital rules on insurance companies under the Collins 
Amendment. The Brown-Johann's bill would clarify that the Collins 
Amendment does not require the FRB to impose a banking capital regime 
by exempting insurers from the Collins Amendment, while leaving intact 
the FRB's other sources of legal authority to impose robust capital 
standards on federally supervised insurance companies. In addition, 
under Brown-Johanns, Basel III bank-centric capital standards would 
appropriately apply to any depository institutions owned by an 
insurance company. We strongly support this legislation and look 
forward to being part of the dialogue as the bill makes its way through 
the Senate.
IV. Macro-economic effects of the application of the Basel III 
        standards on insurers
    Bank-centric capital standards, which do not effectively recognize 
the long dated nature of insurance activities, would likely encourage 
insurers to modify certain practices and strategies that would be 
detrimental to their core activities. Fundamentally, banks' core 
business is lending and maturity transformation. As a result, insurers' 
investment portfolios involve duration matching of assorted longer term 
liabilities. That is, insurers match their long-term liabilities with 
long-term investments. There are a number of distinct features that 
differentiate banks from insurers, including:

  1)  Stable illiquid liabilities. The stability of life insurance 
        liabilities and their relative illiquidity is a fundamental 
        difference from banking deposit liabilities.

  2)  Long-term savings and asset protection products. Insurance 
        products serve long-term savings and asset protection goals, 
        which are fundamentally different from the objectives of bank 
        depositors.

  3)  Long duration assets. Based on the long-term nature of their 
        liability structure, insurance companies invest for a longer 
        duration than banks.

  4)  Adverse Deviation. The business of insurance is built on sound, 
        well tested and proven actuarial science. Reserves are based on 
        assumptions that are reasonably conservative and include 
        provisions for the risk of unfavorable deviation from such 
        assumptions (i.e., mortality, interest rates, withdrawals, and 
        expenses). Insurers apply this discipline to a large range of 
        uncertain events in their long dated portfolios.

  5)  Source of long-term funding for the economy. Insurance companies 
        are a significant source of long-term, stable funding for the 
        corporate, real estate, and governmental sectors of the 
        economy, while banks are primarily a source of short-term 
        financing to these sectors.

    Imposing a capital framework designed to address the maturity 
mismatch inherent to banking on an insurer would create an investment 
portfolio construction challenge where none previously existed. Under 
the Rules, certain long-term investments, which are typically less 
liquid than shorter-term investments, are discouraged. Because the 
Basel III capital framework focuses substantially on assets, rather 
than taking a holistic approach, it does not consider the importance of 
matching the duration of assets and liabilities. To ignore the 
fundamental importance of this concept challenges an insurer's ability 
to properly consider one of the most important elements of insurer risk 
management. The application of enhanced bank-focused standards as 
outlined in the Rules, without considering the existing strict capital 
rules to which insurers already adhere, would have a number of negative 
effects for TIAA-CREF and other insurance-centric SLHCs including:

  1)  Adherence to two regulatory reporting structures which have very 
        different incentives surrounding liquidity and consumer 
        protection;

  2)  Greater costs for insurance products;

  3)  Pressures on insurance reserve conservatism to meet bank 
        definitions of capital; and

  4)  Recording unrealized gains/losses causing short term strategic 
        capital management incentives.

    Simply put, applying bank capital standards to an insurer would 
create a disincentive to invest in the very assets that most promote 
stability and solvency.
V. Conclusion
    The Rules set forth by the Agencies, if applied to insurers, would 
have a detrimental effect on the insurers' ability to offer affordable 
financial products, which would in turn trickle down to individuals who 
utilize insurance products to help them build a secure financial 
future. The Rules also could have macroeconomic implications that, for 
example, would create disincentives for insurers to invest in asset 
classes that promote long-term economic growth such as long-term 
corporate bonds, project finance and infrastructure investments, 
commercial real estate loans, private equity and other alternative 
asset classes.
    Strong capital standards are vital to strengthening the overall 
structure of the U.S. financial system. The existing capital regime 
under which insurers operate has served the industry well and proved 
extremely effective when put to the test during the recent financial 
crisis. We are confident the FRB can develop alternative proposals to 
ensure a strong capital regime that also accounts for the business of 
insurance. Indeed, in our comment letter to the FRB and in our 
subsequent conversations with them, we have proposed alternative 
methodologies for measuring an insurer's capital that support both the 
policy goals of the FRB and ensure a strong capital regime, while also 
accounting for the business of insurance. We hope as they continue to 
study the issue, regulators will find a sensible way to integrate a 
capital structure appropriately designed for insurers. In the meantime, 
we ask Congress to explicitly give the Agencies the ability to ensure 
capital standards are appropriately tailored for insurers.
    Thank you again for the opportunity to testify. Given the potential 
affect the Rules could have on our business and our clients, we have 
been very active in our efforts to educate policymakers about our 
concerns and will continue to leverage all opportunities made available 
to us. We appreciate the Subcommittee taking an interest in this issue 
and having afforded us another venue in which to discuss our concerns.
                                 ______
                                 
