Regulatory Capital Adequacy for Life Insurance Companies

Link: https://www.soa.org/4a194f/globalassets/assets/files/resources/research-report/2023/erm-191-reg-capital-with-final-visuals.pdf

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The purpose of this paper is to introduce the concept of capital and key related terms, as well as to compare and contrast four key regulatory capital regimes. Not only is each regime’s methodology explained with key terms defined and formulas provided, but illustrative applications of each approach are provided via an example with a baseline scenario. Comparison among these capital regimes is also provided using this same model with two alternative scenarios.

The four regulatory required capital approaches discussed in this paper are National Association of Insurance Commissioners’ (NAIC) Risk-Based Capital (RBC; the United States), Life Insurer Capital Adequacy Test (LICAT; Canada), Solvency II (European Union), and the Bermuda Insurance Solvency (BIS) Framework which describes the Bermuda Solvency Capital Requirement (BSCR). These terms may be used interchangeably. These standards apply to a large portion of the global life insurance market and were chosen to give the reader a better understanding of how required capital varies by jurisdiction, and the impact of the measurement method on life insurance company capital.

All of these approaches are similar in that they identify key risks for which capital should be held (e.g., asset default and market risks, insurance risks, etc.). However, they differ in significant ways too, including their defined risk taxonomy and risk diversification / aggregation methodologies, as well as required minimum capital thresholds and corresponding implications. Another key difference is that the US’s RBC methodology is largely factor-based, while the other methodologies are model-based approaches. For the model-based approaches, Solvency II and BIS allow for the use of internal models when certain conditions are satisfied. Another difference is that the RBC methodology is largely derived using book values, while the others use economic-based measurements.

As mentioned above, this paper provides a model that calculates the capital requirements for each jurisdiction. The model is used to compare regulatory solvency capital using identical portfolios for both assets and liabilities. For simplicity, we have assumed that all liabilities originated in the same jurisdiction as the calculation. As the objective of the model is to illustrate required capital calculation methodology differences, a number of modeling simplifications were employed and detailed later in the paper. The model considers two products – term insurance and payout annuities, approximately equally weighted in terms of reserves. The assets consist of two non-callable bonds of differing durations, mortgages, real estate, and equities. Two alternative scenarios have been considered, one where the company invests in riskier assets than assumed in the base case and one where the liability mix is more heavily weighted to annuities as compared to the base case.

Author(s): Ben Leiser, FSA, MAAA; Janine Bender, ASA, MAAA; Brian Kaul

Publication Date: July 2023

Publication Site: Society of Actuaries

Statement of CFPB Director Rohit Chopra, Member, FDIC Board of Directors, on the Proposed Special Deposit Insurance Assessment on Large Banks

Link: https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-on-the-proposed-special-deposit-insurance-assessment-on-large-banks/

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First, we need to simplify our rules while strengthening them. Too many areas of regulation across our economy have become so complicated with weird formulas, dizzying methodologies, and endless loopholes and carveouts. We need simpler rules to prevent future disasters. A better alternative is to create bright line limits, with clear sanctions, including size caps and growth restrictions. Clearly observable metrics make it easier to monitor and increase consistency.

Second, we need to stop subsidizing the largest and riskiest banks by giving out free deposit insurance. When small banks fail, they rarely lead to much cost to the FDIC’s Deposit Insurance Fund, since they can be fairly easily wound down or sold. But when large banks fail, the costs to the Deposit Insurance Fund and broader economy can be steep. To make matters worse, those institutional clients with the biggest deposits feel they can get around insurance limits by going to the biggest banks. In other words, people perceive that the biggest banks get free deposit insurance over the legal limits by way of their too-big-to-fail status.

Fixing our deposit insurance pricing structure is just one small step that could help address this problem. Large, riskier banks should pay more and small, simpler banks should pay less. We should also make the framework countercyclical, so that we aren’t in the position of raising rates when banking conditions are weak.

While today’s proposed special assessment will not fall on small, local banks, the failure of First Republic Bank will be a direct hit to the Deposit Insurance Fund that is not being recouped through this special assessment. It’s a reminder that we need to fix the fund’s pricing over the long term.

