[Federal Register Volume 81, Number 114 (Tuesday, June 14, 2016)]
[Proposed Rules]
[Pages 38631-38637]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-14004]
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FEDERAL RESERVE SYSTEM
12 CFR Chapter II
[Docket No. R-1539]
RIN 7100 AE 53
Capital Requirements for Supervised Institutions Significantly
Engaged in Insurance Activities
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Advance notice of proposed rulemaking.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board)
is inviting comment on an advance notice of proposed rulemaking (ANPR)
regarding approaches to regulatory capital requirements for depository
institution holding companies significantly engaged in insurance
activities (insurance depository institution holding companies), and
nonbank financial companies that the Financial Stability Oversight
Council (FSOC or Council) has determined will be supervised by the
Board and that have significant insurance activities (systemically
important insurance companies). The Board is inviting comment on two
approaches to consolidated capital requirements for these institutions:
An approach that uses existing legal entity capital requirements as
building blocks for insurance depository institution holding companies
and a simple consolidated approach for systemically important insurance
companies.
DATES: Comments must be received no later than August 17, 2016.
ADDRESSES: You may submit comments, identified by Docket No. R-1539;
RIN 7100 AE 53), by any of the following methods:
Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Email: [email protected]. Include Docket
No. R-1539; RIN 7100 AE 53) in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Robert deV. Frierson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue NW.,
Washington, DC 20551.
All public comments will be made available on the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper form in Room 3515, 1801 K Street NW., (between 18th and 19th
Streets NW.), Washington, DC 20006 between 9:00 a.m. and 5:00 p.m. on
weekdays. For security reasons, the Board requires that visitors make
an appointment to inspect comments. You may do so by calling (202) 452-
3684. Upon arrival, visitors will be required to present valid
government-issued photo identification and to submit to security
screening in order to inspect and photocopy comments.
FOR FURTHER INFORMATION CONTACT: Thomas Sullivan, Associate Director,
(202) 475-7656, Linda Duzick, Manager, (202) 728-5881, or Suyash
Paliwal, Senior Insurance Policy Analyst, (202) 974-7033, Division of
Banking Supervision and Regulation; or Laurie Schaffer, Associate
General Counsel, (202) 452-2272, Benjamin W. McDonough, Special
Counsel, (202) 452-2036; Tate Wilson, Counsel, (202) 452-369; David
Alexander, Counsel, (202) 452-2877; or Mary Watkins, Attorney (202)
452-3722, Legal Division.
SUPPLEMENTARY INFORMATION:
I. Introduction
A. Background
Robust capital is an important safeguard to protect the safety and
soundness of financial institutions; enhance the resilience of
financial institutions to position them to better navigate periods of
financial or economic stress; and mitigate threats to financial
stability that might be posed by the activities, material financial
distress, or failure of financial institutions. To help achieve these
benefits, various provisions of Federal law require the Board and other
Federal banking agencies to establish minimum capital standards for
holding companies that own insured depository institutions (IDIs) and
for financial firms that are designated by the FSOC for supervision by
the Board. The capital standards developed by the Board take into
account the overall risk profile and the size, scope, and complexity of
the operations of the institution. Further, the law allows the Board to
tailor the minimum capital requirements applicable to companies that
both own an IDI and significantly engage in insurance activities as
well as for systemically important insurance companies.
The Board's supervisory objectives in setting capital requirements
for the consolidated institution focus on the safety and soundness of
the company and its IDI and on enhancing financial stability, and
complement the primary mission of state legal entity insurance
supervisors, which tends to focus on the protection of
policyholders.\1\ To achieve these objectives, the Board seeks comment
on several approaches to designing a regulatory capital framework for
supervised institutions significantly engaged in insurance activities
that is intended to ensure that the institution has sufficient capital,
commensurate with its overall institution-wide risk profile (1) to
absorb losses and continue operations as a going concern throughout
times of economic, financial, and insurance-related stress (e.g.,
morbidity, mortality, longevity, natural and man-made catastrophes);
(2) to serve as a source of strength to any subsidiary depository
institutions; \2\ and (3) to substantially mitigate any threats to
financial stability that the institution might pose.
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\1\ For discussion regarding state supervision of insurance,
see, e.g., Financial Stability Oversight Council, Basis of the
Financial Stability Oversight Council's Final Determination
Regarding American International Group, Inc. (July 8, 2013),
available at https://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis%20of%20Final%20Determination%20Regarding%20American%20International%20Group,%20Inc.pdf; Financial Stability Oversight Council,
Basis of the Financial Stability Oversight Council's Final
Determination Regarding Prudential Financial, Inc. (Sept. 19, 2013),
available at https://www.treasury.gov/initiatives/fsoc/designations/Documents/Prudential%20Financial%20Inc.pdf.
\2\ 12 U.S.C. 1831o-1. See also, 12 U.S.C. 1844 and Section 706,
Division O, of the Consolidated Appropriations Act, 2016, Public Law
114-113, 129 Stat. 2242 (2015).