                 PREPARED STATEMENT OF DANIEL SCHWARCZ
   Associate Professor and Solly Robins Distinguished Research Fellow
                   University of Minnesota Law School
                             March 11, 2014
    Chairman Brown, Ranking Member Crapo, and Members of the 
Subcommittee, thank you very much for this opportunity to discuss the 
appropriate capital standards to be applied to firms that are 
predominantly engaged in the business of insurance and subject to 
Section 171 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Dodd-Frank''). I hope to make three primary points in 
this testimony, which draws substantially on a co-authored draft 
article, Regulating Systemic Risk in Insurance.\1\ First, I will 
emphasize that the business of insurance can create important systemic 
risks to the larger financial system. The specific contours and 
magnitudes of these systemic risks are constantly evolving based on 
shifts in the insurance industry and its regulation. Second, I will 
suggest that, as contemplated by Dodd-Frank, these risks warrant the 
application of federally designed capital standards to nonbank 
financial companies primarily engaged in the business of insurance that 
the Financial Stability Oversight Council (``FSOC'') designates as 
systemically risky (``Insurance SIFIs''). Unlike State risk-based 
capital rules, which focus primarily on consumer protection, these 
Federal capital standards should focus on the distinctive ways in which 
Insurance SIFIs can pose systemic risk to the larger financial system. 
This approach is perfectly consistent with Section 171. Third, I will 
caution against exempting bank/thrift holding companies from Section 
171 simply because they or a large number of their subsidiaries are 
subject to State insurance capital requirements.
---------------------------------------------------------------------------
    \1\ See Daniel Schwarcz & Steven L. Schwarcz, Regulating Systemic 
Risk in Insurance (March 4, 2014), available at http://ssrn.com/
abstract=2404492 (arguing that systemic risk in insurance can arise due 
to correlations among individual insurers with respect to both their 
interconnections with the larger financial system and their 
vulnerabilities to failure, and that the Federal Insurance Office 
should consequently be empowered to supplement or preempt State law 
when States have failed to satisfactorily address gaps or deficiencies 
in insurance regulation that could contribute to systemic risk).
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(1) Systemic Risk in Insurance
    As exemplified by the dramatic failures of American Insurance Group 
(``AIG'') and various financial guarantee insurers, insurance companies 
and their affiliates played a central role in the 2008 Global Financial 
Crisis.\2\ It is now generally accepted that insurers and their 
affiliates that effectively provide insurance against the default of 
financial instruments--whether through formal insurance policies (as in 
the case of financial guarantee insurers) or through derivatives such 
as credit default swaps (as in the case of AIG)--can contribute to 
systemic risk.\3\ Other ``nontraditional'' insurance activities, such 
as extensive use of securities lending (as in the case of AIG),\4\ or 
mortgage guarantee insurance \5\ can also prove systemically risky.\6\
---------------------------------------------------------------------------
    \2\ Additionally, two holding companies principally engaged in the 
business of insurance received Federal funding in the midst of the 
financial crisis though the U.S. Department of the Treasury's Troubled 
Asset Relief Program. The Hartford Financial Services Group received 
$3.4 billion and Lincoln National Corporation received $950 million. 
Government Accountability Office, Insurance Markets: Impacts of and 
Regulatory Response to the 2007-2009 Financial Crisis (June 2013).
    \3\ The Geneva Association, Cross Industry Analysis, 28 G-Sibs Vs. 
28 Insurers, Comparison of Systemic Risk Indicators (Dec. 11, 2012).
    \4\ A substantial contributor to AIG's woes was its securities 
lending program, which, while coordinated by a noninsurer affiliate of 
AIG, exploited securities owned by AIG's insurers. See William K. 
Sjostrom, Jr, The AIG Bailout, 66 Wash. & Lee L. Rev. 943 (2009).
    \5\ Federal Insurance Office, How to Modernize and Improve the 
System of Insurance Regulation in the United States, (December 2013) 
(suggesting the need for Federal regulation of the mortgage insurance 
industry).
    \6\ See J. David Cummins & Mary A. Weiss, Systemic Risk and the 
U.S. Insurance Sector (2011), available at http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1725512.
---------------------------------------------------------------------------
    But in the last several years, a narrative has emerged suggesting 
that these risks are vanishingly small. This argument emphasizes that 
very few traditional insurers actually failed during the financial 
crisis.\7\ It also stresses that AIG Financial Products--the division 
of AIG that was principally responsible for writing the credit default 
swaps that were the primary (though not sole) source of the company's 
problems--was not regulated as an insurance company, in large part due 
to Federal law.\8\ Finally, it argues that insurers, unlike banks, do 
not have a mismatch in their assets and liabilities.
---------------------------------------------------------------------------
    \7\ Government Accountability Office, Insurance Markets: Impacts of 
and Regulatory Response to the 2007-2009 Financial Crisis (June 2013).
    \8\ See American International Group: Examining What Went Wrong, 
Government Intervention, and Implications for Future Regulation: 110th 
Cong. (2009) (Statement of Eric Dinallo, Superintendent New York State 
Insurance Department).
---------------------------------------------------------------------------
    This narrative, however, ignores important linkages between the 
insurance industry and the rest of the financial system as well as 
insurers' potential vulnerabilities to catastrophic events. Although 
the insurance industry is indeed less systemically risky than the 
banking and shadow banking sectors, it is also structurally capable of 
posing a variety of systemic risks to the larger financial system. 
Perhaps even more importantly, the magnitude and character of these 
risks are themselves constantly evolving and shifting. A decade ago, 
the notion that a company within an insurance group could threaten the 
global financial system through its portfolio of credit default swaps 
would have been viewed--perhaps accurately, at the time--as 
preposterous. The lesson is that the regulation of systemic risk in 
insurance must be designed to proactively identify, assess, and manage 
new potential sources of systemic risk in the industry. With this in 
mind, consider several specific ways in which insurers could 
potentially threaten the stability of the broader financial system.
    Demand for Assets that Spread Systemic Risk: Insurers are among the 
largest and most important institutional investors domestically and 
internationally.\9\ They own approximately one-third of all investment-
grade bonds and, collectively, own almost twice as much in foreign, 
corporate, and municipal bonds than do banks. Their holdings of 
corporate and foreign bonds exceed those of mutual funds and pension 
funds combined.
---------------------------------------------------------------------------
    \9\ This is much more true of the life insurance industry than the 
property/casualty insurance industry. Accordingly, commentators are 
likely correct that the former poses more systemic risk than the 
latter. See, e.g., Steven Weisbart & Robert P. Hartwig, 2011, Property/
Casualty Insurance and Systemic Risk (2011).
---------------------------------------------------------------------------
    Insurers' massive role as investors in financial instruments does 
not just mean that they can be passive victims of financial 
instability. Financial markets, as with all markets, are impacted both 
by supply side forces and demand-side forces. Thus, when insurers 
collectively demand certain types of financial assets, the amount 
supplied and prices of these assets will increase. In fact, recent 
evidence shows the insurance industry played a major role in stoking 
demand for mortgage-backed securities and related instruments in the 
years leading up to the financial crisis.\10\ By 2007, life insurers 
held approximately $470 billion in these securities, accounting for 
about 25 percent of the total market. Their demand for these securities 
skyrocketed in the years preceding the crisis, in large part due to 
unrealized losses in variable annuity products and State capital 
standards that treated highly rated structured securities as very low 
risk.
---------------------------------------------------------------------------
    \10\ Craig Merrill, Taylor D. Nadauld, & Philip Strahan, Final 
Demand for Structured Finance Securities, (Working Paper, January 17, 
2014) available at http://ssrn.com/abstract=2380859. For evidence that 
insurers can play a similar role in misallocating credit in corporate 
bond markets, see Bo Becker, & Victoria Ivashina, Reaching for Yield in 
the Bond Market, Journal of Finance (forthcoming), available at http://
www.hbs.edu/faculty/Publication%20Files/12-103_c2425c59-1647-42df-8d1b-
7b8ed433fb76.pdf.
---------------------------------------------------------------------------
    Insurers were thus substantially responsible for fueling the demand 
for structured finance securities. And, of course, the explosion in 
these instruments has been blamed for indirectly helping to fuel the 
pre-crisis housing bubble.\11\ Notably, insurers' contribution to 
systemic risk in this example occurred even though the terms of their 
assets and liabilities were well matched and most of them ultimately 
avoided failure.
---------------------------------------------------------------------------
    \11\ Facing substantial demand to originate mortgages so that they 
could be packaged together and securitized, banks and other mortgage 
originators increasingly loosened credit standards, allowing more and 
more people to buy houses with loans they ultimately could not afford. 
See Kathleen Engel & Patricia McCoy, the Subprime Virus: Reckless 
Credit, Regulatory Failure, and Next Steps (2011).
---------------------------------------------------------------------------
    Asset Fire Sales: Insurers' massive role as institutional investors 
also means that they can pose systemic risks by triggering or 
exacerbating a ``fire sale'' of specific securities or types of 
securities.\12\ Emerging evidence suggests that insurers did stoke fire 
sales in mortgage-backed securities and related instruments in 2008, 
when many insurers attempted to sell these securities in response to 
regulatory, rating agency, and market pressures.\13\ In offloading 
these securities in a coordinated fashion, insurers contributed to the 
sudden illiquidity of these instruments, causing unrelated financial 
institutions holding these or similar assets to face tremendous 
liquidity pressures. Indeed, the inability of firms to sell or price 
such ``toxic assets'' was the key reason for the failure or near 
failure of numerous banks and investment banks, including Lehman 
Brothers.\14\
---------------------------------------------------------------------------
    \12\ Andrew Ellul, Chotibhak Jotikasthira, & Christian T. Lundblad, 
Regulatory Pressure and Fire Sales in the Corporate Bond Market, 101 J. 
Financial Econ. 596 (2011).
    \13\ Craig B. Merrill, Taylor D. Nadauld, Rene M. Stulz, & Shane 
Sherlund, Did Capital Requirements and Fair Value Accounting Spark Fire 
Sales in Distressed Mortgage-Backed Securities?, NBER Working Paper No. 
18270 (Aug. 2012), available at http://www.nber.org/papers/w18270; 
Andrew Ellul, Pab Jotikasthira, Christian T. Lundblad, Yihui Wang et 
al., Is Historical Cost Accounting a Panacea? Market Stress, Incentives 
Distortions, and Gains Trading (NYU Working Paper, 2012), available at 
http://ssrn.com/abstract=1972027.
    \14\ National Commission on the Causes of the Financial and 
Economic Crisis in the United States, the Financial Crisis Inquiry 
Report (2011).
---------------------------------------------------------------------------
    As above, insurers' seeming role in contributing to fire sales of 
mortgage-backed securities occurred notwithstanding the matching of 
their assets and liabilities or their ultimate avoidance of failure. 
Ironically, insurers' very success in limiting their exposure to 
``toxic assets'' in the early stages of the crisis, and thus 
safeguarding their own financial strength, may have actually 
exacerbated the liquidity troubles of unrelated firms. But just like 
the first people in line during a run on a bank, while insurers may 
have gotten through the financial crisis relatively unscathed, that 
does not mean that they were not instrumental in causing the crisis in 
the first place.
    Simultaneous Failure of Several Large Insurers: Although insurers 
need not fail in order to contribute to systemic risk, the converse is 
not true: substantial failures of several large insurers could well 
disrupt the financial system as a result of insurers' status as massive 
investors. In certain cases, an insurance company could be required to 
quickly liquidate a substantial portion of its portfolio.\15\ This 
might occur if it failed due to a catastrophic event triggering an 
unmanageable numbers of claims, a failure of a reinsurer, or a ``run'' 
on products that permitted policyholders to withdraw funds or take out 
loans against their policy. If many insurers simultaneously experienced 
this type of distress, this could trigger, or exacerbate, the types of 
distortions in capital markets that were witnessed in 2008.
---------------------------------------------------------------------------
    \15\ Of course, there are also cases in which an insurance 
company's failure does not result in an immediate need for the company 
or its receiver to liquidate much of its portfolio. See Insurance 
Oversight and Legislative Proposals: Testimony Before H. Fin. Subcomm. 
on Ins., Hous. and Cmty. Opportunity, 112th Cong. 9 (2011) (Statement 
of Peter Gallanis, National Organization of Life and Health Insurance 
Guaranty Associations) available at https://www.nolhga.com/pressroom/
articles/HFSCnolhgaTestimonyNov15_2011.pdf.
---------------------------------------------------------------------------
    The failure of several large insurers is hardly unimaginable.\16\ 
Insurers are potentially subject to a wide array of catastrophe risks 
that could trigger a wave of claims across numerous insurers within a 
short timeframe. And while insurers attempt to safeguard against such 
risks through policy exclusions, reinsurance, and other risk-management 
techniques, these efforts are hardly fail-safe. For instance, prior to 
9/11, commercial property insurance policies did not contain any 
explicit exclusion for terrorism insurance and insurers did not even 
include this risk in their calculations of premiums. After 9/11, 
insurers insisted that terrorism risk was so large and incalculable 
that they could not provide coverage at all, at least without an 
explicit Federal backstop.\17\ Similarly, life insurers face 
potentially massive exposure to a global pandemic such as the Flu of 
1918, which killed between 20 and 40 million people within a single 
year.
---------------------------------------------------------------------------
    \16\ For instance, in 1991 six major life insurers, each with over 
$4 billion in assets, failed as a result of their common exposures to 
commercial real estate and junk bonds. See Scott Harrington, 
Policyholder Runs, Life Insurance Company Failures, and Insurance 
Solvency Regulation, 15 Regulation 27 (1992).
    \17\ Although the massive losses that insurers incurred in 
connection with 9/11 did not substantially destabilize the industry, 
insurers' sudden and dramatic shift in their willingness to provide 
this coverage suggests that they might well have had events transpired 
differently or had they occurred at the same time as preexisting 
financial instability.
---------------------------------------------------------------------------
    Interconnectedness through Reinsurance: Although insurers attempt 
to manage catastrophe risk through reinsurance arrangements, the 
reinsurance industry itself is potentially subject to catastrophe risk. 
The reinsurance industry is extremely concentrated in a few massive 
firms, such as Swiss Re, Munich Re, and Berkshire Hathaway. In 2009, 
for instance, five reinsurance groups provided approximately 60 percent 
of the world's reinsurance capacity.\18\ This concentration creates 
deep interconnections among insurers, such that the failure of one or 
two major reinsurers could simultaneously impact a substantial segment 
of the insurance industry at once.\19\ This risk is exacerbated by the 
fact that reinsurer financial strength is itself highly opaque, and 
reinsurers often reinsure risks with one another, creating the 
possibility that one reinsurer's failure could have a domino effect on 
other reinsurers.\20\
---------------------------------------------------------------------------
    \18\ International Association Of Insurance Supervisors, 
Reinsurance And Financial Stability (July 2012).
    \19\ See J. David Cummins & Mary A. Weiss, Systemic Risk and the 
U.S. Insurance Sector (2011), available at http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1725512 (``Reinsurance is the primary source of 
interconnectedness within the insurance industry.'').
    \20\ Group of Thirty, Reinsurance and International Markets (2006).
---------------------------------------------------------------------------
    Exposure to Policyholder Runs: Despite their frequent protestations 
to the contrary, life insurers are also not immune to the possibility 
of a run on their products. While this is certainly much less likely 
for life insurers than banks, a significant number of many life 
insurers' policies are subject to early withdrawal and include a 
significant cash surrender value.\21\ Growing competition from life-
settlement companies--which offer policyholders the option of selling 
their policies for cash--will likely increasingly pressure life 
insurers to allow policyholders to cash out of their policies with 
smaller penalties. This, in turn, may make life insurers more 
susceptible to the possibility of a policyholder run. So too might the 
increasing trend among life insurers to make payouts through ``retained 
asset accounts'' that function almost identically to bank accounts.\22\ 
The risk of a policyholder run is exacerbated by the fact that State 
insurance guarantee funds do not generally fully guarantee the value of 
most insurance policies, cannot be spread among companies or policies 
to increase limits (unlike FDIC insurance), and are much less 
financially credible than FDIC insurance as they are not pre-funded or 
explicitly backstopped by the Federal Government.
---------------------------------------------------------------------------
    \21\ See FSOC, Basis for the Financial Stability Oversight 
Council's Final Determination Regarding Prudential Financial Inc. 
(Sept. 19, 2013). The most substantial policyholder run on a U.S. 
insurance company involved Executive Life, where policyholder cash 
surrenders exceeded over $3 billion in the year prior to its failure. 
Although this run was more a product of Executive Life's tenuous 
financial position than the cause of its tenuous position, it did 
indeed have the effect of forcing Executive Life to liquidate a 
substantial percentage of its portfolio. See Scott Harrington, 
Policyholder Runs, Life Insurance Company Failures, and Insurance 
Solvency Regulation, 15 Regulation 27 (1992).
    \22\ See Texas Department of Insurance, Retained Asset Accounts 
Survey (2011), available at http://www.tdi.texas.gov/reports/life/
documents/raareport.pdf (finding in a survey of 160 life insurers open 
retained asset accounts totaling $2.3 billion with respect to 
policyholders living in Texas).
---------------------------------------------------------------------------
    Systematic Under-Reserving: There is a real risk that insurers may 
systematically underestimate reserves for certain types of policies or 
losses. Indeed, a recent proposal by a subcommittee of the Financial 
Research Advisory Committee noted that the ``cyclicality of the 
insurance industry's profits between hard and soft markets implies 
specific periods during which underpricing of risk becomes an industry-
wide phenomenon.''\23\ In the past, such systematic errors in reserving 
have been limited in the life insurance domain, because life insurers 
have historically faced rigid and conservative reserving rules for 
their products.
---------------------------------------------------------------------------
    \23\ See Financial Research Advisory Committee Research 
Subcommittee, OFR Study on the Insurance Sector Recommendation, 
available at http://www.treasury.gov/initiatives/ofr/about/Documents/
FRAC%20Research%20OFR%20Study%20on%20the%20Insurance%20Sector%20
Recommendation.pdf.
---------------------------------------------------------------------------
    However, two recent, and related, developments suggest that this 
longstanding history of conservative reserving in life insurance may 
not extend into the future. First, in the last decade or so, life 
insurers have increasingly used captive insurance companies to escape 
regulatory rules governing reserve setting, a process that some have 
referred to as ``shadow insurance.''\24\ Recent estimates conclude that 
``shadow insurance reduces risk-based capital by 53 percentage points 
(or 3 rating notches) and raises impairment probabilities by a factor 
of four.''\25\ Second, State insurance regulation is currently 
embarking on a fundamental change to its regulatory approach, which 
would grant insurers broad discretion to use internal models to set 
reserve levels. The extensively documented inability of Federal 
regulators to fully understand financial firms' internal risk models 
suggests that large scale errors in life insurer reserving could be a 
problem in the future. This is particularly so given that State 
regulators currently lack sufficient technical expertise or resources 
to undertake a reasonable evaluation of these models on a firm-by-firm 
basis.\26\
---------------------------------------------------------------------------
    \24\ See NY Department of Financial Services, Shining a Light on 
Shadow Insurance (June 2013). Traditionally, captive insurance was 
simply a way for a traditional noninsurance company, such as Coca Cola 
or GM, to self-insure its risks rather than purchase conventional 
insurance. But life insurers realized that they could exploit the rules 
governing captive insurers to avoid what they deemed to be 
``excessive'' reserve requirements. To do this, the life insurer 
transfers some of its risk to the captive insurer via a reinsurance 
transaction. This transaction can reduce reserves because insurers do 
not need to reserve against risks that are transferred to reinsurers 
(even if they are affiliated). Meanwhile, captive insurers are subject 
to a much looser set of solvency rules than ordinary insurers and can 
generally choose their regulator among any of the States. According to 
the New York Attorney General, ``shadow insurance . . . puts the 
stability of the broader financial system at greater risk.'' See 
Benjamin M. Lawsky, N.Y. Superintendent of Fin. Serv., Remarks at the 
22nd Annual Hyman P. Minsky Conference on the State of the U.S. and 
World Economies in New York City (April 18, 2013) available at http://
www.dfs.ny.gov/about/speeches_testimony/sp130418.htm.
    \25\ See Ralph S.J. Koijen and Motohiro Yogo, Shadow Insurance 
(NBER Working Paper No. 19568, (2013), available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=2320921.
    \26\ Federal Insurance Office, How to Modernize and Improve the 
System of Insurance Regulation in the United States, (December 2013).
---------------------------------------------------------------------------
    Ultimately, it is surely true that the insurance industry currently 
poses less systemic risk than the banking sector or the shadow-banking 
sector, as many commentators have emphasized.\27\ At the same time, 
however, the insurance industry is a crucial and dynamic component of 
the American and international financial system, a fact that has been 
documented by various studies quantifying the connections between 
insurers and the rest of the financial system based on historical stock 
prices and similar metrics.\28\ As such, the insurance industry can 
indeed present a meaningful source of systemic risk that cannot be 
easily limited to a pre-defined set of activities.
---------------------------------------------------------------------------
    \27\ See Scott Harrington, The Financial Crisis, Systemic Risk, and 
the Future of Insurance Regulation, 76 J. Risk & Ins. 785 (2009).
    \28\ Monica Billioa, Mila Getmanskyb, Andrew W. Loc, & Loriana 
Pelizzona, Econometric Measures of Connectedness and Systemic Risk in 
the Finance and Insurance Sectors 104 J Fin. Econ. 535 (2012); Faisal 
Balucha, Stanley Mutengab & Chris Parsons Baluch, Insurance, Systemic 
Risk and the Financial Crisis, 36 The Geneva Papers 126 (2011); Viral 
Acharya, Lasse Heje Pedersen, Thomas Philippon, & Matthew P. 
Richardson, Measuring Systemic Risk (2010), available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=1573171.
---------------------------------------------------------------------------
(2) Appropriate Capital Requirements for Insurance SIFIs
    As contemplated by Dodd-Frank, Federal regulators should design, 
implement, and regularly reassess distinct capital and leverage 
standards for insurers that are particularly likely to pose systemic 
risk, including Insurance SIFIs.\29\ A central tenet of federalism is 
that regulatory responsibilities should be assigned, at least in part, 
to the unit of government that best internalizes the full costs of the 
underlying regulated activity.\30\ The rationale for this principle is 
that government entities will only have optimal incentives to take into 
account the full costs and benefits of their regulatory decisions if 
the impacts of those decisions are felt entirely within their 
jurisdictions. Given that systemic risk in insurance is a negative 
externality whose effects are inherently felt nationally and 
internationally, national and international regulatory bodies should 
play a role in regulating insurance SIFIs.
---------------------------------------------------------------------------
    \29\ Nonbank financial companies predominantly engaged in the 
business of insurance and designated as systemically significant by 
FSOC--which I label as Insurance SIFIs--are not necessarily the only 
insurers who may pose systemic risks. For instance, mortgage insurers 
may post systemic risks because of their prominent role in the housing 
market. See Federal Insurance Office, How to Modernize and Improve the 
System of Insurance Regulation in the United States, (December 2013). 
Additionally, as I have argued elsewhere, entire segments of the 
insurance industry may pose systemic risks because of correlations 
among individual insurance companies with respect to both their 
interconnections with the larger financial system and their 
vulnerabilities to failure. For this reason, I believe that a broader 
Federal role in regulating the insurance industry beyond that 
established in Dodd-Frank is appropriate. See Daniel Schwarcz & Steven 
L. Schwarcz, Regulating Systemic Risk in Insurance (March 4, 2014), 
available at http://ssrn.com/abstract=2404492. But because Federal 
regulation in these domains is not authorized by current law and is not 
the subject of this hearing, I do not discuss these issues further in 
the body of my testimony.
    \30\ Wallace E. Oates, Fiscal Federalism (1972).
---------------------------------------------------------------------------
    Federal involvement in designing capital requirements for Insurance 
SIFIs is particularly important because State risk-based capital rules 
are focused predominantly on consumer protection rather than systemic 
stability.\31\ But the regulatory objective of a risk-based capital 
regime has important implications for how that regime should be 
constructed. In other words, capital regimes focused on systemic risk 
can, and should, be designed differently than capital regimes focused 
on consumer protection. Consider several examples of this important 
point.
---------------------------------------------------------------------------
    \31\ Thus, in a Report of the NAIC and the Federal Reserve Joint 
Subgroup on Risk-Based Capital and Regulatory Arbitrage (2002), a 
working group of insurance and banking regulators explained the core 
differences between risk-based capital rules in insurance and banking 
by noting that ``Insurance company regulators place particular emphasis 
on consumer (policyholder) protection'' while ``banking regulators 
focus on depositor protection and the financial stability of regulated 
entities on a going concern basis.''
---------------------------------------------------------------------------
    First, while a risk-based capital regime designed to address 
systemic risk should focus on aggregate capital levels of an entire 
holding company, a capital regime oriented toward consumer protection 
can rely on entity-level capital regulation with strong ring-fencing 
rules. Because of its consumer protection orientation, State insurance 
regulation embraces the latter model: capital requirements are imposed 
solely on individual legal entities, and regulators attempt to protect 
these entities from affiliate or holding company risk. By contrast, a 
capital regime focused on systemic risk demands group-wide capital 
requirements. This is because risk-management, investment and business 
strategies are all generally determined at the holding company 
level.\32\ Group capital rules can also limit the prospect of other 
problems that may have systemic consequences, such as double or 
multiple gearing.\33\
---------------------------------------------------------------------------
    \32\ See Elizabeth F. Brown, The New Laws and Regulations for 
Financial Conglomerates: Will They Better Manage the Risks than the 
Previous Ones?, 60 AM. U. L. REV. 1339 (2011).
    \33\ Bank for Int'l Settlements, Principles for the Supervision of 
Financial Conglomerates Consultative Document (2011). Double or 
multiple gearing involves scenarios in which the same capital is used 
as a buffer against risk by two entities at the same time, such that 
the ``net'' solvency of the group is less than the sum of the capital 
of the group's individual entities.
---------------------------------------------------------------------------
    Second, a capital regime that is focused on systemic risk might 
well be less dependent on credit-rating agencies in setting capital 
charges for assets than would a capital regime focused on consumer 
protection. Currently, State insurance regulation relies substantially 
on rating agencies in determining capital charges for individual 
assets.\34\ Recent changes in State rules regarding credit for 
reinsurance also place a renewed regulatory emphasis on rating 
agencies' assessments of reinsurers' financial strength.\35\ But as has 
now been widely recognized, regulatory reliance on rating agencies can 
increase systemic risk for a variety of reasons. It can lead to the 
systematic underpricing of risk, dull the incentives of rating agencies 
to correctly assess risk, and play a role in triggering fire sales by 
producing coordinated investment decisions across a wide number of 
firms. For these reasons, Dodd-Frank substantially limited reliance on 
credit ratings by all Federal (but not State) regulators.\36\
---------------------------------------------------------------------------
    \34\ Although State insurance regulation has limited its reliance 
on private rating agencies in assessing structured finance vehicles, it 
still relies enormously on private rating agencies to assess the 
quality of insurers' assets. See John Patrick Hunt, Credit Ratings in 
Insurance Regulation: The Missing Piece of Financial Reform, 68 Wash. & 
Lee L. Rev. 1667 (2011).
    \35\ Credit for Reinsurance Model Law,  2(b)-(c), adopted Nov. 6, 
2011, available at http://www.naic.org/documents/
committees_e_reinsurance_related_docs_preface_adopted_ex_
plenary_111106.pdf.
    \36\ Dodd-Frank Act  939A.
---------------------------------------------------------------------------
    Third, a capital regime focused on systemic risk must be sensitive 
to the possibility that it might inadvertently contribute to financial 
instability. As described above, emerging evidence suggests that State 
regulatory capital rules may have played a role in encouraging insurers 
to both invest in mortgage-backed securities and to offload them when 
they were downgraded (or when such downgrades were anticipated). 
Although the literature on how, and when, capital rules and related 
accounting standards can have inadvertent adverse effects on systemic 
risk is still developing, systemic risk regulators must pay acute 
attention to this issue.
    Group-wide capital rules that limit their dependence on credit-
rating agencies and reduce distortions in firm behavior are thus 
crucial for any capital regime that is principally oriented toward 
guarding against systemic risk. But various more specific rules might 
well be appropriate for capital regimes that are designed to guard 
against systemic risk associated with insurance. For instance, such a 
regime might well impose higher capital charges on long-term assets 
with short-term volatility or deep illiquidity relative to an insurance 
capital regime oriented only toward consumer protection. This is 
because a central concern from the perspective of systemic risk is that 
a systemically risky insurer could face sudden liquidity demands for a 
variety of reasons notwithstanding insurers' usual matching of the 
duration of their assets and liabilities. Such liquidity pressures 
could stem from collateral calls associated with derivatives activities 
or securities lending, mass policyholder withdrawals, a sharp increase 
in claims due to catastrophe, or the failure of a reinsurer.
    Similarly, a capital regime designed to guard against systemic risk 
related to insurance might well resist some of the recent developments 
that could weaken life insurer reserve practices. Thus, such a regime 
could reject principles-based reserving in favor of the traditional 
approach to setting life insurers' reserves, given the prominent role 
that reliance on financial firms' own internal models for purposes of 
setting capital played in triggering the 2008 financial crisis. Or, it 
might restrict the credit that insurers can receive by using ``shadow 
insurance'' to reduce their liabilities.
    To be sure, capital requirements for Insurance SIFIs need not--and, 
indeed, should not--mechanistically mirror the capital rules that are 
applied to other types of financial firms. As emphasized in a recent 
letter of Members of Congress, ``Strong capital standards need to be 
consistent with the business models of the industry to which they are 
applicable.''\37\ The systemic risks posed by Insurance SIFIs are both 
different than, and likely less severe than, those posed by large bank 
holding companies, and an appropriate capital regime for Insurance 
SIFIs should reflect these facts. At the same time, an appropriate 
capital regime for Insurance SIFIs should also reflect the fact that 
the central goal of imposing capital requirements on these entities at 
the Federal level is different than the goal of State capital 
requirements. As such, the Federal capital regime applicable to 
Insurance SIFIs cannot merely replicate or defer to the consumer 
protection oriented State capital regime. Capital regimes should be 
designed not only according to the industry to which they apply, but 
also to the regulatory goal that they seek to achieve.
---------------------------------------------------------------------------
    \37\ Letter from Members of Congress to Ben Bernanke, Chairman of 
the Board of Governors of the Federal Reserve System (Dec. 11, 2012).
---------------------------------------------------------------------------
    My understanding of Section 171--based on publicly available legal 
analysis of the provision and several letters from Members of 
Congress--is that it advances these goals. The provision gives the 
Board of Governors of the Federal Reserve System (``Fed'') substantial 
flexibility in determining how to calculate Insurance SIFIs' risk-based 
capital and leverage limits so as to account for the particular risks 
that these entities present.\38\ At the same time, it appropriately 
seeks to ensure that, however these calculations are performed, they do 
not fall below minimum levels.
---------------------------------------------------------------------------
    \38\ Letter from H. Rodgin Cohen to Ricardo Anzaldua, Executive 
Vice President and General Counsel of MetLife Inc., (May 20, 2013), 
available at http://www.federalreserve.gov/SECRS/2013/May/20130523/R-
1438/R-1438_052313_111291_554506713029_1.pdf.; Letter from Members of 
Congress to Ben Bernanke, Chairman of the Board of Governors of the 
Federal Reserve System (Dec. 11, 2012).
---------------------------------------------------------------------------
(3) Appropriate Capital Requirements for Bank/Thrift Holding Companies 
        that Substantially Engage in the Business of Insurance
    Bank and thrift holding companies have long been subject to Federal 
capital and leverage requirements because of the unique risks 
associated with owning an FDIC insured institution. Section 171 
requires the Fed to ensure that these requirements are no less than 
those applicable to ordinary small banks. This, in turn, helps to 
ensure that holding companies of banks and thrifts do indeed serve as a 
source of strength for their FDIC insured subsidiaries, as has long 
been intended by the larger Federal banking regime. Proposed S. 1369 
would exempt bank/thrift holding companies from the Section 171 floor 
if they directly, or through their subsidiaries, derive a substantial 
percentage of their consolidated revenues from the business of 
insurance. This would be a mistake.
    As discussed above, State insurance capital rules and bank/thrift 
capital rules have fundamentally different regulatory objectives. While 
the former focuses on protecting policyholders, the latter aims 
principally to limit the exposure of taxpayers to bank failures and 
minimize the prospect of systemic risk. And, as described above, these 
different orientations have important implications for how the 
corresponding capital regimes are, and should be, structured.
    For these reasons, the fact that a holding company of a depository 
institution is itself subject to State insurance capital requirements 
or derives a substantial amount of its revenue from State-regulated 
insurers does not mean that it should be exempted from the minimum 
floors required by Section 171. Such an entity raises both the consumer 
protection concerns that motivate State insurance regulation and the 
systemic risk/taxpayer protection concerns that motivate the need for 
capital/leverage rules for bank/thrift holding companies. It therefore 
stands to reason that it should be subject to both sets of capital 
rules, as well as to the Section 171 floor. Establishing a special rule 
allowing certain bank/thrift holding companies to avoid Section 171 
would not only create an uneven playing field, but it could encourage 
regulatory arbitrage by allowing holding companies of FDIC insured 
institutions to avoid regulatory requirements by increasing their 
ownership of insurance entities or their own insurance activities.\39\ 
This, in turn, could have the effect of increasing the size of bank/
thrift holding companies.
---------------------------------------------------------------------------
    \39\ An additional concern I have with proposed S. 1369 is that it 
could have the effect of exempting a company from Section 171 on the 
basis of activities that are not subject to State insurance capital 
requirements. S. 1369 incorporates the definition of ``business of 
insurance'' in Dodd-Frank: ``the writing of insurance or the reinsuring 
of risks by an insurer, including all acts necessary to such writing or 
reinsuring and the activities relating to the writing of insurance or 
the reinsuring of risks conducted by persons who act as, or are, 
officers, directors, agents, or employees of insurers or who are other 
persons authorized to act on behalf of such persons.'' Dodd-Frank  
1002. This definition is not explicitly tethered to State insurance 
regulation, as is the proffered rationale for exempting bank/thrift 
holding companies predominantly engaged in insurance from Section 171. 
It therefore may be possible under proposed S. 1369 for a bank/thrift 
holding company to avoid Section 171 on the basis of activities that 
fall within this broad definition of insurance, but are not subject to 
State capital requirements.
---------------------------------------------------------------------------
    Exempting from Section 171 bank/thrift holding companies that 
derive a substantial percentage of their revenue from insurance 
operations but are not themselves regulated as insurance companies 
would be particularly bad policy.\40\ As described above, the State 
insurance capital regime does not apply to holding companies of 
insurance entities. A bank/thrift holding company that derived a 
substantial percentage of its revenue from the insurance operations of 
its subsidiaries, but was not itself an operating insurance company, 
would therefore not face any capital requirements at the holding 
company level under State insurance law. There is consequently no 
justification for providing such entities with a special exemption from 
Section 171.
---------------------------------------------------------------------------
    \40\ In the case of a bank/thrift holding company that was itself 
regulated as an insurance company, State capital rules would apply to 
the holding company entity. However, such regulation would still not 
account for the distinctive risks associated with owning an FDIC 
insured institution.
---------------------------------------------------------------------------
                                 ______
                                 
