The Fed and insurance rules: an eclectic fit

Published in: Risk, Environment, Capital, Regulation, RBC Worldwide, Associations, US - Canada - Bermuda, People, Climate change and sustainability, USA focus

Companies: Federal Reserve, Manulife

The US Federal Reserve created an advisory committee last month – and Manulife’s treasurer Halina von dem Hagen is joining it. She tells Sarfraz Thind about the key issues the market might want to consider right now, including mark-to-market regulation and systemic risk


It is no secret the Federal Reserve is involving itself more in US insurance regulations. Since the Dodd-Frank Act came into effect, regulatory power has edged away from US states, particularly when it comes to international matters.

Just last month, the Fed announced the development of prospective capital standards to govern eight US savings companies under its charge.

With a plethora of insurance regulations being thrashed out in the next half year — including the global Insurance Capital Standard (ICS) — it seems a critical time for rulemaking in the sector.

To help engage with the industry, the Fed has established the Insurance Policy Advisory Committee (IPAC). The first 21 individuals to sit on the board have been announced and its first meeting will be held on 4 November.

Halina von dem Hagen, treasurer and global head of capital at Manulife, is one of those 21 and says the industry is at an important crossroads when it comes to deciding its future business model. She talked to InsuranceERM about some of the key points that she believes merit discussion.

The impact of mark-to-market

The ICS will initially apply to roughly 50 internationally active insurance groups, but its impact will be felt far deeper in the industry. The controversial rule has split opinion on either side of the Atlantic and created no little friction in the process.

With the development of the ICS entering a critical phase, and important announcements expected during the November meeting of the International Association of Insurance Supervisors (IAIS) in Abu Dhabi, its use of mark-to-market methodologies for valuation and solvency requirements is bound to be a top priority for discussion, says von dem Hagen.

"The unqualified use of mark-to-market is outright non-economic for insurance"

She says the trend towards using mark-to-market methodologies in defining capital requirements “is very concerning” and “undermines” the long-term insurance model on which the industry is based in North America and other jurisdictions around the world.

“A mark-to-market perspective treats everything as a trading book, the value of which is to be crystallised today,” she says.

“As a result, the approach shortens artificially the time horizon for commercial decision making, including on illiquid long-term insurance liabilities and their supporting assets that are not intended for ongoing trading.

“I view therefore the unqualified use of mark-to-market as outright non-economic for insurance because it does not take into account the value of time. The methodology forces companies towards short-term thinking and actions.”

Von dem Hagen says the topic is not just academic. Given the long-term illiquid nature of their liabilities, insurers can act as stabilisers in times of market stress. However, mark-to-market type capital methodologies introduce volatility in the reported results that is not related to actual insurer obligations and thus undermines the commercial viability of long-term business, incentivising reductions in long-term insurance liabilities.

“These commercial decisions have public policy implications,” says von dem Hagen. “If the private market doesn’t offer long-term protection to our customers, who will?  Ultimately, it begs the question on the role of the government in providing for retirement and health protection, promoting investments in infrastructure and items such as renewable energy that tend to be long-term.”

"We do not have compelling enough methodologies that would provide the right balance between reacting to market trends that are here to stay and knee-jerk reactions to transitory market fluctuations"

She says the market is already seeing tangible examples of the prospective rules, with insurers reducing their offerings of long-term and guaranteed protection and retirement business. Von dem Hagen says “one cannot underestimate” the role that regulations play on insurance products and investments.

“As an economist, I understand why mark-to-market is so appealing — it is using the most current market information, and all of us have been trained to assume efficient markets that are supposedly always right,” she says.

“Unfortunately, we do not have compelling enough methodologies that would provide the right balance between reacting to market trends that are here to stay and knee-jerk reactions to transitory market fluctuations that are not appropriate for taking action.”

Defense of aggregation

Mark-to-market is, of course, not the only approach to group insurance regulation. The alternative promoted in the US is the aggregation method — of which the Fed’s building block approach is a variant — deemed by North Americans as the most viable given the nature of region’s insurance business. 

The idea is to use the capital frameworks designed locally in each jurisdiction, translating local ratios into one ratio, says von dem Hagen. While she may have had reservations over the methodology at the outset, she now feels it merits thoughtful consideration. 

