On a Supreme Court decision, and a Proposed Financial Overhaul

It will be interesting to see if a U.S. Supreme Court decision today will have any impact on insurers down the road if a federal charter or optional federal charter for insurers does become a reality. The decision finds that state attorneys general could investigate national banks for lending discrimination among other crimes if they do so through the courts.

The court found that states still can enforce fair-lending laws even if national banks come under federal banking regulation.

Last week, the Obama administration released its plan for an overhaul of financial services regulation. The plan does not take a position on whether insurance should be federally regulated or should continue to be regulated by the states. And it does not reference an optional federal charter.

But, if some form of federal regulation is put in place, it will be interesting to watch and see if the Court decision or the reasoning that went into the decision will be used by states to retain authority to regulate insurers.

The long awaited Obama plan has drawn reaction from many in the insurance industry, including the plan to create a Consumer Financial Protection Agency. During a hearing last week, Gary Hughes, executive vice president and general counsel with the American Council of Life Insurers testified before the U.S. House of Representatives Committee on Capital Markets, Insurance and Government Sponsored Enterprises.
Hughes told the House committee that the interests of life insurance consumers would not be well served by establishing a CFPA. He cites four reasons why insurance products currently have adequate protections. According to Hughes, life insurance products are already heavily regulated; have not contributed to the present financial crisis; the regulation of life insurance is tied to solvency and should not be separated with a separate agency; and, that the in-depth understanding of life insurance would not exist at the federal level and within a CFPA.

Ralph Tyler, Maryland insurance commissioner on behalf of the National Association of Insurance Commissioners, Kansas City, Mo., noted the states have “a wide range of consumer protection tools” and consequently, a new agency is not necessary and would cause overlaps that “lead to preemption of state laws and rules designed specifically to address the complexities of insurance.”

Tyler noted state consumer protections including the Unfair Trade Practices Act, and company and producer licensing. Tyler concludes that a competing federal regulator in the form of the agency “no matter how innocuously envisioned, will ultimately erode a state system that is inherently centrist and undeniably effective.”

Comment on the Obama plan was also offered by Moody’s Investors Service in a commentary titled a “Preliminary Assessment of the Obama Administration’s Regulatory Reform Proposal.”

The new plan creates offsetting dynamics involving, on one hand higher capital requirements, leverage limits, consolidated supervision and more restrictions on products (the latter resulting from a Consumer Protection Agency), which make financial institutions safer while, on the other hand, increasing these firms’ cost of funding and, therefore, making them less profitable, according to Jean-Francois Tremblay, a Moody’s vice president-senior analyst. This may be an overall positive factor for creditors, whereas equity investors might see the lower expected EPS negatively. We would expect a safer company to also have lower borrowing costs, he adds.

The special comment offers an initial assessment including the following:
On a proposed Office of National Insurance, the Moody’s report states from a credit perspective that:

• Insurers have generally maintained strong relationships with their state regulators and have been able to achieve modifications in state rules, forbearance of certain statutory requirements, and have received latitude in getting regulatory approval to extract dividends and/or assets from operating companies. National oversight may reduce this flexibility. This could potentially put downward pressure on the ratings of these firms, but it will take time to resolve and there is no immediate implication. Furthermore, such ratings pressure can potentially be offset by other, positive implications arising from a more consistent regulatory framework across institutions and products.
• The lack of uniformity, both nationally and internationally, may have distorted competition and led to poor and sometimes riskier product innovation and, ultimately, higher insurance costs. The new federal regulatory body is expected to have the powers to address these shortcomings, including the power to propose regulations of financial instruments that are designed to look like insurance products, but that in fact are financial products that could present a systemic risk. More uniform and stringent prudential standards would make for a healthier, arbitrage-free competitive environment that would improve the comparability of firms and products and should culminate in a credit positive for policyholders and senior creditors.

• The revised, broader resolution powers pose a potential risk to junior creditors of an insurance holding company. Under the proposal, if an insurance company were failing, the ONI would consult with the Federal Reserve and the FDIC to determine which parts of the insurance group to support. It would have the power to sell or transfer all or any part of the assets of the firm in receivership to a bridge institution or other entity. This means that a number of creditors, especially the most junior ones, could be left with the part of the original entity that holds the underperforming assets. We will closely monitor how the resolution proposal evolves throughout the legislative process and how likely this scenario could materialize.

• For financial guarantors, the elements of the proposal relating to improved reporting and required retained interest in securitization by lenders may, if enacted, diminish the value added by guarantors as the proposals would be expected to improve transparency and alignment of interest between issuers and investors.