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B. The Board's Consolidated Supervision of Systemically Important
Insurance Companies and Insurance Depository Institution Holding
Companies
This ANPR seeks comment on proposed approaches to regulatory
capital requirements that are tailored to the risks of supervised
insurance institutions, including both insurance depository institution
holding companies and systemically important insurance companies.
The Board has broad authority to establish regulatory capital
standards for
[[Page 38632]]
savings and loan holding companies (SLHCs) and bank holding companies
(BHCs) \3\ under the Home Owners' Loan Act (HOLA) and Bank Holding
Company Act, respectively.\4\ The Board's supervisory objectives for
insurance depository institution holding companies include ensuring the
safe and sound operation of the consolidated firms and subsidiary IDIs,
and ensuring that holding companies can serve as a source of strength
for any subsidiary IDIs.\5\ In addition, certain nonbank financial
companies with significant insurance activities have been designated by
the Council pursuant to section 113 of the Dodd-Frank Act \6\ to be
supervised by the Board and made subject to enhanced prudential
standards. For these systemically important insurance companies, the
Board is required under section 165 of the Dodd-Frank Act to establish
enhanced prudential standards, including more stringent risk-based and
leverage capital requirements, as well as stress tests.\7\
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\3\ BHCs that are financial holding companies may engage in
insurance underwriting activities. 12 U.S.C. 1844(k).
\4\ 12 U.S.C. 1841 et seq.; 12 U.S.C. 1467a(g).
\5\ 12 U.S.C. 1831o-1. See also 12 U.S.C. 1467a(g)(5).
\6\ 12 U.S.C. 5323; see also Basis of the Financial Stability
Oversight Council's Final Determination Regarding American
International Group, Inc. (July 8, 2013), available at http://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis%20of%20Final%20Determination%20Regarding%20American%20International%20Group,%20Inc.pdf; Basis for the Financial Stability Oversight
Council's Final Determination Regarding Prudential Financial, Inc.
(Sept. 19, 2013), available at http://www.treasury.gov/initiatives/fsoc/designations/Documents/Prudential%20Financial%20Inc.pdf.
\7\ 12 U.S.C. 5365. Section 165 of the Dodd-Frank Act would also
direct the Board to establish consolidated capital requirements and
administer stress test for any insurance depository institution
holding companies that are BHCs with at least $50 billion in total
consolidated assets. Presently, there are no BHCs that are also
insurance depository institution holding companies.
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With respect to both insurance depository institution holding
companies and systemically important insurance companies, the Board
must establish minimum leverage capital requirements and minimum risk-
based capital requirements that apply (1) on a consolidated basis, and
(2) are at least as stringent as the generally applicable capital
requirements that applied to IDIs at the time the Dodd-Frank Act was
adopted, as well as current generally applicable IDI capital
requirements.\8\ The Dodd-Frank Act has been amended to allow the Board
to tailor these minimum capital requirements as they would apply to
persons regulated by state or foreign insurance regulators.\9\
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\8\ 12 U.S.C. 5371.
\9\ 12 U.S.C. 5371(c)(1).
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The Board currently supervises twelve insurance depository
institution holding companies and two systemically important insurance
companies. Collectively, these firms have approximately $2 trillion in
assets and represent approximately one-quarter of the assets of the
U.S. insurance industry. These institutions range in size from
approximately $3 billion in total assets to about $700 billion in total
assets, and engage in a wide variety of insurance and non-insurance
activities. Some of the firms operate exclusively in the United States,
and some have material international operations. These institutions
have a variety of ownership structures, including stock and mutual
forms of ownership. Some of these institutions prepare financial
statements according to U.S. Generally Accepted Accounting Principles
(U.S. GAAP), and some do not, preparing financial statements only
according to U.S. Statutory Accounting Principles (SAP) filed with
their relevant state insurance regulators. The insurance depository
institution holding companies tend to have simpler structures, often
have an operating company, rather than a holding company, as the top-
tier parent, and have a relatively greater U.S. focus in their
operations. By contrast, the systemically important insurance companies
are relatively larger financial institutions with substantial
international operations, comparatively complex organizational
structures relative to other insurance companies, and non-insurance as
well as insurance activities.
The Board aims to develop regulatory capital frameworks for
insurance depository institution holding companies and systemically
important insurance companies that are consistent with the Board's
supervisory objectives and appropriately tailored to the business of
insurance. The Board is seeking comment on different frameworks that
could be applied to insurance depository institution holding companies
and systemically important insurance companies. As described below,
this ANPR outlines two conceptual frameworks, one of which may be more
appropriate for large, complex, systemically important institutions,
while the other may be more appropriate for generally less complex
firms such as the current population of insurance depository
institution holding companies.