"Critics too hastily discard this approach as a mishmash of different regimes"

“In my view critics too hastily discard this approach as a mishmash of different regimes,” she says. “I have to admit that initially I too was sceptical when exposed to the idea a few years ago, being trained on consolidated group-wide capital methodologies that the Canadian regulator OSFI [Office of the Superintendent of Financial Institutions] have had in place for decades.

“Having thought about it in an open-minded way, I came to appreciate key advantages of this approach. In essence, its foundation recognises that each regulator knows best what is appropriate for the market that they oversee directly.”

Insurance is a very local business, says von dem Hagen, and local regulators understand the needs of local customers, and the product and investment risks inherent in domestic markets. While it may not have the appeal of a “one-for-all methodology,” it has a “grassroots” advantage.

Systemic risk  

Systemic risk has been a concern for regulators since the financial crisis showed the dramatic and correlated spread of financial risks around the world. While the US Financial Stability Oversight Council (FSOC) appears to have resigned its systemically important financial institutions designation to the dust, assessing the issue remains one of top importance given various signs of weakness currently seen in the market.

According to von dem Hagen, the fastest transmission of systemic risk is through liquidity channels. The identification and mitigation of systemic activities – and the prudential rules – should therefore centre on liquidity risk.

“Insurers are typically cash generators with inflows of premia and dividends and coupons on the investment side,” she says. “We also tend to hold large amounts of very liquid assets, including government bonds, on our balance sheets. At the same time, we also tend to have significant exposures to derivatives that we use to mitigate our market risks.  With the move to central clearing, we need to ensure we each have appropriate access to cash to be posted as collateral as markets move.”

"Getting a handle on systemic liquidity necessitates cross-sectoral stress testing"

Looking at the recent repo market turmoil in the US when overnight lending rates rose up to 10% in September and caused a temporary liquidity squeeze for borrowers, cash liquidity is something insurers with their derivative books will need to consider.

“There is a lesson for all of us as to the internal stress testing we need to do on our derivative book and the ability to obtain cash when the need arises,” says von dem Hagen.

Getting a handle on systemic liquidity necessitates cross-sectoral stress testing between banks, asset managers, pension plans and insurers, she argues.

“Individually, it may be very reasonable to assume that we can turn quickly our government bonds or other paper into cash, and that the markets can absorb it. But are our individual actions compatible across financial services, when we aggregate intentions of all participants?

“A cross-sectoral stress test could illuminate us all, proactively identifying any system-wide vulnerabilities and thus allowing for a design of appropriate macro and micro responses.”


Seldom a day passes without some mention of sustainability and it is a subject von dem Hagen says she has strong convictions on.

“Insurers have a long-term horizon for their business, with the wellbeing of policyholders aligned with our own business objectives,” she says. “As such, we have an interest in the sustainability of our environment that we can promote both as investors and issuers.”

Manulife was the first life insurance company to issue a green bond in 2017. Despite being fairly nascent — green bonds contribute approximately 4% of overall bond issuance in Europe and less than half that in the US — insurer interest in sustainable bonds is on the rise, both on the investor and issuer side.

But encouraging growth requires a standardisation of definitions and frameworks to mitigate the key existing risks around issuing green or sustainable bonds relative to regular bonds.

"Every effort that supports our environment is valuable and serves the cause"

“This risk centres around reputation, legal and accounting risk, as sustainable finance requires new frameworks, measurements and disclosures,” says von dem Hagen. “At the same time, if standards become more stringent, these very risks may increase and their mitigation would raise the issuance costs. For now, there is a very limited appetite by investors and issuers to absorb these costs.” 

Von dem Hagen says there is a constructive role for governments to promote the sustainability agenda by incentivising sustainable investment and issuance through tools at their disposal, including tax incentives. On the other hand, she says she is concerned by some “dogmatic” viewpoints in the market which push radical sustainability solutions.

“I am concerned with what I perceive aspects of the debate that tend to dismiss efforts to make progress in reducing carbon emissions if they are not deemed to be radical enough,” she says.  “I believe every effort that supports our environment is valuable and serves the cause.”

It will be ample food for thought for the regulator.

Sarfraz Thind