Insurance is a major component of the US financial system, accounting for over US$5.7 trillion in assets, compared with US$15.8 trillion in the banking sector. Despite its size, the sector has to date largely escaped US federal regulation (remaining controlled at the state level).
The Obama Administration and Democrat-controlled Congress hope to change that by bringing the major financial firms, including insurance companies, into a new federal regulatory framework intended to prevent systemic risk within the financial system. We also mentioned these proposals in the July 2009 edition of Insurance Update.
New details have since been published, and the Trojan horse for the insurance sector is provisions directed at preventing future taxpayer-funded bailouts. The legislation casts its net over all firms, including those in the insurance sector that pose a threat to systemic financial stability due to their combination of size, leverage and interconnectedness (which would end the insurance sector’s exclusion from much stricter bank regulatory regimes). The proposed legislation pursues two tracks to ensure a firm will never again be deemed “too big to fail”.
First, a “systemic risk council” (dubbed the “super-cop” by President Obama) would be created to regulate, when necessary, the financial industry’s biggest players, including those within the insurance sector that pose a threat to systemic financial stability (e.g., AIG). The council, led by the US Treasury Secretary, with the Federal Reserve Chairman serving as second in command, would identify the riskiest firms and have the power to force them to:
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enhance capital requirements;
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take prompt corrective action as capital levels decline;
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integrate the liquidity risk management of a subsidiary into the overall risk management of the entire firm; and
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prepare a “living will” – rapid resolution plans in the event of a severe downturn.
Second, the legislation would require large, failing non-bank financial companies to go through a new bankruptcy process where the government possesses immediate power to put the failing firm through a controlled “resolution” process administered by the Federal Deposit Insurance Corporation (the entity that currently resolves failing banks, successfully). The types of assistance offered by the FDIC to these failing firms would include:
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extending loans;
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purchasing assets and debt obligations;
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assuming or guaranteeing obligations;
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acquiring an equity interest or security;
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taking a lien on any or all assets, including taking a first priority lien on all unencumbered assets; and
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selling or transferring any or all such acquired assets, liabilities, obligations, equity interests or securities.
However, it is still unclear whether the draft bill will be enacted in its current form due to its wide scope, the perceived threat to state insurance authorities, the significant proposed stripping of jurisdiction from the current bankruptcy regime, and the state of gridlock between the two political parties in Washington today. The Obama Administration and outgoing Senator Chris Dodd, the Chairman of the Senate Banking Committee and chief sponsor of this legislation, have set a deadline of the November midterm elections for final passage of the bill.
UPDATE—US Insurance Firms Accept Government Bailout and Now Try to Repay
Despite the US government’s approval of six major US insurance firms to participate in the Troubled Asset Relief Program (TARP), only two of the six ended up taking part. Hartford Financial Services Group accepted US$3.4 billion in bailout funds and Lincoln National Corp. received US$950 million. In the wake of several major (non-insurance) financial firms returning a significant portion of their TARP funds, these two firms find themselves under pressure to do the same.
Lincoln National, after swinging to a 4Q profit of US$102.3 million, has stated that it anticipates paying back its TARP funds by early 2011 with minimal, if any, dilution in equity. Hartford, despite reporting a US$557 million 4Q profit, suffered a US$2.4 billion reduction in capital due in large part to significant injections required by its life insurance arm.
Prior to taking TARP funds, Hartford had accepted a $2.5 billion investment by German insurer Allianz. In that transaction, Allianz received Series D convertible preferred stock, exercisable into common stock at $31.00 per share, and warrants to purchase Series B and Series C convertible preferred stock, exercisable into common stock at $25.32 per share. With a recent closing price over $27.00, the warrants are now in the money, and the Series D Preferred is not far behind.
For further information, please contact:
Edward Tinsley (Edward.tinsley@linklaters.com, (+1) 212 903 9362).
