Dodd-Frank and Its Impact on the Insurance Industry: FSOC, FIO and - PowerPoint PPT Presentation

Dodd-Frank and Its Impact on the Insurance Industry: FSOC, FIO and Beyond Nick Pearson Geoffrey Etherington Teddy Eynon Partner Partner Partner New York, NY New York, NY Washington, DC

Dodd-Frank and Insurance Regulation Presented by: Nick Pearson, Partner New York, New York

Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”)  The US Government’s most significant law-making response to the 2008 financial crisis.  Intended to identify and reduce systemic risk to the US financial system.  Largely bypasses insurance regulation – only 16 of the Act’s 849 pages are directly focused on insurance.

Historical Context: State vs. Federal Regulation of Insurance  Insurance is primarily regulated by the states.  The US Supreme Court decided for and then against state regulation in 1869 and 1944, respectively.  However, in 1945 Congress preserved state regulation through enactment of the McCarran- Ferguson Act.

Dodd-Frank does Not Fundamentally Alter State Regulation of Insurance  Congress reluctant to overturn state regulation of the insurance industry  Lobbying efforts of insurers and state regulators  Effectiveness of state insurance regulation, even through the financial crisis of 2008-2009  Creates the Federal Insurance Office (the “FIO”)  the first permanent federal entity entirely focused on the oversight of the insurance market  Addresses aspects of two relatively narrow areas of insurance regulation:  Surplus Lines Insurance  Reinsurance

The Federal Insurance Office  Part of The Department of the Treasury  FIO Director is appointed by the Secretary of the Treasury.  Michael McRaith has been appointed the first Director of the FIO and has recently left his position as Illinois Director of Insurance in order to step into his new role.  The Dodd-Frank Act does not grant the FIO or The Department of the Treasury any general supervisory or regulatory authority over the business of insurance.  All lines except for:  Long-term care;  Crop insurance under the federal crop insurance program; and  Health insurance.

Functions of the Federal Insurance Office  Monitor all aspects of the insurance industry and report  Report due to Congress in early 2012 on how to modernize and improve the system of insurance regulation in the US  Annual reports to the President and Congress on the insurance industry  Consult with state insurance regulators on insurance matters of national and international importance  Identify insurers that may need supervision by Federal Reserve due to systemic risk  Assist the Secretary of the Treasury in administering federal Terrorism Insurance Program  Coordinate and develop federal policy on international insurance issues and assist in negotiating international agreements on insurance or reinsurance  Perform any other related duties and authorities as directed by the Secretary of the Treasury

Dodd-Frank Act Title V – Nonadmitted and Reinsurance Reform Act of 2010  Dodd-Frank Title V - The Nonadmitted and Reinsurance Reform Act of 2010 (“NARRA”)  Effective July 21, 2011  Preempts non-conforming state regulation  Addresses surplus lines and reinsurance

Changes to the Regulation of Surplus Lines Insurance under the Dodd-Frank Act  Simplification of Insurer Entry into the Surplus Lines Market  Non-US Surplus Lines Insurers – No state may prohibit a surplus lines broker from placing surplus lines insurance with a non-US insurer that is listed on the NAIC Quarterly List of Alien Insurers  US-Domiciled Surplus Lines Insurers – All states are bound by the standards of eligibility contained in the NAIC Non- Admitted Insurer Model Act  Requires all states to exempt qualifying large commercial insureds from the surplus lines laws, including the broker diligent search requirement.  Simplifies regulation and taxation of multi-state risks  Only the insured’s home state can regulate and collect premium tax on the placement of surplus lines policies  Result should be more surplus lines business

Changes to the Regulation of Reinsurance under the Dodd-Frank Act  Does not reduce collateral requirements for alien reinsurers, but opens the door for reform by making a cedent’s domiciliary state’s determination on credit for reinsurance binding on all other states.  Should encourage adoption of lower collateral requirements for unauthorized reinsurers on a state by state basis.  Lower collateral costs for highly rated reinsurers should make them more competitive.  Thus far, Florida, Indiana, New Jersey and New York have relaxed their unauthorized reinsurer collateral requirements.  Other Changes:  Restricts regulation of reinsurance contracts to cedent’s domiciliary state; and  Restricts regulation of reinsurer solvency to the reinsurer’s domiciliary state.

