Regulatory Capital Rules: Risk-Based Capital Requirements for Depository Institution Holding Companies Significantly Engaged in Insurance Activities
| Published date | 24 October 2019 |
| Citation | 84 FR 57240 |
| Record Number | 2019-21978 |
| Section | Proposed rules |
| Court | Federal Reserve System |
Federal Register, Volume 84 Issue 206 (Thursday, October 24, 2019)
[Federal Register Volume 84, Number 206 (Thursday, October 24, 2019)]
[Proposed Rules]
[Pages 57240-57301]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-21978]
[[Page 57239]]
Vol. 84
Thursday,
No. 206
October 24, 2019
Part IIIFederal Reserve System-----------------------------------------------------------------------12 CFR Parts 217 and 252 Regulatory Capital Rules: Risk-Based Capital Requirements for
Depository Institution Holding Companies Significantly Engaged in
Insurance Activities; Proposed Rule
Federal Register / Vol. 84 , No. 206 / Thursday, October 24, 2019 /
Proposed Rules
[[Page 57240]]
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FEDERAL RESERVE SYSTEM
12 CFR Part 217 and 252
[Docket No. R-1673]
RIN 7100-AF 56
Regulatory Capital Rules: Risk-Based Capital Requirements for
Depository Institution Holding Companies Significantly Engaged in
Insurance Activities
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board)
is inviting comment on a proposal to establish risk-based capital
requirements for depository institution holding companies that are
significantly engaged in insurance activities. The Board is proposing a
risk-based capital framework, termed the Building Block Approach, that
adjusts and aggregates existing legal entity capital requirements to
determine an enterprise-wide capital requirement, together with a risk-
based capital requirement excluding insurance activities, in compliance
with section 171 of the Dodd-Frank Act. The Board is additionally
proposing to apply a buffer to limit an insurance depository
institution holding company's capital distributions and discretionary
bonus payments if it does not hold sufficient capital relative to
enterprise-wide risk, including risk from insurance activities. The
proposal would also revise reporting requirements for depository
institution holding companies significantly engaged in insurance
activities.
DATES: Comments must be received on or before December 23, 2019.
ADDRESSES: You may submit comments, identified by Docket No. R-1673 and
RIN 7100-AF 56, by any of the following methods:
Agency website: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Email: [email protected]. Include docket
number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Ann E. Misback, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue NW,
Washington, DC 20551.
All public comments are available from the Board's website at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons or to remove sensitive
personal identifying information at the commenter's request.
Accordingly, comments will not be edited to remove any identifying or
contact information. Public comments may also be viewed electronically
or in paper form in Room 146, 1709 New York Avenue NW, Washington, DC
20006, between 9:00 a.m. and 5:00 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Thomas Sullivan, Associate Director,
(202) 475-7656; Linda Duzick, Manager, (202) 728-5881; Matti Peltonen,
Supervisory Insurance Valuation Analyst, (202) 872-7587; Brad Roberts,
Supervisory Insurance Valuation Analyst, (202) 452-2204; or Matthew
Walker, Supervisory Insurance Valuation Analyst, (202) 872-4971;
Division of Supervision and Regulation; or Laurie Schaffer, Associate
General Counsel, (202) 452-2272; David Alexander, Senior Counsel, (202)
452-2877; Andrew Hartlage, Counsel, (202) 452-6483; or Jonah Kind,
Senior Attorney, (202) 452-2045; Legal Division, Board of Governors of
the Federal Reserve System, 20th and C Streets NW, Washington, DC
20551. For the hearing impaired only, Telecommunication Device for the
Deaf, (202) 263-4869.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Background
A. The Dodd-Frank Act and Capital Requirements for Insurance
Depository Institution Holding Companies
B. The 2016 Advanced Notice of Proposed Rulemaking on Capital
Requirements for Supervised Institutions Significantly Engaged in
Insurance Activities
C. General Comments on the ANPR
D. Comments on Particular Aspects of the ANPR
1. Threshold for Determining a Firm to be Subject to the BBA
2. Grouping of Companies in the BBA
3. Treatment of Non Insurance, Non Banking Companies
4. Adjustments
5. Scalars
6. Available Capital
III. The Proposal
A. Overview of the BBA
B. Dodd-Frank Act Capital Calculation
IV. The Building Block Approach
A. Structure of the BBA
B. Covered Institutions and Scope of the BBA
C. Identification of Building Blocks and Building Block Parents
1. Inventory
2. Applicable Capital Framework
3. Building Block Parents
(a) Capital-Regulated Companies and Material Financial Entities
as Building Block Parents
(b) Other Instances of Building Block Parents
D. Aggregation in the BBA
V. Scaling Under the BBA
A. Key Considerations in Evaluating Scaling Mechanisms
B. Identification of Jurisdictions and Frameworks Where Scalars
Are Needed
C. The BBA's Approach to Determining Scalars
D. Approach Where Scalars Are Not Specified
VI. Determination of Capital Requirements Under the BBA
A. Capital Requirement for a Building Block
B. Regulatory Adjustments to Building Block Capital Requirements
1. Adjusting Capital Requirements for Permitted and Prescribed
Accounting Practices Under State Laws
2. Certain Intercompany Transactions
3. Adjusting Capital Requirements for Transitional Measures in
Applicable Capital Frameworks
4. Risks of Certain Intermediary Companies
5. Risks Relating to Title Insurance
C. Scaling and Aggregating Building Blocks' Adjusted Capital
Requirements
VII. Determination of Available Capital Under the BBA
A. Approach to Determining Available Capital
1. Key Considerations in Determining Available Capital
2. Aggregation of Building Blocks' Available Capital
B. Regulatory Adjustments and Deductions to Building Block
Available Capital
1. Criteria for Qualifying Capital Instruments
2. BBA Treatment of Deduction of Insurance Underwriting Risk
Capital
3. Adjusting Available Capital for Permitted and Prescribed
Practices under State Laws
4. Adjusting Available Capital for Transitional Measures in
Applicable Capital Frameworks
5. Deduction of Investments in Own Capital Instruments
6. Reciprocal Cross Holdings in Capital of Financial
Institutions
C. Limit on Certain Capital Instruments in Available Capital
Under the BBA
D. Board Approval of Capital Elements
VIII. The BBA Ratio, Minimum Capital Requirement and Capital
Conservation Buffer
A. The BBA Ratio and Proposed Minimum Requirement
B. Proposed Capital Conservation Buffer
IX. Sample BBA Calculation
A. Inventory
B. Applicable Capital Frameworks
C. Identification of Building Block Parents and Building Blocks
D. Identification of Available Capital and Capital Requirements
under Applicable Capital Frameworks
E. Adjustments to Available Capital and Capital Requirements
[[Page 57241]]
1. Illustration of Adjustments to Capital Requirements
2. Illustration of Adjustments to Available Capital
F. Scaling Adjusted Available Capital and Capital Requirements
G. Roll Up and Aggregation of Building Blocks
H. Calculation of BBA Ratio and Application of Minimum
Requirement and Buffer
X. Reporting Form and Disclosure Requirements
XI. Impact Assessment of Proposed Rule
A. Analysis of Potential Benefits
1. A Capital Requirement for the Board's Consolidated
Supervision
2. Going Concern Safety and Soundness of the Supervised
Institution
3. Protection of the Subsidiary Insured Depository Institution
4. Improved Efficiencies Resulting from Better Capital
Management
5. Fulfillment of a Statutory Requirement
B. Analysis of Potential Costs
1. Initial and Ongoing Costs to Comply
2. Review of Impacts Resulting from the BBA
3. Impact on Premiums and Fees
4. Impact on Financial Intermediation
C. Assessment of Benefits and Costs
XII. Administrative Law Matters
A. Solicitation of Comments on the Use of Plain Language
B. Paperwork Reduction Act
C. Regulatory Flexibility Act
List of Subjects
PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)
Subpart A--General Provisions
Sec. 217.1 Purpose, applicability, reservations of authority, and
timing.
Sec. 217.2 Definitions.
Subpart B--Capital Ratio Requirements and Buffers
Sec. 217.10 Minimum capital requirements.
Sec. 217.11 Capital conservation buffer, countercyclical capital
buffer amount, and GSIB surcharge.
Subpart J--Capital Requirements for Board-regulated Institutions
Significantly Engaged in Insurance Activities
Sec. 217.601 Purpose, applicability, reservations of authority, and
scope
Sec. 217.602 Definitions: Capital Requirements
Sec. 217.603 BBA Ratio and Minimum Requirements
Sec. 217.604 Capital Conservation Buffer
Sec. 217.605 Determination of Building Blocks
Sec. 217.606 Scaling Parameters Aggregation of Building Blocks'
Capital Requirement and Available Capital
Sec. 217.607 Capital Requirements under the Building Block Approach
Sec. 217.608 Available Capital Resources under the Building Block
Approach
PART 252--ENHANCED PRUDENTIAL STANDARDS (REGULATION YY)
Subpart B--Company-Run Stress Test Requirements for Certain U.S.
Banking Organizations with Total Consolidated Assets over $10
Billion and Less Than $50 Billion
I. Introduction
The Board of Governors of the Federal Reserve System (Board) is
issuing this notice of proposed rulemaking (NPR) to seek comment on a
proposal to establish risk-based capital requirements for certain
depository institution holding companies significantly engaged in
insurance activities (insurance depository institution holding
companies).\1\ As discussed in further detail in the description of the
proposal, insurance depository institution holding companies include
depository institution holding companies that are insurance
underwriters, and depository institution holding companies that hold a
significant percentage of total assets in insurance underwriting
subsidiaries. The proposal introduces an enterprise-wide risk-based
capital framework, termed the ``building block'' approach (BBA), that
incorporates legal entity capital requirements such as the requirements
prescribed by state insurance regulators, taking into account
differences between the business of insurance and banking. The Board
proposes to establish an enterprise-wide capital requirement for
insurance depository institution holding companies based on the BBA
framework, and, separately, to apply a minimum risk-based capital
requirement to the enterprise using the flexibility afforded under
recent amendments to section 171 of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act) to exclude certain state
and foreign regulated insurance operations.\2\ The Board is also
proposing to apply a buffer that limits an insurance depository
institution holding company's capital distributions and discretionary
bonus payments if it does not hold sufficient capital relative to
enterprise-wide risk, including risk from insurance activities. The
minimum risk-based capital requirement is proposed pursuant to the
Board's authority under section 10 of the Home Owners' Loan Act (HOLA)
\3\ and section 171 of the Dodd-Frank Act.\4\
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\1\ In this Supplementary Information, the term ``insurance
depository institution holding company'' means a savings and loan
holding company significantly engaged in insurance activities.
Section IV.B below discusses the threshold proposed to determine
when a depository institution holding company is significantly
engaged in insurance activities. Although the approach described in
this proposal was designed to be appropriate for bank holding
companies that are significantly engaged in insurance activities,
the Board does not propose to apply this rule to bank holding
companies at this time. The Board's portfolio of depository
institution holding companies that are significantly engaged in
insurance activities is currently composed only of savings and loan
holding companies. The Board intends to address the application of
this approach to bank holding companies in the final rule.
\2\ Public Law 111-203, 124 Stat. 1376, 1435-38 (2010), as
amended by Public Law 113-279, 128 Stat. 3107 (2014).
\3\ 12 U.S.C. 1467a.
\4\ 12 U.S.C. 5371.
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II. Background
A. The Dodd-Frank Act and Capital Requirements for Insurance Depository
Institution Holding Companies
In response to the 2007-09 financial crisis, Congress enacted the
Dodd-Frank Act, which, among other objectives, was enacted to ensure
fair and appropriate supervision of depository institutions without
regard to the size or type of charter and streamline the supervision of
depository institutions (DIs) and their holding companies. In
furtherance of these objectives, Title III of the Dodd-Frank Act
expanded the Board's supervisory role beyond bank holding companies
(BHCs) by transferring to the Board all supervisory functions related
to savings and loan holding companies (SLHCs) and their non-depository
subsidiaries. As a result, the Board became the federal supervisory
authority for all DI holding companies, including insurance depository
institution holding companies.\5\ Concurrent with the expansion of the
Board's supervisory role, section 616 of the Dodd-Frank Act amended
HOLA to provide the Board express authority to adopt regulations or
orders that set capital requirements for SLHCs.\6\
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\5\ Public Law 111-203, title III, 301, 124 Stat. 1520 (2010).
\6\ Dodd-Frank Act Sec. 616(b); HOLA Sec. 10(g)(1). Under Title
I of the Dodd-Frank Act, the Board also supervises any nonbank
financial companies designated by the Financial Stability Oversight
Council (FSOC) for supervision by the Board. Under section 113 of
the Dodd-Frank Act, the FSOC may designate a nonbank financial
company, including an insurance company, to be supervised by the
Board. Currently, no firms are subject to the Board's supervision
pursuant to this provision.
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Any capital requirements the Board may establish for SLHCs are
subject to minimum standards under the Dodd-Frank Act. Specifically,
section 171 of the Dodd-Frank Act requires the Board to establish
minimum risk-based and leverage capital requirements on a consolidated
basis for depository institution holding companies.\7\ These
[[Page 57242]]
requirements must be not less than the capital requirements established
by the Federal banking agencies to apply to insured depository
institutions (IDIs), nor quantitatively lower than the capital
requirements that applied to IDIs when the Dodd-Frank Act was enacted.
The Dodd-Frank Act sets a floor for any capital requirements
established under section 171 that is based on the capital requirements
established by the appropriate Federal banking agencies to apply to
insured depository institutions under the prompt corrective action
regulations implementing section 38 of the FDI Act.\8\
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\7\ Section 171 of the Dodd-Frank Act defines ``depository
institution holding company'' to mean a bank holding company or
savings and loan holding company, each as defined in section 3 of
the Federal Deposit Insurance Act (FDI Act), 12 U.S.C. 1813. As
mentioned above, the population of insurance depository institution
holding companies only consists of SLHCs. In requiring minimum
leverage capital requirements for depository institution holding
companies, section 171 of the Dodd-Frank Act provides the Board with
flexibility to develop leverage capital requirements that are
tailored to the insurance business. The Board continues to consider
a tailored approach to a leverage capital requirement for insurance
depository institution holding companies.
\8\ The floor for capital requirements established pursuant to
section 171, referred to as the ``generally applicable''
requirements, is defined to include the regulatory capital
components in the numerator of those capital requirements, the risk-
weighted assets in the denominator of those capital requirements,
and the required ratio of the numerator to the denominator.