The Board is also seeking comment on the criteria that should be
used to determine which supervised institutions are subject to
regulatory capital requirements that are tailored to the business of
insurance. A supervised insurance institution could become subject to
tailored regulatory capital rules based on the significance of these
activities for the consolidated firm. The Board could apply a threshold
based on a percentage of total consolidated assets attributable to
insurance activities. For example, for purposes of determining whether
an SLHC is significantly engaged in insurance activities and should be
subject to capital requirements that are tailored to these risks, the
Board is considering using the threshold in the Board's existing
capital requirements (Regulation Q).\10\ Under this approach, an SLHC
would be subject to the capital requirements as an insurance SLHC if it
held 25 percent or more of its total consolidated assets in insurance
underwriting subsidiaries (other than assets associated with insurance
underwriting for credit risk).\11\ Further, the Board could define
systemically important insurance companies as FSOC-designated nonbank
financial companies with at least 40 percent of total consolidated
assets related to insurance activities (as of the end of either of the
two most recently completed fiscal years), or as otherwise ordered by
the Board. These thresholds could reflect a level of insurance activity
that is significant rather than incidental to the institution's
activities.
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\10\ 12 CFR 217.2.
\11\ 12 CFR 217.2. Depository institution holding companies
comprise BHCs as well as SLHCs. Presently, the population of Board-
supervised insurance depository institution holding companies
includes 12 SLHCs significantly engaged in insurance activities. To
the extent that a BHC met the definition of an insurance depository
institution holding company, the Board would need to consider
whether to exclude the BHC from the Board's Regulation Q and instead
apply a different approach.
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The Board invites comment on all aspects of these frameworks,
including whether these frameworks are workable, would enhance the
resilience of these institutions, and would reduce risks to financial
stability. The Board also invites comment and suggestions on other
frameworks that may better achieve these purposes. In addition, the
Board invites comment on the costs and benefits of these and alternate
approaches, and on the various advantages and difficulties of each
approach. To help the Board address specific issues raised by the
regulatory capital frameworks discussed below, the Board also invites
comment on the
[[Page 38633]]
specific questions listed throughout this notice.
II. Consolidated Capital Frameworks for Supervised Institutions
Significantly Engaged in Insurance Activities: Two Options
In developing and evaluating potential capital frameworks, the
Board relied on its experience in supervision of financial firms and
with the development and application of capital standards through
normal and stressed periods; discussions with affected financial firms,
including firms engaged in insurance activities; the purposes of and
requirements in Federal law; and information and insights provided by
other supervisors, including state insurance supervisors, among other
things.
Insurance supervisors, insurance companies and others have argued
that because liability structures, asset classes, and asset-liability
matching of insurance companies differ markedly from those of a typical
BHC, the capital framework (or frameworks) should be tailored to the
business mix and risk profile of insurance depository institution
holding companies and systemically important insurance companies. They
have also contended that leverage limits based on the ratio of equity
to total assets, which are an important backstop in a banking
regulatory capital framework, may have less value as a risk metric for
supervised institutions significantly engaged in insurance activities
because they do not address the different liability structure that is
inherent to the insurance business. The Board has flexibility to
develop leverage and risk-based capital requirements that are tailored
to appropriately reflect the risks of supervised institutions
significantly engaged in insurance activities.\12\
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\12\ See Insurance Capital Standards Clarification Act of 2014,
Public Law 113-279, 128 Stat. 3017 (2014).
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At the same time, supervisors and commenters recognize that a
capital framework also should take into account all material risk types
(insurance and non-insurance) in these institutions. Capital standards
that do not account for all types of material risks tend to be
ineffective and incent riskier activity. In addition, to the greatest
extent possible, the capital framework should take account of risks
across the entire firm--in the holding company, in regulated
subsidiaries, and in unregulated subsidiaries. The financial crisis
demonstrated that risks of financial distress often spread across an
organization from unregulated subsidiaries to regulated
subsidiaries.\13\ Moreover, the framework should be as standardized as
possible, rather than relying predominantly on a firm's internal
capital models. Greater standardization will produce more consistent
capital requirements, enhance comparability across firms, and promote
greater transparency.\14\
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\13\ For example, severe losses in non-insurance subsidiaries
may undermine confidence in an entire insurance organization and
contribute to a firm's inability to meet obligations. Board of
Governors of the Federal Reserve System, Regulatory Reform, American
International Group (AIG), Maiden Lane II and III, available at
https://www.federalreserve.gov/newsevents/reform_aig.htm.
\14\ Actuarial models, as opposed to asset risk-weighting
models, are nonetheless important in setting insurance reserves.
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The capital framework also should be based on U.S. regulatory and
accounting standards and not foreign regulatory and accounting
standards in order to best meet the needs of the U.S. financial system
and insurance markets while reflecting the risks inherent in the
business of insurance. The framework should strike a reasonable balance
between simplicity and risk sensitivity. Achieving this balance will
help ensure that risks are accurately captured while minimizing
regulatory burden and increasing comparability and transparency across
firms. The framework also should be executable in the short-to-medium
term. Finally, the framework should contribute to the stability of the
financial system and should serve as a good basis for a supervisory
stress test regime to the extent these provisions apply to the
regulated firm.
