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97–304 PDF 2016

S. HRG. 114–94

EXAMINING INSURANCE CAPITAL RULES AND

FSOC PROCESS

HEARING

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED FOURTEENTH CONGRESS

FIRST SESSION

ON

EXAMINING THE FEDERAL RESERVE’S IMPLEMENTATION OF THE COLLINS AMENDMENT TO TAILOR CAPITAL RULES FOR INSURERS ON 

FSOC’S DESIGNATION PROCESS FOR NONBANK SIFIS AND FOR INTERNATIONAL CAPITAL DEVELOPMENTS FOR INSURERS

APRIL 30, 2015

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

Available at: http://www.fdsys.gov/


BANKI-41578DSA with DISTILLER
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

TOM COTTON, Arkansas 

MIKE ROUNDS, South Dakota 

JERRY MORAN, Kansas 

SHERROD BROWN, Ohio 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

JOE DONNELLY, Indiana

WILLIAM D. DUHNKE III, Staff Director and Counsel 

MARK POWDEN, Democratic Staff Director

DAWN RATLIFF, Chief Clerk 

TROY CORNELL, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

MIKE CRAPO, Idaho, Chairman 

MARK R. WARNER, Virginia, Ranking Democratic Member 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

TIM SCOTT, South Carolina 

BEN SASSE, Nebraska 

JERRY MORAN, Kansas 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

ELIZABETH WARREN, Massachusetts 

JOE DONNELLY, Indiana

GREGG RICHARD, Subcommittee Staff Director

MILAN DALAL, Democratic Subcommittee Staff Director

(II)


BANKI-41578DSA with DISTILLER
CONTENTS

THURSDAY, APRIL 30, 2015

Page

Opening statement of Chairman Crapo ................................................................. 1

Opening statements, comments, or prepared statements of: 

Senator Warner ................................................................................................ 2

WITNESSES 

Robert M. Falzon, Executive Vice President and Chief Financial Officer, Prudential Financial, on behalf of the American Council of Life Insurers and 

the American Insurance Association .................................................................. 3

Prepared statement .......................................................................................... 20

Kurt Bock, Chief Executive Officer, COUNTRY Financial, on behalf of PCI 

and NAMIC .......................................................................................................... 5

Prepared statement .......................................................................................... 26

Response to written question of: 

Senator Vitter ............................................................................................ 59

Daniel Schwarcz, Professor and Solly Robins Distinguished Research Fellow, 

University of Minnesota Law School .................................................................. 7

Prepared statement .......................................................................................... 55

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Prepared statement of Elizabeth Brill, Chairperson, Solvency Committee Risk 

Management and Financial Reporting Council, American Academy of Actuaries ....................................................................................................................... 60

Prepared statement of the National Association of Professional Insurance 

Agents ................................................................................................................... 65

(III)


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BANKI-41578DSA with DISTILLER
(1)

EXAMINING INSURANCE CAPITAL RULES AND 

FSOC PROCESS 

THURSDAY, APRIL 30, 2015

U.S. SENATE, SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee met at 10:02 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Mike Crapo, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN MIKE CRAPO 

Senator CRAPO. The hearing will come to order. Welcome, everyone, and, Senator Warner, welcome. Today’s hearing will focus on 

the Federal Reserve’s implementation of the Collins fix to tailor 

capital rules for insurers on FSOC’s designation process for 

nonbank SIFIs and for international capital developments for insurers. 

Banking and insurance present different risk profiles, and Congress recently passed legislation to allow the Federal Reserve the 

ability to tailor holding company capital rules for insurers. 

The Federal Reserve needs to utilize this flexibility so that the 

proposed rule is consistent with the insurance business model and 

follows a formal rulemaking process to maximize opportunities for 

public comment. 

Last year, I requested that the Government Accountability Office 

initiate a study to examine the process FSOC uses when designating nonbank financial institutions as systemically important financial institutions. The report concluded that FSOC’s process 

lacks transparency and accountability, insufficiently tracks data, 

and does not have a consistent methodology for determinations. 

I am interested in finding bipartisan solutions to ensure that 

FSOC is more transparent during the designation process about 

which activities, together or separately, pose the greatest risk from 

a company so that they can be addressed. That includes providing 

an off ramp or a way for a company to take action to mitigate or 

prevent the identified risk and to no longer be designated as a 

SIFI. 

The European Union and the International Association of Insurance Supervisors are undertaking separate initiatives that have 

raised concern also in the United States. The EU’s Solvency II regulatory modernization program includes a reciprocity designation 

which some believe could disadvantage U.S. insurers if the United 


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2

States is not judged a reciprocal jurisdiction. The IAIS, following 

a charge from the Financial Stability Board, is developing new capital standards for insurers. 

These developments raise several questions about the direction 

and timeliness given the regulatory differences between the United 

States and Europe. The American model for insurance regulation 

focuses on policy holder protections and is mainly State-based regulated while the European model is more focused on the impact of 

failure on the overall market in Europe. How will these standards 

likely impact consumers and State-based insurance regulation in 

the United States? If these standards are not compatible with our 

system, what will be our response? These and a number of other 

questions are critical for us to answer, and I look forward to the 

information that will be provided by our witnesses today. 

I also want to again take this opportunity to indicate how 

pleased I am to be working with Senator Warner today. We are 

closely coordinating, and I am confident that we can work together 

to find solutions that will help to address these issues. 

Senator Warner. 

STATEMENT OF SENATOR MARK R. WARNER 

Senator WARNER. Thank you, Chairman Crapo, and thank you 

for holding this hearing. And let me also agree with you on your 

focus on SIFI designation and trying to make sure, as we talked 

at another hearing, that I do not think when we created the notion 

of SIFI that there was the ‘‘Hotel California’’ concern that once you 

check in you can never check out. We do think we need to figure 

out how SIFIs can—if institutions choose to try to leave that designation, that there is a clear and more transparent path. 

I also believe that the United States has a vital interest in the 

success of international organizations designed to improve financial 

supervision and stability. I think we all recall that the financial 

crisis of 2008 was global in nature and taught us that systemic risk 

does not respect geographic borders. The infamous AIGFP, the financial products unit structures derivatives that blew up AIG, was 

headquartered in London, for example. AIG’s interconnected relationships as a counterparty with nearly every major in the United 

States threatened additional instability only a day after Lehman 

Brothers failed. 

The stark examples emanating from London is one of the reasons 

why I have supported increased cooperation amongst global regulators to coordinate regulations in response to risks posed to the 

economy and financial system by financial institutions. It is the 

principal reason why I held a hearing in this Committee in May 

2013 assessing progress on cross-border resolution. 

Understandably, much of the focus on cross-border activity is focused on how to treat derivatives and design adequate bank capital 

standards. I understand, however, that insurance, as the Chairman 

noted, is also receiving significant attention at the International 

Association of Insurance Supervisors in Europe. 

As our regulators pursue discussions at the IAIS, it is important 

to remember that the United States has a unique system of insurance regulation, as was mentioned by the Chairman, namely, 

State-based aimed at ensuring policyholders are made whole in the 


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3

event of an insurance company’s insolvency. This is why I raised 

a number of questions of the Federal Reserve and the Federal Insurance Office in a letter last year to determine how these organizations are taking the U.S. system into account while balancing the 

need for global cooperation and stability. 

Additionally, as some insurance firms now face Federal scrutiny 

as a result of owning thrifts or SIFI designation, it is important for 

the Federal Reserve to distinguish between the business of banking 

and the business of insurance. Again, I think this is an area where 

in the initial Dodd-Frank we perhaps went too far, and so I was 

pleased where Congress passed a fix, the so-called Collins amendment, last year to provide that appropriate flexibility to the Federal 

Reserve in implementing capital standards for insurance firms. I 

am eager to see how those standards will develop. 

Finally, as we look at how we can make the FSOC more transparent and as the FSOC continues to evaluate financial firms, including insurance companies, again, restating what I said earlier, 

the ultimate goal of SIFI designation is to reduce risk, not to simply create a whole new level of regulation. 

So I look forward to hearing from our witnesses, and, again, 

thank you, Mr. Chairman, for calling this hearing. And I think if 

we can find—if there is any group that can find bipartisan agreement, it will be us. Thank you, sir. 

Senator CRAPO. Thank you, Senator Warner. 

We have three witnesses today: Mr. Robert Falzon, Executive 

Vice President and Chief Financial Officer of Prudential Financial, 

Incorporated; Mr. Kurt Bock, who is the Chief Executive Officer of 

COUNTRY Financial; and Mr. Daniel Schwarcz, a professor at the 

University of Minnesota Law School. 

Gentlemen, we welcome you all. We appreciate your taking your 

time and bringing to us your expertise. We would like to ask you 

to take no more than 5 minutes, if you will, to summarize your testimony. Your written testimony is a part of the record, and we 

would like to have plenty of opportunity to engage with you in 

questions and answers. 

With that, we will start with you, Mr. Falzon. Thank you. 

STATEMENT OF ROBERT M. FALZON, EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, PRUDENTIAL FINANCIAL, ON BEHALF OF THE AMERICAN COUNCIL OF LIFE INSURERS AND THE AMERICAN INSURANCE ASSOCIATION 

Mr. FALZON. Thank you. Chairman Crapo, Ranking Member 

Warner, Members of the Subcommittee, I am Rob Falzon, the Chief 

Financial Officer at Prudential Financial. As a domestic nonbank 

SIFI and an internationally active insurer, as well as a global SIFI, 

we cannot thank you enough for holding this oversight hearing on 

these important issues facing the insurance industry. Today I am 

here on behalf of the American Council of Life Insurers and the 

American Insurance Association. 

This morning, I will touch on three areas: first, the appropriate 

implementation of domestic capital standards for insurers under 

supervision of the Federal Reserve; second, developments in international supervision and capital standards; and, third, rationalization of the process of de-designating nonbank SIFIs. 


BANKI-41578DSA with DISTILLER
4

The fundamental business proposition upon which insurance is 

built is that well-run and appropriately capitalized companies will 

be positioned to honor the commitments that we make to our customers for decades into the future and through all economic scenarios. 

Good regulation of insurance is critical to this proposition. If you 

have served on this Committee for a while, it has probably become 

apparent to you that we have not sought to eliminate appropriate 

oversight. Quite the contrary. We support a robust supervision and 

capital regime that provides our customers with confidence that we 

have the financial strength to keep our promises. 

However, with the supervisory power that is invested in our regulators comes the responsibility to ensure it is done appropriately, 

in a way that maps the specific risks we face to the regulatory constructs for holding capital and for managing those risks. 

Members of this Committee and this body showed a clear understanding of this last year when bipartisan legislation sponsored by 

Senators Brown, Johanns, and Collins was approved by unanimous 

consent and signed into law by the President. That bipartisan legislation, for which we appreciate every Member’s support, did not 

eliminate the capital requirements called for in Dodd-Frank. Instead it simply clarified the Federal Reserve’s authority to develop 

regulatory standards that reflect insurance businesses and risks 

rather than defaulting to mandatory, arbitrary, and inappropriate 

bank-centric standards that are completely disconnected to the 

risks of insurance. 