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The Board issued a revised capital rule in 2013, which served to
strengthen the capital requirements applicable to banking organizations
supervised by the Board by improving both the quality and quantity of
regulatory capital and increasing risk-sensitivity. In consideration of
requirements of section 171 of the Dodd-Frank Act, in 2012, the Board
had sought comment on the proposed application of the revised capital
rule to all firms supervised by the Board that are subject to
regulatory capital requirements, including all savings and loan holding
companies significantly engaged in insurance activities. In response,
the Board received comments by or on behalf of supervised firms engaged
primarily in insurance activities that requested an exemption from the
capital rule in order to recognize differences in their business model
compared with those of more traditional banking organizations. After
considering these comments, the Board determined to exclude insurance
SLHCs from the application of the rule.\9\ The Board committed to
explore further whether and how the revised capital rule, hereinafter
referred to as the ``banking capital rule,'' should be modified for
insurance SLHCs in a manner consistent with section 171 of the Dodd-
Frank Act and safety and soundness concerns.
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\9\ 12 CFR part 217 (Regulation Q).
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Section 171 of the Dodd-Frank Act was amended in 2014 (2014
Amendment) to provide the Board flexibility when developing
consolidated capital requirements for insurance depository institution
holding companies.\10\ The 2014 Amendment permits the Board to exclude
companies engaged in the business of insurance and regulated by a state
insurance regulator, as well as certain companies engaged in the
business of insurance and regulated by a foreign insurance regulator.
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\10\ Public Law 113-279, 128 Stat. 3017 (2014).
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The 2014 Amendment to section 171 of the Dodd-Frank Act does not
require the Board to exclude state-regulated, or certain foreign-
regulated, insurers from its risk-based capital requirements. The Board
has considered that exclusion of these insurers from the measurement
and application of all risk-based capital requirements could present
challenges to the Board's ability to timely and accurately assess the
risk profile and capital adequacy of the entire organization and
fulfill the Board's responsibility as a prudential supervisor of the
organization. A more effective regulatory capital framework, reflecting
the Board's objectives as consolidated supervisor of insurance
depository institution holding companies, would capture all risks that
face the enterprise and potentially could jeopardize the organization's
ability to serve as a source of financial strength to the subsidiary
IDI. There is support for taking this approach in both section 171 of
the Dodd-Frank Act and section 10 of HOLA.
Section 171 of the Dodd-Frank Act also provides that the Board may
not require, under its authority pursuant to section 171 of the Dodd-
Frank Act or HOLA, financial statements prepared in accordance with
U.S. generally accepted accounting principles (GAAP) from a supervised
firm that is also a state-regulated insurer and only files financial
statements utilizing Statutory Accounting Principles (SAP).\11\ The
Board notes that, unlike U.S. GAAP, SAP does not include an accounting
consolidation concept. As discussed in detail in subsequent sections of
this notice, the BBA is thus an aggregation-based approach and the
Board's proposal is designed as a comprehensive approach to capturing
risk, including all material risks, at the level of the entire
enterprise or group.
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\11\ 12 U.S.C. 5371(c)(3)(A).
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B. The 2016 Advanced Notice of Proposed Rulemaking on Capital
Requirements for Supervised Institutions Significantly Engaged in
Insurance Activities
On June 14, 2016, the Board published in the Federal Register an
advance notice of proposed rulemaking (ANPR) entitled ``Capital
Requirements for Supervised Institutions Significantly Engaged in
Insurance Activities.'' \12\ In the ANPR, the Board conceptually
described the BBA as a capital framework, contemplated for insurance
depository institution holding companies, based on aggregating
available capital and capital requirements across the different legal
entities in an insurance group to calculate these two amounts at the
enterprise level.\13\ The ANPR described a number of potential
adjustments that could be applied in the BBA, including adjustments to
address variations in accounting practices across jurisdictions in
which insurers operate, double leverage, aggregation across different
jurisdictional capital frameworks, and defining loss-absorbing capital
resources.\14\ In the ANPR, the Board asked questions on all aspects of
the BBA, including key considerations in evaluating capital frameworks
for insurance depository institution holding companies, whether the BBA
was appropriate for these firms as well as advantages and disadvantages
of this approach, and the adjustments contemplated for use in the
BBA.\15\
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\12\ 81 FR 38631 (June 14, 2016).
\13\ As used in this Supplementary Information, ``available
capital'' refers to loss absorbing capital that qualifies for use as
capital under a regulatory capital framework and ``capital
requirement'' refers to a measurement of the loss absorbing
resources the firm needs to maintain commensurate with its risks.
\14\ As used in this Supplementary Information, ``capital
resources'' refers to instruments and other capital elements that
provide loss absorbency in times of stress.
\15\ In the ANPR, the Board also described a framework that was
contemplated for application to nonbank financial companies
significantly engaged in insurance activities (systemically
important insurance companies), the Consolidated Approach (CA). This
framework, based on consolidated financial statement data prepared
in accordance with U.S. GAAP, would categorize insurance
liabilities, assets, and certain other exposures into risk segments,
determine consolidated required capital by applying risk factors to
the amounts in each segment, define available capital for the
consolidated firm, and determine whether the firm has enough
consolidated available capital relative to consolidated required
capital. The Board appreciates the comments it has received
regarding the CA. The Board continues to deliberate a capital
requirement for systemically important insurance companies.
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Among other things, the ANPR provided stakeholders with an
opportunity to comment on the Board's development of a capital
framework for insurance depository institution holding companies at an
early stage. This NPR builds upon the discussion in the ANPR and
reflects the Board's review of comments submitted in response to the
ANPR. The comments are generally addressed below.
[[Page 57243]]
C. General Comments on the ANPR
The Board received 27 public comments on the ANPR from interested
parties including supervised insurance companies, insurers not
supervised by the Board, insurance and other trade associations,
regulatory and actuarial associations, and others. Generally,
commenters supported the Board's proposed tailoring of a capital
requirement that is insurance-centric and appreciated the transparency
and early opportunity to provide comment. Commenters agreed that
capital frameworks should capture all material companies and risks
faced by insurers, reflect on- and off-balance sheet exposures, and
build on existing capital frameworks where possible. According to
commenters, the Board's capital framework also should be informed by
its potential effects on asset allocation decisions of insurers, not
unduly incentivizing or disincentivizing allocation to certain asset
classes. Commenters generally supported the Board's proposal to
efficiently use legal entity capital requirements within an appropriate
capital framework for both insurance depository institution holding
companies and those insurance firms designated by the FSOC as
systemically important. Commenters further suggested that the BBA
should be built on principles that include minimal adjustments to
already-applicable capital frameworks, indifference as to structure of
the supervised firm, comparability across capital frameworks to which
the supervised firm's entities are subject, appropriately reflecting
insurance and non-insurance frameworks, and transparency. Commenters
observed that the BBA would align relatively well with regulators'
treatment of capital at individual companies and, consequently, the
ways that capital may not be fungible.
In the ANPR, the Board asked what capital requirement should be
used for insurance companies, banking companies, and companies not
subject to any company-level capital requirement, as used in the BBA.
For insurance companies subject to the NAIC's risk-based capital (RBC)
requirements, commenters generally supported the use of required
capital at the Company Action Level (CAL) under the NAIC RBC framework,
with some preferring the use of a greater threshold, often termed the
``trend test'' level.\16\ In commenters' views, a key advantage of the
BBA is compatibility with existing legal entity capital requirements.
The BBA was also viewed as being reasonably able to capture the risks
of non-homogenous products across jurisdictions and varying legal and
regulatory environments. Since it is an approach that builds on
existing legal entity capital requirements, the BBA would absorb the
impact of how those requirements treat the subject entities' products.
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\16\ The ``company action level'' under state insurance RBC
requirements is the amount of capital below which an insurer must
submit a plan to its state insurance regulator demonstrating how the
insurer will restore its capital adequacy. The ``trend test level''
adds a margin above the company action level, reflecting the
company's current and recent preceding years' results.
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According to commenters, among the key disadvantages of the BBA
would be that the framework must reconcile possibly divergent valuation
and accounting practices. As an aggregated approach, the BBA may not
align with the insurance depository institution holding company's own
internal approach for risk assessment, which may be conducted on a
consolidated basis. Commenters expressed varying views on whether the
BBA would be prone to regulatory arbitrage, but many noted that this
may not be a shortcoming of the BBA if capital movements are subject to
restrictions. With regard to specific implementation issues, commenters
noted, among other things, that the BBA may entail challenges in
calibrating scalars (the mechanism used to bring divergent capital
frameworks to a common basis), identifying scalars with a sufficient
level of granularity, and addressing differences in global valuation
practices. Furthermore, commenters noted that valuation bases for
required capital may differ from valuation bases for available capital.
Some commenters raised concerns about implementation costs and,
noting that the BBA as set out may tend to have relatively low impact
in terms of costs to regulators and the industry, suggested
implementing the BBA over a timeframe in the range of one to two years.
Multiple commenters agreed that the BBA is expected to have minimal
setup and ongoing maintenance and compliance costs. One commenter noted
that since the BBA is a tailored approach that uses a firm's existing
books and records without compromising supervisory objectives, the
BBA's design is anticipated to aid in controlling the burden.
D. Comments on Particular Aspects of the ANPR
1. Threshold for Determining a Firm To Be Subject to the BBA
The Board sought comment on the criteria that should be used to
determine which supervised firms would be subject to the BBA.
Commenters generally did not disagree with the Board's proposal to
apply the BBA to supervised firms with 25 percent or more of total
consolidated assets attributable to insurance underwriting activities
(other than assets associated with insurance underwriting for credit
risk). One commenter suggested that insurance liabilities, rather than
dedicated assets, should be considered the principal indicator of
insurance activity. Some comments suggested that the Board should
consider a depository institution holding company to be an insurance
depository institution holding company subject to the BBA when either
the ultimate parent of the enterprise is an operating insurance
underwriting company, or, if this is not the case, by applying the 25
percent threshold suggested in the ANPR.
The Board's proposed threshold for treating a depository
institution holding company as significantly engaged in insurance
activities, and thus subject to the BBA, is set out in Section IV.B.
2. Grouping of Companies in the BBA
A preliminary question in applying the BBA is whether and, if so,
how, the individual companies under an insurance depository institution
holding company should be grouped before they are aggregated.
Some comments advocated an approach of keeping all companies
together under a common parent as far up in the organizational
structure as possible. Other comments saw merit to grouping a
subsidiary IDI distinctly from an insurance parent. A number of
commenters voiced views on standards for materiality or immateriality
in determining whether to include companies under an insurance
depository institution holding company when applying the BBA. More
generally, commenters voiced openness to deeming companies immaterial
if they do not pose significant risk to the insurance depository
institution holding company.
The Board's proposed approach to grouping companies in an insurance
depository institution holding company's enterprise in applying the BBA
is set out in Section IV.C.
[[Page 57244]]
3. Treatment of Non-Insurance, Non-Banking Companies
In the ANPR, the Board suggested that subsidiaries not subject to
capital requirements, such as some mid-tier holding companies, would be
treated under the Board's banking capital rule. Commenters expressed
concern that this treatment may not always be appropriate, depending on
whether the subsidiary's activities are more closely aligned with
insurance or banking activities in the enterprise. Commenters suggested
that, where the subsidiary's activities are related to insurance
operations, treating these companies under capital frameworks
applicable to the operating insurance parent of such companies may be
more appropriate.
The Board's proposed treatment of non-insurance, non-banking
companies under the BBA is discussed further in Section IV.C.
4. Adjustments
Generally, commenters favored relatively few or modest adjustments
to available capital and capital requirements under existing capital
frameworks when applying the BBA. According to commenters, adjustments
should be focused on addressing accounting mismatches or gaps or to
eliminate double-counting. Among other things, commenters advocated
adjustments to reverse intercompany transactions and ensure that
adequate capital is held to reflect the risks in captive insurance
companies. Specific proposed adjustments included, among others,
addressing valuation differences, reversing intercompany loans and
guarantees, and reversing the downstreaming of capital.
Numerous commenters advocated the use of adjustments to eliminate
state permitted and prescribed accounting practices, essentially
reverting insurers' accounting treatment to that prescribed by the
NAIC. With regard to implementation burden, one commenter noted that it
likely would not be unduly burdensome to obtain the data related to
permitted and prescribed practices for purposes of applying an
adjustment under the BBA.
In response to the ANPR's question on how the BBA should address
intercompany transactions, commenters suggested that at least some
adjustments for intercompany transactions would be necessary, with
varying views on the types of transactions that should be addressed
through adjustments. Commenters similarly expressed that assets and
liabilities associated with intercompany transactions should not be
charged twice for the risks they pose and that intercompany
transactions that result in shifting risk from one subsidiary to
another should be reviewed.
Many commenters expressed views that unwinding of intercompany
transactions should be limited to those needed to prevent double-
counting of capital. According to comments, capital should be counted
only once as available capital. In particular, commenters highlighted
double-leverage, whereby an upstream company's debt proceeds are
infused into a downstream subsidiary as equity, resulting in equity at
the subsidiary level that is offset by the liability at the parent and,
hence, capital-neutral at the enterprise-level.
The proposed treatment of adjustments in the BBA is addressed in
Sections VI.B and VII.B.
5. Scalars
In the BBA, existing capital requirements would be scaled to a
common basis, addressing, among other things, cross-jurisdictional
differences. Commenters advocated a framework for the BBA that
distinguished between jurisdictions with capital frameworks suitable to
be used and subjected to scalars (scalar-compatible frameworks) versus
those with capital frameworks that should neither be used nor scaled
(non-scalar-compatible frameworks).
A number of commenters advocated that the distinction between
scalar-compatible and non-scalar-compatible frameworks should rest on
three attributes that the frameworks should possess: (1) Risk-
sensitivity; (2) clear regulatory intervention triggers; and (3)
transparency in areas such as reserving, capital requirements, and
reporting of capital measures. For material companies in a non-scalar-
compatible framework, commenters suggested that their data should be
restated to a scalar-compatible framework and then scaled in the BBA.
Section V of this NPR explains the Board's approach to scaling in
the BBA, including the methodology adopted to produce this scaling
approach.
6. Available Capital
Generally, commenters suggested that available capital under the
BBA should be closely aligned with available capital permitted under
state insurance laws. In its ANPR, the Board asked whether the BBA
should include more than one tier of capital.\17\ Commenters generally
did not favor assigning available capital in the BBA to multiple tiers,
citing reasons including the desire to minimize adjustments to existing
capital requirements and audited financial statement data, simplicity
in the BBA's design, and accounting standards' treatment of certain
assets as non-admitted. Commenters further suggested that the Board can
achieve its supervisory objectives with a BBA that includes a single,
rather than more than one, tier of capital.
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\17\ 81 FR 38631, 38635 (June 14, 2016).
