The International Association of Insurance Supervisors (IAIS) is no closer to enacting international capital standards for insurers than it was when it took up the task five years ago, attendees at the recent PCI annual meeting in Chicago heard from a former participant in those negotiations.
Daniel Tarullo, who resigned from the Board of Governors of the Federal Reserve in April 2017, was a key participant in efforts to enhance financial regulation following the financial crisis of 2008. In his PCI address, he reported that differences between the European Union and the United States remain a “substantial obstacle across a range of issues in international capital standard setting.”
In particular, “there’s widespread agreement among U.S. state insurance commissioners and within the relevant parts of the federal government that the EU’s Solvency II directive should not be the basis for IAIS capital standards,” he said.
Variations between Solvency II standards and U.S. general accepted accounting principles could “introduce excessive volatility” in the market, he continued, adding that “we have learned from our experience with banks the dangers of excessive reliance on internal models as the basis for capital regulation.”
Coming to agreement on international capital standard for insurers is proving to be more challenging than in banking.
Banking capital standards, dating from the “Basel I” accord of 1988, were developed essentially on a “blank slate” and constituted “a common frame of reference” for later modifications, according to Tarullo. In contrast, he noted, the IAIS is attempting to develop standards for insurers when there are already national guidelines for maintaining and monitoring insurance capital.
As it is, U.S. insurance regulators may have a hard time deciding whether and how to impose capital standards on insurers that are “internationally active.”
Under a definition developed by the IAIS, an insurer is deemed to be internationally active if it operates in three or more jurisdictions and earns at least 10% of its premium from outside of its home jurisdiction, and if it has at least $50 billion in assets or $10 billion in annual direct written premium.
Insurers with those characteristics account for only “a very small fraction” of U.S. insurance companies, Tarullo said, and they represent a much smaller portion of U.S. insurance assets than the corresponding percentage for U.S. banks that are active internationally.
Given that, Tarullo predicted that regulators will have to determine if the risk profile and activities of internationally active insurers are really much different from other carriers, and warrant more stringent regulation.
“If the new standards were applied only to those [internationally active] firms, they might be placed at an unwarranted competitive disadvantage,” he said. “But if regulators try to avoid this by applying the regulations to all insurers, an equally unwarranted level of complexity and constraint might be imposed on much smaller firms.
“The convoluted approach the IAIS is taking to capital standards is emblematic of the difficulties that organization is having in making progress,” he said.
Regarding the Federal Reserve’s monetary policy, Tarullo said he is frequently asked when the economy, interest rates, and the Fed’s balance sheet will “get back to normal.”
His answer: never, if you expect “normal” to mirror conditions before the 2008 financial crisis.
In particular, “full employment” will not be the same with an aging workforce and more part-time workers. As a result, the “neutral” Fed funds rate of interest (the rate needed to maintain full employment without unleashing inflation) will be nominally lower than in earlier decades.
As for the Fed’s balance sheet, it has expanded to an unprecedented degree, and the Fed’s governors have just begun to shrink it. “There’s never been a reduction of a balance sheet of this size,” Tarullo said. “No one believe it will regain its pre-crisis level.”