                 PREPARED STATEMENT OF H. RODGIN COHEN
                Senior Chairman, Sullivan & Cromwell LLP
                             March 11, 2014
I. Introduction
    Chairman Brown and Ranking Member Toomey, and distinguished Members 
of the Subcommittee, I am honored to be with you today to discuss the 
application of the capital standards in Section 171 of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (``Dodd-Frank'')\1\ to a 
subset of insurance companies.\2\ Let me begin by commending you for 
the leadership you have shown and for your efforts and attention to 
this important issue.
---------------------------------------------------------------------------
    \1\ Pub. L. No. 111-203 (2010).
    \2\ Section 171 is codified at 12 U.S.C.  5371.
---------------------------------------------------------------------------
     Section 171, which is commonly known as the ``Collins Amendment'', 
after its primary sponsor, Senator Collins, establishes certain capital 
standards for designated financial institutions. It is a part of Title 
I, Subtitle C of Dodd-Frank, which includes enhanced prudential 
standards and differentiation mandates in its principal provision, 
Section 165. The insurance companies subject to Section 171, which I 
will refer to as ``Covered Insurance Companies'', are either savings 
and loan holding companies (``SLHCs'') or have been designated by the 
Financial Stability Oversight Council (``FSOC'') for supervision by the 
Board of Governors of the Federal Reserve System (``Federal Reserve'') 
pursuant to Section 113 of Dodd-Frank.\3\
---------------------------------------------------------------------------
    \3\ Sullivan & Cromwell represents Covered Insurance Companies and 
other insurance companies.
---------------------------------------------------------------------------
    Stated simply, the core question raised by the application of 
Section 171 to Covered Insurance Companies is whether they should be 
subject to the same capital framework as that which applies to banks 
(which I will refer as the ``Bank Capital Framework'').
    What is most striking about this question is that I do not know of 
a single legislator or regulator, including the Federal Reserve, who 
believes that, as a matter of policy, the Bank Capital Framework should 
be automatically imposed on insurance companies. Nor do I know of a 
single Member of Congress who maintains that Congress actually intended 
to impose the identical capital regime on these two very different 
businesses. As twenty-four Senators from both parties wrote to the 
heads of the three Federal banking agencies on October 17, 2012: 
``Congress did not intend for the Federal regulators to discard the 
State risk-based capital system in favor of a banking capital 
regime''.\4\
---------------------------------------------------------------------------
    \4\ Letter to Ben. S. Bernanke, Martin J. Gruenberg and Thomas J. 
Curry from Twenty-Four U.S. Senators (Oct. 17, 2012) (the ``October 17, 
2012 Letter''). See also, a December 11, 2012 letter (the ``December 
11, 2012 Letter'') from Thirty-Three Members of Congress of both 
parties to former Chairman Bernanke which explained (in the context of 
the Federal banking agencies' proposed rule to apply the Bank Capital 
Framework to insurance companies) that ``[t]he bank-centric approach of 
the proposed rules is inconsistent with the unique nature of insurance 
and contradicts the intent of Congress.''
---------------------------------------------------------------------------
    Senator Collins herself has made clear that it was not the intent 
of Congress to ``supplant prudential State-based insurance regulation 
with a bank-centric capital regime''.\5\ Instead, Senator Collins 
explained, ``consideration should be given to the distinctions between 
banks and insurance companies. I believe it is consistent with my 
amendment that these distinctions be recognized in the final rule.''\6\
---------------------------------------------------------------------------
    \5\ Letter to Ben S. Bernanke, Martin J. Gruenberg and Thomas J. 
Curry from Senator Susan Collins (Nov. 26, 2012).
    \6\ Id.
---------------------------------------------------------------------------
    Accordingly, we are not debating what the result should be. Both as 
a matter of policy and in terms of carrying out Congressional intent, 
there should be tailored and differentiated capital requirements for 
insurance companies. Instead, the question is how best to achieve that 
result under Section 171.
    My testimony today is divided into four parts. First, I will 
summarize the terms of Section 171. Second, I will outline the relevant 
policy issues. Third, I will attempt to explain why I believe that, as 
a legal matter, the Federal Reserve already has sufficient authority to 
deal appropriately with these issues. Fourth, in the event that the 
Federal Reserve elects not to exercise that discretion, I will explain 
briefly why Congressional action to deal with this matter is both 
necessary and appropriate.
II. Section 171
    Section 171 of Dodd-Frank does not prescribe specific capital 
requirements, but provides two general mandates for both risk-based and 
leverage capital requirements. First, the capital requirements applied 
to companies subject to Section 171 may not be ``less than'' the 
capital requirements applied to banks now or in the future. Second, 
those requirements may not be ``quantitatively lower'' than the bank 
capital requirements in place as of the date of the enactment of Dodd-
Frank. Presumably, the first mandate incorporates the so-called Basel 
III capital framework, as implemented by the Federal banking agencies, 
and the second mandate incorporates the Basel I capital framework, as 
previously implemented by the agencies.
    Section 171 is a part of Subtitle C of Title I of Dodd-Frank, 
entitled ``Additional Board of Governors Authority for Certain Nonbank 
Financial Companies and Bank Holding Companies''. The key operative 
provision of Subtitle C is Section 165, which establishes ``enhanced 
prudential standards'' for ``systemically important financial 
institutions'', i.e., bank holding companies with total consolidated 
assets of $50 billion or more (``BHC SIFIs'') and nonbank financial 
companies designated by FSOC under Section 113 of Dodd-Frank for 
supervision by the Federal Reserve (``Nonbank SIFIs'').\7\
---------------------------------------------------------------------------
    \7\ Section 165 does not expressly apply to SLHCs. As discussed in 
note 16 infra, however, the Federal Reserve has, in effect, made the 
enhanced prudential standards applicable to SLHCs with total 
consolidated assets of $50 billion or more and a significant depository 
subsidiary, as well as to other SLHCs as determined by the Federal 
Reserve.
---------------------------------------------------------------------------
III. Policy Issues
    At the outset, it is seemingly inconceivable that Congress, or any 
regulator, could conclude that the same capital requirements should 
logically or appropriately apply to all financial services companies 
that are deemed systemically important. Various types of financial 
services companies have different business purposes and asset and 
liability structures, and they are exposed to different types of risk. 
As explained in the December 11, 2012 Letter from 33 Members of 
Congress, ``[s]trong capital standards need to be consistent with the 
business models of the industry to which they are applicable''. 
Nonetheless, some have read Section 171, in isolation, to require the 
Federal Reserve to apply automatically the same capital framework 
applicable to banking organizations to all the Covered Insurance 
Companies, as well as all other Nonbank SIFIs.
    It is important to stress that the policy issue is not about the 
need for robust capital requirements for Covered Insurance Companies. 
The conclusion that such requirements are essential should be beyond 
disagreement. Indeed, the insurers themselves, in comment letters to 
the Federal Reserve and other banking agencies, have supported strong 
capital requirements for the industry.\8\
---------------------------------------------------------------------------
    \8\ See, e.g., Letter to Jennifer J. Johnson from MetLife, Inc. 
(April 30, 2012); Letter to Ben S. Bernanke, Martin J. Gruenberg and 
Thomas J. Curry from MetLife, Inc. (Oct. 22, 2012); Letter to the 
Office of the Comptroller of the Currency, Jennifer J. Johnson and 
Robert E. Feldman from Prudential Financial, Inc. (Oct. 22, 2013); and 
Letter to Jennifer J. Johnson, Thomas J. Curry and Robert E. Feldman 
from State Farm Insurance Companies (Oct. 19, 2012).
---------------------------------------------------------------------------
    The real policy question is how best to implement robust capital 
requirements for Covered Insurance Companies. Is it preferable to 
import the Bank Capital Framework into the regulatory regime for 
Covered Insurance Companies or instead to rely principally upon 
substantive regulation under State insurance law, including, most 
pertinently, the risk-based capital requirements developed pursuant to 
the National Association of Insurance Commissioners' Risk-Based Capital 
(``RBC'') framework?
    The application of the Bank Capital Framework to Covered Insurance 
Companies would be inappropriate, redundant and punitive, not only 
because it is a second capital regime (in addition to the RBC 
framework), but because the Bank Capital Framework was not designed to, 
and does not, take into account the critically significant differences 
between the business of banking and the business of insurance. This 
essential point is reflected in comment letters to the Federal Reserve 
by many Members of Congress, including Senator Collins and Members of 
the Senate Banking Committee.\9\
---------------------------------------------------------------------------
    \9\ See, e.g., Letter to Ben S. Bernanke, Martin J. Gruenberg and 
Thomas J. Curry from Senator Susan Collins (Nov. 26, 2012) and the 
December 11, 2012 Letter.
---------------------------------------------------------------------------
    Let me summarize the fundamental difference between the balance 
sheets and business models of banks and insurance companies and why 
that difference compels the conclusion that the Bank Capital Framework 
is not the appropriate framework to govern insurance company capital.
    Banks perform the crucial role in our economy of maturity 
transformation, in which deposits and other short-term liabilities are 
invested in longer-term loans and other assets. This essential role, 
however, creates the potential for a loss of liquidity at banks in the 
event of a loss of this short-term funding. Consequently, in addition 
to enhanced liquidity requirements, the current regulatory framework 
for banks includes a substantially enhanced set of capital requirements 
(and related stress tests) that are designed to create a high level of 
loss-absorbing capital to help ensure that banks can withstand losses 
on assets and resultant strains on liquidity.
    In contrast, insurance companies do not engage in maturity 
transformation and, generally, have long-term liabilities. Moreover, 
historical experience, and the nature, structure and design of 
insurance products, indicate that there is no meaningful risk of 
``policyholder runs''. Among other factors, even if an insurance policy 
can contractually be surrendered, the policyholder may find that a 
comparable policy is not readily available (for example, because of 
age, health, etc.), and the switch could be time-consuming and will 
involve ``breakage'' costs--all in contrast to the ease of switching a 
bank deposit. As a result, capital requirements tailored for banks that 
are funded, in large part, through short-term liabilities do not 
constitute an appropriate framework for the businesses of insurers, 
which are liability-driven and have longer-term assets and liabilities.
    This fundamental difference between the business models and 
liability mixes of banks and insurers, and the consequences for capital 
requirements, was thoughtfully articulated by Federal Reserve Governor 
Daniel Tarullo in testimony before the Senate Banking Committee:

        The problem here, Mr. Chairman, comes I think on the liability 
        side of the balance sheet. Bank-centered capital requirements 
        are developed with an eye to the business model of banks and 
        the challenge that the FDIC would have in resolving a bank, or 
        now a systemically important banking organization that would be 
        in deep trouble.

        The more or less rapid liquidation of a lot of those claims and 
        the runs on a lot of the funding of that institution, lie 
        behind the setting of the capital ratio. But the liability side 
        of an insurance compan[y's] balance sheet, a true insurance 
        company [like] somebody selling life insurance for example, is 
        very different. There's not a way to accelerate the runs of 
        those, of that funding.\10\
---------------------------------------------------------------------------
    \10\ Mitigating Systemic Financial Risk: Hearing Before the S. 
Banking, Housing and Urban Affairs Comm., 113th Cong. (July 11, 2013) 
(testimony of Daniel K. Tarullo).

Likewise, Federal Reserve Chair Janet Yellen testified before the House 
Committee on Financial Services that ``[w]e understand that the risk 
profiles of insurance companies really are materially different . . 
.''.\11\
---------------------------------------------------------------------------
    \11\ Monetary Policy and State of the Economy: Hearing Before the 
H. Financial Services Comm., 113th Cong. (Feb. 11, 2014) (testimony of 
Janet L. Yellen).
---------------------------------------------------------------------------
    It is highly relevant that Congress explicitly recognized that the 
evaluation of the risk of assets could not be separated from 
consideration of the method by which those assets are funded. Section 
165(b)(3)(A) of Dodd-Frank expressly requires the Federal Reserve to 
consider differences between Nonbank SIFIs and BHC SIFIs and, in 
particular (through incorporation of Section 113(a)), the nature of the 
institution's assets and liabilities, including its reliance on short-
term funding. Likewise, former Federal Reserve Chairman Bernanke 
testified that ``insurance companies have both a different composition 
of assets and a different set of liabilities, and appropriate 
regulation needs to take that into account.''\12\
---------------------------------------------------------------------------
    \12\ Monetary Policy and the State of the Economy: Hearing Before 
the H. Fin. Services Comm., 112th Cong. (July 18, 2012) (testimony of 
Ben S. Bernanke).
---------------------------------------------------------------------------
    In Appendix A to this testimony, I have described three specific 
examples of issues that would arise from trying to force Covered 
Insurance Companies into a bank-centric capital regime. These examples 
are intended to be illustrative of the fundamental problem I have just 
described, but should not be taken to suggest there is a finite list of 
issues that if ``fixed'' would eliminate all the negative consequences 
that would result from applying the Bank Capital Framework, even on a 
``retro-fitted'' basis. These are merely symptomatic of the larger 
issue of applying the Bank Capital Framework to insurance companies for 
which it was never intended or designed.
    The examples do illustrate how the application of the Bank Capital 
Framework would require Covered Insurance Companies to hold capital 
that is not correlated to the risk profile of their underlying 
liabilities and assets. The result would be to impose upon Covered 
Insurance Companies lower returns on equity, both in absolute terms and 
in relation to their peer firms (both domestic and international), as 
well as unnecessary regulatory costs. Because lower returns do not 
constitute a viable strategy for Covered Insurance Companies (or their 
investors), their only option to retain marketplace vitality would be 
to increase the costs for their insurance products and services and 
cease offering some products altogether because of the uneconomic 
capital charge. Not only is such an approach obviously antithetical to 
the best interests of consumers and other customers, but it would also 
create a substantial competitive disadvantage for Covered Insurance 
Companies. As set forth in the October 17, 2012 Letter from twenty-four 
Senators, ``applying a bank-focused regime to insurance companies could 
undermine potential supervision and unintentionally harm insurance 
policyholders, savers and retirees''.
    Let me deal briefly with three arguments made against 
differentiation. The first is that we need simplicity in our capital 
rules, and, once we start distinguishing among financial institutions, 
it will not be possible to stop. Simplicity is a legitimate goal, but 
it should not degenerate into simplemindedness if it produces illogic, 
inequity and redundancy. And we are not talking about fine 
distinctions, but an obvious and palpable dichotomy. As the December 
11, 2012 Letter argues persuasively, ``it is not workable to have one 
uniform capital standards regulation to apply across the whole spectrum 
of financial services companies . . . [I]nsurers have a completely 
different business model and capital requirements than banks, which 
must be appropriate recognized in the [capital rules applied to Covered 
Insurance Companies]''.
    The second argument is that an asset should receive the same 
capital charge irrespective of the type of financial services company 
that holds the asset. Although this argument may have an appealing 
simplicity, it results in a divorce of capital from risk because it 
fails to take into account both sides of the balance sheet. It fails to 
consider either the purpose for which the asset is held or the 
institution's ability, due to its liability structure, to hold the 
asset in times of stress. As I just discussed, the risk weighting 
developed for bank assets was not designed to reflect that purpose or 
capability in the context of insurance companies.
    Third, some may argue that any concern about the application of the 
Bank Capital Framework to Covered Insurance Companies is misplaced 
because ``more capital is always better''. That argument can only be 
valid, however, if a company's appeal to investors is, contrary to all 
evidence, divorced from return on equity and its pricing of a product 
is likewise divorced from the capital assigned to it. To the contrary, 
capital requirements that are higher because they are not correlated to 
risk, produce marketplace and competitive distortions. Such 
uncorrelated capital requirements can increase the cost of financial 
products and services and even reduce the availability of lower-margin 
products and services. Once again, the debate is not about whether we 
should have robust capital requirements for all participants in the 
financial services industry--2008 should have resolved that debate once 
and for all. Instead, the only legitimate debate is whether the same 
capital framework should be artificially imposed without regard to the 
nature of the financial services company.
IV. The Federal Reserve's Authority To Tailor the Application of 
        Section 171
    As discussed, there has been an extraordinary ``meeting of the 
minds'' among Members of Congress, regulators and the insurance 
industry that, as a policy matter, the Bank Capital Framework should 
not be applied to Covered Insurance Companies. To date, however, the 
Federal Reserve has expressed a concern that the language of Section 
171 significantly constrains its interpretative ability.\13\
---------------------------------------------------------------------------
    \13\ For example, although in recent testimony before the Senate 
Banking Committee, Federal Reserve Chair Janet Yellen recognized the 
``very significant differences between the business models of insurance 
companies and banks,'' she continued that ``the Collins Amendment does 
restrict what is possible for the Federal Reserve''. (Semiannual 
Monetary Policy Report to the Congress: Hearing Before the S. Banking, 
Housing and Urban Affairs Comm., 113th Cong. (Feb. 27, 2013) (testimony 
of Janet L. Yellen)).
---------------------------------------------------------------------------
    The Federal Reserve may be reluctant to be seen as usurping a 
Congressional prerogative and intervening in an area where Congress has 
legislated. It is also understandable that an administrative agency 
would take the position that, if there is an ambiguity or error in what 
Congress has drafted, the agency should not act until Congress has had 
the opportunity to resolve the issue. Nonetheless, as I have previously 
written in a letter available on the Federal Reserve's Web site, I 
believe that there is sufficient flexibility in the statutory language 
of Dodd-Frank for the Federal Reserve to determine that Covered 
Insurance Companies should not be bound by the same capital regime that 
applies to banking organizations.
    I will now explain why the Federal Reserve has this interpretative 
authority, and can exercise that authority while at the same time 
maintaining fidelity to the plain language of Dodd-Frank and to 
Congressional intent. The analysis of the issue can be best understood 
by dividing it into three parts: the specific language of Section 171; 
the broader context of the Dodd-Frank Act as a whole, in particular, 
Section 165; and what I believe to be the most direct approach the 
Federal Reserve could take to resolve this issue.
A. Section 171 Language
    As noted earlier, Section 171 does not prescribe specific capital 
requirements, but provides that the capital requirements applied to 
companies subject to Section 171 be (i) not ``less than'' the capital 
requirements applied to banks now or in the future nor (ii) 
``quantitatively lower'' than the bank capital requirements in place as 
of the date of the enactment of Dodd-Frank.
    What is striking about the language of Section 171 is the absence 
of a precise and simple statement that Nonbank SIFIs should be subject 
to the Bank Capital Framework. If that were what Congress intended, it 
would have been a simple matter for Congress to have said so. Rather, 
the language of Section 171 calls for a comparability analysis between 
the capital regime imposed by the Federal Reserve on Covered Insurance 
Companies and the Bank Capital Framework, and provides only broad 
guidance as to how the Federal Reserve is to conduct this analysis.
    Because Section 171 is not prescriptive as to how the Federal 
Reserve is to conduct the comparability analysis, the Federal Reserve 
is authorized to adopt a reasonable interpretation of Section 171 to 
fill in these gaps. As the Supreme Court has made clear, in 
circumstances where ``the subject matter . . . is technical, complex, 
and dynamic . . . as a general rule, agencies have authority to fill 
gaps where statutes are silent.''\14\ This fundamental principle of 
regulatory authority applies with full force here. It is presumably 
beyond debate that Section 171 is ``technical'' and ``complex''. It is 
likewise ``dynamic'' because the bank capital rules will continue to 
evolve, as will the assessment of ``comparability''. In dealing with 
subject matter of this nature, it was not error, but logical, for 
Congress to grant significant discretion to the Federal Reserve in 
implementing Section 171.
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    \14\ Nat'l Cable & Telecommunications Ass'n, Inc. v. Gulf Power 
Co., 534 U.S. 327, 339 (2002).
---------------------------------------------------------------------------
    Indeed, in a demonstration of this discretionary latitude, the 
Federal Reserve and the other Federal banking agencies have 
appropriately exercised this discretion in at least one case. In the 
agencies' rules implementing Basel III, the agencies provided that the 
assets in separate accounts that are not guaranteed would generally 
receive a risk weight of 0 percent.
    Accordingly, even reading Section 171 in isolation, the Federal 
Reserve has flexibility to apply capital requirements to Covered 
Insurance Companies that are appropriately tailored for the business 
and risk profile of these institutions.
B. Section 171 in the Broader Context of Subtitle C of Title I of Dodd-
        Frank
    This conclusion is even more compelling when Section 171 is read in 
context with the overall statutory scheme of which it is a part. It is 
a fundamental canon of statutory construction, mandated by the Supreme 
Court, that individual provisions of a statute must be read in the 
context of the overall statutory scheme.\15\ Accordingly, Section 171 
must be read as part of the entirety of Subtitle C of Title I of Dodd-
Frank, which establishes a new, comprehensive framework for the Federal 
supervision of BHC SIFIs and Nonbank SIFIs in order to address the 
risks posed by such institutions to financial stability.
---------------------------------------------------------------------------
    \15\ FDA v. Brown & Williamson Tobacco Corp, 529 U.S. 120, 133 
(2000) (citations omitted) (``It is a `fundamental canon of statutory 
construction that words of a statute must be read in their context and 
with a view to their place in the overall statutory scheme.' . . . A 
court must therefore interpret the statute `as a symmetrical and 
coherent regulatory scheme' . . . and `fit, if possible, all parts into 
an harmonious whole . . . ' ''). See also Conroy v. Aniskoff, 507 U.S. 
511, 515 (1993) (Looking to the ``text and structure of the [statute] 
as a whole'' and following ``the cardinal rule that a statute is to be 
read as a whole . . . since the meaning of statutory language, plain or 
not, depends on context.'' (internal quotations omitted)).
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    A central tenet of Subtitle C is that there must be both robust 
regulation and differentiated regulation. Not only are these two 
objectives not inconsistent, but they are mutually reinforcing because 
regulation that is directed to the actual risk involved is inherently 
more robust than regulation divorced from risk. Therefore, when Section 
171 is read in the context of the other provisions of Subtitle C, it 
must be interpreted consistently with Congress's intent that the 
capital and other requirements for Covered Insurance Companies, and 
other Nonbank SIFIs, be applied in a tailored and flexible manner.
    The cornerstone of Subtitle C's regulatory framework is the 
``enhanced prudential standards'' in Section 165. Section 165 gives the 
Federal Reserve broad authority to apply these standards to Nonbank 
SIFIs, including Covered Insurance Companies,\16\ in a tailored manner. 
Indeed, differentiated application is not merely acceptable but 
required.
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    \16\ Section 165 applies, by its terms, only to BHC SIFIs and 
Nonbank SIFIs. It does not expressly apply to SLHCs. As a result, one 
could argue that, as a technical matter, Section 165 is inapposite to 
the application of Section 171 to SLHCs. In its recent rulemaking 
implementing the enhanced prudential requirements of Section 165, 
however, the Federal Reserve, relying on its general authority under 
the Home Owners' Loan Act to regulate SLHCs, indicated that it would 
expect to apply enhanced prudential requirements to any SLHC that has 
both $50 billion or more in total consolidated assets and a significant 
depository subsidiary. The Federal Reserve indicated that it would also 
apply enhanced prudential requirements to any other SLHC as the Federal 
Reserve considers appropriate. As a result of this Federal Reserve 
position, any argument based on the statutory language that Section 165 
cannot be read to inform Section 171 with respect to insurance-based 
SLHC is not viable.
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    In requiring the Federal Reserve to develop enhanced prudential 
standards for Nonbank SIFIs, Section 165 is replete with instructions 
that the Federal Reserve apply these standards through a differentiated 
approach that takes into account the nature of the institutions and the 
risks they present. Section 165(a)(2)(A) is titled ``Tailored 
Application'', and it expressly authorizes the Federal Reserve to 
``differentiate among companies on an individual basis or by category, 
taking into consideration their capital structure, riskiness, 
complexity . . . and any other risk-related factors that the [Federal 
Reserve] deems appropriate''.
    Three other provisions of Section 165 reinforce this 
differentiation approach.