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The Board's proposed approach to determining available capital
under the BBA is set out in Section VII.
III. The Proposal
A. Overview of the BBA
The proposed BBA is an approach to a consolidated capital
requirement that considers all material risks on an enterprise-wide
basis by aggregating the capital positions of companies under an
insurance holding company after expressing them in terms of a common
capital framework.\18\ The BBA constructs ``building blocks''--or
groupings of entities in the supervised firm--that are covered under
the same capital framework. These building blocks are then used to
calculate the combined, enterprise-level available capital and capital
requirement. At the enterprise level, the ratio of the amount of
available capital to capital requirement amount, termed the BBA ratio,
is subject to a required minimum and buffer, with a proposed minimum of
250 percent and a proposed total buffer of 235 percent.\19\
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\18\ To streamline implementation burden while reflecting all
material risks, the proposed BBA uses the insurance risk-based
capital framework promulgated by the National Association of
Insurance Commissioners (NAIC) as the common capital framework. As
used in this Supplementary Information, ``capital position'' refers
to an expression of a firm's capitalization, typically expressed as
a ratio of capital resources to a measurement of the firm's risk.
\19\ The BBA, as proposed, would apply to insurance depository
institution holding companies. Should the Board later decide that
its supervisory objectives would be appropriately served by applying
the BBA to other institutions, including a systemically important
insurance company, the Board retains the right to subject such a
firm to the BBA by order. In addition, the Board will continue to
evaluate prudential standards applicable to insurance depository
institution holding companies, including those that are triggered by
minimum capital requirements. However, the Board does not propose to
apply Board-run stress testing standards to insurance depository
institution holding companies at this time.
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In each building block, the BBA generally applies the capital
framework for that block to the subsidiaries in that block. For
instance, in a life insurance building block, subsidiaries within this
block would be treated in the BBA the way they would be treated under
life insurance capital requirements. In a
[[Page 57245]]
depository institution building block, subsidiaries would be subject to
Federal banking capital requirements. To address regulatory gaps and
arbitrage risks, the BBA generally would apply banking capital
requirements to material nonbank/non-insurance building blocks. Once
the enterprise's entities are grouped into building blocks, and
available capital and capital requirements are computed for each
building block, the enterprise's capital position is produced by
generally adding up the capital positions of each building block. The
BBA is consistent with the Board's continuing emphasis on adopting
tailored approaches to supervision and regulation in a manner that
streamlines implementation burden.
The BBA framework was designed to produce a consolidated risk-based
capital requirement that is not less stringent than the results derived
from the Board's banking capital rule. To enable aggregation of
available capital and capital requirements across different building
blocks, the BBA proposes a mechanism (scaling) to translate a capital
position under one capital framework to its equivalent in another
capital framework.\20\ At the enterprise level, the BBA applies a
minimum risk-based capital requirement that leverages the minimum
requirement from the Board's banking capital rule, expressed as its
equivalent value in terms of the common capital framework. The minimum
required capital ratio under the BBA begins with this equivalence value
but includes a safety margin to provide a heightened degree of
confidence that the BBA's requirement is not less than the generally
applicable requirement. Thus, the BBA produces results that are not
less stringent than the Board's banking capital rule.
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\20\ Two building blocks under two different capital frameworks
cannot typically be added together if, as is frequently the case,
each framework has a different scale for its ratios and thresholds.
As discussed further below in section V, the BBA proposes to scale
and equate capital positions in different frameworks through
analyzing historical defaults under those frameworks.
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In designing the BBA, the Board considered, among other things, the
activities and risks of insurance institutions, existing legal entity
capital requirements, input from interested parties, comments to the
ANPR, and the requirements of federal law. The Board sought to develop
the BBA to reflect risks across the entire firm in a manner that is as
standardized as possible, rather than relying predominantly on a
supervised firm's internal capital models. Furthermore, the BBA is
built on U.S. regulatory and valuation standards that are appropriate
for the U.S. insurance industry.
Board staff also met with interested parties, including members of
the NAIC, to solicit their views on the overall development of the BBA.
Input from the NAIC and states has helped identify areas of commonality
between the BBA and the Group Capital Calculation (GCC) that is under
development by the NAIC, achieve consistency between those frameworks
wherever possible, and minimize burden upon firms that may be subject
to both frameworks, while remaining respectful of the various
objectives of the relevant supervisory bodies and legal environments.
These considerations exist in the context of the Board's
participation in the international insurance standard-setting process
and development of the international Insurance Capital Standard (ICS),
an approach the Board did not follow in designing the BBA. The ICS is
being developed through the International Association of Insurance
Supervisors (IAIS) as a consolidated group-wide prescribed capital
requirement for internationally active insurance groups (IAIGs).\21\ In
participating in this process, the Board remains committed to
advocating, collaboratively with the NAIC, state insurance regulators,
and the Federal Insurance Office, positions that are appropriate for
the United States. In particular, this includes advocacy for
development of an aggregation method akin to the BBA, and the GCC being
developed by the NAIC, that can be deemed an outcome-equivalent
approach for implementation of the ICS. In 2017, the IAIS decided to
release the ICS in two phases: A five-year monitoring phase beginning
in 2020, during which the ICS would be reported on a confidential basis
to group-wide supervisors (the Monitoring Period), followed by an
implementation phase. The IAIS released a public consultation document
on ICS Version 2.0 in 2018,\22\ and is planning to release ICS Version
2.0, for use in the Monitoring Period, in 2019.\23\
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\21\ Standards produced through the IAIS are not binding upon
the United States unless implemented locally in accordance with
relevant laws.
\22\ IAIS, Risk-based Global Insurance Capital Standard Version
2.0: Public Consultation Document (July 31, 2018), https://www.iaisweb.org/page/supervisory-material/insurance-capital-standard/file/76133/ics-version-20-public-consultation-document.
\23\ IAIS, The IAIS Risk-based Global Insurance Capital Standard
(ICS): Frequently Asked Questions on the Implementation of ICS
Version 2.0 (January 26, 2018), https://www.iaisweb.org/file/71580/implementation-of-ics-version-20-qanda.
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The purpose of the ICS Monitoring Period is to monitor the
performance of the ICS over time. It is not intended to be used as
supervisory mechanism to evaluate the capital adequacy of IAIGs. The
ICS Monitoring Period is intended to provide a period of stability for
the design and calibration of the ICS so that group-wide supervisors,
with the support of supervisory colleges, may compare the ICS to
existing group standards or those in development, assess whether
material risks are captured and appropriately calculated, and report
any difficulties encountered. Reporting during the Monitoring Period
will include a reference ICS as well as additional reporting at the
request of the group-wide supervisor.
The reference ICS is comprised of a market-adjusted valuation
approach (MAV), which is a market-based balance sheet valuation
approach similar to that used under the Solvency II framework, along
with a standard method for determining capital requirements and common
criteria for available capital. At the group-wide supervisor's request,
ICS 2.0 will also include an alternative valuation approach, GAAP with
Adjustments, that is based on local GAAP accounting rules and reporting
with certain adjustments to produce results that are comparable to the
reference ICS. In addition, supervisors may request information on
internal models as an alternative approach for calculating risk
weights. During the Monitoring Period, the IAIS will also continue with
the collection of information and field-testing of the Aggregation
Method.
The reference ICS may not be optimal for the Board's supervisory
objectives, considering the risks and activities in the U.S. insurance
market. In the United States, financial firms frequently serve a
substantial role in facilitating their customers' long-term financial
planning. Insurers in the United States meet consumers financial
planning needs with life insurance and annuity products in addition to
property/casualty products to protect personal and real property and
limit liability. Insurers match life insurance and annuity long-
duration products with a long-term investment strategy.
As proposed, the BBA would appropriately reflect, rather than
unduly penalize, long-duration insurance liabilities in the United
States. In the United States, an aggregation-based approach like the
BBA could also strike a better balance between entity-level, and
enterprise-wide, supervision of insurance firms.
Question 1: The IAIS is currently considering a MAV approach for
the
[[Page 57246]]
ICS; in contrast, the BBA aggregates existing company-level capital
requirements throughout an organization to assess capital adequacy at
various levels of the organization, including at the enterprise level.
What are the comparative strengths and weaknesses of the proposed
approaches? How might an aggregation-based approach better reflect the
risks and economics of the insurance business in the U.S.?
Question 2: In what ways would an aggregation-based approach be a
viable alternative to the ICS? What criteria should be used to assess
comparability to determine whether an aggregation-based approach is
outcome-equivalent to the ICS?
The Board believes that the capital requirements proposed in this
NPR advance the regulatory objectives of the Board as consolidated
supervisor of insurance depository institution holding companies,
including ensuring enterprise-wide safety and soundness, and protecting
the subsidiary IDIs. Based on the Board's preliminary review, the Board
does not anticipate that any currently supervised insurance depository
institution holding company will initially need to raise capital to
meet the requirements of the BBA. Moreover, the BBA is consistent with
the Board's continuing emphasis on adopting a tailored approach to
supervision and regulation in a manner that streamlines implementation
burden.
B. Dodd-Frank Act Capital Calculation
In light of the requirements of the Dodd-Frank Act, in addition to
the BBA, the Board is proposing to apply a separate minimum risk-based
capital requirement calculation (the Section 171 calculation) to
insurance depository institution holding companies that uses the
flexibility afforded under the 2014 amendments to section 171 of the
Dodd-Frank Act to exclude certain state and foreign regulated insurance
operations and to exempt top-tier insurance underwriting companies.
As previously discussed, section 171 of the Dodd-Frank Act requires
the Board to establish minimum risk-based and leverage capital
requirements for depository institution holding companies. These
requirements may not be less than the ``generally applicable'' capital
requirements for IDIs, nor quantitatively lower than the capital
requirements that applied to IDIs on July 21, 2010.\24\ Section 171 of
the Dodd-Frank Act generally requires that the minimum risk-based
capital requirements established by the Board for depository
institution holding companies apply on a consolidated basis.
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\24\ Section 171 of the Dodd-Frank Act defines the ``generally
applicable'' risk-based capital requirements as those established by
the appropriate Federal banking agencies to apply to insured
depository institutions under the prompt corrective action
regulations implementing section 38 of the Federal Deposit Insurance
Act (``FDI Act'') and ``includes the regulatory capital components
in the numerator of those capital requirements, the risk-weighted
assets in the denominator of those capital requirements, and the
required ratio of the numerator to the denominator.''
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Notwithstanding the general requirement of section 171 of the Dodd-
Frank Act that the minimum risk-based capital requirements established
by the Board for depository institution holding companies apply on a
consolidated basis, section 171(c) provides that the Board is not
required to include for any purpose of section 171 (including in any
determination of consolidation) any entity regulated by a state
insurance regulator or a regulated foreign subsidiary or certain
regulated foreign affiliates of such entity engaged in the business of
insurance.
Currently, only a depository institution holding company that is a
bank holding company or a ``covered savings and loan holding company''
\25\ is subject to the Board's banking capital rule, which serves as
the generally applicable capital requirement for IDIs and sets a floor
for any capital requirements established by the Board for depository
institution holding companies. Insurance depository institution holding
companies are excluded from the definition of covered savings and loan
holding company and from the application of the Board's banking capital
rule on a consolidated basis. As a result, a top-tier SLHC that is
significantly engaged in insurance activities and its subsidiary SLHCs
currently are not subject to a consolidated minimum risk-based capital
requirement that complies with section 171 of the Dodd-Frank Act.
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\25\ 12 CFR 217.1(c) and 217.2. Covered savings and loan holding
company means a top-tier savings and loan holding company other
than: (1) A top-tier savings and loan holding company that is:
(i) An institution that meets the requirements of section
10(c)(9)(C) of HOLA (12 U.S.C. 1467a(c)(9)(C)); and
(ii) As of June 30 of the previous calendar year, derived 50
percent or more of its total consolidated assets or 50 percent of
its total revenues on an enterprise-wide basis (as calculated under
GAAP) from activities that are not financial in nature under section
4(k) of the Bank Holding Company Act of 1956 (12 U.S.C. 1843(k));
(2) A top-tier savings and loan holding company that is an
insurance underwriting company; or
(3) A top-tier savings and loan holding company that, as of June
30 of the previous calendar year, held 25 percent or more of its
total consolidated assets in subsidiaries that are insurance
underwriting companies (other than assets associated with insurance
for credit risk).
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Under the proposed Section 171 calculation the Board's existing
minimum risk-based capital requirements would generally apply to a top-
tier insurance SLHC on a consolidated basis when this company is not an
insurance underwriting company. In the case of an insurance SLHC that
is an insurance underwriting company, the requirements would instead
apply to any insurance SLHC's subsidiary SLHC that is not itself an
insurance underwriting company and is not a subsidiary of any SLHC
other than the insurance SLHC, provided that the subsidiary SLHC is the
farthest upstream non-insurer SLHC (i.e., the subsidiary SLHC's assets
and liabilities are not consolidated with those of a holding company
that controls the subsidiary for purposes of determining the parent
holding company's capital requirements and capital ratios under the
Board's banking capital rule) (an insurance SLHC mid-tier holding
company). Except for the option to exclude insurance operations, which
is described in further detail below, the minimum risk-based capital
requirements that would apply for purposes of the Section 171
calculation are the same requirements that are applied under the
generally applicable capital rules, and therefore ensure compliance
with Section 171 of the Dodd-Frank Act.\26\
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\26\ In its most basic form, for the Board's generally
applicable minimum risk-based capital requirement, qualifying
capital is the numerator of the ratio and risk-weighted assets (RWA)
determine the denominator of the ratio. As used in this
Supplementary Information, the terms ``qualifying capital,'' ``risk
weight,'' and ``risk-weighted assets'' are used consistently with
their uses under Federal banking capital rules. Under the Board's
banking regulatory capital framework, the resulting ratio must be,
at a minimum, 4.5 percent when considering common equity tier 1
(CET1) capital, 6 percent when considering total tier 1 capital, and
8 percent when considering total capital.
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The proposed Section 171 calculation would be implemented by
amending the definition of ``covered savings and loan holding company''
for the purposes of the Board's banking capital rule.\27\ Under the
proposal, an insurance SLHC would become a covered savings and loan
holding company subject to the requirements of the Board's banking
capital rule unless it is a grandfathered unitary savings and loan
holding company that derives 50 percent or more of its total
consolidated assets or 50 percent of its total revenues on an
enterprise-wide basis (as calculated under GAAP) from activities that
are not financial in nature.
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\27\ 12 CFR 217.2.