We have spent a lot of time with our new regulators at the Federal Reserve and are impressed with the professionalism and 

knowledge they have brought to this new area of jurisdiction. But 

with any new endeavor, especially one as different from the historic 

charge of regulating banks, the Federal Reserve needs ongoing and 

continued diligence in exploring, understanding, and getting it 

right. 

We are hopeful that in writing capital rules and supervisory 

standards for insurers the Federal Reserve will take the time provided through the Administrative Procedures Act to publish an Advance Notice of Proposed Rulemaking in order to gain as much as 

input as possible to ensure that these rules result in a world-class 

regime, one that properly captures risks and appropriately assesses 

capital. 

While the Federal Reserve is working on fulfilling its domestic 

capital mandate for insurers they supervise, there are also ongoing 

talks with the IAIS to develop a common global supervisory and 

capital framework for large international insurers. We believe it is 

important for the authorities from the United States to remain engaged in these standard-setting forums and to play an active role, 

effectively and successfully representing the interests of the U.S. 

insurance regulators, companies, consumers, and markets. 

While there was initial concern that an overly ambitious timeline 

set by the IAIS would rush into a judgment and a misaligned 

standard, we are pleased with reports that this timeline has been 

extended, affording U.S. authorities more time and latitude to develop appropriate domestic standards before finalizing a global 

framework. We strongly believe that all efforts should focus on getVerDate 0ct 09 2002 15:25 Aug 01, 2016 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 L:\HE3E8B~1\04-30E~1\HEARING\97304.TXT SHERYL

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5

ting domestic standards right before agreeing to any international 

standards. The lessons learned through a robust rulemaking process at home will only help to inform U.S. participants and provide 

them with valuable data and experience in shaping international 

standards. 

We would like to recognize that the U.S. participants—the Federal Reserve, the National Association of Insurance Commissioners, 

and Treasury—have made progress in advocating for appropriate 

standards. However, much work remains to be done and should 

only be done after first getting our standards completed at home. 

Last, I would like to address one other issue which the Committee explored at a hearing last month: FSOC’s SIFI designations. 

As you are aware, Prudential was designated as a SIFI in 2013, 

thus subjecting us to Federal Reserve oversight for the first time 

in the company’s 140-year history. 

We continue to disagree with the determination and believe that 

FSOC reached the wrong conclusion. However, what is not clear to 

us is what we can do to change the outcome or even to reduce our 

systemic footprint. Every year, we have an opportunity to petition 

FSOC to rescind the designation. We have done this. This designation, which requires the same super majority as that needed to designate, is an important provision and underscores that Dodd-Frank 

did not intend the SIFI designation to be permanent. However, 

more meaningful evidence to support the initial designation is both 

appropriate and needed to help companies understand why they 

were initially designated and what actions could be taken to be dedesignated. 

We think one area where Dodd-Frank clearly could be strengthened in would be in requiring the FSOC, when it considers designating a company, to be much clearer in identifying the risk factors 

that are the cause for concern, and in the annual review to clearly 

articulate to companies the steps they can take to reduce their systemic footprint. 

Mr. Chairman, Ranking Member Warner, thank you, and I look 

forward to answering your questions. 

Senator CRAPO. Thank you, Mr. Falzon. 

Mr. Bock. 

STATEMENT OF KURT BOCK, CHIEF EXECUTIVE OFFICER, 

COUNTRY FINANCIAL, ON BEHALF OF PCI AND NAMIC 

Mr. BOCK. Chairman Crapo, Ranking Member Warner, and 

Members of the Subcommittee, my name is Kurt Bock, Chief Executive Officer of COUNTRY Financial, an A-plus rated mutual company providing home, auto, business, life insurance, and investment services to Main Street America. I am testifying on behalf of 

PCI and NAMIC who together represent three-quarters of all property casualty insurers. 

COUNTRY is not a systemically important insurer, but what we 

are is important to almost 1 million households. I am also here on 

their behalf. 

Our insurance market faces unprecedented challenges from increased Federal and international intrusion into the U.S. State insurance regulatory structure. Though not perfect, the State system 

has successfully protected consumers for over 150 years and has 


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fostered the development of a property casualty insurance market 

that is highly competitive, extremely well capitalized, and very stable. 

Most importantly, our U.S. insurance system is consumer-focused 

rather than creditor-centric in contrast to the banking system and 

many international insurance systems that we are being pressured 

to emulate. 

In the Dodd-Frank Act, Congress largely affirmed the primacy of 

State insurance regulation. However, Congress also abolished the 

Office of Thrift Supervision and transferred its authority over insurance holding companies with thrifts to the Federal Reserve, 

which has had numerous unintended consequences. 

COUNTRY Financial is a Main Street insurer that owns a very small thrift, only $30 million in assets, focused on wealth management for our customers. We have no transactional deposits or 

loans. Despite this minimal banking footprint, COUNTRY is now 

subject to Federal Reserve regulation, including detailed discovery 

questionnaires and regular visits by examiners that seek to learn 

all aspects of our businesses. 

Our industry has no complaints about the very professional Federal Reserve staff, but what we do wonder is whether Congress 

truly intended to create Fed supervision of Main Street insurers 

and whether the Fed’s efforts can be more proportional to the 

banking risk involved. 

It is essential that the Fed get it right when it comes to setting 

a capital standard for companies they regulate, such as adopting 

an aggregate legal entity capital approach, relying on State-based 

measures and triggers. 

Our industry is also very concerned about international agencies 

that are trying to pressure the United States to compromise on 

global standards that would undermine our current U.S. regulatory 

system and its focus on consumer protection. When I hear our Federal representatives are overseas negotiating new global insurance 

standards, I really have to ask: What problem are they trying to 

fix? The chief mission of bodies such as the International Association of Insurance Supervisors ought to be to facilitate a stronger 

global insurance regulatory environment through cooperation and 

coordination, rather than attempting to create one-size-fits-all requirements for every country in the world. One-size-fits-all does not 

work in bathing suits or when devising global regulatory standards. 

Furthermore, IAIS decisions are largely made behind closed 

doors. Stakeholder comment letters, testimony, and debates with 

the IAIS seem to fall on deaf ears, with key decisions appearing to 

have been preordained. I hope you are as deeply concerned by this 

lack of transparency and accountability as I am. 

U.S. insurers have been told not to worry because these international standards do not have the force of law and must still be 

adopted domestically. However, we were also told there would be 

opportunities to debate the global designations of systemically important insurers, yet U.S. regulators have faithfully executed domestically every single SIFI designation that was agreed internationally, in some cases even over the strong objections of FSOC’s 

insurance experts and the primary functional regulators. 


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COUNTRY Financial and our trades focus starts and ends with 

the consumer, and it is not at all clear that the current domestic 

and international regulatory activities will benefit them in any 

way. Ultimately, there will be a cost which the policyholder will be 

asked to pay. 

We welcome your oversight and legislative involvement on these 

issues. One first step would be to pass the Policyholder Protection 

Act, introduced by Senators Vitter and Tester. This bill would ensure that Federal banking regulators cannot inappropriately use 

assets intended to protect insurance consumers to bail out other affiliated financial firms and that State regulators retain the power 

to resolve troubled insurers in the manner they judge most appropriate. 

We applaud Senators Heller and Tester for their leadership in 

discussing potential legislative reforms, and on behalf of NAMIC 

and PCI, but most importantly on behalf of all of our consumers, 

we would very much appreciate your involvement and action on 

these issues. 

I would be glad to answer any questions. 

Senator CRAPO. Thank you very much, Mr. Bock. 

Mr. Schwarcz. 

STATEMENT OF DANIEL SCHWARCZ, PROFESSOR AND SOLLY 

ROBINS DISTINGUISHED RESEARCH FELLOW, UNIVERSITY 

OF MINNESOTA LAW SCHOOL 

Mr. SCHWARCZ. Thank you very much, Chairman Crapo, Ranking 

Member Warner. Today I am going to talk about two issues paralleling my written testimony. The first issue I want to talk about 

is FSOC transparency. 

As you know, one of the core goals of Dodd-Frank was to ensure 

that firms that pose a systemic risk to the economy, like AIG, like 

Lehman Brothers, like Bear Stearns, are regulated appropriately in 

light of that fact. 

To accomplish that, Dodd-Frank created FSOC and entrusted 

FSOC with a flexible and adaptive approach to attempt to discern 

whether individual firms pose a systemic risk to the larger economy. That flexible and adaptive approach was born of experience, 

and that experience was that trying to formulaically define what 

types of institutions pose a systemic risk does not work. We 

thought we had done that well by saying that banks defined are 

systemically risky and firms like AIG that are just insurance companies are not. But the financial system is too fluid and too complicated to allow for simple, formulaic definitions of systemic risk. 

In that light, Dodd-Frank created FSOC and said consider all of 

these factors, including your own judgment, and on the basis of an 

individualized judgment, decide whether firms are systemically 

risky. 

I believe that that was appropriate, but it, of course, inevitably 

creates potential transparency concerns. And the reason for that is 

that any broad standard that allows for adaptability and flexibility 

is going to at the same time create some level of opacity. 

My view is that FSOC has done a reasonable job of balancing the 

inherent transparency concerns in its structure with transparency. 

The most important thing that I think FSOC has done that I think 


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it is important to recognize is it created a quantitative screen at 

the front end whereby firms are not going to be designated as systemically significant, at least presumptively, if they do not meet 

certain quantitative thresholds. That provides substantial certainty 

to most nonbank financial firms that they are not systemically 

risky. 

It also has adopted additional reforms more recently to enhance 

transparency. Now, that is not to say that FSOC could not improve 

further, and I do support the idea that FSOC should be clearer in 

its designations about what types of activities and features of SIFIs 

render them a SIFI and what firms might be able to do to get out 

of SIFI designation. 

But what I want to caution against is the notion that clear formulas or clear quantitative thresholds can be enunciated such that 

firms can either avoid SIFI designation in the first place or achieve 

an off ramp. 

Systemic risk is not currently susceptible to easy, simple definitions, and that is why we have an expert body of financial regulators that we entrust to do a searching job. So while I support the 

idea of a process for firms to appeal the idea of SIFI designation 

and to ask whether specific reforms would allow them an off ramp, 

what I think we need to be careful to avoid is mandating some sort 

of clear off ramp that would be formulaic and that would not respect the need to engage in individualized risk assessment. 

The second issue I want to talk about with my brief time remaining involves capital standards. As you know, the Federal Reserve 

is entrusted with developing capital standards for firms that are 

designated as SIFIs as well as for insurance companies that own 

an FDIC-insured institution. That capital regime should indeed be 

designed in light of both the strengths and the weaknesses of the 

State risk-based capital framework. That framework works well to 

protect policyholders, I believe. But at the same time, it is not specifically designed to address systemic risk concerns. That is not the 

province traditionally of State insurance regulators. 