Dodd-Frank and its Impact on the Insurance Industry: Financial Stability Oversight Council (FSOC) and New Developments: Federal Advisory Committee on Insurance (FACI) Presented by: Geoffrey Etherington, Partner New York, New York

What is the FSOC?  FSOC Authorized—Title I, Subtitle A of Dodd Frank - Attachment A  Ten voting members—Chaired by Secretary of the Treasury—Sec. 111(b)(1)  Nine are federal banking, securities, housing or commodities regulators  On June 27, 2011, President Obama nominated Roy Woodall, former Kentucky Insurance Commissioner, as the independent member “having insurance expertise.” Mr. Woodall must be confirmed by the Senate—Sec. 111(b)(1)(J)  Five non-voting (Sec. 111(b)(2)) including:  Director of Federal Insurance Office—Michael McRaith, Illinois Insurance Director—assumed position June 13, 2011  A state insurance commissioner—John Huff, Missouri Department of Insurance, Financial Institutions and Professional Registration—designated by NAIC

FSOC Mission—Sec. 112(a)(1)  Identify risks to US financial stability related to large, interconnected bank holding companies and nonbank financial companies  Eliminate expectations that any firm is too big to fail  Respond to emerging threats to US financial markets

Regulation of Insurers and Reinsurers that May Pose Systemic Risks  Nonbank financial company defined (Sec. 102(a)(4)— Attachment B ) as a US or foreign company that:  Engages in the US in  Activities that are financial in nature under Section 4(k) of Bank Holding Company Act of 1956, 12 U.S.C. Sec. 1843 (BHCA).  Insurance and reinsurance activities are financial in nature under Section 4(k) of the BHCA

Regulation of Insurers and Reinsurers that May Pose Systemic Risks (cont.)  FSOC may direct Board of Governors of the Federal Reserve (FRB) to regulate an insurance or reinsurance company or holding company as a nonbank financial company  If its “material financial distress…could pose a threat to the financial stability of the United States”—Sec. 113(a) and (b)  FSOC to consider the following factors (Sec. 113(a)(2) and (b)(2)):  Leverage  Off-balance sheet exposures  Relationships with other significant nonbank financial and bank holding companies  Importance as source of credit or liquidity

Regulation of Insurers and Reinsurers that May Pose Systemic Risks (cont.)  Extent to which assets are managed rather than owned and whether ownership of managed assets is diffuse  Nature, scope, size, scale, concentration, interconnectedness and mix of activities  Degree of current regulation  Amount and nature of financial asset  Amount and types of liabilities, including reliance on short- term funding  Other factors deemed appropriate

FSOC Proposed Rulemaking – January 2011  FSOC proposes to focus on six categories to determine if nonbank financial company poses systemic risk--1310.10(a) and .11(a) of proposed rule-- Attachment C  Size  Lack of substitutes for the financial services and products provided  Interconnectedness with other financial firms  Leverage  Liquidity risk and maturity mismatch  Existing regulatory scrutiny

FSOC Proposed Rulemaking – January 2011 (cont.)  In Supplementary Information in the Federal Register notice, FSOC indicated that (See III. Overview of Proposed Rule):  Size, lack of substitutes and interconnectedness measure risk of possible “spillover” from financial distress of a nonbank financial company  Leverage, liquidity risk and maturity mismatch and existing regulatory scrutiny measure “how vulnerable” a nonbank financial company is to financial distress  FSOC wants to develop “quantitative metrics” for the six categories

FSOC Proposed Rulemaking – January 2011 (cont.)  Comments as to proposed rule closed on February 25, 2011—See Attachment D for some of these comments  Industry groups including ACLI, AIA, RAA and PCIA and the Property and Casualty Insurers Coalition, consisting of ACE, Allstate, CNA, Liberty Mutual, Nationwide, State Farm and USAA  CEA, a federation of European insurers and reinsurers, commented  Most comments sought delay of rule making until voting member of FSOC with insurance industry expertise and Federal Insurance Office (FIO) director appointed  Other comments asserted that participants in the insurance and reinsurance industry are not likely to pose systemic threats