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[[Page 57247]]
As a result of this amendment to the definition of ``covered
savings and loan holding company,'' insurance SLHCs generally would
become subject to the minimum risk-based capital requirements in the
Board's banking capital rule. However, under the proposed rule, top-
tier holding companies that are engaged in insurance underwriting and
regulated by a state insurance regulator, or certain foreign insurance
regulators, would not be required to comply with the generally
applicable risk-based capital requirements.\28\ Instead, those
requirements would apply to any insurance SLHC mid-tier holding
companies, as defined in the proposed rule.
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\28\ In accordance with section 171 of the Dodd-Frank Act, a
foreign insurance regulator that fall under this provision is one
that ``is a member of the [IAIS] or other comparable foreign
insurance regulatory authority as determined by the Board of
Governors following consultation with the State insurance
regulators, including the lead State insurance commissioner (or
similar State official) of the insurance holding company system as
determined by the procedures within the Financial Analysis Handbook
adopted by the [NAIC].''
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As noted, under the proposed Section 171 calculation, an insurance
SLHC subject to the generally applicable risk-based capital
requirements (i.e., that is not a top-tier insurance underwriting
company) could elect not to consolidate the assets and liabilities of
all of its subsidiary state-regulated insurers and certain foreign-
regulated insurers. By making this election, an insurance SLHC could
determine that assets and liabilities that support its insurance
operations should not contribute to the calculation of risk-weighted
assets or average total assets under the generally applicable capital
requirements.
With regard to the regulatory capital treatment of an insurance
SLHC's (or insurance mid-tier holding company's) equity investment in
subsidiary insurers that do not consolidate assets and liabilities with
the holding company pursuant to the election, the proposal presents two
alternative approaches for comment.\29\ Under the first alternative,
the holding company could elect to deduct the aggregate amount of its
outstanding equity investment in its subsidiary state- and certain
foreign-regulated insurers, including retained earnings, from its
common equity tier 1 capital elements. Under the second alternative,
the holding company could include the amount of its investment in its
risk-weighted assets and assign to the investment a 400 percent risk
weight, consistent with the risk weight applicable under the simple
risk-weight approach in section 217.52 of the Board's banking capital
rule to an equity exposure that is not publicly traded.\30\ The Board
recognizes that fully deducting from common equity tier 1 capital an
insurance SLHC's equity investment in insurance subsidiaries in some
cases could yield inaccurate or overly conservative results for the
section 171 calculation, for example, where the holding company has
issued debt to fund equity contributions to the insurance subsidiaries.
Conversely, any risk weight approach for equity investments in
insurance subsidiaries must be calibrated to reflect risk, facilitate
comparability of capital requirements for insurance and non-insurance
depository institution holding companies, and avoid creating incentives
for regulatory arbitrage. The Board continues to consider these issues,
and invites comment on optional approaches to exclude insurance
operations from the calculation of consolidated regulatory capital
requirements.
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\29\ The amount of the holding company's outstanding equity
investment, including retained earnings, in a subsidiary insurer can
be best determined as the equity of the subsidiary under U.S. GAAP.
\30\ 12 CFR 217.52(b)(6).
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As previously noted, in addition to risk-based capital
requirements, section 171 requires the Board to establish minimum
leverage capital requirements for depository institution holding
companies. The Board's banking capital rule includes a minimum leverage
ratio of 4 percent tier 1 capital to average total assets.\31\ The
Board is not currently proposing a leverage capital requirement for
insurance SLHCs under the BBA framework or as part of the section 171
compliance calculation, and continues to evaluate methodologies to
apply leverage capital requirements to these institutions.
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\31\ Under the Board's banking capital rule, the leverage ratio
is the ratio of tier 1 capital to average total consolidated assets
as reported on the Call Report, for a state member bank, or the
Consolidated Financial Statements for Bank Holding Companies (FR Y-
9C), for a bank holding company or savings and loan holding company,
as applicable minus amounts deducted from tier 1 capital under 12
CFR 217.22(a), (c) and (d). See 12 CFR 217.10(b)(4).
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Question 3: As an alternative to consolidation, what are the
advantages or disadvantages of permitting a holding company to
deconsolidate the assets and liabilities of its subsidiary state- and
certain foreign-regulated insurers, and deduct from equity its
investment in these subsidiary insurers?
Question 4: As an alternative to consolidation, what are the
advantages or disadvantages of permitting a holding company to
deconsolidate the assets and liabilities of its subsidiary state- and
certain foreign-regulated insurers, and risk weight the holding
company's equity investment in these subsidiary insurers?
Question 5: What is the appropriate risk weighting for a holding
company's equity investment in its subsidiary state- and certain
foreign-regulated insurers?
Question 6: What other calculations, if any, should the Board
consider to ensure that the minimum risk-based capital requirement for
insurance depository institution holding companies complies with
section 171 of the Dodd-Frank Act?
Question 7: Should the generally applicable minimum leverage ratio
be excluded from the section 171 calculation?
Question 8: What are the advantages or disadvantages of applying
the generally applicable minimum leverage capital requirement to an
insurance SLHC or insurance SLHC mid-tier holding company, as defined
in this proposal, with the same exclusion of insurance subsidiaries as
set out in this proposal for the generally applicable minimum risk-
based capital requirement?
Question 9: What are the advantages or disadvantages of applying a
supplementary leverage ratio requirement to an insurance SLHC or
insurance SLHC mid-tier holding company, as defined in this proposal,
with the same exclusion of insurance subsidiaries as set out in this
proposal for the generally applicable minimum risk-based capital
requirement?
A holding company electing to de-consolidate the assets and
liabilities of all of its subsidiary state- and certain foreign
regulated insurers would make this election, and indicate the manner in
which it will account for its equity investment in such subsidiaries,
on the applicable regulatory report filed by the holding company for
the first reporting period in which it is subject to the Section 171
calculation. A holding company seeking to make such an election at a
later time, or to change its election due to a change in control,
business combination, or other legitimate business purpose, would be
required to receive the prior approval of the Board.
Question 10: What would the benefits and costs be of allowing a
holding company to elect not to consolidate some, but not all, of its
subsidiary state- and certain foreign-regulated insurers?
Question 11: When should the Board permit a holding company to
request to change a prior election regarding the capital treatment of
its insurance subsidiaries?
[[Page 57248]]
IV. The Building Block Approach
A. Structure of the BBA
The proposed BBA is an approach to a consolidated capital
requirement that aggregates the capital positions of companies under an
insurance depository institution holding company, adjusted as
prescribed in the proposed rule, and scaled to a common capital
framework. The proposed BBA would group companies into subsets of the
full enterprise, called building blocks, where the company that owns or
controls each building block is termed a ``building block parent.'' The
purpose of a building block is to group together companies generally
falling under the same capital framework (namely, the framework of the
building block parent). Each building block parent's applicable capital
framework would be used to determine that parent's capital
position.\32\ The proposed BBA would scale or convert the capital
positions of non-insurance building block parents to their insurance
building block parent equivalents and then aggregate the capital
positions to reach an enterprise-wide capital position. In this manner,
the BBA reflects the risks and resources of the subsidiaries within
each building block and, thus, a consolidation of all material risks in
the insurance depository institution holding company's enterprise.
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\32\ For instance, if a particular building block parent is a
U.S. operating insurer, the applicable capital framework would be
NAIC RBC as adopted by the insurer's domiciliary state. In the BBA,
all of the parent's subsidiaries would be reflected in the manner
that they are treated under NAIC RBC. If a building block parent is
an insured depository institution, the applicable capital framework
would be Federal bank capital rules. In the BBA, the IDI's
subsidiaries would be consolidated and reflected through the IDI's
capital position in accordance with the Federal banking capital
rules.
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An important part of applying the BBA is identifying the building
block parents in an insurance depository institution holding company's
enterprise. Section IV.C below discusses the steps to determine the
building block parents, including identifying an inventory of companies
from which building block parents are identified based on the
applicable capital framework assigned to the companies for use in the
BBA. Ultimately, all of the building blocks are aggregated into the
top-tier depository institution holding company's building block,
thereby resulting in an amount of available capital and capital
requirement for the top-tier depository institution holding company
used to calculate its BBA ratio.
B. Covered Institutions and Scope of the BBA
The proposed BBA would apply to depository institution holding
companies significantly engaged in insurance activities. The Board
proposed in the ANPR that a firm would be subject to the BBA if the
top-tier parent were an insurance underwriting company or 25 percent of
its total assets were in insurance underwriting subsidiaries. In this
NPR, the Board proposes to leave this threshold unchanged. A firm would
be subject to the BBA if: (1) The top-tier DI holding company is an
insurance underwriting company; (2) the top-tier DI holding company,
together with its subsidiaries, holds 25 percent or more of its total
consolidated assets in insurance underwriting subsidiaries (other than
assets associated with insurance underwriting for credit risk related
to bank lending); \33\ or (3) the firm has otherwise been made subject
to the BBA by the Board.
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\33\ For purposes of this threshold, a supervised firm would
calculate its total consolidated assets in accordance with U.S.
GAAP, or, if the firm does not calculate its total consolidated
assets under U.S. GAAP for any regulatory purpose (including
compliance with applicable securities laws), the company may
estimate its total consolidated assets, subject to review and
adjustment by the Board.
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As consolidated supervisor of the top-tier DI holding company of an
insurance depository institution holding company, the Board proposes to
include, within the scope of the BBA calculation, all owned or
controlled subsidiaries of this top-tier parent.\34\ While the Board
could have opted to exclude certain subsidiaries (e.g., those that are
immaterial), the Board considers that a capital requirement including
all owned or controlled companies within the scope of the BBA better
reflects a consolidated, enterprise-wide perspective of the risks faced
by the insurance depository institution holding company. Companies that
are not owned or controlled by a top-tier DI holding company and that
do not own or control an IDI would fall outside of the BBA's scope. For
instance, a top-tier DI holding company may have a sister company that
does not control an IDI. The sister company would fall outside of the
scope of the BBA's application because it lacks the requisite
connection to the IDI. Under a different structure, an insurance
depository institution holding company may control an IDI that is also
controlled by another insurance depository institution holding company,
where both insurance depository institution holding companies are part
of the same organization generally regarded as a single group. Both of
these top-tier DI holding companies would be within the BBA's scope.
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\34\ The Board recognizes that, where a firm's structure
includes a number of companies that control an IDI, it may be more
practical and efficient, particularly in terms of reducing
implementation burden, to treat, for purposes of the BBA, a mid-tier
entity as the top-tier SLHC with the upstream controlling
entity(ies) left outside of the BBA's scope. For instance, if an
insurance institution is controlled by a company significantly
engaged in non-insurance, commercial activities, it may be
practical, and without compromising the quality of the Board's
consolidated supervision, to focus the BBA's application on the
insurance institution rather than the broader commercial enterprise.
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Currently, the insurance depository institution holding companies
are all SLHCs and the current proposed definition of top-tier
depository institution holding company in the BBA only encompasses
SLHCs. However, it is possible for a bank holding company (which is
also a depository institution holding company under the FDI Act) to be
significantly engaged in insurance activities as determined by applying
the threshold described earlier in this section. In particular, under
the Economic Growth, Regulatory Relief, and Consumer Protection Act
(EGRRCPA),\35\ Federal savings associations with total consolidated
assets of up to $20 billion, as reported to the Office of the
Comptroller of the Currency (OCC) as of year-end 2017, may elect to
operate as a covered savings association.\36\ The Board is still
considering these recent legislative changes. However, the Board
presently does not see reason to apply different capital requirements
to an insurance depository institution holding company that controls a
covered savings association and an insurance depository institution
holding company that controls any other IDI. Preliminarily, the Board
anticipates harmonizing the regulation of BHCs and SLHCs significantly
engaged in insurance activities, in each case determined by applying
the threshold described earlier in this section. This could result in
BHCs significantly engaged in insurance activities falling within the
scope of the final rule implementing the BBA.
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\35\ Public Law 115-174, 132 Stat. 1296 (2018).
\36\ EGRRCPA Section 206.
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Question 12: What are the advantages and disadvantages of including
all insurance depository institution holding companies (including bank
holding companies significantly engaged in insurance activities and
insurance depository institution holding companies that control covered
savings associations) within the scope of the final BBA rule, as
planned?
[[Page 57249]]
C. Identification of Building Blocks and Building Block Parents
1. Inventory
In order to identify the set of companies that would be grouped
into building blocks and aggregated, an insurance depository
institution holding company would first identify an inventory of all
companies in its enterprise. Some of the companies in the inventory
would be building block parents. The remaining companies would be
assigned to building block parents.
To construct the inventory, the Board prefers including a broad set
of companies that reflects the firm's full enterprise under the BBA's
scope and provides an appropriately wide range of candidates for
building block parents. A framework for constructing the inventory that
relied on, for instance, the definitions of ``control'' under U.S. GAAP
may be burdensome to apply and set a relatively higher bar for
inclusion of affiliates, resulting in too few companies appearing on
the inventory. The Board notes that the NAIC's Schedule Y, filed
annually as part of the SAP financial statements, is advantageous in
utilizing a standard for ``control'' that enables more subsidiaries and
affiliates to be included.
Because it is possible that certain banking, SLHC, or nonbanking
companies may not appear on the supervised firm's Schedule Y (but would
appear on the firm's regulatory filings with the Board), the Board
sought to augment the inventory by adding to the set of companies
obtained from Schedule Y the companies appearing on the Board's Forms
FR Y-6 and FR Y-10. These forms use a definition of control setting out
scenarios where one company has control over another through a variety
of ways, including ownership, control of voting securities, and
management agreements. The Board considers that through the combination
of companies appearing on Forms FR Y-6 and FR Y-10, and the NAIC's
Schedule Y,\37\ the BBA would reflect a sufficiently wide set of
companies as potential building block parents as well as capturing all
material risks. Moreover, by utilizing reports already prepared by
insurance depository institution holding companies, including those
reported to state insurance regulators, the BBA proposal aims to
minimize burden in the process of inventorying companies.
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\37\ The Schedule Y used for this purpose is the one included in
the most recent statutory annual statement for an operating insurer
in the insurance depository institution holding company's
enterprise.
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While the inventory in the BBA will generally comprise the
companies shown on the forms discussed above, the Board also seeks to
ensure that the supervised firm's organizational and control structure
does not materially alter the scope of risks that the BBA considers.
Firms may engage in transactions with counterparties not shown on these
forms, where these transactions have the effect of transferring risk or
evading application the BBA. For such circumstances, the BBA includes a
mechanism to include these counterparties in the inventory.
As discussed below, applying the BBA and performing its
calculations rests on identifying the building block parents among the
companies in the inventory. Once these building block parents are
identified, all of their subsidiaries, whether or not listed on the
inventory, would fall within the scope of the BBA.
