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December 19, 2011updated 13 Apr 2017 8:46am

The Dodd-Frank regulatory conundrum

Under the Dodd-Frank Act, all but the very largest US life insurers appear likely to be subject to additional regulation by the Federal Reserve Board But this could change at the whim of newly-created bodies, the Financial Stability Oversight Council and Federal Insurance Office

By Charles Davis

Under the Dodd-Frank Act, all but the very largest US life insurers appear likely to be subject to additional regulation by the Federal Reserve Board. But this could change at the whim of newly-created bodies, the Financial Stability Oversight Council and Federal Insurance Office. Charles Davis reports.


US insurance companies breathed an initial sigh of relief after escaping the regulatory crosshairs of the new Consumer Financial Protection Bureau (CFPB). However, the industry may not escape entirely from greater compliance burdens as the Dodd-Frank Act continues to produce new regulations.

Banks selling insurance and debt protection products likely could face heightened scrutiny, as the act gave the new bureau the power to review whether banks are doing an adequate job of disclosing terms to customers of nearly all financial services products of institutions with total assets over $10bn.

While this excludes all but the largest insurers, the ways in which the CFPB decides to review disclosures of large institutions could work its way down the regulatory food chain to all banks that provide life insurance, credit insurance and debt protection services

Many Dodd-Frank Act provisions call for studies that could result in new rules, so the long-term impact is unknown.

Regulatory developments set in motion by the act are only now starting, but it’s clear that several potential effects on life insurance are emerging.

But the insurance industry can claim some initial victories in what was excluded from the act. The most significant was that neither Congressional leaders nor Obama administration officials chose to take on the fight of proposing federal regulation of insurance.

The act leaves the current regime of state regulation in place, and, in one important battle, drew an even stronger line in the sand by rebuffing the Security and Exchange Commission’s (SEC) attempt to gain jurisdiction over indexed products.


Back-door route

The drama is far from over, though, as the act did create the new Federal Insurance Office, which is charged with the task of studying potential federal regulation of insurance and is seen in some quarters as a back-door route for federal regulation of insurance.

The act also rather ominously grants potential regulatory authority to federal banking regulators and the newly created Financial Stability Oversight Council over large non-bank institutions.

It authorises the council to determine that “material distress” at a non-bank financial company or the nature or operations of the company could pose a threat to US financial stability, and to determine if the Board of Governors of the Federal Reserve System (Fed) should supervise the company.

If the council designated an insurer’s parent holding company as a “significant non-bank”, that company would be required to register and file reports with the Fed and be subject to heightened prudential standards including capital and liquidity requirements.

In addition to other duties, the council is charged with monitoring domestic and international financial regulatory proposals, including insurance and accounting issues. The council is charged with advising Congress and making recommendations in areas that will enhance the stability of the financial markets. The act specifically listed insurance as one of the areas for which the council is to monitor and provide advice.

Insurers, bank insurance units and brokerage firms also are closing watching implementation of the Volcker Rule, a provision in the act designed to prevent proprietary trading by restricting sponsorship and investment in hedge funds and private equity funds by what the law calls ‘banking entities’.

Banking entities are broadly defined to include non-bank companies with an affiliated insured bank or savings association. This means that if an insurer owns an insured depository institution, the Volcker Rule’s prohibitions could apply to the entire complex.


Some success

Insurers successfully sought an exception allowing insurance companies to conduct proprietary trading for their general accounts, but for insurers that own an insured depository institution, the Volcker Rule could have a huge impact on hedge fund and private equity fund formation and operation.

Perhaps the largest unanswered question posed by the act is the potential fiduciary duty of broker-dealers. The SEC is directed by the law to consider rules to impose a fiduciary duty standard on broker-dealers with the goal of harmonising standards of care owed by broker-dealers and investment advisers for investment advice to retail customers.

Harmonisation generated tremendous controversy during the legislative process that gave rise to the act, with insurance industry advocates strongly opposed to adoption of a fiduciary duty standard for broker-dealers.

Insurance industry representatives continue to work on clarifying provisions of the act. Several insurers testified in support of amendments to Dodd-Frank in November, aiming to reduce bureaucratic burdens inadvertently created when the law was enacted.

Members of the House Financial Services Subcommittee are weighing changes to Dodd-Frank that would streamline the Federal Insurance Office’s subpoena process, add more confidentiality protections for data collected by those subpoenas and an insurance company exemption for subpoenas originating from the Office of Financial Research.

Appearing before the subcommittee, insurance regulators affirmed their willingness to participate in the implementation of the Dodd-Frank Act, but stressed that industry bore no responsibility for excesses in other financial services industries that gave rise to the law.

Joseph Torti, deputy director and superintendent of insurance and banking at the Rhode Island Department of Business Regulation, testified on behalf of the National Association of Insurance Commissioners. Torti said the association has not taken an official stance on Dodd-Frank, but is a willing partner in its implementation.

The NAIC, Torti said, “strongly believes the implementation of Dodd-Frank by the federal agencies or any legislative efforts to amend it should be consistent with Dodd-Frank’s recognition of the uniqueness of the insurer business model and the strength of the national state-based system of insurance regulation”.

The civil tone of the hearing belies the contentiousness between federal regulators and insurers, who see no reason to lump the industry in with other, riskier sectors of the financial services industry. The coming months and years will provide a steady stream of regulatory battles as Dodd-Frank slowly takes shape.

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