And so my view is that the Fed needs to design a capital regime 

that is appropriate to address systemic risk concerns. What would 

that mean? I believe that means that the Fed needs to start with 

a consolidated balance sheet. It needs to look through individual 

legal entities that are the structure of the risk-based capital framework and specifically avoid some of the potential shell games that 

can be played with individual legal entities that can be used to 

limit a risk. 

Moreover, I believe that the Fed framework needs to consider the 

possibility of valuing assets at market value, because when you are 

dealing with a systemic firm, part of your concern has to be about 

how would that systemic firm deal with a scenario in which it did 

have to liquidate its portfolio immediately. 

So for those reasons, I believe that it is appropriate for the Fed 

to engage with the IAIS and to take elements of the IAIS framework with it in terms of developing a broader standard. 

Thank you very much. 

Senator CRAPO. Thank you very much, Mr. Schwarcz. 

Before I go to the questions, I have received statements from the 

American Academy of Actuaries and the National Association of 


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Professional Insurance Agents, which I would like to enter into the 

record, without objection. Seeing none, they will be entered into the 

record. 

Senator CRAPO. Let me start with a question. I just would like 

to ask a general question to the entire panel, and it is basically on 

the off-ramp question, which you each have discussed to some extent in your statements. And, by the way, I think that the information you presented both in your written testimony as well as what 

you have presented here today has been very helpful. 

The FSOC Member with Expertise, Mr. Woodall, has stated that 

FSOC should be more transparent during the designation process 

about which activities, together or separately, pose the greatest 

risk from a company so that they can be addressed, and each of you 

have discussed this in general. My question basically relates to 

whether there is an agreement from the panel or whether you have 

some further observations on the issue as to whether FSOC should 

specify the systemically risky activity that caused the company to 

be designated and how this could provide guidance or a road map 

to take action to mitigate or prevent the identified risk. 

Why don’t we start with you, Mr. Falzon, if you have any response to that. 

Mr. FALZON. Thank you, Senator. So a couple of thoughts. 

First, we disagree with the designation of Prudential as being 

systemically risky. There is an annual process that is provided to 

us post-designation that allows us to petition against that designation. We have done that, and we will continue to do so. The frustration or challenge that we face is that lacking the justification for 

the on ramp, we lack the tools to define the off ramp. I hear the 

points that have been made by my colleague to the far left on the 

potential risks of being overly quantitative in that specification of 

the off ramp. However, I believe that if you are able to designate 

a company and define those characteristics that cause it to be systemic, you ought to similarly be able to designate those characteristics that would cause it to be less systemic. 

If you think about the objective of this regulation, it is not to 

simply classify companies as systemic and then box them in that 

and hold them into that designation for a long term but, rather, to 

encourage them to reduce those activities that are leading to systemic risk in the U.S. economy. Without the tools to identify the 

activities that give rise to that risk, we are unable to address appropriately our activities in a way that would be constructive and 

responsive to the intent of the regulation. 

Senator CRAPO. Thank you. 

Mr. Bock? 

Mr. BOCK. Thank you, Chairman. I will just preface this by saying we are in the business of managing risk, and to know the why 

and the how is always important to us. And we do a good job of 

managing it when we know the why, which I believe is one of the 

issues, and in terms of the lack of transparency of the process. 

Our concerns obviously come down to Main Street, and Main 

Street’s concern is what would be next, what would be next in this 

process, because it appears that size is a part of the designation, 

not necessarily activities, and for us it really extends Fed oversight 


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into activities that do not pose systemic risk. So for us our questions always are: What is going to be next? 

Senator CRAPO. Thank you. 

Mr. Schwarcz? 

Mr. SCHWARCZ. I believe that in a case where you have an institution where there is a single activity that poses a systemic risk, 

then absolutely FSOC should specify that. But I also believe it to 

be the case that FSOC’s opinions, at least with respect to certain 

institutions, have suggested that there are a number of activities 

that in the aggregate pose a risk. 

Now, I do believe that FSOC should be clearer about the relative 

importance of those activities in its overall designation. But I also 

think that when, for instance, you have five or six or seven different factors that are playing in, it is the interaction of those factors. And for that reason, it is harder to say, well, if you stop this 

activity, you are no longer systemic. That is why I support a more 

robust process for petitioning plans and saying, look, if we stop 

these two or three activities, or if we change our risk profile in this 

way, would this allow us an off ramp? I think that is the more appropriate approach. 

Senator CRAPO. So if I understand you correctly, Mr. Schwarcz, 

you are suggesting that there be an ability for a designated company or a company that is in the process of being evaluated to engage with FSOC and to understand the factors that are being analyzed and engaging in an analysis or a discussion between the parties to determine whether changes in the risk factors could result 

in a different outcome, whether the designation has already occurred or whether the process is simply being analyzed. 

Mr. SCHWARCZ. Absolutely. I completely agree with that. I just 

think we need to be careful to recognize that these issues are very 

complex, and so sometimes it is going to be a dialogue back and 

forth, and it is not going to be something you can clearly define ex 

ante.

Senator CRAPO. My time has expired for my questions, but I do 

want to just ask, very quickly, Mr. Falzon, did you have that kind 

of experience with Prudential as the designation process moved forward? 

Mr. FALZON. No, we have not. And while I take the points mentioned that there may be a variety of activities that give rise to the 

designation, I believe that the FSOC has an obligation to provide 

a road map of whatever combination of criteria are necessary in 

order to de-risk the institution on a U.S. systemic basis. 

Senator CRAPO. All right. Thank you. 

Senator Warner? 

Senator WARNER. Mr. Chairman, I want to continue in this line 

of questioning, because when we had Secretary Lew here recently, 

I think we had pretty broad agreement from both sides of the aisle 

that there needed to be this clearer path to de-designation. I think 

Professor Schwarcz’s point is a good one, that because there is a 

variety of factors that go into this designation, it may not be a single metric that allows you to de-designate. And I guess one of the 

things that we have seen starting, I believe, around the turn of the 

year, FSOC internally and Treasury internally announced changes 

both in terms of trying to improve transparency. We had Secretary 


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Lew here saying that he agreed with the sense that, again, back 

to my ‘‘Hotel California’’ analogy, that you should be able to check 

out even if you do get stuck checking in. 

And, Mr. Falzon, just recognizing that you have disagreed with 

the designation from its starting point and filed, have you seen any 

kind of change in approach in the last couple of months since it 

seems like the FSOC and Treasury have kind of been moving in 

this direction? 

Mr. FALZON. Our period for review for reaffirmation of the designation, our opportunity to petition is coming up in late summer 

or early fall of this year. We have just received notice, I believe, 

that, in fact, this process has begun. So we have not had the opportunity to see a change in behavior since the first time that we petitioned was in advance of the hearings that you just referenced. 

I would hope that there would be a change in conduct. I have not 

yet seen evidence of that. 

Senator WARNER. What about in terms of—there also seemed to 

be a greater acknowledgment that there needed to be more 

iterative back-and-forth as you even go through the designation 

process, so, again, more conversation. Have you seen any of those 

changes to date? 

Mr. FALZON. We have not been a participant in any of the conversations. Now, recognize that we have already been designated, 

and, therefore, our opportunity to engage in a dialogue in advance 

of designation has already passed. So what we are hopeful is that 

that dialogue would occur in the context of the annual reviews in 

which we have this petition opportunity. Again, we have not yet 

seen that, but there is time between now and when that comes up 

for formal review. 

Senator WARNER. I guess one thing I would also like to ask comments from the whole panel is I think one of the things that we 

have seen progress is that there is a growing recognition from the 

Fed and others that the insurance business is different than the 

banking business, and, you know, one of the tools that I think most 

of the banks would concur with is that the process of the stress 

tests have been effective and are a good measuring tool. 

How do we go about and how do you think any kind of general 

comments about a stress test on the insurance side of the ledger 

that could be as effective as it has proven to be on the banking 

side? Just quickly going down the whole panel. 

Mr. FALZON. Yes, that is an excellent question. Let me reiterate 

the very point that you made. In our interactions with the Fed, 

particularly post the passage of the Collins amendment fix, we 

have actually seen a marked difference in our interactions with the 

Fed, and it is much more open and constructive, and we have welcomed that. So there has been a visible difference. 

With regard to stress testing, stress testing applies to insurance 

companies just as it applies to banks. Stress testing is different for 

an insurance company than it is for a bank. You need to look at 

a combination of market stresses and insurance stresses, and you 

need to recognize that those stresses typically do not manifest 

themselves in the very short term. There are certain risks that we 

take that would manifest themselves in the short term, catastrophic risk by way of example. But many of the risks we take are 


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associated with long-term liabilities, things like life insurance. 

That is a mortality risk. The evidence as to whether that mortality 

risk was appropriately taken or not will be very far into the future. 

And so as you think about stress testing, you need to think about 

adapting it to the very specific risks that we take. 

We do believe that there is a single construct that you can use 

for the insurance industry that would capture the variety of risks 

that insurers take by having bespoke inputs into that construct. 

And we are working across the life and P&C industry in order to 

develop that construct and bring it in a proposal to the Federal Reserve . 

Senator WARNER. Very briefly, Mr. Bock and Dr. Schwarcz. 

Mr. BOCK. Thank you, sir. For us, obviously it is important, as 

you have all recognized, to understand that insurance is different 

than banking. But also property/casualty companies are different 

than life. Our issues and stress are always different, and liquidity 

is something that is not an issue for us in terms of our stresses. 

But we do ensure that we follow those insurance risks through our 

modeling, cap modeling, et cetera, to make sure that obviously we 

protect our policyholders, which is the goal of our testing. 

Mr. SCHWARCZ. Absolutely, I think stress testing is very important. I think the difference is the Fed needs to stress-test specific 

to systemic circumstances, and so the types of stresses that it is 

going to consider are stresses to the broader financial system that 

occur simultaneously with stresses to the firm. 

The other point I would like to make is it is absolutely true that 

most of the time life insurers’ liabilities are long term. But the very 

reason or one of the core reasons why firms get designated as SIFIs 

even though they engage predominantly in insurance is because liabilities that seem long term and usually are long term can become 

short term in systemic scenarios. For instance, policyholders can 

cash out or surrender; guaranteed investment contracts can be canceled. So stress testing for SIFIs needs to specifically look at the 

possibility that otherwise long-term liabilities will become short 

term and ask whether or not the firm can handle that given the 

sort of dominant assumption that in most times the liabilities are 

very long term and predictable. 

Mr. FALZON. Senator, I need to object to the observation that was 

just made. I think that both the review process for Prudential as 

a designation as a SIFI and that that was done for Metropolitan 

Life, we demonstrated with a body of evidence that, in fact, the acceleration of liabilities on an insurance company’s balance sheet 

does not give rise to systemic risk and, in fact, has been fairly modest. The evidence does not support the conjecture of that argument. 

Mr. SCHWARCZ. Can I just say one thing? Much of the information is not in the public domain, so I cannot say one way or another 

whether that is right. 