An illustration of this step in applying the BBA is presented in
Section IX.A.
2. Applicable Capital Framework
In the BBA, the term ``applicable capital framework'' refers to a
regulatory capital framework that is used to determine whether a
company should be a building block parent, and, once a company is
assigned to a building block, to measure the capital resources of that
company and the amount of risk the company contributes to the overall
enterprise. Once a company is identified as a building block parent,
its applicable capital framework would be used to reflect the capital
position across all of the subsidiaries in the building block,
including subsidiaries that are not directly subject to any regulatory
capital framework.
For the insurance operations, insurance capital requirements are
likely to best reflect the underlying risks.\38\ For instance, the
applicable capital framework for U.S. insurance operating companies may
be life or property and casualty (P&C) risk-based capital (RBC). The
Board's proposal to use the regulatory capital framework promulgated by
the NAIC for an insurance company or operation as the applicable
capital framework (e.g., the P&C RBC for a P&C insurer) takes into
consideration the NAIC capital framework's reflection of the potential
impact of various risk exposures, including liabilities, on the
solvency of that type of insurer. For material insurance companies that
lack a regulatory capital framework for which scaling can be performed
under the BBA, such as some captive insurance companies, the Board
proposes to apply the NAIC's RBC, after restating such companies'
financial information according to SAP.\39\
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\38\ As discussed further below, the insurance operations in an
insurance building block can encompass operating insurers and
subsidiaries that are not subject to a regulatory capital framework.
Unless those subsidiaries are later assigned to a bank building
block, through the operations discussed below, the treatment of
these companies under insurance capital rules would be used in the
BBA. To best reflect the risks in the enterprise while streamlining
implementation burden, the Board proposes to apply this treatment
rather than applying the Board's banking capital rule universally to
noninsurance companies. As discussed below, those that are material
may meet the definition of a material financial entity and, where
applicable, be treated under the Board's banking capital rule.
\39\ A discussion of the proposed BBA's definition of
``material'' appears in Section IV.C.3.
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For banking companies, the Board was mindful of the reflection of
risks in the banking capital requirements. The Board proposes to
incorporate the regulatory capital framework established for a
depository institution by its primary Federal banking regulator as the
depository institution's applicable capital framework, because the
capital framework has been calibrated to reflect the potential impact
of various risk exposures common to banking organizations (primarily in
the form of assets) on the risk profile of a depository institution. In
particular, an IDI's applicable capital framework is determined as
follows: \40\ For nationally-chartered IDIs, the applicable capital
framework is the capital rule as set forth by the OCC.\41\ For state-
chartered IDIs that are members of the Federal Reserve System, the
applicable capital framework is the Board's banking capital rule, and
for those that are not members, the capital rule as set forth by the
FDIC.\42\ In addition, applying bank capital requirements to certain
other non-insurance subsidiaries, referred to in the BBA as ``material
financial entities'' (MFEs), can mitigate the risk of regulatory
arbitrage by disincentivizing the reallocation of assets between
banking, insurance, and other companies in the institution. Where the
rule proposes to apply Federal bank capital rules, insurance depository
institution holding companies would apply them using the same elections
(e.g., treatment of accumulated other
[[Page 57250]]
comprehensive income) as they would when applying bank capital rules to
a subsidiary IDI.\43\
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\40\ Note that a foreign bank would typically not meet the
definition of an IDI, which includes entities whose deposits are
insured by the FDIC without regard to whether the entity's deposits
are insured by any other program. In the BBA, any foreign bank would
be subject to the Board's banking capital rule.
\41\ 12 CFR part 3, 12 CFR part 167.
\42\ 12 CFR part 324; 12 part CFR 217.
\43\ This accords with the rule set out in 12 CFR
217.22(b)(2)(iii), which specifies that ``Each depository
institution subsidiary of a Board-regulated institution that is not
an advanced approaches Board-regulated institution must elect the
same option as the Board-regulated institution pursuant to [12 CFR
217.22(b)(2)].''
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The Board proposes to include, within the scope of the BBA, the
insurance depository institution holding company predominantly engaged
in title insurance through a tailored application of the Board's
banking capital rule.\44\ The NAIC has not promulgated a risk-based
capital standard for title insurance companies. In the absence of an
insurance capital framework for title insurance, and in light of the
different nature of title insurance compared with life and P&C
insurance, the Board has determined to apply the Board's banking
capital rule to an insurance depository institution holding company
predominantly engaged in title insurance. Currently, there is one
insurance depository institution holding company that is predominantly
engaged in title insurance. The Board's proposed application of the BBA
to this firm is facilitated by the fact that the title insurance
depository institution holding company, like other large title
insurers, prepares consolidated financial statements in accordance with
U.S. GAAP.
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\44\ Later sections in this Supplementary Information discuss
aspects of applying the Board's banking capital rule to the
insurance depository institution holding company predominantly
engaged in title insurance.
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As a simplified example of the determination of companies'
applicable capital frameworks, consider an insurance depository
institution holding company consisting of a life insurance top-tier
parent with two subsidiaries, a P&C insurer and the IDI. Each of these
companies would fall under a different applicable capital framework,
namely, for the top-tier parent, NAIC RBC for life insurance; for the
P&C subsidiary, NAIC RBC for P&C insurance; and for the IDI, the
appropriate Federal banking capital rule. A further illustration of
this step in applying the BBA is presented in Section IX.B.
Question 13: The Board invites comment on the proposed approach to
determine applicable capital frameworks. What are the advantages and
disadvantages of the approach? What is the burden associated with the
proposed approach?
3. Building Block Parents
Under the proposed BBA, a building block parent can be one of
several different types of companies. The first is the top-tier
depository institution holding company. In the absence of any other
identified building block parents, the top-tier depository institution
holding company's building block would contain all of the top-tier
depository institution holding company's subsidiaries. A second type of
building block parent is a mid-tier holding company that is a
``depository institution holding company'' under U.S. law. Treating
these companies as building block parents will allow for the
calculation of a separate BBA ratio at the level of these companies in
the enterprise and help to ensure that these companies remain
appropriately capitalized. The balance of this subsection discusses the
remaining types of building block parents.
(a) Capital-Regulated Companies and Material Financial Entities as
Building Block Parents
For two categories of companies that could be identified as
building block parents, companies that are subject to company-level
capital requirements (capital-regulated companies) and MFEs, the
analysis is conducted in the same manner. For each of these companies
in the inventory, the supervised firm analyzes whether that company's
applicable capital framework differs from that of the next capital-
regulated company, MFE, or DI holding company encountered when
proceeding upstream in the supervised firm's inventory. If so, that
company is identified as a building block parent. The identification of
building block parents, particularly capital-regulated companies and
material financial entities, can be illustrated through the following
decision tree, which would be applicable for each company in the
insurance depository institution holding company's enterprise.
[[Page 57251]]
[GRAPHIC] [TIFF OMITTED] TP24OC19.026
[[Page 57252]]
For example, if a firm's top-tier depository institution holding
company is a life insurer that has two direct subsidiaries--a P&C
insurer and the IDI--the firm would analyze whether the P&C company's
applicable capital framework (NAIC RBC for P&C insurers) differs from
that of the top-tier DI holding company (NAIC RBC for life insurers).
Upon finding that the applicable capital frameworks are different, the
P&C insurer would be a building block parent. The same would be the
case for the IDI, whose applicable capital framework (a Federal banking
capital rule) differs from the capital framework of its life insurance
parent. However, if the P&C subsidiary has a further downstream P&C
subsidiary, the firm would compare the latter P&C company's applicable
capital framework only against that the P&C subsidiary immediately
below the life insurer.\45\ Thus, the downstream P&C subsidiary would
not be identified as a building block parent.
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\45\ Although the downstream P&C subsidiary has two companies
upstream of it--the life parent and its direct subsidiary P&C
insurer--the downstream P&C subsidiary's applicable capital
framework would only be compared against the framework of the next-
upstream capital regulated company.
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If the capital framework of a capital-regulated company or MFE is
the same as that of the next-upstream capital-regulated company, MFE,
or DI holding company, generally the companies will remain in the same
building block except for one case. This exceptional case is where a
company's applicable capital framework treats the company's
subsidiaries in a way that does not substantially reflect the
subsidiary's risk. For instance, there are situations in which NAIC RBC
may not fully reflect the risks in certain subsidiaries (typically,
certain foreign subsidiaries) that assume risk from affiliates.\46\ In
such cases, the subsidiary (which could be a capital-regulated company
or MFE) would be identified as a building block parent so that its
risks can more appropriately be reflected in the BBA.
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\46\ The BBA proposes to apply NAIC RBC to such subsidiaries.
However, under state laws, the application of NAIC RBC on the parent
would not normally operate to include the available and required
capital from applying NAIC RBC to the subsidiary. However, when the
is identified as a building block parent in the BBA, the
subsidiary's available and required capital under NAIC RBC would be
reflected by the parent after aggregation.
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While the current population of insurance depository institution
holding companies does not include material non-U.S. operations,
additional considerations in identifying capital-regulated companies as
building block parents may arise in cases of an insurance depository
institution holding company's insurance subsidiaries subject to non-
U.S. capital frameworks. Whether such companies can be identified as
building block parents depends on whether the companies' applicable
capital frameworks can be scaled to NAIC RBC, the common capital
framework used in the BBA. If a scalar has been developed for the
applicable capital framework, the capital-regulated non-U.S. insurance
subsidiary would be identified as a building block parent. Where a
scalar has not been developed for the applicable capital framework, but
the aggregate of the enterprise's companies falling under the non-U.S.
insurance capital framework is material,\47\ the BBA proposes a
provisional scaling approach so that these companies could be
identified as building block parents. In all other cases, capital-
regulated non-U.S. insurance subsidiaries would not be identified as
building block parents.
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\47\ The proposed BBA's application of the term ``material'' is
discussed below.
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As discussed above, an MFE is a financial entity that is material,
subject to certain exclusions. The proposed definition of ``financial
entity'' in the BBA enumerates several types of companies engaged in
financial activity consistent with similar enumerations in other rules
applied by the Board. To develop the proposed definition of ``financial
entity,'' the Board began with the definition of the same term under
the Board's existing rules,\48\ and made modifications to tailor to
insurance enterprises and the BBA (principally, the removal of the
prong for employee benefit plans, since these are unlikely to exist
under insurance depository institution holding companies).
---------------------------------------------------------------------------
\48\ See 12 CFR 252.71(r).
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The proposed definition of materiality consists of two parts. In
the first part, a company is presumed to be material if the top-tier
depository institution holding company has exposure to the company
exceeding 1 percent of the top-tier's total assets.\49\ In this
context, ``exposure'' includes:
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\49\ The supervised firm must calculate its total consolidated
assets in accordance with U.S. GAAP, or if the firm does not
calculate its total consolidated assets under U.S. GAAP for any
regulatory purpose (including compliance with applicable securities
laws), the company may estimate its total consolidated assets,
subject to review and adjustment by the Board.
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The absolute value of the top-tier depository institution
holding company's direct or indirect interest in the company's capital;
the top-tier depository institution holding company or any
of its subsidiaries providing an explicit or implicit guarantee for the
benefit of the company; and
potential counterparty credit risk to the top-tier
depository institution holding company or any subsidiary arising from
any derivatives or similar instrument, reinsurance or similar
arrangement, or other contractual agreement.
There may be cases in which these enumerated presumptions may not fully
capture subsidiaries that are otherwise material. To accommodate these
cases, the second part of the proposed definition of ``material'' would
consider a subsidiary to be material when it is significant in
assessing the insurance depository institution holding company's
available capital or capital requirements. Factors that indicate such
significance include risk exposure, activities, organizational
structure, complexity, affiliate guarantees or recourse rights, and
size.\50\ This definition, tailored to insurance and the BBA, accords
with the Board's prior rulemakings and actions utilizing considerations
of materiality.\51\
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\50\ Here, the consideration of significance reflects the
potential to influence the Board's supervisory judgments and
assessments of the insurance depository institution holding company.
\51\ See 12 CFR part 243 (Regulation QQ) and Reporting Form FR
2052b.
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Question 14: What other definitions of materiality, if any, should
the Board consider for use in the BBA? Examples may include a threshold
based on size, off-balance sheet exposure, or activities including
derivatives or securitizations.
Question 15: What thresholds, other than the proposed threshold for
exposure as a percentage of total assets, should the Board consider for
use in the BBA's definition of materiality? What are advantages and
disadvantages of using a threshold based on the top-tier depository
institution holding company's building block capital requirement? \52\
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\52\ To reconcile a potential circularity of having a definition
of materiality that relies on the current year's building block
capital requirement, the threshold could be based on the company
capital requirement of the capital-regulated company in the
supervised insurance organization with the greatest assets, for the
first year, and the prior year's building block capital requirement
for the top-tier depository institution holding company for
subsequent years.
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The notion of a material financial entity is proposed to address a
variety of companies not subject to a capital requirement and that
could pose risk to the safety and soundness of the insurance depository
institution holding company or its subsidiary IDI. For instance, an
insurance depository institution holding company may have a material
derivatives trading subsidiary not presently subject to any capital
framework. Additionally, a company under an insurance depository
institution holding company may serve as a funding vehicle for other
companies in the institution, borrowing and downstreaming funds to
affiliates.
[[Page 57253]]
Among other companies that could be MFEs are certain insurance
companies that exist to reinsure risk from affiliates. The Board
proposes that when such companies, and the insurance depository
institution holding company's use of and transactions with such
companies, could pose material financial risk to the insurance
depository institution holding company, such companies' financial
information should be restated in accordance with SAP.\53\ Such
companies as restated should be subjected to capital treatment under
RBC and included in the BBA as MFEs.
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\53\ This application of SAP would be consistent with the way
SAP is applied in the BBA, reflecting the proposed adjustments. One
such adjustment that is relevant is the use of Principle-Based
Reserving (PBR) on business that is currently grandfathered. See
section VI.B.3.
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The BBA includes certain exceptions whereby companies that are
financial entities and material would nonetheless not be treated as
MFEs. Where a company primarily functions as an intermediary through
which other companies within the insurance depository institution
holding company's enterprise conduct activities (e.g., manage or hedge
risk through the use of reinsurance or derivatives or investment
partnerships), the proposed BBA allows the insurance depository
institution holding company to elect to not treat such a company as an
MFE. In such a case, the firm would be required to allocate the
company's risks to other companies within the insurance depository
institution holding company's enterprise.
In addition, the Board proposes that certain types of companies
would be ineligible to be MFEs: A financial subsidiary as defined in
GLBA Section 121 and a subsidiary primarily engaged in asset
management. In the case of a financial subsidiary, the equity of these
subsidiaries is deducted, and the assets and liabilities not
consolidated, under the Board's banking capital rules. Treating such a
subsidiary as an MFE, and calculating qualifying capital and RWA for
such a subsidiary, may not fully accord with the Board's current
banking capital rules.