Finally, as Swiss policymakers made clear regarding the recent turmoil involving Credit Suisse, more people are saying the quiet part out loud: the current resolution plans filed by the largest financial institutions in the world, which purport to show how the firms could fail without a government bailout or economic chaos, are essentially a fairy tale.5

The latest failures are another reminder that we must work to eliminate the unfair advantages bestowed upon too-big-to-fail banks. New laws and old laws alike provide a roadmap to end too-big-to-fail and the resulting risks to financial stability, fair competition, and the rule of law.6

Author(s): Rohit Chopra

Publication Date: 11 May 2023

Publication Site: Consumer Finance Protection Bureau

Capital regulation and the Treasury market

Link: https://www.brookings.edu/research/capital-regulation-and-the-treasury-market/

PDF: https://www.brookings.edu/wp-content/uploads/2023/03/Brookings-Tarullo-Capital-Regulation-and-Treasuries_3.17.23.pdf

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The dramatic, though short-lived, disruption of the market for U.S. Treasury debt in September 2019 and the more profound market dislocations at the onset of the COVID crisis in March 2020 have raised the issue of whether the treatment of central bank reserves and sovereign debt in bank capital requirements exacerbated the problems. Changes have been proposed to the Enhanced Supplementary Leverage Ratio (eSLR) and G-SIB (Global Systemically Important Bank) capital surcharge, both of which apply only to the eight U.S. banks designated as globally significant. Because these banks are some of the most important dealers in U.S. Treasuries, regulatory disincentives to hold and trade Treasuries can adversely affect the liquidity of the world’s most important debt market.

Disagreement over whether to adjust the eSLR, the surcharge or both is often just a version of the continuing debate over the right level of required capital. Some banking interests seize on episodes of Treasury market dysfunction to argue for reductions in the eSLR and surcharge. Some regulators, elected representatives, and commentators see any adjustments as weakening post-Global Financial Crisis (GFC) capital standards. Yet it is possible to reduce the current regulatory disincentive of banks, especially at the margin, to hold and trade Treasuries without diminishing the overall capital resiliency of large banks.

The concern with eSLR is that when it is effectively the binding regulatory capital constraint on a bank, that institution will limit its holding and trading of Treasuries. The eSLR can be modified to accommodate considerably more intermediation of Treasuries without significantly undercutting its regulatory rationale. As for the G-SIB surcharge, there are some unproblematic changes that could help.  But the chief complaints from banks about the G-SIB surcharge will be harder to satisfy without undermining the rationale of imposing higher capital requirements on systemically important banks.

Even with a change in the eSLR, banks’ holdings of Treasuries would continue to be subject to capital requirements for market risk. Moreover, as the failure of Silicon Valley Bank has demonstrated, the exclusion of unrealized gains and losses on banks’ available-for-sale portfolio of debt securities, including Treasuries, can give a misleading picture of a bank’s capital position. Following the Federal Reserve’s 2019 regulatory changes, only banks with more than $700 billion in assets or more than $75 billion in cross-jurisdictional activity are required to reflect unrecognized gains and losses in their capital calculations. The banking agencies should consider a significant reduction in these thresholds.

Far-reaching deregulatory changes would not remedy all that is worrisome in Treasury markets today. As the studies cited in the full paper emphasize, a multi-pronged program is needed. In any case, it would be misguided to seek greater bank capacity for Treasury intermediation at the cost of undermining the increased resiliency of the most important U.S. banking organizations or international bank regulatory arrangements. At the same time, it would be ill-advised not to recognize the changes in Treasury markets, beginning with their increased size because of fiscal policy. The modifications of capital regulation, especially the eSLR, outlined in the paper should ease (though not eliminate) constraints on banks holding and trading Treasuries without endangering the foundations of the post-GFC reforms.

Author(s): Daniel K. Tarullo

Publication Date: 17 Mar 2023

Publication Site: Brookings

Federal Reserve to End Emergency Capital Relief for Big Banks

Link: https://www.wsj.com/articles/federal-reserve-to-end-emergency-capital-relief-for-big-banks-11616158811

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The Federal Reserve said it was ending a yearlong reprieve that had eased capital requirements for big banks, disappointing Wall Street firms that had lobbied for an extension.

Friday’s decision means banks will lose the temporary ability to exclude Treasurys and deposits held at the central bank from lenders’ so-called supplementary leverage ratio. The ratio measures capital — funds that banks raise from investors, earn through profits and use to absorb losses — as a percentage of loans and other assets. Without the exclusion, Treasurys and deposits count as assets. That will likely force banks to hold more capital or reduce their holdings of those assets, both of which could ripple through markets.

Analysts have been keying on the issue, which is widely viewed on Wall Street as carrying potential implications for markets from bonds to stocks to commodities.

Author(s): Andrew Ackerman, David Benoit

Publication Date: 19 March 2021

Publication Site: Wall Street Journal