    First, Subsection 165(b)(3)(A) requires the Federal 
        Reserve, in applying enhanced prudential standards, to take 
        into account differences between Nonbank SIFIs and BHC SIFIs, 
        including the following factors:

      whether the institution is already regulated by a primary 
        financial regulator;

      the nature and mix of the institution's activities;

      the amount and nature of the institution's liabilities, 
        including the degree of reliance on short-term funding; and

      other appropriate risk-related factors, as determined by 
        the Federal Reserve.\17\
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    \17\ Section 165(b)(3)(A), as applicable to Covered Insurance 
Companies, incorporates Section 113(a), which lists the considerations 
FSOC must take into account when determining whether to designate an 
institution as a Nonbank SIFI.

    Second, Section 165(b)(3)(D) explicitly requires the 
        Federal Reserve to ``adapt the required standards as 
---------------------------------------------------------------------------
        appropriate in light of any predominant line of business''.

    Third, Section 165(b)(4), as applicable to Covered 
        Insurance Companies, requires the Federal Reserve to consult 
        with the insurance commissioner representative on the FSOC 
        prior to implementing enhanced prudential requirements under 
        Section 165 to the extent those requirements are likely to have 
        a significant impact on Covered Insurance Companies.

    These multiple provisions of Section 165 make clear that Congress 
expected the Federal Reserve to tailor its enhanced prudential 
standards to the particular circumstances of insurance companies (and 
other Nonbank SIFIs), including with respect to capital requirements.
    In addition to Section 165, Section 169, which applies 
independently to modify both Section 165 and Section 171, requires the 
Federal Reserve to ``take any action'' that it ``deems appropriate'' to 
avoid imposing requirements that are duplicative of requirements 
already imposed on institutions by other provisions of law. It is 
difficult to imagine a clearer instruction, a broader grant of 
discretion to a Federal banking regulator or a provision that more 
directly applies to the treatment of Covered Insurance Companies under 
Section 171. Given that Covered Insurance Companies are already subject 
to the comprehensive RBC framework under State insurance law, imposing 
the Bank Capital Framework on Covered Insurance Companies would be not 
merely duplicative of, but would be at odds with, the State law capital 
requirements. Accordingly, even if Section 171 could otherwise be read 
to require the application of the Bank Capital Framework to Covered 
Insurance Companies (which, as noted, I believe it should not), Section 
169 is such a clear and broad grant of authority that it would override 
any such requirement and would require the Federal Reserve to take 
action to avoid imposing the Bank Capital Framework on Covered 
Insurance Companies.
    Another fundamental canon of statutory construction that is 
directly relevant to this analysis is that different statutory 
provisions must be read consistently rather than in conflict.\18\ 
Indeed, the Federal Reserve and the other banking agencies have 
acknowledged that ``the relationship between the requirements of 
section 171 and other aspects of [Dodd-Frank], including section 165, 
must be considered carefully and . . . all aspects of [Dodd-Frank] 
should be implemented so as to avoid imposing conflicting or 
inconsistent regulatory capital requirements''.\19\ It is seemingly 
incontrovertible that reading Section 171 to preclude differentiation 
would conflict with the basic mandate in Section 165 to require 
differentiation. Likewise, such a reading of Section 171 would conflict 
with the Section 169 requirement to avoid duplication.
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    \18\ See note 15 supra. See also Watt v. Alaska, 451 U.S. 259, 266-
67 (1981) (``[W]e decline to read the statutes as being in 
irreconcilable conflict without seeking to ascertain the actual intent 
of Congress . . . We must read the statutes to give effect to each if 
we can do so while preserving their sense and purpose.'') (citations 
omitted).
    \19\ 76 Fed. Reg. 37,620, 37,626 (June 28, 2011).
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    Moreover, there is no indication in Section 171 itself, or 
elsewhere in Subtitle C, that Section 171 was intended to ``override'' 
Congress's basic instructions in Sections 165 and 169 for the 
development and application of capital and other prudential standards 
for Covered Insurance Companies in a tailored, flexible and 
nonduplicative manner. Sections 165, 169 and 171 can only be reconciled 
if Section 171 is interpreted to require a comparable capital regime as 
opposed to an identical capital regime. This approach would fulfill the 
objectives of all three provisions, whereas any more prescriptive 
reading of Section 171 would undermine the Section 165 requirements of 
tailoring and differentiation and the Section 169 restrictions on 
duplication. Any more prescriptive reading is also illogical. It would 
imply that Section 171 imposed more stringent capital requirements on 
Covered Insurance Companies than Section 165, even though Section 165 
is the key provision that is supposed to impose enhanced (i.e., more 
stringent) capital and other requirements than those generally applied 
under Section 171.
    There is one other issue of statutory consistency. Both Section 
5(c)(3) of the Bank Holding Company Act \20\ and the McCarran-Ferguson 
Act of 1945 \21\ codify the long-standing Federal policy that State 
laws are to regulate the business of insurance. A reading of Section 
171 that overrides this policy would create a conflict that is not 
necessary.
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    \20\ 12 U.S.C. 1844(c)(3)(A).
    \21\ 12 U.S.C.  1012(b).
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    Thus, upon analyzing Section 171 in context of Subtitle C as a 
whole, in particular, Sections 165 and 169, and other statutory 
schemes, the Federal Reserve is clearly authorized to apply the 
requirements of Section 171 to Covered Insurance Companies in a 
tailored, flexible and nonduplicative manner that recognizes and 
accounts for the differences between Covered Insurance Companies and 
banks.
C. A Solution Consistent with the Plain Language of Section 171 and 
        Subtitle C
    The Federal Reserve may have several options to interpret Section 
171 in a way that is both consistent with its terms and maintains 
fidelity to Subtitle C as a whole. The solution, however, that I will 
now describe may be the most direct and consistent approach. There are 
two steps.
    First, the Federal Reserve would make a determination that the RBC 
framework that already applies to the insurance operations of Covered 
Insurance Companies is comparable to the Bank Capital Framework. If, 
however, the Federal Reserve were to conclude, after consultation with 
insurance regulators, that the existing minimum capital levels required 
under the RBC framework are not sufficiently stringent for ``enhanced 
prudential standards'', the answer is not to substitute an entirely 
different capital framework. Rather, the Federal Reserve can simply 
require that Covered Insurance Companies maintain some percentage 
greater than 100 percent of the RBC framework's required capital levels 
to achieve a level of stringency deemed appropriate to support such 
operations.
    Second, the Federal Reserve would apply the Bank Capital Framework 
on a consolidated basis to the top-tier holding company of a Covered 
Insurance Company, but with what is in effect an adjustment for the 
insurance operations. Any assets of the top-tier holding company held 
in an insurance company that complies with the RBC framework (as it may 
be modified by the Federal Reserve) would receive a risk weight of 0 
percent and the RBC capital attributable to those insurance company 
assets would be deducted from total capital. Under this approach, the 
holding company's noninsurance assets and activities (including parent 
company only assets), i.e., those not regulated under the RBC 
framework, would continue to be subject to the existing Bank Capital 
Framework and would require separate and appropriate levels of capital 
to support such activities. A similar approach could be applied to the 
leverage requirements.
    This approach would not only assure robust and differentiated 
capital requirements and reconcile the various relevant provisions of 
Subtitle C, but also would have several other advantages. First, it 
would apply the Bank Capital Framework to the parent company entity on 
a consolidated basis, which conforms with Section 171. This result also 
addresses directly the concern that Senator Collins and former FDIC 
Chairman Bair identified as an impetus for Section 171--that, in the 
financial crisis, holding companies were a source of weakness, rather 
than strength, to their operating subsidiaries.\22\ Second, it would be 
grounded in the Federal Reserve's existing authority, which the Federal 
Reserve has exercised previously,\23\ to modify risk weights in the 
existing Bank Capital Framework in order to tailor those requirements 
for insurance company assets. Third, it would satisfy the not ``less 
than'' and not ``quantitatively lower than'' requirements in Section 
171 by leaving in place the numerical ratios underlying the Bank 
Capital Framework (that is, the numerical ratio requirements under 
Basel I and Basel III). Fourth, it would build on the existing RBC 
framework tailored to Covered Insurance Companies, and thereby satisfy 
the mandate in Section 169 for the Federal Reserve to take action to 
avoid imposing duplicative requirements on Covered Insurance Companies.
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    \22\ 156 Cong. Rec. S3459, 3460 (daily ed. May 10, 2010).
    \23\ As the Federal banking agencies have recognized, Congress did 
not forbid the agencies from modifying, over time or in response to 
changes in circumstances, the calculation of the components of the 
numerical ratios in the bank capital requirements. See 77 Fed. Reg. 
52,888, 52,892 (Aug. 30, 2012).
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    This suggested approach would also give effect to Congressional 
intent, as evidenced both in the comments of Senator Collins and in the 
December 11, 2012 Letter in which thirty-three Members of Congress 
asked the Federal banking agencies to ensure that the capital 
requirements for Covered Insurance Companies ``consistently reflect 
congressional intent by incorporating the State risk-based capital 
system and applying capital standards that accommodate the existing 
framework for companies engaged in the business of insurance''.
    Finally, this approach could be implemented by relying solely on 
the flexibility inherent in the language of Section 171. That is, by 
applying the numerical ratios in the Bank Capital Framework, the 
Federal Reserve would be quite literally imposing capital requirements 
that are not ``less than'' nor ``quantitatively lower than'' the bank 
capital requirements referred to in Section 171. This approach becomes 
even more compelling when considered in the context of the broader 
statutory scheme in Subtitle C, where tailoring and avoiding 
duplication are the repeated and unambiguous instructions from 
Congress.
V. Congressional Action
    Even though, as just discussed, I believe the Federal Reserve has 
the authority to resolve this issue, and there are solutions available 
to the Federal Reserve in the exercise of that authority, there is 
obviously a distinction between having the authority to take an action 
and having a statutory requirement to do so. Moreover, in the Federal 
Reserve's recent promulgation of its rules under Section 165, it 
postponed a decision on the capital requirements applicable to Covered 
Insurance Companies to further study the issue. I hope that during this 
additional period of study, and in view of the firm Congressional 
support for resolution of the issue, the Federal Reserve will move 
expeditiously to find an interpretative solution to the problem, 
whether in the way I have suggested or in some other way.
    If, however, the Federal Reserve is not prepared to act promptly, I 
would strongly urge Congress to act to prevent a result that is so 
clearly unwarranted and potentially so damaging. The legislation 
previously proposed by Senators Brown and Johanns, and today by Senator 
Collins, represents a sound basis for moving forward. In asking for 
Congress to act in this matter, I realize that it may seem a ``heavy 
lift'', not because of the substance, but because of a reluctance to 
permit any amendment to the Dodd-Frank Act. The concern is apparently 
that any amendment would open the door to further amendments that are 
much more controversial and divisive.
    But certainly Dodd-Frank is not such a perfect piece of legislation 
that any and all amendments should be resisted for all time. When the 
absence of an amendment would result in perpetuating an adverse result 
that Congress has clearly stated, on a bipartisan basis, it did not 
intend, Congress should not be irrevocably barred. Indeed, Congress 
would be departing from its own fundamental principles if it sought to 
bind future Congresses from absolutely any reconsideration of what was 
legislated by its predecessors.
    I do recognize the concern about ``opening up'' Dodd-Frank when 
there has not been sufficient time to evaluate its impact. But, if 
there were ever to be any change, this is the time and place to do so. 
An amendment to clarify Section 171 would be both surgical and 
noncontroversial; of most importance, it is the right result.
VI. Conclusion
    In summary, given the virtually unanimous support for finding a 
solution to the policy issue raised by Section 171, and the flexibility 
the Federal Reserve has under the terms of Section 171 and Subtitle C, 
the Federal Reserve can, and should, act to avoid the negative 
consequences of applying the Bank Capital Framework to Covered 
Insurance Companies. In the absence of prompt Federal Reserve action, I 
urge Congress to act.
Appendix A
1. Policy Loans:
    As a service to its customers, an insurance company may loan a life 
insurance policyholder up to the existing cash surrender value of his 
or her policy, secured by the cash surrender value of the policy. The 
cash surrender value of the policy is a liability on the insurance 
company's balance sheet. In this way, the loan is fully collateralized, 
but unlike a collateralized bank loan, the insurance company is not 
subject to the risk that the collateral will not cover its exposure 
under the loan. If the policyholder defaults, the insurance company 
will reduce the benefits it pays to the policyholder, which will result 
in the insurer reducing the liability it records for the policy. An 
insurance company can always recoup a $100 policy loan default by 
reducing its liability to the customer under the policy by $100.
    Despite the fact that the policy loan never exposes the insurance 
company to credit or market risk, under the Bank Capital Framework--
with the mindset of a traditional collateralized bank loan--would 
require an insurance company to hold Tier 1 capital against the loan at 
a risk weight of 20 percent.
2. Guaranteed Separate Accounts:
    Many insurance companies offer an insurance product that allows a 
customer to place funds with an insurance company to be invested and 
managed by the insurance company, separately from its general assets, 
with the goal of providing the customer with the income stream from the 
investments, often upon retirement. These so-called ``separate 
accounts'' may be in guaranteed or nonguaranteed form and have varying 
features and conditions. The basic concept is that, with a guaranteed 
account, the insurance company guarantees the customer a fixed income 
stream, with the insurance company exposed if the value of assets in 
the account drops below a guaranteed amount at the end of the 
investment period. Annuities are frequently in the form of a guaranteed 
separate account.
    In the banking context, a guarantee is viewed as a contingent 
liability that may become fully due at any time. In the insurance 
context, the separate account products such as annuities are typically 
structured in such a way that the full liability is not all due at 
once; the period over which the guaranty payment is made is both long 
(often 15-20 years) and requires a long waiting period (often 10 years) 
before any payment is made. This contractual protection substantially 
eliminates the liquidity concern that the insurance company would need 
to draw on its own assets to make up for the full amount of the 
shortfall all at once.
    The Bank Capital Framework includes no tailoring for insurance 
company guaranteed accounts with these protective features. Moreover, 
because U.S. generally accepted accounting principles require a 
provision to be made on the insurance company's books to reflect the 
amount of the insurance company's exposure for the guarantee, requiring 
additional capital be held against not just the exposure but the entire 
account results in double-counting.
3. Corporate Bonds:

