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January 09, 2019

While speaking at the American Council of Life Insurers (ACLI) Executive Roundtable in Florida, Randal K. Quarles of FED provided some updates on the forthcoming proposal on insurance holding company capital requirements, often referred to as the Building Block Approach. He also discussed the importance of insurance sector to the economy and the role of FED in the consolidated supervision of insurance firms.

After stating that Dodd-Frank Act gave FED regulatory responsibilities for insurance holding companies that choose to own a federally insured depository institution and those designated by FSOC, Mr. Quarles moved on to discuss the advance notice of proposed rulemaking (ANPR) on insurance capital requirements, which FED had issued in June 2016. The ANPR had set out two frameworks for capital standards that are each unlike the capital rules for bank holding companies: a "consolidated approach" applicable to systemically important insurance companies and a "Building Block Approach" to be applied to savings and loan holding companies or bank holding companies with significant insurance activities. The Building Block Approach, as set out in the ANPR, was fashioned as a framework that builds on the regulatory capital rules of subsidiaries' functional regulators—state or foreign insurance regulators for insurance subsidiaries and federal banking regulators for insured depository institutions—to provide a consolidated capital requirement. He mentioned that FED appreciates the comments received, including from the ACLI and other interested parties, and has worked hard to reflect the perspectives of commenters in developing the framework. FED expects to publish a formal proposal in the "not-too-distant future."

He then explained that, for various reasons, in designing the Building Block Approach, FED had decided against applying the bank holding company capital rules to supervised insurance firms, the "capital approach akin to the European Solvency II framework," and the Insurance Capital Standard (ICS) by IAIS. He added that for any form of an ICS to be implementable globally, it needs to be suitable for the U.S. insurance market. The current core proposal in the ICS would face implementation challenges in the United States. For instance, such a framework may fail to adequately account for the U.S. accounting frameworks, both Generally Accepted Accounting Principles (GAAP) and the NAIC's Statutory Accounting Principles, can introduce excessive volatility, and may involve excessive reliance on the internal models of supervised firms. This motivates FED's advocacy of an aggregation alternative and the use of an alternative valuation method that derives from U.S. GAAP in the ICS. 

The proposed Building Block Approach is an approach to a consolidated capital requirement that considers all material risks in the enterprise by aggregating the capital positions of companies under an insurance holding company, after making some adjustments and scaling them to a common capital regime. These building blocks are then used to calculate combined, enterprise-level capital resources and requirements. In each building block, the Building Block Approach generally applies the capital regime for that block to the subsidiaries in that block. For instance, in a life insurance building block, subsidiaries within this block would be treated in the Building Block Approach the way they would be treated under life insurance capital requirements. The Building Block Approach would apply insurance capital rules consistently, without regard to permitted accounting practices granted by an individual state, thus uniformly applying statutory accounting principles as set forth by NAIC. Measures to avoid double-counting, including double-leverage, that could arise from intercompany transactions would be built into the approach's aggregation process.

Other areas where adjustments would be made include provisions to comply with the Collins Amendment of the Dodd-Frank Act—for instance, allowing only instruments meeting the criteria under the FED's bank capital rules to qualify as capital for an insurance holding company—and technical adjustments. Two building blocks under two different capital regimes cannot simply be added together if, as is frequently the case, each regime has a different scale for its ratios and thresholds. The Building Block Approach proposes to scale and equate capital positions in different regimes through analyzing historical defaults under those regimes. In conclusion, Mr. Quarles reinforced that FED remains committed to discharging its domestic authority responsibly in a way that recognizes the unique business of insurance companies. Additionally, FED will continue to advocate for international insurance standards that promote a global level playing field and work well for the U.S. insurance market. 


Related Link: Speech

Keywords: Americas, US, Insurance, Accounting, Building Block Approach, Capital Requirements, Dodd Frank Act, US GAAP, FED

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