What I can say is that the FSOC decided in its public basis that 

indeed there was systemic risk associated with the possibility of a 

run on—and that was one of the bases of its designation. So I cannot personally say whether that is right. I have not gone through 

the books. They are not available to me. But FSOC has indicated 

that is one of the reasons why both Prudential and MetLife were 


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designated, and for that reason, stress tests need to take that into 

account. 

Senator WARNER. Thank you, Mr. Chairman. I hope we get a second round. I have got a couple more questions I would like to ask. 

Senator CRAPO. We will. 

Senator Warren? 

Senator WARREN. Thank you very much, Mr. Chairman. 

You know, Congress is debating whether to give the President 

fast-track authority, that would reduce Congress’ ability to shape 

major trade agreements. The fast-track bill would give the President that authority potentially through 2021, and that means that 

fast track would apply not only to TPP in Asia but also to the 

TTIP, the trade deal that we are currently negotiating with the European Union. 

Now, one of my concerns about fast track is that a future President could use it to negotiate a TTIP agreement that weakens our 

financial rules or disrupts our regulatory system. The European approach to regulation is different from our own in many respects, 

and harmonizing our rules in a trade deal could mean real problems in regulating our financial services industry. 

Take insurance regulation, for example, what we are talking 

about here today. The International Association of Insurance Supervisors, or IAIS, is working on finalizing new capital standards 

for ‘‘internationally active insurance groups.’’ But Europe and the 

United States have very different approaches to regulating insurers 

with Europe using higher capital standards and the United States 

using reinsurance to protect policyholders. 

So, Mr. Falzon, could you describe how the European regulatory 

approach compares to the American regulatory approach and how 

those differences affect how European and U.S. insurers operate? 

Briefly, if you could. 

Mr. FALZON. Very briefly, first, we do support the engagement on 

the U.S. side in the international development of a global set of 

standards. We would note that the United States is the largest insurance market in the world, and, in fact, as was heard in earlier 

testimony to this Committee, if you took the top 50 insurance markets and you made each individual State a market, we would account for 26 of the largest 50 insurance markets in the world. 

Senator WARREN. I am asking about the difference, though, in 

the regulatory approach. 

Mr. FALZON. Yeah, so the point being, however, that we should 

be leading in the development of these global standards. In terms 

of the differences, the European model is based on a system of the 

business model that they have and the accounting constructs that 

they have. Now, that accounting construct is something called 

IFRS, very different than U.S. GAAP. It has a marked-to-market 

concept embedded within it, and it leads to a type of accounting 

which is not well suited to the products that we deliver in the 

United States, particularly those products in the insurance arena 

which are long term and demonstrate enormous volatility if you 

begin to mark them to market. 

Senator WARREN. OK. Very helpful. 


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Professor Schwarcz, so you think it makes sense for the Fed and 

our State insurance regulators to tailor those capital standards to 

fit the existing regulatory structure in the United States? 

Mr. SCHWARCZ. Absolutely, I do, and I think that the way that 

that needs to be done is for the Fed to consider specifically the 

ways in which the State risk-based capital regime is focused on policyholder protection, and to then say, OK, well, what do we need 

to do to supplement that regime to bring a macroprudential perspective, a systemic risk perspective? 

So I think that that question of how to supplement is one that 

requires being very cognizant of the unique regulatory regime we 

have and building on that regime to address different concerns 

than those that are at the core of what State insurance regulators 

do. 

Senator WARREN. Good. Thank you. That is very helpful. I believe in strong capital standards for financial institutions, but I am 

glad that in the case of IAIS capital standards, there is going to 

be an opportunity for our regulators to tailor those standards to fit 

the American approach to regulation. 

What alarms me is that if regulatory changes are included in a 

future trade deal with the EU, that opportunity for tailoring disappears. We have stronger financial rules than the EU in many 

areas. If Congress passes fast track now and a future President in 

2018 or 2020 agrees to weaken financial rules as part of the trade 

deal with Europe, it will take only 51 votes in the Senate to make 

those changes the law. 

That should worry anyone who supported Dodd-Frank and who 

believes that we need strong rules to prevent the next financial crisis. So thank you all for being here. 

Thank you, Mr. Chairman. 

Senator CRAPO. Thank you, Senator Warner and Senator Warren. We have got both of you sitting here. 

I want to pursue the same line of thinking just from a little different angle, and that is with regard to international capital standards. Two of the three insurance companies that FSOC has designated as systemically important were first designated by the 

international Financial Stability Board, and because three voting 

members of FSOC first engaged at the international FSB level to 

determine if a U.S. company is systemically important, there is a 

concern that the FSOC designation for those companies was predetermined essentially and that something very similar is going to 

occur now as we deal with capital standards. 

This is something that, Mr. Bock, you raised in your testimony, 

and so I want to go to you first. But before I do so, I guess the 

question is: Is this a valid concern? And do these developments 

raise questions about the direction and timeliness given the regulatory differences between the United States and European models? Mr. Bock, we will start with you, and then let us go to Mr. 

Schwarcz and Mr. Falzon. 

Mr. BOCK. Thanks, Mr. Chairman. Obviously, as Senator Warren 

indicated and as you have heard many times, there is a tremendous difference between our systems. The timetables and regulations really should not be driven by international pressures. We 

certainly have to recognize the State system in the United States 


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has been a valuable system, has protected U.S. consumers for 150 

years. So our concern is that, yes, it is being driven fast, and we 

have not gotten our Federal standard in front of us yet to even understand that. So for us, the concern that you have is the same 

concerns that we have. 

Senator CRAPO. Thank you. 

Mr. Schwarcz? 

Mr. SCHWARCZ. So I guess I would distinguish between designating a firm as systemically significant and then capital rules. 

Whether or not a firm is systemically significant I think should be 

a question that the Europeans have just as much insight in as we 

do. I mean, the question is really one of, to the extent a firm failed 

in a sort of weak financial setting, would that have broader consequences in the financial system. So I think it is appropriate in 

that context to learn from what the Europeans think and what 

other people in the international community think. That should not 

preordain our conclusion, but absolutely I think it should inform it. 

My understanding is that that is exactly what happened, that it 

informed our decision, but it did not in any way preordain it. 

To distinguish the capital question, when you are talking about, 

OK, exactly how should you implement capital rules, that is a 

question that, I think as we have discussed earlier in this hearing 

and as Senator Warren’s question raised, one needs to implement 

capital standards in a particular jurisdiction that are reflective of 

the broader regulatory system. 

So I absolutely, again, think we need to learn from the IAIS. We 

need to learn from our international colleagues. There are some 

elements of the capital regime they are developing that I think 

should be incorporated. But I think that we cannot sort of adopt 

wholesale the views that they are developing, and I do not think 

that is what will happen. But I do think we need to learn from 

them and take them seriously. 

Senator CRAPO. Thank you. 

Mr. Falzon? 

Mr. FALZON. It is difficult to compare or to speculate as to whether the designation internationally influenced the domestic designations because both processes lacked transparency. And, in fact, the 

global process has no transparency whatsoever. We had a single 

conference call that we were involved in in the process of that entire designation, and so we are not part of a hearing or an opportunity to present or appeal. So difficult to speculate. 

With respect to our regulatory system, I would share the observation that we have a strong system in place that actually on the 

whole has done quite well in the United States and that we should 

be leveraging that, plugging the gaps that exist in that system, 

when we think about things around group supervision that were 

evidenced as areas of weakness through the crisis, but that basic 

construct enhance, in order to provide the systemic protection that 

we all agree is important, should then be developed and exported 

as opposed to relying on a convention that is developed in an international arena to be imported into our marketplace. 

Senator CRAPO. Well, thank you. This is very helpful. It is a very 

important discussion. As Senator Warren’s comments indicate, 

there is a concern that this interaction between the U.S. and EuroVerDate 0ct 09 2002 15:25 Aug 01, 2016 Jkt 000000 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 L:\HE3E8B~1\04-30E~1\HEARING\97304.TXT SHERYL

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pean models, through trade negotiations or otherwise, may be utilized to weaken U.S. standards. I hear the same thing argued from 

the other side, folks worried that it may be utilized to force the 

United States to adopt standards or designations that we did not 

want to nor need to adopt. So it is a very interesting conversation 

and a problematic issue that we need to get resolved properly. 

Senator Warner? 

Senator WARNER. Thank you, Mr. Chairman. While Senator Warren and I differ on the trade approach, I concur she raises an interesting question that I have not fully thought through and think we 

need to get some answers on. 

I have kind of two slightly off-topic questions. One is we have 

had this extraordinarily low interest rate environment for some 

time and potentially foreseeably into the future. What does that do 

in terms of your balance sheet risks? I mean, obviously there is a 

lot of good things about that low interest rate phenomenon, but for 

the insurance industry it poses a different series of risks. Again, if 

very briefly we could get some response. 

Mr. FALZON. So low interest rates are a challenge for the industry in that it reduces our long-term profitability should it be sustained in our return on equity. 

From a balance sheet standpoint, however, the risk of low interest rates already sits on our balance sheet. Statutory reserving requires that we do a stress test on low interest rates, and in that 

stress test we dramatically lower the level of rates from where they 

are today and presume that they stay at the depressed level over 

a lifetime. 

The reserve that gets created by virtue of that scenario then has 

to be booked onto our balance sheet and backed with real hard financial assets. So from a balance sheet standpoint, the risk of sustained low interest rates has already been reflected and accounted 

for, and we are well suited to protect our customer obligations and 

to prevent any systemic consequences of that environment prevailing for a longer period of time. 

Senator WARNER. Mr. Bock and Professor Schwarcz? 

Mr. BOCK. Thank you, Senator. The challenge obviously, as you 

know, it does compress margins. One of the challenges obviously is 

not to reach for risk in order to generate income. We do not do 

that. As a mutual company, we take care of our policyholders first, 

and that means we do the appropriate things to manage in an unprecedented low interest rate environment. 

Mr. SCHWARCZ. I generally agree with what has been stated. The 

one thing I do want to sort of emphasize is that there are certain 

elements of the State regime, particularly the reserving regime, 

that do, in fact, protect policyholders, but there is also some change 

afoot with respect to how companies book reserves, and that is 

going to allow greater use of internal models. And then there has 

also been a very broad phenomenon of what some people call ‘‘shadow insurance,’’ where firms have been taking lower reserves by 

using affiliate transactions. 

So one of the core things that the Fed needs to do, I believe, in 

its supervision and perhaps in its capital requirements is to make 

sure that the types of protections that we have seen historically are 


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not gamed or are not traded away with new regimes that are not 

time-tested. 