    The Bank Capital Framework is, in a number of respects, tailored 
for the types of assets held by banks in relatively large amounts. For 
example, there are different, tailored risk weights for mortgage loans 
(based on the quality of the loan), sovereign debt (based on categories 
for various countries), exposures to other U.S. depository institutions 
and credit unions and exposures to U.S. public sector obligations 
(based on whether the obligation is general or revenue).
    Insurance companies generally hold a significant portion of their 
assets in corporate bonds--and a greater portion than do banks because 
bond maturities better fit the insurance company's asset-liability 
matching and investment needs. Yet, the Bank Capital Framework is not 
tailored for corporate debt, so, unlike the RBC framework, there is no 
distinction between higher and lower quality bonds (as there is for 
mortgage loans and sovereign debt under both the Bank Capital Framework 
and the RBC framework), subjecting all corporate bonds to a 100 percent 
risk weight. This relatively crude approach is understandable when 
corporate bonds represent only a small portion of the assets that banks 
hold, but not when they represent a much larger portion at insurance 
companies. This exemplifies how the Bank Capital Framework simply was 
not designed to be applied to insurance companies.
                                 ______
                                 
                   PREPARED STATEMENT OF AARON KLEIN
            Director, Financial Regulatory Reform Initiative
                        Bipartisan Policy Center
                             March 11, 2014
    Chairman Brown, Ranking Member Toomey, Members of the Subcommittee, 
thank you very much for the opportunity to testify at this hearing of 
the Subcommittee on Financial Institutions and Consumer Protection. I 
have tremendous respect for the critical role this Committee plays in 
shaping the financial regulatory and economic policies that have an 
enormous effect on the lives of all Americans. I am especially honored 
to appear before you, having served for over 8 years on the 
professional staff of the Committee on Banking, Housing, and Urban 
Affairs, mostly as Chief Economist for former Chairmen Sarbanes and 
Dodd.
Bipartisan Policy Center Financial Regulatory Reform Initiative (FRRI)
    I serve as the Director of the Financial Regulatory Reform 
Initiative at the Bipartisan Policy Center. Founded in 2007 by former 
Senate Majority Leaders Howard Baker, Tom Daschle, Bob Dole, and George 
Mitchell, BPC is a Washington-based think tank that actively seeks 
bipartisan solutions to some of the most complex policy issues facing 
our country. In addition to financial regulatory reform, BPC has 
ongoing projects in housing, immigration, and the Federal budget. The 
Financial Regulatory Reform Initiative's overarching objective is to 
promote policies that balance financial stability, economic growth, and 
consumer protection. Finding the right capital regulations for 
insurance companies under the Dodd-Frank Act is a critically important 
issue. I commend you for focusing the Committee's attention on the 
issue. My testimony will focus on the following four key points:

  1.  The business of insurance is fundamentally different from that of 
        banking and hence must be subject to appropriate yet different 
        capital standards.

