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Conservative-leaning groups on Tuesday urged the U.S. Congress to remove the ability of the Financial Stability Oversight Council to tag insurers as “too big to fail,” but a Wharton School professor encouraged legislators to keep the council’s protection powers in place.
The FSOC currently has the power to designate financial institutions as systemically important financial institutions subject to heightened capital requirements and reporting rules, although a legislative proposal currently being drafted would eliminate the controversial designation for nonbank financial institutions such as insurers. The council has used that authority to designate four nonbank institutions as SIFIs, including American International Group Inc.
But the council applies its designation authority “inconsistently and arbitrarily,” according to a report prepared by the Republican staff of the House Financial Services Committee released in February.
“For a long time, the actions and deliberations of FSOC were a mystery” because the majority of the council’s deliberations took place in executive sessions closed to the public, Congress and non-FSOC regulators and little documentation was kept, Rep. Ann Wagner, R-Mo., chair of the House subcommittee on oversight and investigations, said at the Tuesday hearing.
“The staff report verifies what we know: that Washington is simply unable to accurately identify and define systemic risk,” she said. “Instead, government bureaucrats have acted very subjectively and with very little transparency or accountability in exerting their power.”
But the Republican staff report “subjects the council to a degree of after-the-fact review inconsistent with the flexibility that Congress gave the council” on how it evaluates companies and attempts to isolate particular aspects of the council’s analysis to make arguments about inconsistency, said David Zaring, associate professor of legal studies and business ethics at The Wharton School of the University of Pennsylvania in Philadelphia.
“This picking and choosing is really not consistent with the way that FSOC designations work,” Mr. Zaring said, adding that only two insurers are actively designated as SIFIs and there is no indication that more designations are being considered.
Rep. Al Green, D-Texas, ranking member of the subcommittee, said the Republicans want to repeal a bureau that is designed to protect consumers.
“It’s there to prevent another AIG,” he said, referring to the government’s $185 billion rescue of the insurer in 2008. “It did so with (General Electric).”
In July 2013, the council voted to designate AIG and Norwalk, Connecticut-based General Electric Capital Corp. Inc. as SIFIs, with Newark, New Jersey-based Prudential Financial Inc. also designated as a SIFI in September 2013. But the council voted to rescind GE’s SIFI designation in June 2016 after the company changed its business by divesting assets and changing its funding model.
“While GE Capital transformed itself in an effort to move away from designation, it is clear that there were business reasons to restructure the company anyway,” Mr. Zaring said. “And as the CEO of AIG (Peter Hancock) has observed, designation ‘just simply isn't a binding constraint on our capital returns and our objectives. So, we don't spend too much time worrying about it.’ For that insurance company, designation has not been a burden, but rather a regulatory requirement that has not imperiled its business or ability to make plans for the future.”
But the FSOC’s designation of GE as a SIFI forced the company to jettison a very profitable business line, said Paul Kupiec, a resident scholar at the American Enterprise Institute in Washington.
Douglas Holtz-Eakin, president of center-right advocacy group the American Action Forum in Washington, urged legislators to remove the council’s ability to designate insurers as SIFIs, particularly as insurance companies are already subject to prudential and state regulation.
“The designation process has costs — consequential costs for the firms, for their customers and the economy as a whole and it’s a mistake to ignore these costs,” he said.
The council does not conduct a cost-benefit analysis even though designating an entity a SIFI can cost the company between $5 billion to $8 billion, Ms. Wagner said.
But Mr. Green questioned the costs of not designating insurance companies as SIFIs, with the lack of a designation of AIG as a SIFI before the financial crisis in particular causing “a great deal of stress.”
“AIG is the ultimate example of why we have to regulate some of the insurance companies, not all of them, some of them,” he said.
There has not been a financial crisis since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act despite worldwide financial turmoil, Mr. Zaring said.
“There’s definitely a sense that financial institutions, especially nonbanks, are more solvent and have better protections in place for a crisis and I think a lot of that has to do with the fact that they know FSOC is watching,” he said.
“I would say the FSOC has done nothing on regulation,” Mr. Kupiec countered.
A planned legislative proposal would eliminate the controversial “too big to fail” designation for nonbank financial institutions such as insurers.