'Systemically important' designations, the EU-US covered agreement and US enthusiasm for the IAIS may all disappear over the next four years with Donald Trump as president. Some state commissioners are planning to make the most of an administration that, like them, sees too much power in the hands of federal authorities. Callum Tanner reports
For as long as they have existed, state insurance commissioners have carefully guarded their right to regulate insurers in their own backyards. The National Association of Insurance Commissioners (NAIC) is celebrating its 145th year and many state-based insurance laws go back even further. It was not until the 2007-08 financial crisis that this status quo was meaningfully disrupted.
After mass bailouts and identification of systemic failings in banking and insurance, the Dodd Frank Act of 2010 established the Federal Insurance Office (FIO) to monitor all aspects of the insurance sector and gave more powers to the Federal Reserve. It also created the Financial Stability Oversight Council (FSOC), chaired by the US Treasury secretary, handing it power to designate insurers as systemically important financial institutions (Sifi), requiring higher capital and participation in federal stress tests.
Already these new federal powers have been resisted by MetLife which successfully removed its Sifi designation in federal court in March, but now state insurance commissioners think they can go even further once Donald Trump is president.
Even if Dodd Frank is not fully repealed or majorly reformed, the approach of the FIO, FSOC and Federal Reserve is likely to be very different under the next administration.
"You have to remember that insurance commissioners have been around for about 150 years. The FIO experiment has been alive for just over five. Many people would say that experiment has failed," says a senior insurance regulator in the US.
In Trump, the US will have a leader that is aggressively pro-business and anti-regulation. Republicans Jeb Hensarling and Paul Ryan have already floated the idea of a Dodd Frank repeal to the House of Representatives, with Trump's support. If this happens and nothing replaces it, the entire architecture of federal insurance regulation would be disbanded and leave state commissioners and US insurers free of federal oversight.
Even if Dodd Frank is not fully repealed or majorly reformed, the approach of the FIO, FSOC and Federal Reserve is likely to be very different under the next administration. This has implications not just for the dynamics of state-federal tensions in the US, but also reduces the likelihood of mutual recognition of insurance regimes with the EU in the form of a covered agreement.
Some US regulators also say there will also be less enthusiasm for global regulatory standards under development by the International Association of Insurance Supervisors (IAIS).
The senior US regulator, who preferred to remain anonymous for this article, believes one of the first things the next administration will target is the FSOC. "The role of the Federal Reserve related to insurance just got a lot less interesting," he says.
State commissioners never really saw the need for Sifi designations given, what they see as, the lack of systemic risk in traditional insurance and the strength of state-based insurance regulation – especially since the model holding company act came into force at the end of 2015.
The federal overlay to the act has been Sifi designation, but this is now likely to be reconsidered under the Trump administration.
"Whether Prudential and AIG's designations are unwound by a new FSOC, in the courts, or if congress has a different take on Dodd Frank, we may likely see a return of the states being the sole consolidated regulator for those firms," says the regulator.
The US Treasury, under Obama, has argued that this would leave a big gap in financial regulation and leave policyholders and taxpayers at risk. After a federal court ruled in MetLife's favour on removing its Sifi label in March, the US treasury tweeted that it would fight the decision that it believes undermines its ability to "protect the entire global economy". An appeal court heard the government's case in October, but proceedings were kept under seal.
"There is a cost to all of that regulation, and policyholders may ask 'is it worth it?'" Nick Gerhart, Iowa Insurance Commissioner
Nick Gerhart, insurance commissioner for the state of Iowa, says he cannot say whether Sifi designation will come to an end or not, but believes it would not be a problem if they did because he does not think traditional insurance is systemic.
AIG, the poster child for systemic risk in insurance, "should have been regulated at the federal level anyway" by the Office of Thrift Supervision, "but wasn't regulated very well," Gerhart says.
At AIG's investor day in November, chief executive Peter Hancock said changes to the make-up of the FSOC might lead the body to re-evaluate the importance of Sifi designation. The insurer has previously argued that even though it has substantially de-risked since 2008, its largely traditional insurance balance sheet is now subject to Sifi rules.
That may not last, however, given that Trump's choice for Treasury secretary, and therefore also FSOC chair, is Goldman Sachs veteran Steve Mnuchin. Under his leadership expectations are that Sifi designations in insurance are more likely to be repealed or reformed.
"There is a cost to all of that regulation, and policyholders may ask 'is it worth it?' Insurance experts as well as my peers, that have been part of the FSOC, have given dissenting opinions explaining why we don't think it is," says Gerhart.
The FIO, Federal Reserve and FSOC all declined to comment for this article. In the past, the FIO and Federal Reserve have emphasised that they are working collaboratively with the state regulators to raise supervision standards.
Many state commissioners are also hopeful the US government will take a different approach with the EU on a covered agreement once Trump is president. The agreement, which has been officially negotiated on for just over a year, would remove collateral barriers for EU reinsurers operating in the US and in return recognise the US regime as equivalent to Solvency II.