  2.  Regulators need to overcome their ``bank-centric'' approach when 
        regulating insurance companies.

  3.  The Dodd-Frank Act envisions regulators overcoming bank-
        centricity and empowers them to do so.

  4.  A more optimal regulatory approach should include a Federal 
        insurance regulator and optional Federal charter. The benefits 
        of such a regulator grow if the Federal Reserve is unable to 
        adjust its bank-centric approach to insurance companies.
Insurance and Banking are Fundamentally Different Businesses, With 
        Different Balance Sheets, Business Models, and Risk Profiles
    To understand why it is so important that insurance companies be 
subject to insurance-based capital regimes, not bank-based capital 
regimes, one must first appreciate the fundamental differences in their 
business models, balance sheets, and risk profiles.
The Business of Insurance
    At its core the business of insurance is about aggregating risks 
and matching assets to liabilities. Insurance companies are in the 
business of taking on risk of different tenures and matching assets and 
reserves against this risk. The precise approach varies tremendously by 
the type of insurance product. A company that provides auto insurance, 
usually on a 6- or 12-month basis, has to have a different asset and 
liquidity structure than a company that provides life insurance, which 
is often issued on a multi-decade contract.
    Aggregating risk avoids adverse selection by offering highly 
competitive products that attract broad market share and a large pool 
of customers to minimize risks. Insurance companies that are able to 
capture more of a given market are able to more accurately protect 
themselves against adverse selection and statistically unlikely 
outcomes. By accumulating and pooling risk, insurance companies allow 
people to transfer the financial risk of getting into a car accident, 
losing a loved one, or outliving their assets to a broad risk pool. 
Aggregating appropriate risk thus paradoxically makes insurance 
companies safer.
The Business of Banking
    Unlike insurance companies, which agglomerate and manage risk, 
banks are in the business of mitigating risk. Over-concentration in a 
specific business line is a classic ``red flag'' for regulators of 
safety and soundness problems. A key purpose of banks is to transfer 
timing risk; banks allow depositors to instantly access their funds, 
while using deposits to make longer-term loans to consumers and 
businesses. This process is often referred to as maturity 
transformation. As the Bipartisan Policy Center's Failure Resolution 
Task Force found, ``maturity transformation is the socially beneficial 
process by which financial institutions fund themselves with short-term 
borrowings and use these funds to make longer-term loans or investments 
in other illiquid assets. Without maturity transformation, our modern 
economy would grind to a halt.''\1\
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    \1\ John F. Bovenzi, Randall D. Guynn, and Thomas H. Jackson, ``Too 
Big to Fail: The Path to a Solution,'' Bipartisan Policy Center, May 
2013, p. 17. Available at: http://bipartisanpolicy.org/sites/default/
files/TooBigToFail.pdf.
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Can Banking and Insurance Coexist?
    Some economists and policymakers have argued that there are 
economies of scale in mixing the provision of banking and insurance 
services. This theory was prominent in the 1990s and was one of the 
driving forces behind the Gramm-Leach-Bliley Act, which repealed the 
prohibition on the mixing of banking and insurance. The theory was 
tested more than 15 years ago on a large scale with the merger of 
Citicorp and Travelers Group. Many commentators at the time expected 
more mergers and the creation of ``financial supermarkets'' to provide 
both services. At the time, Travelers CEO Sanford Weill said that the 
merger would create ``a model of the financial services company of the 
future,'' a sentiment shared by others in the industry.\2\
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    \2\ Yvette D. Kantrow and Liz Moyer, ``Citi, Travelers: A Global 
Leader Takes Shape,'' American Banker, April 7, 1998. Available at: 
http://www.americanbanker.com/175/citi-travelers-a-global-leader-takes-
shape-1041890-1.html.
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    As an empirical economist, I check to see how well reality has 
matched theory. In the case of the proposed value of combining banking 
and insurance businesses, the expected benefits have not materialized. 
With one important exception, which I will discuss in a moment, there 
are no examples in the United States of mixing banking and insurance on 
any significant commercial scale, although there are examples of 
successful acquisitions of smaller banks and thrifts. The Citi-
Travelers merger has been unwound and, in the absence of other similar 
mergers, it seems as if these businesses do not mix, even without 
regulatory barriers.
    A model exception has been the successful provision of banking and 
insurance services by USAA. What is interesting about USAA is that it 
operates its business on a field-of-membership basis, more analogous to 
a credit union than to a bank. Technically, USAA has a thrift regulated 
by the Office of the Comptroller of the Currency (OCC) and a thrift 
holding company regulated by the Federal Reserve. The membership 
requirement involves family military service. The reputation of the 
company providing both services is also extremely high,\3\ although I 
would not know firsthand, as I am not eligible for its insurance or for 
its bank lending activity.
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    \3\ See Tempkin Group, Net Promoter Score Benchmark Study, 2012, 
October 2012. Available at http://www.temkingroup.com/research-reports/
net-promoter-score-benchmark-study-2012/. See also David Rohde, ``In 
the Era of Greed, Meet America's Good Bank: USAA,'' The Atlantic, 
January 27, 2012. Available at http://www.theatlantic.com/business/
archive/2012/01/in-the-era-of-greed-meet-americas-good-bank-usaa/
252161/.
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Can Regulators Overcome Bank-Centricity To Properly Regulate Insurance 
        Companies?
Dodd-Frank Empowers the Federal Reserve To Provide Capital Regulation 
        for Insurers
    Dodd-Frank decided to treat thrifts and thrift holding companies 
nearly the same way it treats banks and bank holding companies, moving 
their supervision to the OCC for thrifts and the Federal Reserve at the 
holding company level.\4\ Whether the continued bifurcation of 
regulation between holding company and insured depository is a wise 
decision is beyond the scope of this hearing, but is something that the 
Bipartisan Policy Center's Regulatory Architecture Task Force is 
examining and will discuss in a report to be released this spring.
---------------------------------------------------------------------------
    \4\  12 U.S.C.  5412 (b)(2)(B) and 12 U.S.C.  5412 (b)(1)(A).
---------------------------------------------------------------------------
    The Federal Reserve is the regulator for a diverse set of insurance 
companies under Dodd-Frank. It is unclear how broadly appreciated that 
was during consideration of all of the aspects of Dodd-Frank, including 
the adoption of the Collins Amendment. What is clear is that Dodd-
Frank's decision to move the regulatory responsibility for thrift 
holding companies and nonbank SIFIs to the Federal Reserve was given 
along with the ability and responsibility for the Federal Reserve to 
recognize differences between these entities and develop appropriate 
capital structures, tailored to each entity or separate class of 
institutions. The broad authority to tailor was codified in Title I, 
Subtitle C of the Dodd-Frank Act.\5\
---------------------------------------------------------------------------
    \5\ 12 U.S.C.  5365(a)(2)(A).
---------------------------------------------------------------------------
The Importance of Tailoring Capital Standards for Insurance
    The economic rationale for capital regulation and for tailoring is 
clear but bears repeating. Capital regulation is necessary for many 
purposes, including, to ensure the safety and soundness of financial 
institutions so that customers can use these products efficiently and 
effectively. There are two main approaches to quantifying capital 
regulation for any financial institution. The first is a nonrisk-
sensitive approach, the leverage ratio, which creates a ceiling on 
total risk-taking. However, using the leverage ratio alone can have the 
perverse effect of encouraging institutions to take on more risk by 
treating all liabilities as equally risky and requiring the same amount 
of capital. Thus, a risk-based method of capital regulation is required 
to quantify risk levels for various assets and liabilities and require 
appropriate capital.
    The financial crisis demonstrated the problems inherent with over-
reliance on risk modeling. The mispricing of risk is one of the 
hallmarks of financial crises. Institutions, regulators, markets, and 
models are all susceptible to this mistake. I cannot predict in which 
area we will misprice and incorrectly evaluate risk in the future, but 
I am certain that it will happen again.
    The fundamental question is now how to develop appropriate metrics 
for both leverage and risk-based capital as it applies to insurance 
companies. Insurance companies differ fundamentally from banks in how 
one measures risk and leverage; thus a different capital system, 
specifically tailored for insurance companies, is necessary. A 
Bloomberg Government report studying this question concluded that: 
``the risks that insurers face are different from banks, and that 
regulating insurers as if they are banks may be inappropriate and 
unfair to insurance companies.''\6\
---------------------------------------------------------------------------
    \6\ Christopher Payne, ``Basel Capital Rules May Hinder U.S. 
Insurers,'' Bloomberg Brief: Financial Regulation, April 26, 2013. 
Available at: http://www.bloombergbriefs.com/files/
Financial_Regulation_042613_p1.pdf.
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Did Regulators Draw the Right Lessons from the Crisis for Insurers?
    An example of the difference in regulatory mindset necessary for 
insurance companies can be seen by the treatment of separate accounts. 
Regulators made a key mistake in the run-up to the financial crisis by 
allowing banks to keep structured investment vehicles (SIVs) off their 
balance sheets, exempting SIVs from capital reserve requirements. The 
SIVs were ``canaries in the coal mine'' before the last financial 
crisis. Assets that were supposed to be low risk were in fact risky and 
required banks to raise significant capital during stressed periods--
just at the moment that capital was especially costly. Post financial 
crisis, regulators have altered their approach, allowing fewer SIVs to 
be classified as ``off balance sheet.'' For this, regulators should be 
commended.
    Regulators, particularly the Federal Reserve, have also seen their 
post-crisis power broadly expanded. The Federal Reserve Board now has 
supervisory authority over many insurance companies as well as all 
SIFIs. As the Board's authority expands, it is encountering new 
products that banks don't offer and are accounted for differently, such 
as separate accounts. As defined by the Office of Financial Research 
(OFR), separate accounts are those ``in which an asset manager selects 
assets on behalf of large institutional investors or high net-worth 
individuals under mandates defined in an investment management 
agreement. Clients retain direct and sole ownership of assets under 
management.''\7\
---------------------------------------------------------------------------
    \7\ Office of Financial Research, ``Asset Management and Financial 
Stability,'' September 2013. Available at: http://www.treasury.gov/
initiatives/ofr/research/Documents/OFR_AMFS_
FINAL.pdf.
---------------------------------------------------------------------------
    Insurance companies use these separate accounts for products such 
as variable annuities. The question is whether these accounts are 
treated as ``on'' or ``off'' balance sheet for regulatory purposes. To 
answer this, regulators must consider the risks separate accounts carry 
for insurance companies. Historically, insurance has been regulated by 
the States, which have recognized that funds in separate accounts are 
more analogous to stock market accounts. Stock brokers are not required 
to hold capital against their clients' accounts since the assets in 
those accounts do not belong to the broker. Banks, on the other hand, 
must retain capital against deposits, since the deposits are 
liabilities for banks, and are subject to runs.
    A question remains as to whether Federal regulators such as OFR, 
the Federal Reserve, and the Financial Stability Oversight Council 
(FSOC) will draw the appropriate line with respect to separate 
accounts. If the regulators discover that a nonbank is putting its own 
solvency at risk and not accounting for separate accounts properly that 
would merit new regulatory treatment. So far, data from OFR and from 
the States' historical experience regulating insurance companies does 
not support that conclusion. Instead, it raises concerns that bank 
regulators are misapplying bank-centric lessons into a nonbank world 
without a clear understanding of the different risks, balance sheets, 
revenue streams, and business models.
The Right Way to Think About Capital Standards
    Good regulatory structures involve both minimum capital 
requirements through leverage limits and more sophisticated risk-based 
capital structures. Both need to be targeted and tailored to the 
business that they are regulating. As we have seen, insurance and 
banking are fundamentally different businesses with different risk 
profiles. Therefore, they require different capital regulatory and 
supervisory structures. The Dodd-Frank Act anticipated this and 
provided the Board with the necessary flexibility to tailor prudential 
standards accordingly to different businesses.
    There is broad agreement that tailoring is the right approach. 
Federal Reserve Board Chair Janet Yellen said it best: ``[T]here are 
very significant differences between the business models of insurance 
companies and the banks that we supervise and we are taking the time 
that is necessary to understand those differences and to attempt to 
craft a set of capital and liquidity requirements that will be 
appropriate to the business models of insurance companies.''\8\ The 
question is whether the Board will follow through on Chair Yellen's 
wise words with carefully considered, differentiated capital standards 
for insurers that recognize they are not banks.
---------------------------------------------------------------------------
    \8\ Victoria Craig, ``Janet Yellen Talks Disappointing Data, 
Weather on Capitol Hill,'' Fox Business, February 27, 2014. Available 
at: http://www.foxbusiness.com/economy-policy/2014/02/27/janet-yellen-
talks-dissapointing-data-weather-on-captiol-hill/.
---------------------------------------------------------------------------
Dodd-Frank Envisions and Empowers Regulators To Overcome Bank-
        Centricity
    Dodd-Frank made clear in several of its provisions the importance 
and need for Federal regulators to develop and implement nonbank 
capital regimes for regulated nonbank entities, and the ability for 
them to do so. These provisions can be found, for example, in sections 
112, 120, 165, and 616.\9\ These themes were reiterated to regulators 
by Chairman Johnson (D-SD) and Ranking Member Crapo (R-ID) in their 
letter to regulators last year: ``In setting the new capital rules for 
the United States institutions, your agencies face a formidable task to 
carefully tailor the new rules to the unique risks of institutions 
while neither hampering lending nor undermining the strength of our 
financial system.''\10\
---------------------------------------------------------------------------
    \9\ 12 U.S.C.  112 (a)(2)(I); 12 U.S.C.  120 (b)(2)(B); 12 U.S.C. 
 165 (b)(1)(A)(i); 12 U.S.C.  165 (b)(1)(B)(i); 12 U.S.C.  165 
(c)(1); 12 U.S.C.  616 (d)(b).
    \10\ U.S. Committee on Banking, Housing, and Urban Affairs, 
``Johnson and Crapo Urge Regulators to Address Concerns on Basel III,'' 
February 13, 2013. Available at: http://www.banking.senate.gov/public/
index.cfm?FuseAction=Newsroom.PressReleases&ContentRecord
_id=f321c69d-e901-e0ee-14eb-2ae6b730ee91&IsPrint=1.
---------------------------------------------------------------------------
    I am not an attorney and will not venture an opinion on how the 
Federal Reserve should interpret these provisions as they relate to 
section 171, often referred to as the Collins Amendment. I will point 
out however, that there is broad support, with which I concur, that 
capital standards should be tailored for different business models with 
different risk profiles. This was the clear intention of Dodd-Frank.
    Even if individual bank regulators are unable or unwilling to use a 
tailored approach, the FSOC could solve this problem without additional 
legislation. Among the duties imposed upon the FSOC in section 112 is 
the duty to make recommendations to: (1) member agencies on general 
supervisory priorities and principals that reflect the outcome of 
discussions among the member agencies; (2) the Board concerning the 
establishment of heightened prudential standards, including capital 
standards, for nonbank financial companies supervised by the Board; and 
(3) primary financial regulators to apply new or heightened standards 
and safeguards for financial activities or practices that could create 
or increase risks of significant liquidity, credit, or other problems 
spreading among bank holding companies, nonbank financial companies, 
and U.S. financial markets.\11\
---------------------------------------------------------------------------
    \11\ 12 U.S.C.  5322 (a) (2).
---------------------------------------------------------------------------
    If these two preferred approaches are not implemented--the 
following of the intention of Congress by the Federal Reserve, or the 
use of FSOC's authority to make recommendations that the Fed could then 
adopt--I would then support a legislative solution to this problem such 
as the one proposed by Senators Brown and Johanns in S. 1369.
The Case for Federal Insurance Regulation in a Post-Dodd-Frank World
    BPC's Regulatory Architecture Task Force has been examining the 
entire financial regulatory structure, as it exists in a post Dodd-
Frank world. The task force's report will be released next month and 
will contain many recommendations for how we can improve our current 
regulatory structure. One of those recommendations will be to create a 
Federal insurance regulator and an optional Federal charter. This 
recommendation follows previous bipartisan calls for a Federal 
insurance regulator, including legislation introduced by now Chairman 
Tim Johnson (D-SD) and then Senator John Sununu (R-NH),\12\ as well as 
the comprehensive regulatory restructuring plan issued by the Treasury 
Department under Secretary Henry ``Hank'' Paulson, Jr.\13\ It is also 
consistent with the framework proposed by Secretary Timothy Geithner in 
the 2009 Treasury White Paper, ``Financial Regulatory Reform, A New 
Foundation: Rebuilding Financial Supervision and Regulation.''\14\
---------------------------------------------------------------------------
    \12\ The National Insurance Act of 2007, S. 49, 110th Congress, 
2007.
    \13\ The Department of the Treasury, ``Blueprint for a Modernized 
Financial Regulatory Structure.'' March 2008. Available at: http://
www.treasury.gov/press-center/press-releases/Documents/Blueprint.pdf.
    \14\ The Department of the Treasury, ``Financial Regulatory Reform, 
A New Foundation: Rebuilding Financial Supervision and Regulation,'' 
June 17, 2009. Available at: http://www.treasury.gov/initiatives/
Documents/FinalReport_web.pdf.
---------------------------------------------------------------------------
    Dodd-Frank did not follow those calls, but did create a new Federal 
Insurance Office (FIO) within the Treasury Department in order to build 
Federal expertise in insurance. The FSOC was given the authority to 
designate any insurance company as a SIFI and hence transfer regulatory 
authority to the FRB. An independent voting member was also created for 
the FSOC with the requirement that s/he have insurance expertise.
    How has this worked so far? We have limited data as Dodd-Frank is 
not yet 4-years old, but the data we do have indicates disagreement and 
a lack of consistency. The only public disagreement so far in the 
designation process among FSOC members was in the designation of 
Prudential, Inc. Roy Woodall, the independent commissioner with 
insurance expertise, dissented on the vote to designate Prudential and 
was joined by the acting FHFA director. In his dissent, Commissioner 
Woodall said that the FSOC's analysis underlying the decision to 
designate Prudential was, ``antithetical to a fundamental and seasoned 
understanding of the business of insurance, the insurance regulatory 
environment, and the State insurance resolution and guaranty fund 
systems,'' and that the designation, ``will ultimately lead to the 
imposition of requirements that are by all indications ill-suited for 
insurance companies.''\15\
---------------------------------------------------------------------------
    \15\ S. Roy Woodall, Jr., dissent to the FSOC's designation of 
Prudential, Inc. delivered to Council members, September 19, 2013, pp. 
1, 7-8. Available at: http://www.treasury.gov/initiatives/fsoc/council-
meetings/Documents/September%2019%202013%20Notational%20Vote.pdf.
---------------------------------------------------------------------------
    The upcoming report from BPC's Systemic Risk Task Force will 
analyze the FSOC process, focusing particularly on questions regarding 
the FSOC's authority and its desire to regulate entities and 
institutions as compared to the regulation of activities. As long as 
designation of entities remains the main tool at the FSOC's disposal, 
it would be reasonable to expect a continued focus on designation. To a 
person with a hammer in his hand, problems tend to look like nails.
Has Dodd-Frank Created a Unified Voice for the United States on an 
        International Basis?
    One of the major goals in creating the FIO was to establish a 
unified Federal voice on insurance for international regulatory 
purposes. Dodd-Frank gave the FIO the authority ``to coordinate Federal 
efforts and develop Federal policy on prudential aspects of 
international insurance matters, including representing the United 
States, as appropriate, in the International Association of Insurance 
Supervisors [IAIS].''\16\ The Treasury Department echoes this, stating 
that a goal of the FIO is ``to represent the United States on 
prudential aspects of international insurance matters, including at the 
International Association of Insurance Supervisors.''\17\ However, the 
Federal Reserve, citing its newly acquired regulatory responsibilities 
over many insurance companies, recently applied for a seat on the IAIS. 
The Board's decision to request a seat is understandable given its 
desire to acquire additional knowledge and expertise on insurance. 
However, it also sends an unclear signal to the international community 
as to who speaks for the United States between the chair of the Federal 
Reserve Board, the director of FIO, or the NAIC, which represents State 
insurance commissioners, the functional regulators for insurance 
companies today. The Federal Reserve should publicly affirm that the 
FIO is the lead representative for the United States on the IAIS. This 
remains an example of the effect of the duplicative and unclear 
delegation of authority over regulation of insurance companies.
---------------------------------------------------------------------------
    \16\ 12 U.S.C.  313 (c)(1)(E).
    \17\ U.S. Department of the Treasury, ``About: Domestic Finance--
Federal Insurance Office.'' Available at: http://www.treasury.gov/
about/organizational-structure/offices/Pages/Federal-Insurance.aspx.
---------------------------------------------------------------------------
Conclusion
    BPC's Financial Regulatory Reform Initiative has found that Dodd-
Frank empowered financial regulators with substantial authority and 
flexibility to use their tools to improve regulation and achieve better 
regulatory outcomes for both financial services providers and end users 
of those financial services. We have seen multiple examples of 
regulators doing just that, ranging from the Federal Deposit Insurance 
Corporation's Single Point of Entry approach to the Consumer Financial 
Protection Bureau's use of an open and transparent rulemaking process. 
We have also found multiple instances where regulators could have taken 
a better approach, such as the Volcker Rule. And, we have found several 
instances where additional statutory changes are required, including 
the need to add a chapter to the Bankruptcy Code to complement Title II 
of Dodd-Frank, and the desirability of an independent inspector general 
for the CFPB. However, our work has shown that regulators have 
significant tools at their disposal to get things right.
    It is clear that banks and insurance companies are fundamentally 
different businesses, which require substantially different capital 
regimes. In my opinion, Dodd-Frank gave the Federal Reserve Board the 
necessary authority to the tailor its capital rules for insurance 
companies. The law clearly supports a tailored approach for insurance 
companies as well as all nonbank SIFIs. Dodd-Frank envisions a less 
bank-centric regulatory approach to the nonbanks the Board regulates 
after FSOC designation. It also empowers the FSOC as it relates to 
authorities as well as institutions. And, it empowers the Federal 
Reserve and FSOC as it relates to capital rules for nonbanks such as 
insurers.
    If the Federal Reserve Board is unwilling, or unable, to implement 
the tailoring regime required in Dodd-Frank to insurance companies, I 
would support a legislative solution such as S. 1369 as introduced by 
Senators Brown and Johanns. This would be a prominent example of the 
inability of regulators to adhere in practice to the construct created 
in Dodd-Frank. Whether this signals an isolated instance or a larger 
problem remains to be seen. It would add credence to the already strong 
argument in favor of some form of dedicated Federal insurance 
regulation that recognizes and understands the uniqueness of the 
insurance industry and its importance to our economy.
                                 ______
                                 