The Board invites comment on the considerations that should guide
the development of a regulatory capital framework for insurance
depository institution holding companies and systemically important
insurance companies.
Question 1. Are these identified considerations appropriate? Are
there other considerations the Board should incorporate in its
evaluation of capital frameworks for supervised institutions
significantly engaged in insurance activities?
Question 2. Should the same capital framework apply to all
supervised insurance institutions?
Question 3. What criteria should the Board use to determine
whether a supervised insurance institution should be subject to
regulatory capital rules tailored to the business of insurance?
Question 4. If multiple capital frameworks are used, what
criteria should be used to determine whether a supervised insurance
institution should be subject to each framework?
Question 5. In addition to insurance underwriting activities,
what other activities, if any, should be used to determine whether a
supervised institution is significantly engaged in insurance
activities and should be subject to regulatory capital requirements
tailored to the business mix and risk profile of insurance?
The remainder of this section will describe two potential
regulatory capital frameworks for supervised institutions significantly
engaged in insurance activities; discuss the strengths and weaknesses
of each approach; and suggest ways in which each approach could be
effectively applied. The Board invites comment on all aspects of each
approach. The Board will then use these comments to develop a specific
proposal, likely based on these two approaches, and invite public
comment on that specific proposal.
A. Option 1: Building Block Approach
The Board has traditionally set capital requirements for holding
companies on a consolidated basis.\15\ Among other things, a
consolidated capital standard deters firms from placing assets in a
particular legal entity, where the assets may be subject to lower, or
no, capital requirements. Many SLHCs that are supervised insurance
institutions because they own depository institutions do not produce
consolidated financial statements.\16\ This presents potential
challenges to the development of consolidated capital requirements that
would not impose undue burden on these institutions.
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\15\ See 12 CFR part 217.
\16\ Section 171(c)(3) of the Dodd-Frank Act, as amended,
prohibits the Board from requiring, pursuant to the Dodd-Frank Act
or HOLA, supervised institutions that only prepare financial
statements in accordance with SAP to prepare financial statements in
accordance with U.S. GAAP. 12 U.S.C. 5371(c)(3)(A)-(B).
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One approach that would accommodate this would aggregate capital
resources and capital requirements across the different legal entities
in the group to calculate combined qualifying and required capital. A
firm's aggregate capital requirements generally would be the sum of the
capital requirements at each subsidiary. This is a building block
approach (BBA). The capital requirement for each regulated insurance or
depository institution subsidiary would be based on the regulatory
capital rules of that subsidiary's functional regulator--whether a
state or foreign insurance regulator for insurance subsidiaries or a
federal banking regulator for IDIs. The BBA would then build upon and
aggregate legal entity (insurance, non-insurance financial, non-
financial, and holding company) qualifying capital
[[Page 38634]]
and required capital, subject to adjustments.
Under this approach, the regulatory capital requirements for a
regulated insurance underwriting firm would be determined by reference
to the rules of the appropriate state or foreign insurance supervisor
for the firm. The regulatory capital requirement for each IDI generally
would be determined under the Board's Regulation Q or under other
capital rules applicable to IDIs.\17\ The regulatory capital
requirement for any other regulated non-insurance or unregulated
subsidiary legal entity, such as a mid-tier holding company, would also
be determined under the Board's Regulation Q.
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\17\ 12 CFR part 217.
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As discussed further below, BBA may require the use of several
types of adjustments in the calculation of a firm's enterprise-wide
capital requirement. Adjustments may be necessary to conform or
standardize the accounting practices under SAP among U.S.
jurisdictions, and between SAP and foreign jurisdictions. Similarly,
adjustments may be necessary to eliminate inter-company transactions.
Additionally, the BBA may require consideration of cross-
jurisdictional differences. As discussed below, this would be achieved
through the use of scalars. Scalars may, for example, be appropriate to
account for differences in stringency applied by different insurance
supervisors, and to ensure adequate reflection of the safety and
soundness and financial stability goals, as opposed to policyholder
protection, that the Board is charged with achieving.
The ratio of aggregate qualifying capital to aggregate required
capital would represent capital adequacy at a consolidated level.
Represented in an equation, the BBA could be summarized as follows:
[GRAPHIC] [TIFF OMITTED] TP14JN16.000
Question 6. What are the advantages and disadvantages of
applying the BBA to the businesses and risks of supervised
institutions significantly engaged in insurance activities?
Question 7. What challenges and benefits do you foresee to the
development, implementation, or application of the BBA? To what
extent would the BBA utilize existing records, data requirements,
and systems, and to what extent would the BBA require additional
records, data, or systems? How readily could the BBA's calculations
be performed across a supervised institution's subsidiaries and
affiliates within and outside of the United States?
