Dodd-Frank Wall Street Reform May Significantly Impact Insurers
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which effects comprehensive changes to the regulation of financial services in the United States and subjects the insurance industry to substantial additional federal regulation. Dodd-Frank directs existing and newly-created government agencies and bodies to promulgate regulations implementing the law, a process anticipated to occur over the next few years following enactment of the legislation. While no one can cannot predict with any certainty the requirements of the regulations ultimately adopted, or how Dodd-Frank and such regulations will affect the financial markets generally, key aspects of Dodd-Frank’s potential impact on the insurance industry include:
Insurers will become subject, as savings and loan holding companies, to regulation by the Board of Governors of the Federal Reserve System (“FRB”), which will have authority, among other powers, to impose capital requirements on insurers and their subsidiaries. The FRB has authority to set capital regulations and exercise general supervisory authority the insurance industry.
Insurers designated by the newly established Financial Stability Oversight Council (“Council”) as “systemically significant companies,” will become subject to unspecified stricter prudential standards, including stricter requirements and limitations relating to risk-based capital, leverage, liquidity and credit exposure, as well as overall risk management requirements, management interlock prohibitions and a requirement to maintain a plan for rapid and orderly dissolution in the event of severe financial distress. Failure to meet defined measures of financial condition could result in substantial restrictions on their businesses.
Insurers will become subject, as savings and loan holding companies (and particularly if designated as a “systemically significant company”) to stress tests to be promulgated by the FRB which could cause them to alter their business practices or affect the perceptions of regulators, rating agencies, customers, counterparties or investors of their financial strength.
As a savings and loan holding company, an insurer (and its subsidiaries) will become subject to the “Volcker Rule” provisions of Dodd-Frank prohibiting, subject to the rule’s exceptions, “proprietary trading” and the sponsorship of, and investment in, funds (referred to in Dodd-Frank as hedge funds or private equity funds) that rely on certain exemptions from the Investment Company Act of 1940, as amended (collectively, “covered funds”). It is possible that regulations could require insurers and their subsidiaries to dispose of covered fund investments, significantly alter their business practices in these operations and/or diminish the attractiveness of their covered fund products to clients. In addition, actions taken by other financial entities in response to the Volcker Rule could potentially negatively affect the market for, returns from or liquidity of their investments in covered funds affiliated with such other financial entities.
Dodd-Frank creates a new framework for regulation of the over-the-counter (“OTC”) derivatives markets which could impact various activities of insurers and insurance affiliates which use derivatives for various purposes (including hedging interest rate, foreign currency and equity market exposures). Final regulations adopted could substantially increase the cost of hedging and related operations, affect the profitability of various products or their attractiveness to the insurers’ clients, or cause them to alter their hedging strategies or implementation thereof.
Dodd-Frank establishes a Federal Insurance Office within the Department of the Treasury which will perform various functions with respect to insurance and will conduct a study on how to modernize and improve the system of insurance regulation in the United States, including by increased national uniformity through either a federal charter or effective action by the states.