Senator WARNER. Well, I want to make sure we get to Senator 

Scott, so I will just ask, Professor Schwarcz, if you want to just add 

one other comment. The NAIC witness last week raised similar 

concerns that there are—I share the fact that they are a very different business than the banking industry. But we have seen insurers start to move to more alternative investment products, use of 

hedge funds, other kind of things that fall out of the plain vanilla 

formula. Do you want to make a comment about that? I think that 

does raise concerns on my——

Mr. SCHWARCZ. Absolutely. I think one of the core lessons of the 

crisis is that the financial system is constantly evolving, and very 

sophisticated firms are engaging in transactions that look a lot 

more like banking. So, for instance, we are seeing some funding 

agreements that FSOC has pointed out that creates short-term liabilities, securities lending that can create some short-term liabilities and bank-run-like dynamics. We have guaranteed investment 

contracts that in some ways create guarantees that can create longterm concern and liquidity concerns. 

So I think that it is important that we are cognizant of the fact 

that while the core insurance business is very different than the 

core banking business, insurers are, at least in many cases, engaging in activities that are closer on the spectrum to banking or in 

between. And that is why we need to have a flexible and adaptive 

regulatory system rather than one that embraces very formulaic, 

quantitative standards. 

Senator WARNER. Thank you. 

Thank you, Mr. Chairman. 

Senator CRAPO. Thank you. 

Senator Scott. 

Senator SCOTT. Thank you, Mr. Chairman. I was just in a tax 

working group before I came here, so I think it is a good point that 

while we examine insurance regulation here and banking, we also 

keep in mind the unique insurance provisions in our Tax Code and 

how they impact companies and policyholders. Thank you, panelists, for being a part of this discussion this morning. 

I think sometimes it is easy for us here in Washington to get 

caught up in the alphabet soup of financial regulators and discussions about complex Dodd-Frank regulations and provisions. All of 

these are very important, but I would like to take a step back and 

just recall that what we are talking about today really all boils 

down to how it affects the policyholder. 

I learned from my time in the insurance industry of about 25 

years that there are a few variables when it comes to products: the 

terms of the insurance and the price. And I also learned that there 

are all kinds of people with all kinds of insurance needs. So I think 

it is important that our discussion focus on the availability and the 

flexibility of a diverse set of insurance products. 

And I worry that if we fail to shape regulation around the bedrock principle of policyholder protection that has served our Statebased system so well for so long, we are going to eliminate products 

from the market or make them so expensive for average folks to 

afford. 


BANKI-41578DSA with DISTILLER
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Mr. Bock, do you have any thoughts about this? And can you 

help me bring this Washingtonspeak down to a kitchen table economics point of view? 

Mr. BOCK. Well, let me try to do what others failed to do. Obviously, for our industry, for the property and casualty industry, it 

is important to protect the policyholder, to keep our promises, and 

you have seen our capital, our surplus to premium go up. We have 

more surplus now to be able to take care of our policyholders in 

this industry than ever before. That is important. Anything that 

would put that at risk is actually putting our customers at risk, our 

consumers at risk, because as you did say, it would cause us to 

have to pass on whatever price it might be—the price of additional 

efforts in order to raise capital, to raise ourselves to levels that 

would limit us from doing what we need to do to take care of our 

customers. So, to me, I fully agree. 

The one thing that we are concerned about obviously with all the 

alphabet soup, as you say, is that in all this we do not think goals 

are aligned, and for us, in our company, when our goals are 

aligned, our customers are served, our consumers are taken care of. 

And regulatory bodies should be no different, and this is an area 

of our concern. We do not think our regulatory bodies are aligned. 

Senator SCOTT. The lack of expertise in some of our regulatory 

bodies may be part of the reason why they are not aligned. 

Mr. BOCK. Absolutely. And we do look to you, we do look to our 

elected officials to give them the guidance that they need. 

Senator SCOTT. Thank you. 

Mr. Falzon, obviously Prudential has been designated as a SIFI 

by the FSOC, which subjects them to additional regulation by the 

Fed. On Tuesday, I asked Mr. Woodall about Prudential’s designation and whether he agreed with me that regulators with experience in an industry should have a greater say in whether to designate a company in that industry. Obviously, Mr. Woodall dissented very forcefully from the Prudential designation decision. 

You touched on this during your testimony. Could you elaborate 

on this? And do you have any concrete ideas for reforming the designation process to give greater weight to regulators with experience in the industry? 

Mr. FALZON. We have engaged in the request for commentary on 

the FSOC process and have made a number of suggestions. In 

those suggestions, the theme that would run throughout that is increased transparency, increased interaction and dialogue, and clarity around the basis of designation. And we think addressing each 

of those and the variety of specific initiatives they could do in order 

to accomplish that would be helpful to coming to the right conclusions, that the transparency and interaction would include the 

input from experts. And whether the experts are part of that process in the form of voting members or part of that process in the 

form of expert testimony, we think that that would enhance the 

overall designation process. 

Senator SCOTT. Thank you. One of the points I wanted to convey 

during this hearing is that as we struggle with the right regulatory 

environment, the expertise in the industry that you are regulating 

seems to be incredibly important and oftentimes missing. And if we 

are going to make sure that the goal, the objective is to protect the 


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policyholder, perhaps we should start with the policyholder and 

work our way back to the regulatory environment as opposed to 

transposing banking regulatory environment over the insurance industry in a way that is inconsistent with the best interests long 

term of the policyholder. 

Thank you. 

Senator CRAPO. Well, thank you, Senator Scott, and I can speak 

for myself that at the level of this Committee and Congress, we are 

really glad to have someone with expertise in this industry to talk 

with us and work with us, and we appreciate your contribution. 

Senator SCOTT. Thank you. I am glad I have Travis with me, too. 

Thank you. 

[Laughter.] 

Senator CRAPO. I have no further questions. Senator Warner, 

Senator Scott, do you have any further questions? 

Senator SCOTT. No, sir. Back to the working group. 

Senator CRAPO. All right. Well, we want to thank this panel. I 

have said this already, but your written testimony as well as your 

presentations today have been very helpful. We obviously have 

some very significant issues to deal with, and this Committee is 

going to be grappling with those issues, and what you have helped 

us to understand today will be very beneficial in that regard. 

Without anything further, this hearing is adjourned. 

[Whereupon, at 11 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 


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PREPARED STATEMENT OF ROBERT M. FALZON

EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, PRUDENTIAL FINANCIAL

ON BEHALF OF THE AMERICAN COUNCIL OF LIFE INSURERS AND THE AMERICAN

INSURANCE ASSOCIATION

APRIL 30, 2015

Chairman Crapo and Ranking Member Warner, my name is Robert Falzon, and 

I am Executive Vice President and Chief Financial Officer of Prudential Financial. 

I am testifying today on behalf of the American Council of Life Insurers (‘‘ACLI’’) 

and the American Insurance Association (‘‘AIA’’). ACLI is the principal trade association for U.S. life insurance companies with approximately 300 member companies 

operating in the United States and abroad. ACLI member companies offer life insurance, annuities, reinsurance, long-term care and disability income insurance, and 

represent more than 90 percent of industry assets and premiums. The American Insurance Association (AIA) is the leading U.S. property-casualty insurer trade organization, representing approximately 325 insurers that write more than $127 billion 

in U.S. premiums each year. AIA member companies offer all types of property—

casualty insurance, including personal and commercial auto insurance, commercial 

property and liability coverage for small businesses, workers’ compensation, homeowners’ insurance, medical malpractice coverage, and product liability insurance. 

ACLI and AIA appreciate the opportunity to address the ongoing development of 

capital rules by the Federal Reserve Board (the ‘‘Board’’) applicable to those insurers 

that have been designated as systemically important by the Financial Stability 

Oversight Council (‘‘FSOC’’) or that own savings and loan associations, the related 

group insurance capital standard being developed by the International Association 

of Insurance Supervisors (‘‘IAIS’’), and the transparency and fairness of the FSOC 

designation process. 

Prudential Financial is one of the three insurers that has been designated as systemically important by FSOC, and as a consequence my company was intimately involved with the legislation enacted late last year enabling the Board to craft capital 

standards suitable for an insurance enterprise. In addition, I am personally involved 

in the overall industry effort to work with the Board to come up with the actual 

capital rules that will be applied to those insurance groups now subject to the 

Board’s jurisdiction. 

The Collins Amendment & The Insurance Capital Standards Clarification 

Act 

Please allow me to thank Chairman Crapo, Ranking Member Warner and the 

Members of this Subcommittee for your leadership in support of the Insurance Capital Standards Clarification Act of 2014. As you know, this legislation, authored by 

Senator Susan Collins, Senator Sherrod Brown, Senator Mike Johanns, Representative Gary Miller, and Representative Carolyn McCarthy, was unanimously approved 

by the Senate and House last year. This essential legislation clarified Federal Reserve Board authority to develop capital standards for insurance companies subject 

to Board supervision that reflect insurance businesses and risks, rather than defaulting to inappropriate bank standards. The unanimous support for this legislation in both the Senate and House constituted a definitive statement of Congressional intent that insurance capital standards must be appropriately designed and 

tailored. The legislation was also an important recognition that the business of insurance is substantially and fundamentally different from the business of banking, 

and that supervision of these different industries, particularly where capital adequacy is being assessed, should account for their different risk profiles, balance 

sheets, and business models. 

Without question, capital standards are stronger when they are appropriately designed for the type of company to which they are applied. Appropriately designed 

and tailored capital standards further the goals of prudential supervision and provide the highest level of safety and protection for consumers. In the case of insurance, the application of bank standards would have disrupted the operations of well 

capitalized insurance companies. In fact, capital standards governing banks and 

bank holding companies should never be applied to insurance entities. 

In the near future, we expect that the Board will begin drafting a proposed regulation establishing a consolidated group capital standard for insurers that are savings and loan holding companies, or that have been designated by the FSOC as systemically important. Earlier this year, we met with senior representatives of the 

Board to stress the importance of moving forward with a proposal that reflects the 

well established methodologies for measuring the financial strength and resiliency 

of an insurance group. We have continued our communications with the Board’s 


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staff on the issue since then, and will continue to do so as this process unfolds. 

Since the passage of the Act, we are encouraged by the Board’s approach to the 

issue and are hopeful that any proposed regulation will reflect the clear Congressional intent behind its passage. 

International Insurance Capital Standards 

The International Association of Insurance Supervisors (IAIS) is working to develop an international group Insurance Capital Standard (ICS) as part of IAIS work 

on a proposed Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame). ComFrame is a set of international supervisory standards focusing on group-wide supervision of Internationally Active Insurance Groups 

(IAIGs). Under the current proposed ComFrame definition of an IAIG, there are 

likely to be approximately 50 IAIGs around the world. IAIGs are defined as companies that operate in three or more countries, generate more than 10 percent of their 

revenue from outside their home country, and meet significant size requirements. 

The U.S. insurance industry is concerned about the haste with which the ICS is 

being developed, particularly in the context of Congress’ passage into law of the Insurance Capital Standards Clarification Act in December 2014. The IAIS timeline 

must accommodate full implementation of that law and a formal rulemaking process 

for development of domestic insurance capital standards by the Board. 