Question 8. What scalars and adjustments are appropriate to
implement the BBA, and make the BBA effective in helping to ensure
resiliency of the firm and comparability among firms, while
minimizing regulatory burden and incentives and opportunity to evade
the requirements?
Question 9. To what extent is the BBA prone to regulatory
arbitrage?
Question 10. Which jurisdictions or capital regimes would pose
the greatest challenges to inclusion in the BBA?
Question 11. How should the BBA apply to a supervised
institution significantly engaged in insurance activity where the
ultimate parent company is an insurer that is also regulated by a
state insurance regulator? Are there other organizational structures
that could present challenges?
The key strengths of the BBA include the following: (1) It
efficiently uses existing legal-entity-level regulatory capital
frameworks; (2) it is an approach that could be developed and
implemented expeditiously; (3) it would involve relatively low
regulatory costs and burdens for the institutions; and (4) it would
produce regulatory capital requirements that are tailored to the risks
of each distinct jurisdiction and line of business of the institution.
The key weaknesses of the BBA include: (1) At the top-tier level,
it is an aggregated, but not a consolidated, capital framework; (2) it
would not discourage regulatory arbitrage within an institution due to
inconsistencies across jurisdictional capital requirements and also may
be vulnerable to gaming through techniques such as double leverage
(i.e., when an upstream entity issues debt to acquire an equity stake
in a downstream entity); (3) it would need to account for inter-company
transactions, which may result in extensive adjustments; (4) it would
require the Board to determine scalars regarding a large number of
state and foreign insurance regulatory capital regimes; and (5) it
likely would require legal-entity-level stress tests, presenting
challenges to appropriate reflection of diversification and inter-
company risk transfer mechanisms and other transactions.
The strengths of the BBA would appear to be maximized and its
weakness minimized were the BBA to be applied to insurance depository
institution holding companies, which generally are less complex, less
international, and not systemically important. In this context,
incremental safety and soundness benefits would appear to be
complemented by the lower compliance costs due to the smaller number of
scalars involved. In particular, the BBA is standardized, executable,
applies U.S.-based accounting principles for U.S. legal entities,
accounts for material insurance risks, strikes a balance between risk-
sensitivity and simplicity, and is well-tailored to the business model
and risks of insurance.\18\
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\18\ In addition, the BBA could be implemented in a manner
consistent with section 171(c)(3) of the Dodd-Frank Act.
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For the systemically important insurance companies, the BBA may not
capture the full set of risks these firms impose on the financial
system without significant use of adjustments and scalars, thereby
negating any potential burden reduction from the approach. These firms
also tend to prepare financial statements under U.S. GAAP, thereby
making a consolidated capital requirement less burdensome to compute.
Accordingly, the BBA may not be appropriate for systemically important
insurance companies.
The Board continues to analyze whether the BBA is appropriate as a
regulatory capital framework and whether it may be appropriate for all
insurance depository institution holding companies or only a subset of
these firms. Specifically, the Board is considering whether larger or
more complex insurance depository institution holding companies should
be subject to a regulatory capital framework other than the BBA.
Question 12. Is the BBA an appropriate framework for insurance
depository institution holding companies? How effective is the BBA
at achieving the goal of ensuring the safety and soundness of an
insurance depository institution holding company?
Question 13. Would the BBA be appropriate for larger or more
complex insurance companies that might in the future acquire a
depository institution?
Further, the Board seeks comment on the following key issues
regarding the design and implementation of the BBA.
[[Page 38635]]
Baseline capital requirements at the legal-entity level. The BBA
framework would begin with the baseline capital requirements at each
legal entity. For example, for state-regulated insurance entities, the
BBA could use different triggering thresholds from the state risk-based
capital framework (e.g., the Company Action Level, the Authorized
Control Level), or some other level as the appropriate baseline capital
requirement. For some regulated foreign insurance entities, the Board
would need to decide whether the local minimum capital requirement,
prescribed capital requirement, or some other requirement is the
appropriate baseline. For subsidiary IDIs, the BBA could use the
minimum common equity tier 1, tier 1, or total risk-based capital
requirements under the standardized approach in the Board's Regulation
Q, as well as the tier 1 leverage ratio. For unregulated subsidiaries,
the BBA could use the risk-based capital or leverage requirements for
depository institutions or some other, similarly stringent approach.
Question 14. In applying the BBA, what baseline capital
requirement should the Board use for insurance entities, banking
entities, and unregulated entities?
State-by-state and international variances in accounting or capital
treatment for supervised institutions significantly engaged in
insurance activities. The accounting practices for insurance companies
can vary from state to state due to permitted and prescribed practices,
and can result in significant differences in financial statements
between similar entities filing SAP financial statements in different
states. Regulators both within and outside of the U.S. have the
authority to take actions with respect to insurance companies that may
result in variances from standard accounting practices. The BBA would
need to address international or state regulator approved variances in
accounting or capital requirements for regulated insurance entities.