In the case of a subsidiary primarily engaged in asset management,
the Board considers that a registered investment adviser under the
Investment Advisers Act of 1940 would not be an MFE. As a non-insurance
company, the applicable capital regime under the BBA for an investment
adviser would be the Federal banking capital rules. These rules are
built on the calculation of RWA and presently do not have dedicated,
robust, and risk-sensitive treatment of operational risk. Moreover,
investment advisers do not typically report all assets under management
on their balance sheets and can face substantial operational risk. As
such, measuring these subsidiaries' capital positions using the Board's
banking capital rules may not provide a complete depiction of the
subsidiaries' risks. Furthermore, in insurers' organizational
structures, asset manager subsidiaries can exist under non-operating or
shell holding companies. To the extent that such holding companies
under insurance depository institution holding companies are not
engaged in financial activities, they would not constitute financial
entities under the BBA.
Question 16: The Board invites comment on the use of the material
financial entity concept. What are the advantages and disadvantages to
the approach? What burden, if any, is associated with the proposed
approach?
Question 17: The Board invites comment on the proposed treatment of
intermediaries. What are the advantages and disadvantages of the
approach? What burden, if any, is associated with the proposed
treatment?
Question 18: What risk-sensitive approaches could be used to
address the risks presented by asset managers in an insurance
depository institution holding company's enterprise?
Question 19: What forms or structures, if any, do asset managers or
their holding companies take in insurance enterprises, such that they
may fall within the proposed definition of an MFE?
(b) Other Instances of Building Block Parents
The BBA allows for three additional cases in which a company is
identified as a building block parent. First, a company is a building
block parent when it is:
Party to one or more reinsurance or derivative
transactions with other inventory companies;
Material; and
Engaged in activities such that one or more inventory
companies are expected to absorb more than 50 percent of its expected
losses.
Second, the case could arise where a company under an insurance
depository institution holding company is jointly owned by more than
one building block parent, where the jointly owned company is not
itself a building block parent. Furthermore, the company may be
consolidated in the applicable capital framework of one or more of the
building block parents. In such a case, the aggregation in the BBA
could result in double counting of the risks and resources of the
jointly-owned company. To avoid this outcome, the proposed BBA would
identify the jointly-owned company as a building block parent,
whereupon the aggregation and consideration of allocation shares,
discussed below, would avoid double-counting.
Finally, depending on an insurance depository institution holding
company's organizational structure, it may be more convenient or less
burdensome to treat, as a building block parent, a company that is not
identified as such through the operations described above, or vice
versa.
Each of these cases of identifying or declining to identify
building block parents is achieved through the reservation of authority
provision proposed in the BBA.\54\ Factors that the Board may consider
in determining to treat or not treat a company in an insurance
depository institution holding company's enterprise as a building block
parent in this manner include, but are not limited to, operational ease
or convenience in applying the BBA, adequate risk sensitivity and
reflection of risks posed to the safety and soundness of the supervised
institution and/or its subsidiary IDI, and minimizing implementation
burden in the insurance depository institution holding company's
fulfillment of regulatory reporting and compliance requirements.\55\
Moreover, certain transaction structures result in material risks being
moved outside of regulatory capital frameworks, or moved to regulatory
capital frameworks that do not fully reflect these risks.\56\ The BBA
accommodates such scenarios by reserving for the Board the authority to
make adjustments to the set of inventory companies that are building
block parents.
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\54\ See proposed Section 601(d)(3).
\55\ Likewise, this provision allows the Board to not treat a
company as a building block parent where that company would be a
building block parent by operation of the rule. The same
considerations identified here could guide the Board in the exercise
of this authority.
\56\ Such transactions could include, among other things,
certain reinsurance or derivative transactions involving a
counterparty that was formed or acquired by or on behalf of the
insurance depository institution holding company where no inventory
company has more than a negligible ownership stake in the
counterparty.
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An illustration of this step in applying the BBA is presented in
Section IX.C below.
Question 20: Are the additional instances where the Board proposed
to identify building block parents appropriate? For example, with
regard to a company that would be a building
[[Page 57254]]
block parent because it is a party to one or more reinsurance or
derivative transactions with other inventory companies, is material,
and is engaged in activities such that one or more inventory companies
are expected to absorb more than 50 percent of its expected losses,
would a different level of expected losses (i.e., a level other than 50
percent) be more appropriate?
D. Aggregation in the BBA
After identifying all of the building block parents and their
applicable capital frameworks, the BBA would determine available
capital and capital requirements, make appropriate adjustments and
translate as needed to the common capital framework used in the BBA,
the NAIC's RBC. The BBA uses a bottom up approach to aggregation. This
approach will generate a BBA ratio for each company in the organization
that is a depository institution holding company under the FDI Act,
i.e., the top tier depository institution holding company and any mid-
tier depository institution holding company. The top tier parent and
any subsidiary depository institution holding company may be subject to
a capital framework other than the NAIC's RBC. In that instance, the
building block available capital and building block capital requirement
are scaled to NAIC RBC to compute the BBA ratio that those levels in
the organizational structure.
The purpose of aggregating companies within the BBA is to reflect
the ownership interests of building block parents in subsidiaries and
affiliates in order to provide an accurate measure of available capital
without double counting. In the BBA, this is achieved by determining a
building block parent's ``allocation share'' of any downstream building
block parent. The following three examples may further illustrate the
determination of allocation shares in the proposed BBA:
An upstream company that is a building block parent
(upstream building block parent) owns 100 percent of a subsidiary that
is also a building block parent (downstream building block parent). The
downstream building block parent's available capital is comprised
solely of the equity owned by the upstream building block parent.
[ssquf] The upstream building block parent's allocation share in
the downstream building block parent is 100 percent.
An upstream building block parent (BBP A), and another
building block parent (BBP B) at the same level in the corporate
hierarchy as BBP A, together own a downstream building block parent,
where BBP A owns 30 percent and BBP B owns 70 percent.
[ssquf] BBP A's allocation share in the downstream building block
parent is 30 percent and BBP B's allocation share is 70 percent.
Upstream building block parents BBP A and BBP B jointly
own a downstream building block parent, where BBP A owns 30 percent and
BBP B owns 70 percent. In addition, BBP A owns a surplus note issued by
the downstream building block parent, which represents 20 percent of
the downstream building block parent's available capital. Consider
further that the carrying value of the downstream building block parent
(and its capital excluding the surplus note) is $100 million and the
surplus note is for $25 million.
[ssquf] BBP A's allocation share is the surplus note ($25 million)
plus its prorated share of the downstream building block parent's
equity ($30 million), divided by the downstream building block parent's
total available capital ($125 million), or 44 percent. BBP B's
allocation share is 56 percent.
As a simple example, consider the hypothetical insurance depository
institution holding company presented in Section IV.C.2. Suppose the
life parent's Total Adjusted Capital (TAC) is $500 million and its
Authorized Control Level (ACL) RBC is $100 million. Suppose the P&C
subsidiary's TAC and ACL are $40 million and $10 million, respectively.
Aggregating the P&C subsidiary and life parent is seamless, since the
life parent's RBC figures already include the P&C subsidiary, i.e.
before and after aggregation of the P&C subsidiary under the BBA, the
life parent's TAC and ACL are the same. For the life parent's
subsidiary IDI, suppose the IDI's total capital is $27 million and its
RWA is $150 million. After scaling (see the scaling parameters and
explanation of this example in Section V below), its available capital
is $17.5 million and its capital requirement is $1.6 million. Suppose
the life parent's carrying value of the subsidiary IDI is $30 million,
and the IDI's contribution to the life parent's ACL is $2 million.
Aggregating the IDI into the life parent in accordance with the BBA
results in available capital of $487.5 million,\57\ and capital
requirement of $99.6 million.\58\
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\57\ This is calculated as the life parent's TAC ($500 million),
minus its carrying value of the IDI ($30 million), plus the IDI's
scaled total capital ($17.5 million).
\58\ This is calculated as the life parent's ACL RBC ($100
million), minus the contribution to ACL by the IDI ($2 million),
plus the IDI's scaled capital requirement ($1.6 million).
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A further illustration of this step in applying the BBA is
presented in Section IX.G.
Question 21: How can the Board improve the calculation of
allocation share? Should the Board further clarify the data sources for
the inputs to the allocation share calculation? Would it be better to
use a simpler methodology, such as relying only on common equity
ownership percentages?
V. Scaling Under the BBA
A. Key Considerations in Evaluating Scaling Mechanisms
In the BBA, the calculation referred to as ``scaling'' translates a
company's capital position under one capital framework to its
equivalent capital position in another framework. This translation
allows appropriate comparisons and aggregation of metrics. In
evaluating different approaches to determining scalars, the Board was
primarily informed by considerations including reasonableness of the
approaches' assumptions, ease of implementation, and stability of the
parametrization resulting from the approaches. Reasonable assumptions
include those that are reflective of supervisory experience, as opposed
to those that are crude and unlikely to produce accurate translations.
Ease of implementation refers to the ease with which scaling parameters
can be derived in an approach, which can vary based on availability of
data on companies' experience under a framework. The stability of
parametrization refers to the extent to which changes in assumptions or
data affect the value of scaling parameters.
As an Appendix to this proposed rule, the Board is publishing a
white paper that supplements the determination of the scaling
parameters in this proposed rule.\59\ The white paper identifies and
assesses a number of approaches to developing scalars, and helps
explain the underlying assumptions and analytical framework supporting
the scaling approach and equations proposed in this rule. The Board has
incorporated that analysis in its consideration and is publishing the
white paper to make it more accessible to the public.
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\59\ See Comparing Capital Requirements in Different Regulatory
Frameworks (2019). The Board relied on the white paper, including
the explanations and analysis contained therein, in this rulemaking
and incorporates it by reference.
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B. Identification of Jurisdictions and Frameworks Where Scalars Are
Needed
Because all of the current insurance depository institution holding
[[Page 57255]]
companies are U.S.-based insurers that own IDIs, which are subject to
Federal bank capital rules, scaling from the Board's banking capital
rule to the NAIC's RBC (and vice versa) will be needed in the BBA. The
Board also performed an analysis to determine whether scaling between
any other capital frameworks would currently be needed.
With regard to scaling between U.S. and non-U.S. jurisdictions
(e.g., non-U.S. insurance to U.S. insurance), the Board reviewed the
companies under each insurance depository institution holding company
that would be subject to this proposal using the Board's existing
supervisory data cross-referenced with data available from the NAIC.
Because all foreign non-insurance operations would be analyzed using
the Board's banking capital rule, the Board focused on non-U.S.
insurance operations. None of the non-U.S. insurance subsidiaries of
current insurance depository institution holding companies appeared to
be material to their group. The Board therefore is not presently
proposing scaling for non-U.S. insurance capital frameworks.\60\
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\60\ The Board continues to review insurance depository
institution holding companies' operations in non-U.S. jurisdictions
and may later propose scaling for non-U.S. insurance capital
frameworks, depending on further evaluation of these companies,
frameworks, and risk and activities therein.
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C. The BBA's Approach to Determining Scalars
After considering potential scaling methods and the analysis in the
referenced white paper, the Board proposes to use an approach to
scaling in the BBA based on historical bank and insurer default data
(the probability of default approach). The proposal uses historical
default rates to analyze the meaning of solvency ratios and preserves
this in translating values between capital frameworks. While default
definitions can be difficult to align across capital frameworks, an
underlying purpose of many solvency ratios is to assess the probability
of a firm defaulting and default data currently appears to be the best
available economic benchmark for capitalization metrics.
Using the probability of default approach, the Board proposes to
use the following scaling formulas, which are explained more fully in
the referenced white paper. The first equation below calculates the
equivalent ACL under NAIC RBC based on an amount of risk-weighted
assets under Federal banking capital rules. The second equation below
calculates TAC under NAIC RBC, based on an amount of tier 1 plus tier 2
qualifying capital under Federal banking capital rules. The third and
fourth equations cover scaling back from NAIC RBC to Federal banking
capital rules.
1. NAIC ACL RBC = 0.0106 * RWA
2. NAIC TAC = (Banking Rule Total Capital)-0.063*RWA
3. RWA = 94.3* NAIC ACL RBC
4. Banking Rule Total Capital = NAIC TAC + 5.9* NAIC ACL RBC
This scaling approach reflects a total balance sheet
perspective.\61\ Available capital under two different frameworks may
have differences that distort the picture of a firm's capital position
in one framework compared with the other. U.S. GAAP is based on a
going-concern assumption. By contrast, U.S. SAP is generally more
conservative, based on a liquidation (realizable value or gone concern)
assumption. To reflect accounting differences such as these, the
proposed scaling approach scales available capital in addition to the
capital requirement. Scaling from bank capital rules to insurance
capital rules is applied to the total of combining common equity tier
1, additional tier 1, and tier 2 capital under the Board's banking
capital rule because there is only one tier of capital in the BBA and
NAIC RBC.
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\61\ The notion of the ``total balance sheet perspective''
refers to the idea that an accounting framework affects valuations
of assets, liabilities, and equity, and thus can affect calculation
of required and available capital. From this standpoint, scaling
required capital without also considering whether available capital
needs to be scaled can result in an incomplete depiction of a
company's capital position.
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In the example of a simple insurance depository institution holding
company presented in Sections IV.C.2 and IV.D above, the life insurance
parent's subsidiary IDI had total capital of $27 million and RWA of
$150 million. To calculate scaled available capital and required
capital, the IDI's amounts under Federal banking capital rules are used
in the equations shown above. Specifically, scaled capital requirement
= 0.0106 * $150 million = $1.59 million and scaled available capital =
$27 million - (0.063 * $150 million) = $27 million - $9.45 million =
$17.55 million.\62\
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\62\ The amounts in the example in Section IV.D above are
rounded for convenience.
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A further illustration of this step in applying the BBA is
presented in Section IX.F.
D. Approach Where Scalars Are Not Specified
As proposed, the BBA only includes scaling between Federal bank
capital rules and NAIC RBC. However, depending on how insurance
depository institution holding companies change their structures and
business mixes over time, or new insurance depository institution
holding companies come under Board supervision, the BBA may need to
include scaling from other frameworks. While the Board will not propose
scalars for specific capital frameworks not present in the existing
population of insurance depository institution holding companies, the
proposed BBA includes a framework by which the scaling would be
provisionally determined for a capital framework where no scalar is
specified, should the need arise.