The IAIS recently announced that it will take a staged or incremental approach 

to developing the ICS over several years with the ultimate goal of global convergence around one standard in the longer term. This signals a longer, rational and 

thoughtful process to developing the ICS than originally identified. With that said, 

we will not grow complacent, we have not claimed victory—we will continue to actively engage our U.S. representatives to the IAIS as well as international supervisors to make sure that they remain true to a more deliberative approach to ICS 

development—one that reflects a capital/solvency framework that is appropriate for 

the U.S. insurance market and consumers. 

The U.S. representative members of the IAIS will be informed by a deliberative 

rulemaking process by the Board that draws on the risk-based capital framework 

currently utilized by the States, and they will bring that experience to bear in the 

international process. The IAIS timeline should not be elevated above the importance of developing an international standard that is complementary to local capital 

standards and results in a level competitive playing field that promotes private market expansion around the world. The ICS would clearly benefit from the work of the 

Board, and the insurance industry supports appropriate adjustments to the IAIS 

timeline for the ICS to accomplish these objectives. Importantly, the IAIS has 

slowed its overly aggressive timeline for development of the ICS, which can only be 

implemented through a State or Federal rulemaking process. 

Any ICS must be rooted in principles that are common to insurance in all jurisdictions, but must also be flexible enough to recognize and appropriately reflect existing accounting practices and the need for jurisdictional differences based on market, 

societal and consumer needs. Such flexibility is an essential precondition to the 

United States and other jurisdictions’ willingness and political ability to adopt it 

into law and put it into practice. 

In fact, Team USA, consisting of the Board, State Insurance Supervisors, and the 

Treasury Department’s Federal Insurance Office (FIO), has been forcefully advocating that any ICS cannot be finalized that does not allow for the foundational elements of the U.S. regulatory system. We understand that the IAIS will begin field 

testing two different approaches to the ICS this year. One of these approaches was 

largely developed, advanced and endorsed by all members of Team USA and is more 

representative of the U.S. regulatory framework. These two approaches will be field 

tested by more than 25 global firms, including several U.S.-based companies, over 

the next several years. This is another positive step. We commend the Board, State 

Insurance Supervisors, and FIO for working together to achieve this outcome. 

Another factor slowing the pace of ICS development is a realization by policymakers in markets around the world that life insurers not only meet a tremendous 

social need for protecting individuals and their families, but also are fundamentally 

important as one of the few industries that invest for the long term in infrastructure. Those investments are key drivers of global job creation and economic growth. 

We believe that it is critical for the United States to elevate this issue to the political level of the G20. The balance of regulatory intensity and investment and growth 

needs to be made at the macro political and economic level and not only by regulators who are not responsible for job creation and economic recovery. In a similar 

way, property-casualty companies provide the insurance that makes infrastructure 

development possible, as well as investments that support continued growth. It is 

critical that capital standards promote those roles to the benefit of consumers and 


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a healthy economy with robust private insurance markets. We are optimistic that 

with high level political appreciation for the role that insurers play in the global 

economy, policies can be developed that begin a virtuous cycle of growth and stability. 

Solvency II and the U.S.–EU Regulatory Dialogue Project 

The core intent of Solvency II was and is to improve the prudential regulation 

of the European Common Market in insurance. As we recognize that Solvency II is 

an internal European undertaking, we have been engaged on ‘‘third country’’ provisions, which are intended to extend the benefits of unilateral recognition to insurers 

and reinsurers that conduct business into and out of the EU but are headquartered 

elsewhere. 

We have strongly advocated that the U.S. regulatory regime is equivalent in outcome to Solvency II and that this should be recognized by the European Commission. We are pleased that there has been a productive process established between 

the U.S. Federal and State Governments and the European Commission and the 

European Member State regulators through their statutory consultative body the 

European Insurance and Occupational Pension Authority (EIOPA). 

This process, called the U.S.–EU Regulatory Dialogue Project, is in its fourth year 

of a detailed information exchange intended to build greater transatlantic understanding between regulators of the different U.S. and EU approaches to achieving 

the same regulatory outcomes of stability, consumer protection and fair competition. 

In our opinion, this regulatory confidence building has been a tremendous success 

in removing misunderstanding and paving the way for the United States to be 

deemed either transitionally or permanently equivalent by the European Union. 

This positive progress however is not a foregone conclusion and the Dialogue 

Project process requires continued work by all sides. We believe that the maintenance of a positive relationship between the world’s two largest markets is simply 

too important to be disrupted by perceived differences in regulatory approach. We 

also commend the State supervisors and FIO for the time and effort they have made 

to patiently explain the U.S. system and to address potential misperceptions. 

The U.S.–EU Dialogue Project has had the ancillary benefit of bringing together 

U.S. and EU regulators within the IAIS decisionmaking process. We urge this continued expansion of coordination between U.S. and EU regulators within the IAIS 

to support markets where all competitors are held to the same high standards of 

solvency, market conduct and consumer protection. 

The FSOC Designation Process 

While FSOC has made improvements to its designation process, we believe additional reforms are necessary to enhance transparency and ensure a fairer overall 

designation and de-designation process. Our suggestions for improvement focus on 

the following: providing better and more transparent procedural safeguards; affording greater weight to the views of an insurer’s primary financial regulator; implementing an ‘‘activities-based approach’’ for evaluating the systemic importance of insurers; putting in place a viable process for de-designation; and promulgating the 

regulations required by Section 170 of the Dodd-Frank Act. 

Improve Procedural Safeguards 

One of the most important improvements to the FSOC designation process would 

be to require that a company under consideration be provided with access to the entire FSOC record. 

A company that advances to the third and final stage of review has no way of 

knowing what materials FSOC believes are relevant, whether and in what form the 

materials it submits are provided to voting members of FSOC, or what materials, 

in addition to those submitted by the company, FSOC staff and voting members reviewed and relied upon. In other words, a company is not provided with the evidentiary record upon which the voting members will make a proposed or final determination. 

In addition, FSOC should have separate staff assigned to its enforcement and adjudicative functions. Council staff who identify and analyze a company’s suitability 

for designation and author the notice of proposed determination and final determination should not also advise Council members in deciding whether to adopt the 

notice of proposed determination and final determination. Dividing Council staff between enforcement and adjudicative functions would protect the independence of 

both functions. Communications between Council members and enforcement staff 

should also be memorialized as part of the agency record and provided to companies 

under consideration for designation. 

For an insurer, we believe an essential part of the designation process must be 

to afford special weight to the views of the FSOC member with insurance expertise. 


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FSOC must vote, by two-thirds of the voting members then serving including the 

affirmative vote of the Chairperson, to issue a final determination. The requirement 

for a supermajority vote is intended to ensure that designation is reserved for companies that pose the most obvious risk to the financial stability of the United States. 

Yet, the members of FSOC vote as individuals rather than as representatives of 

their agencies. Thus, the vote is based upon their own assessment of risks in the 

financial system rather than the assessment of their respective agencies. Moreover, 

the voting process gives equal weight to views of all members, regardless of a member’s experience in regulating the type of company being considered for designation. 

In the case of a company primarily engaged in the business of insurance, special 

weight should be given to the views of the Council member with insurance experience. 

Upon receipt of a final designation, a company may seek judicial review before 

a Federal court. Even this safeguard, however, is subject to limitations. A company 

has only 30 days in which to file a complaint, and loses the right to do so beyond 

that date. We believe that timeframe should be extended. Moreover, filing the complaint should carry an automatic stay of supervision by the Federal Reserve Board. 

While a company is challenging the legitimacy of a designation, it should not be 

forced to simultaneously establish a comprehensive infrastructure (e.g., systems, 

procedures, and controls) to comply with Board supervision. 

Finally, from a procedural standpoint, we believe FSOC should be prevented from 

misapplying the ‘‘material financial distress’’ standard for designation. With respect 

to insurers, it seems clear that FSOC assumed the existence of material financial 

distress at a company and then concluded that such distress could be transmitted 

to the broader financial system. Under a material financial distress standard that 

actually meets the statutory requirements of the Dodd-Frank Act, FSOC would need 

to employ the 11 statutory factors to first determine whether the company is vulnerable to material financial distress based upon its company-specific risk profile and, 

if it is, then determine whether the company’s failure could threaten the financial 

stability of the United States. FSOC should not be able to designate a company on 

an assumption it is failing, but instead should designate a company only when a 

company’s specific risk profile—including its leverage, liquidity, risk and maturity 

alignment, and existing regulatory scrutiny—reasonably support the expectations 

that the company is vulnerable to financial distress, and then that its distress could 

threaten the financial stability of the United States. The purpose of designations 

should be to regulate nonbanking firms that are engaged in risky activities that realistically ‘‘could’’ cause the failure of the firm, not to regulate firms that are not 

likely to fail. 

Afford Greater Weight to the Views of an Insurer’s Primary Financial Regulator 

In drafting the Dodd-Frank Act, Congress recognized that many nonbank financial companies are subject to supervision and regulation by other financial regulators. Insurance companies, for example, are subject to comprehensive regulation 

and supervision by State insurance authorities. Thus, Congress directed FSOC to 

consult with other primary regulators when making a designation determination, 

and required FSOC to consider ‘‘the degree’’ to which a company is already regulated by another financial regulator. Congress also gave the Federal Reserve Board 

authority to exempt certain classes or categories of nonbank financial companies 

from supervision by the Board, and directed the Board to take actions that avoid 

imposing ‘‘duplicative’’ regulatory requirements on designated nonbank companies. 

FSOC’s designation of insurance companies shows little deference to these requirements. In the case of MetLife, for example, FSOC discounted State insurance 

regulation even after the Superintendent of the New York State Department of Financial Services (NYDFS), Benjamin Lawsky, told FSOC that: (1) MetLife does not 

engage in nontraditional, noninsurance activities that create any appreciable systemic risk; (2) MetLife is already closely and carefully regulated by NYDFS and 

other regulators; and (3) in the event that MetLife or one or more of its insurance 

subsidiaries were to fail, NYDFS and other regulators would be able to ensure an 

orderly resolution. Similarly, in his dissent in the Prudential case, the Council member with insurance experience noted that the scenarios used in the analysis of Prudential were ‘‘antithetical’’ to the insurance regulatory environment and the State 

insurance company resolution and guaranty fund systems, and all three of 

Prudential’s primary State insurance regulators submitted statements rebutting any 

argument that Prudential could cause systemic risk. 

This lack of deference to an insurer’s primary financial regulator is particularly 

troubling given the fact that insurance, unlike every other segment of the financial 

service industry, does not have any of its primary regulators as voting members of 


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FSOC. Moreover, none of the primary regulators of the three insurers that have 

been designated were ‘‘at the table’’ when FSOC designation decisions were made. 

Implement an ‘‘Activities-Based’’ Approach for Insurance 

The Dodd-Frank Act gives FSOC two principal powers to address systemic risk. 

One power is the authority to designate nonbank financial companies for supervision by the Federal Reserve Board. The other power is an ‘‘activities-based’’ authority to recommend more stringent regulation of specific financial activities and 

practices that could pose systemic risks. FSOC has not been consistent in its exercise of these powers. In the case of the insurance industry, FSOC has actively used 

its power to designate. In the case of the asset management industry, FSOC has 

undertaken an analysis of the industry so it can consider the application of more 

stringent regulation for certain activities or practices of asset managers, and it has 

not designated any asset management firm to date. 