Question 15. How should the BBA account for international or
state regulator approved variances to accounting rules?
Question 16. What are the challenges in using financial data
under different accounting frameworks? What adjustments and/or
eliminations should be made to ensure comparability when aggregating
to an institution-wide level?
Question 17. What approaches or strategies could the Board use
to calibrate the various capital regimes without needing to make
adjustments to the underlying accounting?
Inter-company transactions. Any approach to regulatory capital for
a supervised institution significantly engaged in insurance activities
that aggregates qualifying capital and required capital at different
legal entities within the institution should address inter-company
transactions. Although inter-company transactions are naturally
eliminated in consolidated accounting and regulatory frameworks, in an
aggregated framework like the BBA, some inter-company transactions
could generate redundancies in capital requirements, while others could
reduce the required capital of a legal entity without reducing the
overall risk profile of the institution. The BBA should include a
treatment for inter-company transactions between different legal
entities in the same supervised institution.
Question 18. How should the BBA address inter-company
transactions?
Scalars. An important component of the BBA is that scalars would
serve to bring jurisdictional capital frameworks to comparable levels
of supervisory stringency. The BBA would need an appropriate scalar for
each local regulatory capital regime, and therefore also would need a
set of principles for determining those scalars. Any necessary scalars
would be designed to reflect differences in supervisory purposes
appropriate for insurance.
Question 19. What criteria should be used to develop scalars for
jurisdictions? What benefits or challenges are created through the
use of scalars?
Consolidation of qualifying capital. Under one version of a BBA
framework, an insurance depository institution holding company or
systemically important insurance company generally would determine its
aggregate qualifying capital position by summing the qualifying capital
position at each of its legal entities. A weakness of this approach is
that it could enable the supervised institution to engage in
substantial double leverage--that is, the institution's top-tier legal
entity could fund its equity investments in its subsidiaries by
substantial borrowings. Such an institution could have substantial
qualifying capital positions at each of its major subsidiaries (and
thus a robust BBA capital ratio) but could have a weak consolidated
capital position.
To address this limitation of a simple BBA, the Board is
considering adopting a version of the BBA that would determine an
institution's aggregate qualifying capital position on a uniform,
consolidated basis. Under such an approach, the BBA would continue to
draw upon capital requirements set by the local regulators of each
legal entity, but would use a single definition of qualifying capital
for supervised institutions and would apply that definition to the
institution on a fully consolidated basis. To implement this version of
the BBA, the Board would need to develop a definition of consolidated
regulatory capital for supervised institutions significantly engaged in
insurance activities, including rules to address minority interests.
Question 20. What are the costs and benefits of a uniform,
consolidated definition of qualifying capital in the BBA?
Question 21. If the Board were to adopt a version of the BBA
that employs a uniform, consolidated definition of qualifying
capital, what criteria should the Board consider? What elements
should be treated as qualifying capital under the BBA?
Question 22. Should the Board categorize qualifying capital into
multiple tiers, such as the approach used in the Board's Regulation
Q? If so, what factors should the Board consider in determining
tiers of qualifying capital for supervised institutions
significantly engaged in insurance activities under the BBA?
B. Option 2: Consolidated Approach
The Board is also considering a consolidated approach (CA) to
capital with risk segments and factors appropriate for supervised
insurance institutions.
The CA is a proposed capital framework for supervised institutions
significantly engaged in insurance activities that would categorize
insurance liabilities, assets, and certain other exposures into risk
segments; determine consolidated required capital by applying risk
factors to the amounts in each segment; define qualifying capital for
the consolidated firm; and then compare consolidated qualifying capital
to consolidated required capital. Unlike the BBA, which fundamentally
aggregates legal-entity-level qualifying capital and required capital,
the CA would take a fully consolidated approach to qualifying capital
and required capital. As distinguished from the Board's consolidated
capital requirements for bank holding companies, the CA would use risk
weights and risk factors that are appropriate for the longer-term
nature of most insurance liabilities.
The foundation of the CA, for systemically important insurance
companies, would be consolidated financial information based on U.S.
GAAP, with adjustments for regulatory purposes. Application of the CA
to insurance depository institution holding companies that do not file
U.S. GAAP financial statements would require the development of a
consolidated approach based on SAP. Initially, the CA could be
[[Page 38636]]
simple in design, with broad risk segmentation, but could evolve over
time to have an increasingly granular segmentation approach with
greater risk sensitivity. Represented as an equation, the CA could be
summarized as follows:
[GRAPHIC] [TIFF OMITTED] TP14JN16.001
Question 23. What are the advantages and disadvantages of
applying the CA to the businesses and risks of supervised
institutions significantly engaged in insurance activities?
Question 24. What are the likely challenges and benefits to the
development, implementation, and application of the CA? To what
extent could the CA efficiently use existing records, data
requirements, and systems, and to what extent would the CA require
additional records, data, or systems?
Question 25. To what extent would the CA be prone to regulatory
arbitrage?