This provisional approach would be used for a non-U.S. insurance
subsidiary when its regulatory capital framework is scalar compatible,
as defined in the proposed rule. The proposed rule defines ``scalar
compatible framework'' as (1) a framework for which the Board has
determined scalars or (2) a framework that exhibits the following three
attributes: (a) The framework is clearly defined and broadly applicable
to companies engaged in insurance; (b) the framework has an
identifiable intervention point that can be used to calibrate a scalar;
\63\ and (c) the framework provides a risk-sensitive measure of
required capital reflecting material risks to a company's financial
strength. Where the non-U.S. insurance subsidiary's regulatory capital
framework is not scalar compatible, the BBA proposes to apply U.S.
insurance capital rules to the company.
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\63\ As used in this Supplementary Information, ``intervention
point'' refers to a threshold for the ratio of available capital to
capital requirement at which the relevant regulator may take action
against the supervised firm under applicable law.
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Question 22: The Board invites comment on the proposed approach to
scalars and the associated white paper. What are the advantages and
disadvantages of the approach? What is the burden associated with the
proposed approach?
Question 23: How should the Board develop scalars for international
insurance capital frameworks if needed?
VI. Determination of Capital Requirements Under the BBA
A. Capital Requirement for a Building Block
The proposed BBA determines aggregate capital requirements by
beginning with the capital requirements at each building block. For
building block parents that are subject to NAIC RBC in the BBA, the
Board proposes to use the ACL amount of required capital under NAIC RBC
as the input to
[[Page 57256]]
aggregation. For building block parents subject to the Board's banking
capital rule, the Board proposes to use total risk-weighted assets as
the input to aggregation. An illustration of this step in applying the
BBA is presented in Section IX.D below.
B. Regulatory Adjustments to Building Block Capital Requirements
The main categories of adjustments to capital requirements under
the proposed BBA (the denominator in the BBA ratio) are discussed
below.\64\
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\64\ The BBA proposes an adjustment to available capital
requiring that building block parents deduct the amount of their
investments in their own capital instruments along with any
investments made by members of their building block, to the extent
such instruments are not already excluded from available capital. In
the proposed rule, a corresponding adjustment is made in determining
building block available capital.
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Question 24: The Board invites comments on all aspects of the
proposed adjustments to capital requirements. Should any of the
adjustments be applied differently? What other adjustments should the
Board consider?
An illustration of this step in applying the BBA is presented in
Section IX.E.2 below.
1. Adjusting Capital Requirements for Permitted and Prescribed
Accounting Practices Under State Laws
The accounting practices for insurance companies can vary from
state to state due to permitted and prescribed practices, which can
result in significant differences in financial statements between
similar companies filing SAP financial statements in different states.
Regulators both within and outside of the United States have the
authority to take actions with respect to insurance companies in the
form of variations from standard accounting practices. An issue for the
BBA is whether and how to address international or state regulator-
approved variations in accounting or capital requirements for regulated
insurance companies.
The proposed BBA contains adjustments to address permitted
practices, prescribed practices, or other practices, including legal,
regulatory, or accounting, that departs from a capital framework as
promulgated for application in a jurisdiction. To serve the Board's
supervisory objectives, the Board proposes an adjustment to capital
requirements (the denominator in the BBA ratio) to reverse state
permitted and prescribed practices (and, where relevant, any approved
variations applied by solvency regulators other than U.S. state and
territory insurance supervisors). The Board considers that this
proposed adjustment provides for a consistent representation of
financial information across all companies in the jurisdiction.
The Board anticipates that the majority of permitted and prescribed
practices would primarily affect available capital, but includes the
adjustment to capital requirements for completeness and because
permitted practices to balance sheet items such as reserves can have
secondary impacts on the NAIC RBC calculation. Extensions or other
company-specific treatments may also affect capital requirements as
calculated under non-U.S. insurance capital frameworks.
2. Certain Intercompany Transactions
Although intercompany transactions are eliminated in consolidated
accounting frameworks, in an aggregated framework like the BBA, some
intercompany transactions could introduce redundancies in capital
requirements or raise the potential to overstate risk at the
aggregated, enterprise-wide level. Others could reduce the capital
requirement of a company without reducing the overall risk to the
institution. The Board considers that some adjustments to capital
requirements for intercompany transactions may be appropriate for the
BBA. For instance, intra-group reinsurance, loans, or guarantees can
result in credit risk weights at the subsidiary level without
generating additional risk at the enterprise level. In this scenario,
eliminating risk weights in the appropriate companies' capital
requirements may better reflect total enterprise-wide risk.
The BBA thus proposes an adjustment for the elimination of charges
for the possibility of default of the top-tier depository institution
holding company or any subsidiary thereof. However, in many cases, the
impact on enterprise-wide capital requirement from this reflection of
risk may be small or immaterial. The Board thus proposes to make this
adjustment optional, i.e., allowing the insurance depository
institution holding company the option to eliminate the credit risk
weight in capital requirements at one company party to the intercompany
transaction.
3. Adjusting Capital Requirements for Transitional Measures in
Applicable Capital Frameworks
Similar to the availability of permitted and prescribed practices
and other approved variations, transitional measures are sometimes
included under capital frameworks during implementation.\65\ While such
measures are important for application of regulatory capital
frameworks, in practice, the framework, without applying the
transitional measures, can provide a more accurate reflection of risk
as intended by that framework. The BBA thus proposes an adjustment to
remove the effects of any grandfathering or transitional measures under
an applicable capital framework in determining capital requirements.
Along with the adjustment for permitted and prescribed practices and
other aspects of the rule, this adjustment is anticipated to help
increase the comparability of results among supervised firms.
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\65\ In the United States insurance market, one prominent impact
of this proposed adjustment would be to accelerate the application
of principles-based reserving. This adjustment could also encompass
transitional measures in Europe, such as the long-term
grandfathering of disparate accounting of insurance liabilities, if
a jurisdiction in Europe were to become relevant in the application
of the BBA.
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4. Risks of Certain Intermediary Companies
As described in Section IV.C, an insurance depository institution
holding company has the option to not treat as an MFE a company that
meets the definition of an MFE. Typically, such a company would be one
that serves as a pass-through or risk management intermediary for other
companies under the insurance depository institution holding
company.\66\ If an insurance depository institution holding company
were to make this election, the risks posed by this company must
nonetheless be reflected in the BBA. As proposed, the BBA would require
the insurance depository institution holding company to allocate the
risks that the company faces to the other companies in the enterprise
with which the company engages in transactions.
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\66\ Frequently a pass-through company like this enters into
transactions with affiliates (e.g., operating insurers) and enters
into back-to-back transactions with third parties to manage risks on
a portfolio basis
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5. Risks Relating to Title Insurance
For an insurance depository institution holding company
predominantly engaged in title insurance, the risks are reflected in
part in the company's claim reserve liability, but the Board's banking
capital rule would not risk-weight this amount. To determine an
appropriate risk weight to apply to this liability, the Board reviewed
data from historical title claim reserves and observed a risk
comparable to assets that have been assigned a 300 percent risk weight
in the Board's banking capital rule. In order to tailor
[[Page 57257]]
the Board's banking capital rule to an insurance depository institution
holding company predominantly engaged in title insurance, the Board
proposes to adjust capital requirements by applying a risk weight of
300 percent to the firm's claim reserves relating to title insurance
business, as reflected in the firm's U.S. GAAP financial
statements.\67\
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\67\ A significant asset of typical title insurers is an asset
known as the title plant, which, under U.S. GAAP, would be
considered an intangible asset (Financial Accounting Standards
Board, Accounting Standards Codification Topic 950-350). The Board
continues to see the U.S. GAAP treatment as appropriate in applying
the Board's banking capital rule to the insurance depository
institution holding company predominantly engaged in title
insurance.
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Question 1: Is the proposed risk weighting approach for risks
relating to title insurance appropriate? For example, would a different
risk weight (i.e., a risk weight other than 300 percent) be more
appropriate?
C. Scaling and Aggregating Building Blocks' Adjusted Capital
Requirements
In order to bring capital requirements from various frameworks to a
comparable basis before aggregation, the BBA would scale capital
requirements. Capital requirement amounts for building block parents
would be scaled by application of the parameters set out in Section V
above.
The BBA aggregates a downstream building block's capital
requirements into those of its upstream building block parent by
scaling to the upstream parent's capital framework and adding to the
upstream parent's capital requirement. This rollup includes adjusting
for the parent's ownership of the building block prior to adding in the
scaled capital requirement for the building block. In performing this
rollup, building blocks are aggregated to achieve a consolidated,
enterprise-wide reflection of capital requirements. Ultimately, all
building blocks under the top-tier depository institution holding
company would be scaled and rolled up into the capital position of the
top-tier depository institution holding company.
An illustration of this step in applying the BBA is presented in
Section IX.H.
VII. Determination of Available Capital Under the BBA
A. Approach to Determining Available Capital
1. Key Considerations in Determining Available Capital
A firm's capital resources should be accessible to absorb losses
and not have features that cause the firm's financial condition to
weaken in times of stress. In developing the BBA the Board was informed
by its review of existing capital frameworks--including the NAIC's RBC,
the Board's banking capital rules, and their objectives, taking into
account, among other things, considerations of the permanence and
subordination of capital resources; the right of the issuer to make,
cancel, or defer payments under a capital instrument; and the absence
of encumbrances.
In many capital frameworks, including the Board's banking capital
rule, qualifying capital is divided into tiers. In general, tiers of
capital can represent different levels of capital resources'
availability and loss-absorbency. Capital in a higher tier may
represent the ability to absorb losses such that the institution can
continue operations as a going concern, while capital in a lower tier
may represent resources that serve as a supplementary cushion to a
higher tier and aid the institution in the event of resolution (i.e., a
gone/near-gone concern).
By contrast, the state insurance capital framework uses one tier of
capital. In the proposed BBA, the frameworks most often applicable to
the supervised firms' building blocks will be U.S. state insurance
capital frameworks. The NAIC RBC framework began as an early warning
system, providing a risk sensitive ``safety net'' for insurers that
provides for timely regulatory intervention in the case of insurer
distress or insolvency.\68\ Among other things, intervention is based
on a comparison of TAC to required capital at ACL. As such, the NAIC
RBC framework and TAC, in part through reliance on SAP financial data
for their development and implementation, reflect aspects of a ``gone
concern'' or liquidation value standard.\69\ Moreover, TAC, as a single
tier of capital, is a component of the RBC framework at intervention
levels other than ACL.
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\68\ See NAIC, Risk-Based Capital, http://www.naic.org/cipr_topics/topic_risk_based_capital.htm.
\69\ NAIC, NAIC Group Capital Calculation Recommendation, p. 2
(2015), available at http://www.naic.org/documents/committees_e_grp_capital_wg_related_cap_calc_reccomendation.pdf.
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The proposed BBA contains one tier of available capital. This
approach achieves the supervisory objectives sought to be achieved
through the BBA in a manner that achieves simplicity of design.
2. Aggregation of Building Blocks' Available Capital
The Board proposes to determine available capital in the BBA by
aggregating available capital under the frameworks applicable to the
companies in an insurance depository institution holding company,
subject to certain limited adjustments, rather than applying a
consistent definition or set of criteria to all capital instruments for
inclusion in the BBA. Since the BBA will determine aggregate capital
requirements by beginning with capital requirements from company
capital frameworks (prior to adjustments and scaling), determining
available capital in a different manner could introduce
inconsistencies. Moreover, applying a single set of definitional
criteria, as occurs in the Board's banking capital rule, may be
facilitated when the subject firms prepare consolidated financial
statements in accordance with U.S. GAAP or other rules. However, doing
this may be more challenging in the context of differing bases of
accounting across building blocks in the BBA applied to insurance
depository institution holding companies.
Mechanically, the proposed rule determines available capital under
the BBA similarly to how it determines capital requirements, namely, by
rolling up available capital from downstream building block parents
into upstream building block parents, with certain adjustments and
scaling. The aggregation of available capital eliminates double
leverage or multiple leverage by deducting upstream parents'
investments in subsidiaries that are building block parents.\70\
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\70\ In a case of double-leverage, for instance, the parent's
investment in subsidiary, replaced by the building block available
capital, will continue to have an offsetting liability from the
parent's debt issuance. If double-leverage or double-gearing exists
within a building block, where the upstream (capital-providing)
company and downstream (capital-receiving) company are in the same
building block, the double-leverage would not be inflating capital
for the building block. If double-leverage occurs with the upstream
company in one building block and the downstream in a different
building block, the upstream building block parent would deduct its
downstreamed capital to the capital-receiving company, thereby
avoiding double-counting in the calculation.
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In addition, the proposal requires an insurance depository
institution holding company to deduct upstream holdings within a
building block, i.e., an investment by a subsidiary of a building block
parent in the building block parent's capital instrument. The purpose
of this deduction is to avoid the potential for inflation of a
supervised firm's available capital through inter-affiliate
transactions, and furthermore, to avoid a potential circularity in the
BBA calculation.
[[Page 57258]]
B. Regulatory Adjustments and Deductions to Building Block Available
Capital
This section discusses adjustments in the BBA to determine
available capital, performed at the level of each building block. The
next section (subsection VII.C below) discusses two final adjustments,
made at the level of the top-tier parent once all building block
available capital is aggregated.
Question 25: The Board invites comments on all aspects of the
proposed adjustments to available capital. Should any of the
adjustments be applied differently? What other adjustments should the
Board consider?
An illustration of adjusting available capital in applying the BBA
is presented in Section IX.E.2.
1. Criteria for Qualifying Capital Instruments
Adjustments at the level of determining building block available
capital include deducting any capital instrument, issued by a company
within the building block that fails one or more of the eleven criteria
for Tier 2 capital under the Board's banking capital rule, as codified
in section 217.20(d) of the Board's Regulation Q.\71\ While the current
population of insurance depository institution holding companies has
relatively less publicly issued capital or debt instruments compared to
stock companies, the Board considers it appropriate to set these
criteria to reflect the Board's supervisory goals and objectives,
ensure adequate loss absorbency of available capital under the BBA with
a measure of consistency, and take into account the possibility of
changes to the population of insurance depository institution holding
companies. The criteria apply a measure of consistency to capital
instruments for inclusion as available capital under the BBA. Depending
on their characteristics, capital instruments allowable as available
capital under company-level capital frameworks may also satisfy these
criteria, thereby qualifying under the BBA.
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\71\ The criteria are listed in Section 608(a) of the proposed
rule.
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Question 26: What other criteria, if any, should the Board consider
for determining available capital under the BBA?
Question 27: One of the criteria, concerning capital instruments
that contain certain call features, requires the top-tier depository
institution holding company to obtain prior Board approval before
exercising the call option. Should the Board apply a de minimis
threshold below which this approval is not needed?
