Labyrinthine law threatens our life insurance now

Dodd-Frank, the law more properly known as the 2010 Wall Street Reform and Consumer Protection Act, was intended to stabilize the financial system and end the problem of “Too Big to Fail” banks.

Now, however, non-bank financial institutions that were never part of the problem are getting caught up in Dodd-Frank’s labyrinthine bureaucracy as government overreaches its powers.

For the life insurance industry, this could cause significant problems. If Dodd-Frank is not reformed, all of us who purchase life insurance are bound to see fewer products, with higher premiums and lower benefits likely, according to one independent study.

Dodd-Frank gives regulators the power to designate certain financial institutions as “Systemically Important Financial Institutions,” or SIFIs. Life insurers were included as possible targets because of the federal bailout of insurance giant AIG at the onset of the financial crisis.

However, AIG’s life-insurance business was not the problem. Rather, the part of the firm that got into trouble was its financial-products division in London, where the credit-default swaps and other products it offered became overexposed to major risks during the crisis. This arm of the business was overseen not by insurance regulators but by the federal Office of Thrift Supervision. AIG’s failure was a failure of management and regulation, not of insurance products.

Insurance products are already heavily regulated by the states, and have not caused significant problems for the financial system to date. Insurance companies that do not diversify into banking activities are exceptionally stable, because their whole business model is predicated on prudent assessment of the risk of an inevitable event.

Banks, on the other hand, come and go with regularity. A life insurer that threw caution out the window, as many banks did when they issued expensive mortgages to low-income borrowers, would quickly go out of business.

Yet the Financial Stability Oversight Council, a regulatory agency set up under Dodd-Frank, has already decided that AIG, GE Capital and Prudential should be treated as SIFIs, and is reportedly considering adding MetLife to that list. While some large banks have actively courted the SIFI designation, regarding it almost as a badge of honor, Prudential appealed the decision. On Sept. 19, the Financial Stability Oversight Council — in effect, acting as its own appeals court — rejected the appeal, although a dissenting member stated that the council lacked “a fundamental and seasoned understanding of the business of insurance.”

Prudential had good reason to appeal. The regulations imposed by SIFI designation are much more costly for non-banks than for banks, and create perverse incentives for them. An April study by the consultancy Oliver Wyman found that it would raise consumers’ aggregate life-insurance premiums from $3 billion to $8 billion a year, with the bulk affecting retirees, who will see their incomes drop. Moreover, SIFI designation sends the signal that the government will not allow the institution to fail. That could increase insurance firms’ willingness to tolerate risk — and thus make them less stable.

The regulators’ interest in gaining power over insurance firms is also mystifying in light of the fact that five years after the passage of Dodd-Frank, they have not yet finished writing its rules. As of Nov. 1, 280 rules were supposed to have been finalized. Only 110 have been. If the government were regulating itself, it should have imposed severe sanctions based on this performance.

Finally, and perhaps most importantly, the criteria regulators use for deciding which firms to designate as SIFIs do not include any assessment of whether the firm is actually “systemically important” to the economy as a whole. Insurance companies are simply not as interconnected with the rest of the financial system as banks are, so even if a major insurer were to fail, that would not cause widespread financial instability. Rather, the designation appears to be imposed based on the fact that the regulators can impose it, not on whether they should.

The designation of insurance companies as SIFIs is a clear case of executive overreach. A bill currently in the Senate (S. 1369), which has bipartisan support, would partly alleviate this by amending Dodd-Frank to establish separate SIFI criteria for the insurance industry. This is the least lawmakers could do to reduce the burdens the act places on the industry — a real-life mystery SIFI theater.