The CA has strengths and weaknesses as a regulatory capital
framework. The key strengths of the CA include the following: (1) It
has a simple and transparent factor-based design; (2) it covers all
material risks of supervised institutions significantly engaged in
insurance activities; (3) it is a fully consolidated framework that has
the potential to reduce regulatory arbitrage opportunities and the risk
of double leverage; (4) it would be relatively expeditious for the
Board to develop and for institutions to implement, particularly in
light of its broad risk segmentation as implemented initially; and (5)
it would provide a solid basis upon which to build consolidated
supervisory stress tests of capital adequacy for institutions subject
to stress testing requirements.
The key weaknesses of the CA include the following: (1) The
initially simple design of the CA would result in relatively crude risk
segments and thus limited risk sensitivity, and (2) substantial
analysis would be needed to design a set of risk factors for all the
major segments of assets and insurance liabilities of supervised
institutions significantly engaged in insurance activities. In
addition, a separate SAP-based version of the CA would need to be
developed for the insurance depository institution holding company
population if CA were ever applied to an insurance depository
institution holding company that only uses SAP.
Based on the Board's initial analysis of the CA's strengths and
weaknesses and comparing the CA against the considerations set forth
above, it appears that the CA may be an appropriate regulatory capital
framework for systemically important insurance companies. The CA, as a
consolidated capital framework, would reduce the opportunity for
regulatory arbitrage and the potential for double leverage. The CA also
would more easily enable supervisory stress testing and other
macroprudential features for systemically important insurance
companies.
The advantages of the CA are most salient for systemically
important insurance companies that, by definition, are large, and
internally and externally complex institutions. For insurance
depository institution holding companies, which generally are smaller
and less complex, these benefits may be outweighed by the additional
implementation costs.
Question 26. Is the CA an appropriate framework to be applied to
systemically important insurance companies? What are the key
challenges to applying the CA to systemically important insurance
companies? How effective would the CA be at achieving the goals of
ensuring the safety and soundness of a systemically important
insurance company as well as minimizing the risk of a systemically
important insurance company's failure or financial distress on
financial stability?
Question 27. What should the Board consider in determining more
stringent capital requirements to address systemic risk? Should
these requirements be reflected through qualifying capital, required
capital, or both?
Further, the Board seeks comment on the following key issues
regarding the design and implementation of the CA.
Definition of qualifying capital. Implementation of the CA would
require the development of a uniform, consolidated definition of
qualifying capital that is appropriate for all institutions subject to
the CA.
Question 28. What should the Board consider in developing a
definition of qualifying capital under the CA? What elements should
be treated as qualifying capital under the CA?
Question 29. For purposes of the CA, should the Board categorize
qualifying capital into multiple tiers? What criteria should the
Board consider in determining tiers of qualifying capital for
supervised institutions significantly engaged in insurance
activities under the CA?
Segmentation of exposures. Implementing the CA would require a
framework for segmenting or disaggregating balance-sheet assets,
balance-sheet insurance liabilities, and certain off-balance-sheet
exposures. Appropriate segmentation would be important to ensure that
similar risks face broadly similar capital requirements and that the
capital regime produces an appropriate degree of risk sensitivity while
minimizing the opportunities for regulatory arbitrage. This
segmentation process would account for differences among insurance
risks as well as between insurance risks and banking and other non-
insurance, financial risks. While the initial version of the CA likely
would have broad risk segments, the CA could evolve over time to become
more risk sensitive. One option for implementing the CA for
systemically important insurance companies would be to use the
segmentation framework in the Board's proposed Consolidated Financial
Statements for Insurance Systemically Important Financial
Institutions.\19\
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\19\ 81 FR 24097 (Apr. 25, 2016).
Question 30. What risk segmentation should be used in the CA?
What criteria should the Board consider in determining the risk
segments? What criteria should the Board consider in determining how
granular or risk sensitive the segmentation should be?
Question 31. What challenges does U.S. GAAP present as a basis
for segmentation in the CA?
Question 32. What are the pros and cons of using the risk
segmentation framework in the proposed Consolidated Financial
Statements for Insurance Systemically Important Financial
Institutions as the basis of risk segmentation for the CA?
Exposure amounts. The CA would need to identify the exposure
amounts of the various kinds of balance-sheet assets, balance-sheet
insurance liabilities, and off-balance-sheet exposures of an
institution. Although in many cases, the reported amount of a
particular exposure may be appropriate for purposes of the CA, in other
cases the financial information of an institution may require
adjustments. For example, adjusting insurance liabilities may be
necessary in order to include additional, relevant information, such as
current assumptions, or to better match the valuation of related
assets. Further, the CA would require the determination of the
appropriate exposure amounts for derivatives and other off-balance-
sheet items in order to accurately reflect the risk exposure in
determining required capital.
[[Page 38637]]
Question 33. How should the CA reflect off-balance-sheet
exposures?