               PREPARED STATEMENT OF MICHAEL W. MAHAFFEY
        Chief Risk Officer, Nationwide Mutual Insurance Company
                             March 11, 2014
    Chairman Brown, Ranking Member Toomey, and Members of the 
Subcommittee, thank you for the opportunity to appear before you to 
discuss the critical issue of the appropriate capital framework for 
insurers supervised by the Federal Reserve. My name is Michael Mahaffey 
and I am the Chief Risk Officer for Nationwide Mutual Insurance Company 
(Nationwide). I am testifying on behalf of Nationwide but will also 
represent the perspective of a diverse group of insurers that fall 
under Federal Reserve supervision. Those insurers include both 
insurance savings and loan holding companies (SLHCs) and insurance 
companies that have been or may be designated by the Financial 
Stability Oversight Council (FSOC) as systemically important financial 
institutions (SIFIs).
    As Nationwide's Chief Risk Officer, I am responsible for overseeing 
the company's approach to managing its risk profile, including the key 
functions of Stress Testing and Enterprise Risk and Capital Modeling, 
Measurement and Management. A critical part of my role is to ensure 
that Nationwide meets its internal and external capital requirements so 
the company is always well positioned to honor its promises to our 
policyholders. In my capacity as Nationwide's Chief Risk Officer, I 
believe I can offer a helpful perspective on appropriate capital 
regimes for insurers and the consequences of imposing bank-centric 
capital rules on companies like Nationwide.
About Nationwide
    Nationwide is a Fortune 100 mutual insurance company based in 
Columbus, Ohio. For almost 100 years Nationwide has been helping our 
policyholder members protect what is most important to them through our 
property and casualty and life insurance businesses.
    Roughly half of Nationwide's revenue is derived from our property 
and casualty businesses, and half is derived from our life insurance 
and related businesses. As a result, Nationwide is representative of 
both the property and casualty and the life insurance industries. 
Nationwide Mutual and its property and casualty insurance subsidiaries 
primarily provide personal auto, homeowners, and commercial insurance 
products to households and businesses all across the country. In 
addition, Nationwide Life Insurance Company, a subsidiary of Nationwide 
Mutual, primarily provides life insurance, individual annuities, and 
private and public-sector retirement plans. Nationwide also provides 
banking products and services through Nationwide Bank, a Federal 
savings bank insured by the FDIC.
    As of December 31, 2013, Nationwide had approximately $183 billion 
in combined assets, while Nationwide Bank had approximately $6 billion 
in assets. While Nationwide Bank is critical to our customers and our 
business strategy, it is important to note that it represents less than 
3 percent of the total assets of the combined organization.
    Notwithstanding the bank's de minimis relative size, by virtue of 
its ownership of Nationwide Bank, Nationwide is registered as an SLHC. 
As an SLHC, Nationwide is now subject to Federal Reserve supervision 
and regulation pursuant to the Dodd-Frank Act, including new prudential 
requirements designed to enhance the safety and soundness of banking 
organizations. These include the Collins Amendment's consolidated 
capital requirements, capital stress-testing requirements, and the 
Volcker Rule.
The Applicability of the Collins Amendment to Insurers
    Pursuant to the Dodd-Frank Act, two categories of insurance 
companies came under Federal Reserve supervision--insurers that own 
depository institutions (and are thus SLHCs) and insurers that are 
designated by the FSOC as nonbank SIFIs. The Dodd-Frank Act conferred 
authority on the Federal Reserve to establish group capital 
requirements for both categories of companies. Section 616 of Dodd-
Frank granted the Federal Reserve the authority under the Home Owners' 
Loan Act (HOLA) to establish group capital requirements for insurance 
SLHCs. Likewise, Section 165 of the Dodd-Frank Act provided the Federal 
Reserve authority to establish group capital requirements for insurance 
SIFIs.
    Insurance SLHCs and insurance SIFIs are also subject to the minimum 
group capital requirements as set forth in the Collins Amendment. The 
Collins Amendment establishes a ``generally applicable'' minimum 
capital floor that is no lower than that which was in effect for banks 
at the time Dodd-Frank was enacted.
    As an SLHC, Nationwide is subject to the Collins Amendment. In 
addition, our depository institution, Nationwide Bank, is also 
independently subject to the minimum capital standards in the Collins 
Amendment. We support the application of the Basel banking capital 
standards to Nationwide Bank and we are not seeking to exempt 
Nationwide Bank from the Collins Amendment or in any way alter the 
capital requirements as applied to Nationwide Bank.
    Furthermore, we do not oppose utilization of a group-wide capital 
framework for insurance SLHCs and insurance SIFIs. Capital strength is 
core to our business proposition--providing our policyholders with 
financial protection when they need it the most.
    However, it is critically important that any capital framework 
established by the Federal Reserve for insurance SIFIs and insurance 
SLHCs utilize the appropriate tools. These institutions are 
predominantly insurance organizations and it would be inappropriate to 
measure their capital needs using a tool that is designed for banks.
    By way of analogy, it would be wholly inappropriate to apply an 
insurance-centric capital framework on a group-wide basis to bank 
holding companies, bank SIFIs like JP Morgan or Wells Fargo, or to 
banks that each happened to own small insurance operations.
The Statutory Construction Issue
    As you know, the purpose of the Collins Amendment is to ensure that 
certain financial institutions are subject to a minimum capital 
requirement. The economic crisis underscored the need to ensure that 
financial institutions hold enough capital to weather severe economic 
stress. We wholeheartedly support strong capital rules, which protect 
financial institutions, the broader economy, and everyday Americans.
    Again, we are not seeking lower capital requirements for insurers 
or their depository institution subsidiaries. We only seek to ensure 
that any capital standards established by the Federal Reserve utilize 
appropriate methodologies and accurately reflect the risks inherent in 
the business of insurance, which we believe is consistent with 
Congress' intent in adopting the Collins Amendment.
    We also believe that the plain language of the Collins Amendment 
permits the Federal Reserve to establish a separate, tailored, group 
capital framework for insurance SLHCs and insurance SIFIs. However, the 
Federal Reserve has maintained an interpretation of the Collins 
Amendment that constrains their ability to tailor the rules and would 
require the imposition of bank-centric Basel capital rules on insurance 
SLHCs and insurance SIFIs. Despite this interpretation, Federal Reserve 
officials have repeatedly agreed with policymakers and industry 
officials that a one-size-fits-all approach is undesirable.
    We respectfully, but strongly, disagree with an interpretation of 
the Collins Amendment that would prevent the Federal Reserve from 
establishing a separate capital framework that is appropriately 
tailored to the risks inherent in the business of insurance. Our 
company and trade association comment letters articulate this view in 
detail, as do several comment letters from respected attorneys who are 
experts in the field. Of prominent note, the author of the Collins 
Amendment, Senator Susan Collins, has stated that ``it was not 
Congress's intent that Federal regulators supplant prudential State-
based insurance regulation with a bank-centric capital regime . . . 
[C]onsideration should be given to the distinction between banks and 
insurance companies . . . I believe it is consistent with my amendment 
that these distinctions be recognized in the final rules.''\1\ We are 
pleased that the Federal Reserve is still examining this issue 
carefully and are hopeful that the agency will ultimately agree that 
the existing statutory language provides sufficient flexibility to 
establish a capital framework for insurance SLHCs and insurance SIFIs 
that more accurately accounts for the unique risk and capital profiles 
of insurers.
---------------------------------------------------------------------------
    \1\ Letter from Senator Susan Collins to the Federal Reserve, the 
Federal Deposit Insurance Corporation, and the Office of the 
Comptroller of the Currency, November 26, 2012.
---------------------------------------------------------------------------
Support for a Legislative Solution
    However, we are cognizant that if the Federal Reserve continues to 
hold the view that the Collins Amendment prevents the agency from 
establishing a tailored capital framework for insurance SLHCs and 
insurance SIFIs, the result will be the application of bank standards 
on insurers. This could have unintended negative consequences for 
consumers, the insurance market, and the economy. For these reasons, we 
support Congress passing legislation to clarify that the Federal 
Reserve, consistent with the original intent of the Collins Amendment, 
can and should establish a separate, tailored capital regime for 
insurers that appropriately reflects the industry's unique business 
model, risk profile, and asset-liability management practices.
    Specifically, we support S. 1369, legislation introduced by 
Senators Brown and Johanns last year which has a broad, bipartisan 
group of cosponsors. S. 1369 would clarify that the Federal Reserve is 
not required to impose a bank regime on insurers by exempting insurers 
from the Collins Amendment. The bill would leave intact Sections 616 
and 165 of the Dodd-Frank Act, which are the Federal Reserve's two 
other sources of legal authority to impose robust capital standards on 
insurers supervised by the Federal Reserve. In addition, under the 
Brown-Johanns bill, Basel III banking standards would continue to 
appropriately apply to depository institutions owned by an insurance 
company. Simply put, the Brown-Johanns bill would not affect the 
Federal Reserve's ability to impose group capital requirements on 
insurers; it would only clarify that the agency has the authority to 
tailor those standards to insurers' business models by utilizing the 
appropriate tools.
    We strongly support this legislation and applaud the bill's 
sponsors for their leadership on this issue. We also greatly appreciate 
the helpful involvement of Sen. Collins in the legislative effort. We 
look forward to being part of any sensible solution that protects 
policyholders without subjecting our companies to a capital framework 
that was designed for banks and which is inappropriate for our business 
model.
The Role of Nationwide Bank in Nationwide Enterprise
    As an SLHC, Nationwide is subject to the Collins Amendment by 
virtue of its ownership of Nationwide Bank. The same is true for the 
other SLHCs, including TIAA-CREF, who is also testifying today.
    As an insurance SLHC, Nationwide has opted to continue to offer 
competitively priced, reliable banking products despite the obvious 
regulatory costs. Nationwide's online bank represents a way to 
supplement the insurance services we provide to our life and property 
casualty members.
    As an example, Nationwide Bank played a critical role in the 
aftermath of the tornado that devastated Joplin, Missouri in 2011. 
Nationwide was able to quickly make insurance claims payments through 
Nationwide Bank debit cards issued to its policyholders who did not 
have access to bricks-and-mortar banks and who desperately needed these 
insurance payments in the wake of the disaster. The ability to offer 
this type of product through Nationwide Bank helps our policyholders 
get back on their feet sooner during a difficult situation.
    Other insurance SLHCs have similar stories--we are not striving to 
become large commercial banks, but rather, to provide important 
complementary products to our insurance customers. Some insurers have 
divested their banks; however, we believe strongly that it is in the 
best interest of our customers (and indeed the banking system) to have 
access to affordable retail banking products from the strong insurance 
companies they trust.
The Bank-centric Basel III Framework is Inappropriate for Insurers
    I'd now like to turn to why imposing a bank-centric capital regime 
on insurers is inappropriate for assessing their capital adequacy.
    The Basel Committee on Banking Supervision developed the Basel 
banking capital regime, including its most recent iteration, Basel III, 
specifically for banks and not insurers. At a very high level, the 
Basel framework is almost entirely focused on the asset side of a 
company's balance sheet, because in the banking industry, that is 
primarily where risk resides. The predominant risks facing a banking 
organization include credit risk, market risk, counterparty risk and 
liquidity risk. As a result, an asset-based capital framework that is 
primarily focused on a these risk types is suitable for assessing 
capital for a banking organization.
    However, Basel III, as implemented in the United States does not 
provide for critically important differences in company liability 
structures, liquidity profiles, or asset-liability management 
requirements. Consequently, such banking frameworks are not appropriate 
for insurers because they do not capture important liability based 
insurance risks (and associated risk management practices) that must be 
considered when determining capital requirements for such companies.
    Relative to insurers, banking organizations tend to hold riskier 
assets that are funded by short-term liabilities, making the 
traditional banking model more sensitive to changes in asset prices and 
vulnerable to a risk of runs on deposits and a pull-back from short-
term creditors in a very short period of time. Consequently, systemic 
economic events can subject banks to destabilizing ``runs'' and force 
them to quickly sell assets at a loss to meet their demand deposit 
obligations and funding needs. Furthermore, without a sufficient level 
of loss-absorbing capital, these banks would likely be unable to act as 
a source of credit to the U.S. economy. Without an appropriate level of 
capital, the fire sale of assets and pull-back of credit could have 
further systemic implications. This occurred during the most recent 
financial crisis due to the interconnectedness of the banking industry 
with the rest of the financial system.
    Conversely, the primary risks facing insurers, found on the 
liability side of the balance sheet, are generally not as sensitive to 
the same systemic economic risks. These insurer liability risks 
include, for example, weather risk, mortality risk and morbidity risk. 
Both life and property and casualty insurers invest upfront premium 
payments in assets to satisfy liabilities that, by their nature, are 
generally longer-term and typically dependent upon the occurrence of 
uncertain events that are not highly correlated to macroeconomic 
cycles.
    While insurers are subject to asset risks based on the investments 
held to meet long-dated liabilities, these risks do not expose 
insurance companies to the same ``run'' scenarios as found in banking. 
These asset risks manifest themselves in different ways for insurance 
companies due to the nature of the insurance liabilities and asset 
liability management practices which include accepting premiums up 
front and investing them to meet future liabilities.
    Again, property and casualty and life insurance policies are 
typically payable only upon the occurrence of a certain idiosyncratic 
trigger event not tied to economic cycles. While premature surrenders 
of life insurance policies can occur, significant penalties discourage 
this behavior and mitigate its impact. As a result, insurance policies 
are not prone to sudden and widespread ``withdrawals'' as bank deposits 
can be and, therefore, insurer liability and asset risks do not pose 
the same systemic risk implications that are found in the business of 
banking.
Imposing the Basel III Banking Framework Would be Potentially Harmful 
        to both the Insurance Industry and the Economy
    In addition to being inappropriate for insurers, the Basel regime 
is potentially harmful when applied to these companies because of their 
distinct business models. Insurers hold longer duration assets than 
banks. Insurers are significantly less reliant than banks on borrowed 
debt, especially short-term debt, and do not require the same level of 
liquidity as banks. However, insurance companies must engage in careful 
asset-liability management to ensure policyholder are protected, a 
business need the Basel regime also ignores.
    One salient example of the inappropriateness of the Basel III 
capital framework as applied to insurers is its 100 percent risk weight 
to all corporate exposures, which fails to distinguish corporate 
exposures based on the credit quality of the borrower. As has been 
raised in comment letters, a 100 percent risk weight for investment-
grade corporate bonds held by insurers overstates the risk associated 
with these assets, particularly when compared to a bank's commercial 
and industrial loans, which are materially more risky but which receive 
the same 100 percent risk weight. The insurance industry writ large has 
substantially larger holdings of corporate bonds than banking, and is, 
in fact, the largest investor in corporate bonds in the entire U.S 
economy. As of year-end 2012, corporate bonds comprised about 48 
percent of life insurer general account assets as compared to around 6 
percent for banks. Corporate bonds can provide an effective investment 
for meeting a long-dated policyholder obligation. Thus, overstating the 
risk on such a substantial portion of an insurer's investment portfolio 
will have a significant impact on insurance SLHCs and insurance SIFIs. 
These companies would be required to hold more capital for these high-
quality investments, which could in turn impact the affordability and 
availability of insurance products with long-term liabilities.
    As an alternative to incurring high capital charges for investment-
grade corporate bond holdings, insurers subject to a Basel regime could 
decide to take on additional credit risk by shifting their investment 
portfolios to higher-yielding, lower-quality corporate bonds that would 
receive the same 100 percent risk weight under the Basel III final 
rule. Taking on additional credit risk would, as one would expect, 
worsen the insurer's capital position under the State risk-based 
capital framework, even though the insurer's capital adequacy would be 
unchanged under the Basel III framework.
    Simply put, the Basel III framework's 100 percent, ``one-size fits 
all'' risk weight for corporate exposures provides a clear example of a 
framework that was designed for banks, which do not invest heavily in 
corporate bonds, and which is inappropriate for assessing the capital 
needs of an insurance company.
    The risk-weight for corporate bonds is just one example of why the 
Basel regime is inappropriate and harmful as applied to insurers. There 
are many others, including the regime's treatment of insurer separate 
accounts, which we believe receive inappropriate treatment under the 
Basel regime. These separate account assets would potentially receive 
capital charges for risk not borne by the insurer, resulting in a 
substantial and unreasonable capital cost which likely would impact 
insurers' ability to offer these important products. Furthermore, the 
risk weights applied in the Basel regime would over-charge for some 
risks, entirely ignore others and potentially incent the wrong risk 
measurement and therefore the wrong risk taking behavior. In total, it 
is likely some insurers would be forced to hold excessive capital that 
could cause a contraction in credit, and negatively affect availability 
and affordability of many insurance products.
The State Risk-Based Capital Regime
    The regulatory cornerstones to any discussion of group-wide 
insurance capital requirements are the State risk-based capital (RBC) 
models. Insurance is already heavily regulated by State law. Shortly 
after the United States adopted the Basel I framework for banks in 
1989, insurers became subject to the State RBC regime. The State RBC 
framework actually consists of three distinct capital models, each 
tailored to the unique risk profiles of life, property and casualty, 
and health insurers separately. Each model determines the amount of 
risk-based capital required by an insurance company given its 
investment portfolio, business activities, and the liability risks it 
has assumed. Regardless of what regime the Federal Reserve imposes on 
insurers that are federally supervised, we will also continue to be 
subject to State RBC requirements. We strongly support the RBC regime 
and the appropriate capital standards it requires for each of the life, 
property and casualty, and health insurance business models.
    The RBC system places particular emphasis on policyholder 
protection and the important differences between insurance business 
risks. The purpose of the RBC regime is to provide customers and 
regulators with a high degree of confidence that an insurer can pay all 
claims over the entire duration of its insurance contracts in force.
    Under the State RBC system, insurers hold capital to appropriately 
reflect the risks of their assets and their liabilities (and indeed 
potential mismatches between the two). The value of certain insurance 
company liabilities (current and future claims) are measured by the 
probability and severity of likely claims over a given period of time. 
While insurance companies are in the business of managing risk, and 
most do an excellent job of it, any capital regime such as Basel III 
that does not properly reflect insurer liabilities and the insurance 
business model has the potential to increase risk, not contain it.
Conclusion
    Again, thank you for the opportunity to appear before you to 
discuss our views on the appropriate capital regime for insurers. In 
conclusion, I would like to reiterate a few important points. First, we 
are not objecting to group supervision by the Federal Reserve. Second, 
we are not objecting to the concept of comprehensive group capital 
requirements for SLHCs or insurance SIFIs. Third, we are not objecting 
to utilization of the Basel III framework for our bank. Finally, we are 
not seeking lower capital standards--indeed we support strong 
capitalization as part of our core business proposition. We are simply 
advocating that there is no ``one size fits all'' model for assessing 
risk and by extension no universally applicable framework for 
determining capital requirements, that can be effectively applied 
regardless of business model. We believe strongly that the Federal 
Reserve should have the latitude to utilize any tool (or combination of 
tools) necessary to effectively assess the risk profile, and therefore 
capital requirements, of a holding company, taking into account 
material differences in their business models. Therefore, we strongly 
urge the passage of legislation that clarifies that the Federal Reserve 
has the flexibility to tailor capital rules to insurance companies 
under the agency's supervision. We thank you for the opportunity to 
comment, and look forward to being part of a bipartisan policy solution 
to this important issue.

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