FSOC held a public conference on the asset management industry in order to hear 

directly from the asset management industry and other stakeholders, including academics and public interest groups, on the industry and its activities. 

Furthermore, following its meeting on July 31, 2014, FSOC issued a ‘‘readout’’ 

stating that FSOC had directed its staff ‘‘to undertake a more focused analysis of 

industry-wide products and activities to assess potential risks associated with the 

asset management industry.’’

In contrast, FSOC has not held any public forum at which stakeholders could discuss the insurance industry and its activities. Instead, FSOC has used its power to 

designate three insurance companies for supervision by the Federal Reserve Board. 

ACLI and AIA support the more reasoned approach that FSOC has taken in connection with the asset management industry and believes that FSOC should be required to use its power to recommend regulation of the specific activities of a potential designee before making a designation decision with respect to that company. 

FSOC’s power to recommend more stringent regulation of specific activities and 

practices has distinctive public policy advantages over its power to designate individual companies for supervision by the Federal Reserve Board. FSOC’s power to 

recommend primary regulator action brings real focus to the specific activities that 

may involve potential systemic risk and avoids the competitive harm that an individual company may face following designation. As noted above, in certain markets, 

such as insurance, designated companies can be placed at a competitive disadvantage to nondesignated companies because of different regulatory requirements. Finally, the power to recommend avoids the ‘‘too-big-to-fail’’ stigma that some have associated with designations. 

FSOC’s recommendations for more stringent regulation of certain activities and 

practices must be made to ‘‘primary financial regulatory agencies.’’ These agencies 

are defined in the Dodd-Frank Act to include the SEC for securities firms, the CFTC 

for commodity firms, and State insurance commissioners for insurance companies. 

A recommendation made by FSOC is not binding on such agencies, but the DoddFrank Act includes a ‘‘name and shame’’ provision that encourages the adoption of 

a recommendation. That provision requires an agency to notify FSOC within 90 

days if it does not intend to follow the recommendation, and FSOC is required to 

report to Congress on the status of each recommendation. 

Permit Companies to Petition for a Designation Review Based on a Change in Operations or Regulation 

FSOC is required to review the designation of a company on an annual basis. A 

company also should have the opportunity to petition for a review based upon a 

change in its operations, such as the divestiture of certain business lines, or a 

change in regulation. Moreover, during a review, FSOC should be required to provide a company with an analysis of the factors that would lead FSOC to de-designate a company. This would lead a company to know precisely what changes in 

its operations or activities are needed to eliminate any potential for the company 

to pose a threat to the financial stability of the United States. 

Promulgate the regulations required by Section 170 of the Dodd-Frank Act 

Section 170 of the Dodd-Frank Act directs the Federal Reserve Board, in consultation with FSOC, to issue regulations exempting certain classes or categories of companies from supervision by the Federal Reserve Board. However, to date no such 

regulations have been issued. This requirement represents yet another tool Congress created to delineate between those entities that pose systemic risk and those 

that do not. How such regulations might affect insurance companies, if at all, is unknown. But presumably the regulations will shed additional light on what metrics, 

standards or criteria operate to categorize a company as nonsystemic. The primary 

goal here should be to clearly inform companies of how to conduct their business 


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and structure their operations in such a way as to be nonsystemic. Only if that primary goal cannot be met should the focus turn to regulating systemic enterprises. 

Conclusion 

The insurance industry strongly supports full implementation of the Insurance 

Capital Standards Clarification Act. In addition, the insurance industry supports a 

formal rulemaking process with notice and public comment for the development of 

insurance capital standards to ensure that the Federal Reserve Board has the best 

information and input from public stakeholders. The goal of this process should be 

the development of capital standards that are specifically designed and tailored for 

the insurance business model. Furthermore, this domestic process should not be condensed, abridged, or confused by IAIS standard setting. Because the IAIS would 

benefit from the work of the Federal Reserve Board, and because the U.S. position 

is certain to be informed by that work, the IAIS timeline for the development of the 

ICS must accommodate the U.S. process. This sequencing is essential to good market and regulatory outcomes for U.S. companies and consumers, and also for a 

healthy outcome to the international discussion. 

The insurance industry also supports reform of the FSOC process, including improved procedures for de-designation and increased consideration of the views of primary insurance regulators. These reforms would strengthen the FSOC and its regulatory goals of identifying and diminishing systemic risk. 

Chairman Crapo, Ranking Member Warner, thank you for the opportunity to testify before the Subcommittee today.


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1 Nothing in Dodd-Frank compels the Fed to use the same capital regime for Insurance SIFIs 

and Insurance Savings and Loan Holding Companies. However, many seem to anticipate that 

the Fed will design a single capital regime for both entities, and then apply a capital surcharge 

to Insurance SIFIs. 2Dodd-Frank § 113(a). 3See generally Daniel Schwarcz & Steven Schwarcz, Regulating Systemic Risk in Insurance, 

81 U. Chi. L. Rev. 1569 (2014). 

PREPARED STATEMENT OF DANIEL SCHWARCZ

PROFESSOR AND SOLLY ROBINS DISTINGUISHED RESEARCH FELLOW

UNIVERSITY OF MINNESOTA LAW SCHOOL

APRIL 30, 2015

Chairman Crapo, Ranking Member Warner, and Members of the Subcommittee, 

thank you very much for this opportunity to discuss the Financial Stability Oversight Council’s (‘‘FSOC’’) process for designating nonbank financial companies as 

systemically significant institutions. In my testimony today, I plan to make two central points regarding this process and its consequences for companies that are engaged primarily in the business of insurance. 

First, I will emphasize that the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (‘‘Dodd-Frank’’) constructed FSOC’s designation process to be flexible 

and adaptive because systemic risk is itself complicated and evolving. Although this 

design choice inevitably reduces transparency, FSOC has done a reasonably good job 

of addressing this concern. For instance, FSOC’s development of a quantitative 

screen in the first stage of its designation process helps assure the vast majority 

of nonbank financial institutions that they will not be deemed systemically significant. At the same time, FSOC’s refusal to rely exclusively on quantitative metrics 

in its designation process or to define a simple, formulaic ‘‘off-ramp’’ for designated 

firms preserves its ability to effectively evaluate and monitor the potential systemic 

importance of individual firms. 

After addressing the transparency of FSOC’s designation process, I will turn to 

the consequences of a systemic risk designation for nonbank financial companies 

that are principally engaged in insurance (‘‘Insurance SIFIs’’). Perhaps the most important such consequence is that Insurance SIFIs—in addition to Insurance Savings 

and Loan Holding Companies 1—will be subject to consolidated capital rules to be 

crafted by the Board of Governors of the Federal Reserve System (‘‘Fed’’). I will suggest that these rules should focus on the potential ways in which the States’ RiskBased Capital (‘‘RBC’’) regime fails to fully account for systemic risk concerns. In 

particular, the consolidated capital regime should use as its starting point firms’ 

consolidated balance sheets, rely on market-based valuations of firms’ assets, and 

generally avoid reliance on firms’ internal models in setting capital or reserve requirements. 

(1) Transparency in FSOC’s Designation Process 

One of the central goals of Dodd-Frank is to limit the risk that individual companies can pose to the general economy in times of financial market turbulence. As 

exemplified by the substantial role of American International Group (‘‘AIG’’) in the 

2008 Global Financial Crisis, the historical assumption that such systemic risk is 

cabined to banks and their holding companies is inaccurate in today’s financial 

world. Instead, firms engaging in a wide variety of financial activities can, in certain 

circumstances, contribute to the fragility of the financial system in times of general 

market stress. 

To address this reality, Dodd-Frank empowered FSOC to designate nonbank financial firms as entities that could pose a threat to U.S. financial stability. Rather 

than requiring FSOC to use specific activity-based or quantitative thresholds in executing this responsibility, Dodd-Frank instructed FSOC to consider 10 broad factors. 

Tellingly, Dodd Frank also authorized FSOC to consider ‘‘any other risk-related factors that the Council deems appropriate.’’2 Dodd-Frank thus tasked FSOC—a council of the Nation’s leading financial regulators—with employing a broad and evolving approach to identifying systemically significant nonbank financial institutions. 

This flexible approach to identifying systemically significant nonbank financial institutions reflects a key lesson of the financial crisis: that systemic risk can arise 

in new and distinctive guises due to the massive complexity and interconnections 

that have evolved, and continue to evolve, within our financial system.3 Just as the 

errant assumption that only banks could create systemic risk was substantially responsible for the 2008 global financial crisis, any specific quantitative or activitybased definition of systemically significant nonbank financial institutions in DoddFrank would undoubtedly have been under-inclusive. This, in turn, would have 


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4See 77 Fed. Reg. 21,637 (Apr. 11, 2012). FSOC issued an advance notice of proposed rulemaking in 2010, a first notice of proposed rulemaking in early 2011, a second notice of proposed 

rulemaking in late 2011, and a Final Rule and Interpretive Guidance in 2012. 5These are (i) direct exposure of other firms to the systemic firm, (ii) abrupt liquidation of 

the systemic firm’s assets, and (iii) the disruption of a critical function or service provided by 

the systemic firm. 6This framework focuses on (i) size, (ii) interconnectedness, (iii) substitutability, (iv) leverage, 

(v) liquidity risk and maturity mismatch, and (vi) existing regulatory scrutiny. 7The final rule established two post-screen stages of review. In the first (i.e., ‘‘stage two’’), 

the Council considers a broad range of quantitative and qualitative information that is available 

through existing public and regulatory sources. As originally described in the final rule, firms 

being reviewed during this stage would not be notified of this fact. In the final evaluation stage 

(i.e., ‘‘stage three’’), firms that FSOC continued to believe could pose a systemic risk would be 

subject to a more detailed review in which they would be invited to submit relevant materials. 8These quantitative metrics ‘‘represent the framework categories that are more readily quantified: size, interconnectedness, leverage, and liquidity risk and maturity mismatch.’’ Id. at 

21,642. 9FSOC did reserve its discretion to evaluate a financial firm as posing potential systemic 

risks even if it was screened out in Stage One. 10 Id. 11Government Accountability Office, Financial Stability Oversight Council, Further Actions 

Could Improve the Nonbank Designation Process (Nov. 2014). 

incentivized financial firms to take on risks that were not captured by the applicable 

statutory definition but where extreme losses could have been externalized on to the 

broader financial system and the general public. 

As with all broad legal standards, the flexibility of the FSOC designation scheme 

as established in Dodd-Frank inevitably creates potential concerns regarding its 

transparency. Any legal standard that relies on expert decisionmakers to apply a 

broad multifactor test will necessarily sacrifice predictability and transparency in 

favor of flexibility and adaptability. This is particularly true in a domain such as 

systemic risk, which is highly technical, constantly evolving, and not fully understood by the academic or regulatory communities. 