"There are rumblings that a lot of planning is going on to embed some real policy decisions in the eleventh hour before the next administration comes in"
In September NAIC vice-president Julie McPeak slammed the EU and federal bureaucrats for trying to solve a problem she said was "of the EU's own creation".
Under Trump most think an agreement will be less likely. The President-elect has said that in his first day in office he will scrap the Trans-Pacific Partnership, and is seen as unlikely to sign up to the Trans-Atlantic Trade and Investment Partnership (TTIP), proposed under Obama. The covered agreement was loosely attached to TTIP and seen to be one of the European Commission and United States Trade Representative's bargaining chips for the wider trade deal.
Commissioner Gerhart says the Trump administration will present an opportunity for state regulators to push back on the covered agreement.
"We will now be able to sit down and educate on why we think some of the points in the covered agreement are not necessary and duplicative, and how we would put in other guard rails to protect consumers," he says.
The anonymous regulator says he "highly suspects" the new government will "take a different tone and approach" in dealing with the EU next year. However, the threat of scrapping the covered agreement under Trump could also lead the Obama administration to attempt a quick deal on the covered agreement before Trump is inaugurated, he says.
"The FIO has gone into areas with questionable legal authority and there are rumblings that a lot of planning is going on to embed some real policy decisions in the eleventh hour before the next administration comes in," he says. "The perfect example is mutual recognition of regulation between the EU and the US, where we have reached an impasse."
Asked if a deal will be signed before the next administration comes into place, a spokesperson for the European Commission said "we indeed hope to conclude a deal soon."
Many think that if it is not signed by 20 January, it never will be.
US in IAIS?
The final battle where state regulators could now have the upper hand is with the International Association of Insurance Supervisors (IAIS). Although the IAIS cannot enforce regulation on its own, it is currently setting the policy agenda for regulators around the world.
Governor Daniel Tarullo of the Federal Reserve Board has already signalled that the insurance capital standard (ICS), being developed by the IAIS as a micro-prudential regime for internationally active firms, is not suitable for the US market in its current form. But that is not to say the ICS, or rules for global systemically important insurers (G-Siis), will not one day form part of the US regime.
Last week, a group of five global insurance companies, including AIG, developed a valuation metric for the ICS, somewhere between GAAP+ and market adjusted valuation. This is an attempt to find a compromise between US and EU accounting.
That may be wasted effort if Trump's top picks for senior federal regulators no longer see any value in IAIS participation.
"You are going to see a diminished enthusiasm and participation at the IAIS in the coming 12 to 18 months," says the senior regulator.
Iowa's Gerhart also thinks US regulators, both state and federal, will be apathetic towards IAIS work under Trump. "I have been critical of the IAIS work for over two years. I went to one of the [IAIS] meetings and I said at the time, 'I don't think I ever need to come back'."
If commissioners regain some or all of their authority from federal regulators, IAIS rulemaking is likely to fall far down their list of priorities. And even if FIO, FSOC and Federal Reserve powers are maintained, they will be headed up by Treasury secretary Mnuchin.
As one senior UK insurance industry representative puts it: "On the whole, it is difficult to identify the contribution of [the] ICS to making America great again."
The NAIC's Julie McPeak was re-elected to vice-chair of the IAIS in November, and FIO and Federal Reserve representatives currently drive forward a lot of the work at the IAIS. If the US is no longer involved in the future, insurers across the globe would likely conclude that efforts at a global capital standard have been a failure.
The implications of more powerful insurance commissioners are therefore not just limited to the US. In four years' time the Trump presidency may not have just scuppered post-crisis federal regulation in the US, but also regulation in development across the globe.
State vs state
State-federal tensions have dominated US insurance regulation over the last eight years, but some think state commissioners might now turn on each other under Trump.
Given state commissioners are not themselves politically impartial - being either directly elected or appointed by state governors - some think the Trump administration could cause tensions between the states. This risks the new enemy being fellow commissioners rather than federal regulators.
The two largest states by insurance market are California and New York. California's commissioner is David Jones, a directly elected Democrat, while Maria Vullo, New York's commissioner, was appointed by Democratic governor Andrew Cuomo. While they regulate firms in arguably the two most important states for insurance in the country, they face working with a majority of Republican commissioners across state lines.
As a consequence, both Democratic and Republican commissioners, along with their attorney generals, could be emboldened to act more independently in their approach to regulation, according to Matt Josefowicz, chief executive at insurance consulting firm Novarica in Boston.
"Some of the large powerful states that tend Democratic will feel there is a regulatory vacuum they are stepping into," he says. "If federal power starts to eclipse, the large powerful states are more likely to step into the breach."
As an example of this happening to a certain extent already, New York state has proposed cyber privacy rules which Josefowicz says are very prescriptive on how insurers need to handle data breaches. These kinds of added requirements from Democratic commissioners could be more likely in the future if federal authorities step back, he says.
"Insurers may find themselves dealing with aggressive state regulators with strong positions on things like privacy and cyber security."