Question 34. Under what circumstances should U.S. GAAP be used
or adjusted to determine the exposure amount of insurance
liabilities under the CA?
Factors. The CA would involve a set of Board-determined factors to
be applied to the exposure amounts of assets, insurance liabilities,
and off-balance-sheet items in each risk segment. The factor for each
risk segment would reflect the riskiness of the segment and the capital
required to support that risk. Because of the different liability
structures between insurance companies and banks, some of the
applicable insurance risk factors may differ from the analogous risk
factors that apply to banks.
Question 35. What considerations should the Board apply in
determining the various factors to be applied to the amounts in the
risk segments in the CA?
Question 36. What challenges are there in determining risk
factors for global risks?
Minimum ratio. The CA would require the establishment of a minimum
ratio of consolidated qualifying capital to consolidated factor-
weighted exposures in the CA. In addition, one or more definitions of
capital adequacy (e.g., ``well capitalized'' or ``adequately
capitalized'') would be needed for early remediation and other
supervisory purposes.
Question 37. What criteria should the Board consider in
developing the minimum capital ratio under the CA and definitions of
a ``well-capitalized'' or ``adequately capitalized'' insurance
institution?
C. Other Assessed Frameworks
In developing the two general approaches discussed here, the Board
considered a number of other potential regulatory capital frameworks
that did not appear to meet the Board's supervisory objectives for
supervised institutions significantly engaged in insurance activities.
For example, consideration was given to applying a risk-based capital
rule that is based solely on the Board's existing capital requirements
for banking organizations (Regulation Q) to supervised institutions
significantly engaged in insurance activities. Such an approach would
not recognize the unique risks, regulation, and balance sheet
composition of insurance firms. Although bank-like capital requirements
may be appropriate for exposures that a supervised institution
significantly engaged in insurance activities holds in a non-insurance
subsidiary, an approach based solely on the Board's Regulation Q would
not capture significant insurance risks. The Board is not aware of any
major country that imposes bank capital requirements on insurance
firms.
The Board also reviewed an approach that entirely excluded
insurance subsidiaries and applied capital requirements only to the
non-insurance parts of the supervised firm. This approach would, by
definition, not capture all the material risks of the organization.
While section 171 of the Dodd-Frank Act, as amended, permits the Board
to exclude state and foreign regulated insurance entities in
establishing minimum consolidated leverage and risk-based capital
requirements, the parent holding company should be a source of capital
strength to the entire entity, including to the subsidiary insurance
companies and IDIs. To do this effectively, a consolidated capital
requirement must take into account the risks within the consolidated
organization, including insurance risks.
A capital approach based on the European Solvency II framework was
considered, but would not appear to be appropriate for systemically
important insurance companies and insurance depository institution
holding companies in the United States.\20\ Use of a Solvency II-based
capital framework would not adequately account for U.S. GAAP and may
introduce excessive volatility due to discount rate assumptions.
Moreover, use of a Solvency II-based approach would involve excessive
reliance on internal models. Internal models make cross-firm
comparisons difficult and can lack transparency to supervisors and
market participants. Additionally, such an approach would not be
executable in the short-to-medium term; the notable challenges of the
Solvency II regime have resulted in significantly extended
implementation periods in various European jurisdictions.
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\20\ See Council Directive 2009/138, On the Taking-Up and
Pursuit of the Buisness of Insurance and Reinsurance (Solvency II),
2009 O.J. (L 335) 1 (EC).
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The Board also analyzed a potential regulatory capital framework
for supervised institutions significantly engaged in insurance
activities that is based on internal stress testing. This approach
would rely on internal models, be highly novel and complex, would
entail a large and lengthy construction project, and would require a
substantial dedication of supervisory resources to superintend. The
Board intends to continue exploration of internal stress testing as it
builds its supervisory stress testing program for systemically
important insurance companies and its broader supervision program for
supervised institutions significantly engaged in insurance activities.
Question 38. Should the Board reevaluate any of these
approaches? What additional consideration, if any, should the Board
give to any of the regulatory capital approaches discussed above?
III. Conclusion
The Board is seeking information on all aspects of its approaches
to insurance regulatory capital and invites comment on the appropriate
consolidated capital requirements for systemically important insurance
companies and insurance depository institution holding companies. In
addition, the Board invites comment on all of the questions set forth
in this ANPR, as well as other issues that commenters may wish to
raise.
In connection with this ANPR, the Board will review all comments
submitted and supplementary information provided, as well as
information regarding insurance regulatory capital derived from the
Board's regulatory and supervisory activities. Once the Board has
completed its review, the Board anticipates that it will issue a notice
of proposed rulemaking to establish a regulatory capital framework for
supervised institutions significantly engaged in insurance activities.
By order of the Board of Governors of the Federal Reserve
System, June 9, 2016.
Robert deV. Frierson,
Secretary of the Board.
[FR Doc. 2016-14004 Filed 6-13-16; 8:45 am]
BILLING CODE 6210-01-P