To help address these inevitable transparency concerns, FSOC engaged in a prolonged process of rulemaking to more specifically describe its criteria for determining which nonbank financial firms might pose systemic risks to the financial 

system.4 FSOC’s Final Rule and Interpretive Guidance defined three potential 

‘‘channels’’5 through which a nonbank financial firm might transmit systemic risk 

and established a six-part analytical framework 6 to guide its assessment of individual firms. At the same time, FSOC specifically declined commentators’ requests 

to establish a simple formula that would link the transmission channels to the analytical framework or that would determine how the six-factor analytical framework 

would be weighted in a final determination. Such an approach, FSOC noted, would 

be inconsistent with the qualitative nature of many of Dodd-Frank’s statutory considerations and with robust assessment of individual financial firms’ unique risk 

profiles. 

Nonetheless cognizant of continuing transparency concerns, FSOC did develop a 

formulaic quantitative test to screen out only a small subset of all nonbank financial 

firms for potential systemic risk designation. Under this screen (which occurs at 

‘‘stage one’’ of FSOC’s designation process), firms are generally identified for more 

searching quantitative and qualitative assessment by FSOC 7 if their total consolidated assets surpass $50 billion and they satisfy one of five additional quantitative 

standards.8 The effect of this quantitative screen is to provide substantial certainty 

to the vast majority of nonbank financial institutions that they will not be designated as systemically significant institutions.9 At the same time, this approach appropriately reflects the reality—illustrated by the crisis and embedded within DoddFrank—that the potential for a firm to pose a systemic risk to the larger financial 

system cannot currently ‘‘be reduced to a formula.’’10

In recent months, FSOC has responded to continued concerns regarding the transparency of its process by adopting additional reforms suggested by various stakeholders. Among other things, these reforms will inform firms earlier in FSOC’s process if they are being considered for designation and will allow those firms to submit 

relevant information to the Council at that point. It will also provide firms that 

have been designated as systemically significant with an enhanced opportunity to 

participate in the Council’s annual reevaluation of that designation. 

To be sure, none of this is to suggest that FSOC could not further improve the 

transparency of its operations. In particular, FSOC’s public basis for designating 

nonbank financial firms as SIFIs could more clearly articulate the relative importance of the identified factors in explaining the Council’s reasoning.11 Additionally, 

FSOC could more clearly develop a process for allowing a SIFI to seek the Council’s 


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12 In a Report of the NAIC and the Federal Reserve Joint Subgroup on Risk-Based Capital 

and Regulatory Arbitrage (2002), a working group of insurance and banking regulators explained the core differences between risk-based capital rules in insurance and banking by noting 

that ‘‘Insurance company regulators place particular emphasis on consumer (policyholder) protection’’ while ‘‘banking regulators focus on depositor protection and the financial stability of 

regulated entities on a going concern basis.’’ 13See, e.g., Daniel Schwarcz, Testimony before the Senate Subcommittee on Financial Institutions and Consumer Protection regarding ‘‘Finding the Right Capital Regulation for Insurers’’ 

(March 11, 2014); ‘‘Legislative Proposals to Reform Domestic Insurance Policy’’ (May 20, 2014); 

Daniel Schwarcz, Testimony before the House Subcommittee on Insurance, Housing and Community Opportunity regarding ‘‘Insurance Oversight and Legislative Proposals’’ (Nov. 16, 2011). 14 Consistent with the IAIS’s proposed approach, this balance sheet could then be broken down 

into three components: insurance, banking, and noninsurance financial and material nonfinancial activities. See International Association of Insurance Commissioners, Basic Capital Requirements for Global Systemically Important Insurers (July, 2014). 15See generally Daniel Schwarcz, A Critical Take on State-Based Group Regulation of Insurers, 5 U. Cal. Irv. L. Rev. (forthcoming, 2015), available at http://ssrn.com/abstract=2593897. 16 Robert L. McDonald & Anna L. Paulson, AIG in Hindsight (April, 2015), NBER Working 

Paper No. w21108, available at SSRN: http://ssrn.com/abstract=2596437. 17See generally Ralph S. J. Koijen & Motohiro Yogo, Shadow Insurance (February 18, 2015), 

Swiss Finance Institute Research Paper No. 14–64, available at http://ssrn.com/

abstract=2320921; Federal Insurance Office, How to Modernize and Improve the System of InContinued

opinion regarding whether specific transactions or alterations to the firm’s risk profile would allow it to shed its designation as a SIFI. 

Nonetheless, in my view, FSOC has done a reasonable job of promoting the transparency of its designation process given the inherently multi-factored and complex 

nature of its responsibility. It has also rightly resisted calls to develop simple rules 

defining systemically risky nonbank financial firms or a formulaic ‘‘off-road’’ for systemic risk designation. The nature of systemic risk is too fluid, complex, and poorly 

understood to allow for such simple formulas. By using clear quantitative metrics 

only to narrow the field of potential systemically risky nonbank financial institutions, while promoting greater participation and transparency among stakeholders 

in the post-screen assessment process, FSOC has struck a reasonable balance between transparency, on the one hand, and flexibility and adaptability, on the other. 

(2) Consolidated Capital Rules for Insurance SIFIs 

Under Dodd-Frank, those nonbank financial firms that are deemed systemically 

significant by FSOC are subject to enhanced prudential rules and supervision by the 

Fed. Perhaps the most important element of this regime is the application of new 

risk-based capital standards on a consolidated basis, which Dodd-Frank directs the 

Fed to develop. The Insurance Capital Standards Clarification Act of 2014 authorized the Fed to tailor these capital standards to the distinctive risks posed by insurers, which are different than the risks posed by banks. But, at the present time, 

the Fed has not made clear how precisely it intends to use this authority. 

In my view, the Fed should design capital standards for Insurance SIFIs that 

focus on the potential ways in which the policyholder-protection design of State RBC 

rules may fail to fully account for systemic risk concerns.12 As I have emphasized 

on multiple occasions in prior congressional testimony,13 the regulatory objectives 

of any risk-based capital regime have important implications for how that regime 

should be constructed. For that reason, capital regimes focused on systemic risk can, 

and should, be designed differently than capital regimes focused on policyholder protection. 

Given this perspective, I believe that the Fed should consider implementing a capital regime for insurance SIFIs that is consistent with three broad principles. First, 

that regime should use as its starting point the consolidated balance sheet of the 

firm.14 The current State-based RBC regime focuses exclusively on the balance 

sheets of individual insurance entities. Although this regime generally works well 

to promote policyholder protection, it has important limitations when it comes to 

regulating systemic risk.15 This is most obvious with respect to AIG’s use of a noninsurance subsidiary to issue Credit Default Swaps prior to the 2008 crisis. But it 

was also importantly illustrated by AIG’s use of a complex securities lending program to ‘‘transform insurance company assets into residential mortgage-backed securities and collateralized debt obligations, ultimately losing at least $21 billion and 

threatening the solvency of the life insurance companies.’’16 More recently, the Daniel Schwarcz, Testimony before the House Housing and Insurance Subcommittee regarding entity-based focus of the RBC regime has allowed insurance companies to 

utilize complex transactions with ‘‘captive’’ affiliates that may create systemic 

risks.17


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surance Regulation in the United States (2014); New York State Department of Financial Services, Shining a Light on Shadow Insurance: A Little-Known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk (June 2013). 18Federal Insurance Office, How to Modernize and Improve the System of Insurance Regulation in the United States (2014). 

Second, the Fed should seriously consider designing its capital regime for insurance SIFIs to require valuation of assets at market rates. Market-based valuations 

are more relevant than accounting values when it comes to systemic risk regulation, 

because it is precisely in times of potential systemic risk transmission that liabilities 

previously perceived to be long-term can become short-term. To the extent this occurs, then systemic firms may find themselves compelled to sell their assets at prevailing market rates. Market valuation of assets is also more consistent with emerging international norms, thus tending to promote cross-jurisdictional comparability, 

which is important from a systemic risk perspective. Although market valuation 

does create potential concerns regarding artificial capital fluctuations that could 

possibly contribute to fire-sale dynamics, these issues could conceivably be dealt 

with by adjusting required capital levels in times of economic stress. 

Third, the Fed should not allow firms to use their own internal models to determine adequate capital levels and it should also proceed with caution in accepting 

State Principles-Based Reserving (PBR) reforms that will allow insurers greater 

freedom to use internal models to set their reserves. A central lesson of the 2008 

global financial crisis is that firms’ internal models can often be overly optimistic, 

which should not be surprising given the incentives firms have to maintain lower 

capital levels and increased leverage. Moreover, in many cases it is simply not realistic to rely on regulators to police firms’ internal models due to the complexity of 

these models and the imbalance of resources available to regulators and private 

firms.18

These principles are broadly consistent with elements of the group-wide, consolidated capital requirements for systemically significant insurers that are being developed by the International Association of Insurance Supervisors (IAIS). Moreover, the 

IAIS has made substantial progress in recent years in crafting and testing the technical features of this framework. Of course, the Fed should remain cognizant of this 

country’s unique insurance regulatory scheme in determining how the IAIS’s capital 

standards should apply to insurance SIFIs in the United States. But it should also 

seriously consider adopting elements of this scheme that would provide a more 

macroprudential perspective than the State RBC regime, which focuses on policyholder-protection. For this reason, I believe that the Fed should continue to be an 

active participant in the IAIS’s development of consolidated capital standards, and 

should draw on these developments in implementing a consolidated capital requirement for insurance SIFIs in the United States. 


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RESPONSE TO WRITTEN QUESTION OF KURT BOCK FROM 

SENATOR VITTER 

Q.1. Mr. Bock, in your statement you stated, ‘‘We have no transactional deposits or loans. Despite this minimal banking footprint, 

COUNTRY is now subject to Federal Reserve regulation, including 

detailed discovery questionnaires and regular visits by examiners 

that seek to learn all aspects of our business.’’

How much time and resources has your company used to comply 

with these new regulations? Do you believe that this allocation of 

resources has affected the ability of COUNTRY to grow at its maximum rate?

A.1. Since the beginning of our regulation under the Federal Reserve, COUNTRY Financial has had significantly increased administrative burdens on our compliance and regulatory staff. For example, 25 percent of COUNTRY’s regulatory and compliance staff 

time is now spent communicating with the Federal Reserve even 

though COUNTRY’s depository institution is only $30.5 million in 

assets—less than 0.2 percent of our holding company. In addition, 

COUNTRY has had to engage both inside and outside counsel in 

interpreting and responding to requests for information or interpretation of rules. We have also added documentation and reporting 

requirements, which are in excess and duplicative to our current 

OCC and State regulatory requirements. 

While this reallocation of resources has not stopped COUNTRY 

from continuing to grow, the added burden has further stretched 

our risk management and regulatory compliance areas and taken 

senior executive attention away from other important strategic 

areas within the property casualty and financial services markets. 

The overall impact from new regulation has been added administrative costs, which the organization has largely absorbed within 

our existing structures, with marginal, if any benefit to the policyholder.


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ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD


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