The Board proposes that certain instruments frequently used by
insurers, surplus notes,\72\ could be eligible for inclusion in
available capital under the BBA, provided that the notes meet the
criteria to qualify as capital under the BBA. Treatment of surplus
notes under state insurance capital framework remains unaltered by the
BBA. Moreover, it appears reasonable to conclude that issuers of
surplus notes may or may not have contemplated all of the criteria for
available capital under the BBA when issuing surplus notes that are
presently outstanding.
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\72\ Surplus notes generally are financial instruments issued by
insurance companies that are included in surplus for statutory
accounting purposes as prescribed or permitted by state laws and
regulations, and typically have the following features: (1) The
applicable state insurance regulator approves in advance the form
and content of the note; (2) the instrument is subordinated to
policyholders, to claimant and beneficiary claims, and to all other
classes of creditors other than surplus note holders; and (3) the
applicable state insurance regulator is required to approve in
advance any interest payments and principal repayments on the
instrument.
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The Board is thus proposing to include a grandfathering provision
for surplus notes issued by a top-tier depository institution holding
company or its subsidiary to a non-affiliate prior to November 1, 2019.
This allows existing and currently planned surplus notes to qualify
without any modifications, but future surplus notes would be expected
to comply with all requirements after a short notice period. Under this
grandfathering, these notes are deemed to meet criteria set out in
proposed Section 608(a) that they may not otherwise meet, provided that
the surplus note is currently capital under state insurance capital
frameworks (a company capital element as set out in the proposed rule)
for the issuing company.
Question 28: Are there other approaches, other than grandfathering,
that the Board should consider to address surplus notes issued by
insurance depository institution holding companies or their
subsidiaries before November 1, 2019?
Question 29: What grandfathering date should the Board use?
Certain instruments used as capital resources may have call options
that could be exercised within five years of the issuance of the
instrument, specifically for a ``rating event.'' The Board proposes
section 217.608(f) in the BBA to accommodate these capital resources.
2. BBA Treatment of Deduction of Insurance Underwriting Risk Capital
As set out above, under application of the proposed BBA, certain
capital-regulated companies, including IDIs and other companies subject
to the Federal bank capital rules, would be identified as building
block parents. In applying the Board's banking capital rule to
determine available capital, one deduction from qualifying capital
relates to the deduction of the amount of the capital requirement for
insurance underwriting risks established by the regulator of any
insurance underwriting activities of the bank, including such
activities of a subsidiary of the bank. In the context of the BBA, an
aggregation-based framework that is structurally and conceptually
different from the Board's banking capital rule, the risk-sensitive
amount of required capital is aggregated into the enterprise-wide
capital requirement. Measuring enterprise-wide risk based on insurance
underwriting activities is among the core supervisory objectives that
the BBA serves. Deducting capital requirements for insurance
underwriting activities, when aggregate capital requirements will
reflect this risk, could overly penalize an insurance depository
institution holding company.
The Board's banking capital rule deducts, for a depository
institution holding company insurance subsidiary, the RBC for
underwriting risk from qualifying capital (and assets subject to risk
weighting). In the BBA, this deduction would be eliminated in
calculating building block available capital since the insurance risks
are being aggregated, rather than deducted.
3. Adjusting Available Capital for Permitted and Prescribed Practices
Under State Laws
As explained above in section VI with regard to capital
requirements, the accounting practices for insurance companies can vary
from U.S. state to state due to permitted and prescribed practices, and
can result in significant differences in financial statements between
companies with similar financial profiles but domiciled in different
states. An issue for the BBA is whether and how to address regulator-
approved variations in determining available capital. Similar to the
adjustment described above to the calculation of building block capital
requirements (the denominator of the calculation), the Board proposes
to include adjustments to available capital (the numerator in the BBA
ratio) to reverse the impact of these accounting
[[Page 57259]]
practices, as well as any other approved variation as proposed in the
BBA.\73\
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\73\ In the proposed BBA, this refers to a permitted practice,
prescribed practice, or other practice, including legal, regulatory,
or accounting, that departs from a solvency framework as promulgated
for application in a jurisdiction.
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4. Adjusting Available Capital for Transitional Measures in Applicable
Capital Frameworks
As with the corresponding adjustment in determining capital
requirements under the BBA, similar to the availability of permitted
and prescribed practices or other approved variations, transitional
measures are sometimes adopted in capital frameworks during
implementation. While such measures are important for application of
regulatory capital frameworks, in practice, the framework without
applying the transitional measures can provide a more accurate
reflection of loss absorbing capital as intended by that framework. The
BBA thus proposes an adjustment for the removal of the effects of any
grandfathering or transitional measures, under a regulatory capital
framework, in determining available capital.
5. Deduction of Investments in Own Capital Instruments
To avoid the double-counting of available capital, and in light of
the Board's supervisory objectives in designing the BBA, the proposal
requires building block parents to deduct the amount of their
investments in their own capital instruments along with any such
investments made by members of their building block, to the extent such
instruments are not already excluded from available capital. In
addition, under the proposal, a capital instrument issued by a company
in an insurance depository institution holding company's enterprise
that the firm could be contractually obligated to purchase also would
have been deducted from capital elements. The proposal notes that if an
insurance depository institution holding company has already deducted
its investment in its own capital instruments from its available
capital, it would not need to make such deductions twice.
The proposed rule requires an insurance depository institution
holding company to look through its holdings of an index to deduct
investments in its own capital instruments, including synthetic
exposures related to investments in own capital instruments. Gross long
positions in investments in its own capital instruments resulting from
holdings of index securities would have been netted against short
positions in the same underlying index. Short positions in indexes to
hedge long cash or synthetic positions could have been decomposed to
recognize the hedge. More specifically, the portion of the index
composed of the same underlying exposure that is being hedged could
have been used to offset the long position only if both the exposure
being hedged and the short position in the index were covered positions
under the market risk rule and the hedge was deemed effective by the
banking organization's internal control processes which would have been
assessed by the primary federal supervisor of the banking organization
or is reported as a highly effective hedge by insurance supervisors
under Statement of Statutory Accounting Principle 86. If the insurance
depository institution holding company found it operationally
burdensome to estimate the investment amount of an index holding, the
proposal permits the institution to use a conservative estimate with
prior approval from the Board. In all other cases, gross long positions
would be allowed to be deducted net of short positions in the same
underlying instrument only if the short positions involved no
counterparty risk. In determining such net long positions, the proposed
BBA would exclude such positions held in a separate account asset or
through an associated guarantee, unless the relevant separate account
fund is concentrated in the company.
6. Reciprocal Cross-Holdings in Capital of Financial Institutions
A reciprocal cross-holding results from a formal or informal
arrangement between two financial institutions to swap, exchange, or
otherwise hold or intend to hold each other's capital instruments. The
use of reciprocal cross-holdings of capital instruments to artificially
inflate the capital positions of each of the financial institutions
involved would undermine the purpose of available capital, potentially
affecting the safety and soundness of such financial institutions.
Under the proposal, in light of the Board's supervisory objectives in
designing the BBA, reciprocal cross-holdings of capital instruments of
companies in an insurance depository institution holding company's
enterprise are deducted from available capital. The proposed deduction
encompasses reciprocal cross-holdings between building block parents
and companies external to the insurance depository institution holding
company, and such holdings between building block parents and other
companies within the insurance depository institution holding company's
enterprise.
C. Limit on Certain Capital Instruments in Available Capital Under the
BBA
In light of the Board's supervisory objectives in designing the
BBA, the Board proposes to limit available capital under the BBA
arising from investments in the capital of unconsolidated financial
institutions. This treatment is consistent with the Board's banking
capital rule and treatment of non-insurance SLHCs under the Board's
rules. The proposed BBA incorporates the limit on investments in the
capital of unconsolidated financial institutions in the manner
currently done under the Board's banking capital rule.
To operationalize this limitation in the context of the BBA, a
proxy for consolidation is also needed because the U.S. GAAP definition
is not presently applicable to the full population of current insurance
depository institution holding companies. The proposed BBA would not
treat a company appearing on the insurance depository institution
holding company's inventory as an unconsolidated financial institution.
Moreover, investments in the capital of unconsolidated financial
institutions would be determined as the net long position calculated in
accordance with 12 CFR 217.22(h), provided that separate account assets
or associated guarantees would not be regarded as an indirect exposure.
As a result, the look-through treatment under 12 CFR 217.22(h) would
not be applied to separate account assets or associated guarantees.
As noted above, the proposed BBA contains one tier of available
capital, but as discussed in this Section VII.C, certain limitations
may apply. The criteria set out in subsection VII.B.1 set a baseline
threshold for capital instruments to be includable as available capital
under the BBA. However, certain more stringent criteria for capital
instruments can isolate instruments that are more loss absorbing and of
higher quality. These criteria are reflected in the Board's banking
capital rule corresponding to capital instruments includable as common
equity tier 1 capital, as codified in section 217.20(b) of the Board's
Regulation Q.\74\
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\74\ As noted in the proposed rule, two technical adjustments
are proposed to adapt language under the Board's banking capital
rule to the appropriate counterpart(s) in the BBA.
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Consistent with the Board's supervisory objectives, the Board aims
to ensure that an insurance depository institution holding company does
not
[[Page 57260]]
hold capital largely using capital instruments of lower quality or loss
absorbing capability. In order to ensure that the majority of an
insurance depository institution holding company's available capital
consists of instruments meeting the criteria in this subsection VI.C,
the proposed BBA would limit, at the level of building block available
capital for the top-tier parent, capital instruments meeting the
criteria in subsection VII.B.1, but not meeting the criteria in in 12
CFR 217.20(b), as modified in the proposed BBA (tier 2 capital
instruments), to be no more than 62.5 percent of the building block
capital requirement for that top-tier parent.
In reaching this proposal, the Board considered expressing this
limit as a percentage of the top-tier parent's building block available
capital excluding capital instruments qualifying for inclusion in the
BBA but not meeting the criteria in 12 CFR 217.20(b), as modified in
the proposed BBA. Ignoring any impact of scaling, in light of the
Board's supervisory objectives in designing the BBA, this percentage of
such available capital could be determined in the context of the
minimum capital requirements under the Board's banking capital rule.
The Board considered that a limit expressed in this manner was less
favorable from a supervisory standpoint. In times of stress, in the
Board's supervisory experience, available capital typically declines
more rapidly than required capital. As a result, in such times, a
supervised firm's capacity to count existing or newly issued tier 2
capital instruments towards regulatory requirements generally would
decline in tandem if they were limited as a percentage of other
available capital. By contrast, expressing the limit as a percentage of
capital requirement avoids much of this procyclicality. Supervised
firms would also have a less volatile limit under which to count or
issue tier 2 capital instruments in a case where the firm's capital
levels fell close to or below the required minimum amounts.
Question 30: What alternate formulations of the limit on tier 2
capital may be more appropriate, while still ensuring appropriate
quality of capital?
Question 31: Aside from a limit on tier 2 capital instruments, are
there other ways to ensure sufficiently loss absorbing available
capital and/or prevent an institution from relying disproportionately
on capital resources that are less loss absorbing?
As discussed below, the minimum capital requirement under the BBA
is for the top-tier parent to hold building block available capital at
least equal to 250 percent of its building block capital requirement.
In light of the Board's supervisory objectives in designing the BBA,
this minimum requirement corresponds to, and is therefore at least as
stringent as, the minimum requirement under the Board's banking capital
rule of 8 percent of risk-weighted assets. In light of the BBA's limit
on tier 2 capital instruments (62.5 percent of the top-tier parent's
building block capital requirement), an insurance depository
institution holding company holding exactly the minimum requirement
level of available capital therefore holds at least 187.5 percent of
the top-tier parent's building block capital requirement through
available capital other than tier 2 instruments (e.g., instruments
satisfying the criteria for common equity tier 1 capital, retained
earnings, other elements of statutory surplus, etc.). This firm would
therefore have this latter form of capital sufficient to cross a
threshold of 6 percent of risk-weighted assets, in the context of the
Board's banking capital rule.\75\
---------------------------------------------------------------------------
\75\ Said differently, if the firm's available capital is
distributed 187.5/250, or three-fourths, as resources other than
tier 2 instruments, this available capital would, in the context of
the Board's banking capital rule, amount to three-fourths of the
minimum requirement, or 6 percent of risk-weighted assets. The
firm's tier 2 capital, held in the amount of 62.5 percent of the
top-tier parent's building block capital requirement, would be one-
fourth of available capital at the minimum requirement under the
Board's banking capital rule, corresponding to 2 percent of risk-
weighted assets in the context of the Board's banking capital rule.
---------------------------------------------------------------------------
Thus, the BBA's proposed limitation on tier 2 instruments means
that insurance depository institution holding companies would
effectively meet the requirements under the Board's banking capital
rule applicable to additional tier 1 capital plus common equity tier 1
capital using building block available capital excluding tier 2
instruments.\76\ The Board considers that applying the proposed limit
on tier 2 instruments achieves a simpler, more tractable application of
minimum capital requirements under the BBA without introducing
implementation costs outweighing these benefits. In addition, this
approach facilitates the Board's use of only one tier of capital in the
BBA.
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\76\ The BBA, as proposed, does not reflect or utilize the
criteria for additional tier 1 capital under the Board's banking
capital rule. However, in the Board's supervisory experience, the
incidence of insurers utilizing capital instruments that meet the
criteria of additional tier 1, but not the criteria of common equity
tier 1 is not common, and when utilized, does not frequently
represent a material proportion of the insurer's capital.
---------------------------------------------------------------------------
As a simple illustration of these limits, consider further the
example presented in Sections IV and V above. Suppose the life
insurance parent did not hold any investment in the capital of
unconsolidated financial institutions, but had issued $35 million in
surplus notes owned by third parties. Suppose further that these
surplus notes qualify for inclusion as available capital under the BBA,
but are not grandfathered surplus notes. The life insurance parent's
capital requirement of $99.6 million would be used to determine the
limit on surplus notes and other tier 2 instruments that are includable
as available capital. Here, the insurance depository institution
holding company could not include more than $62.25 million of tier 2
instruments in available capital,\77\ and as a result, the firm can
include all of its external-facing surplus notes in available capital.
A more fulsome illustration of this step in applying the BBA is
presented in Section IX.G below.
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\77\ This amount is calculated as $99.6 * 62.5%.
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D. Board Approval of Capital Elements
The BBA proposal also includes a provision concerning Board
approval of a capital instrument. In accordance with the proposal,
existing capital instruments will be includable in available capital
under the BBA. However, over time, capital instruments that are
equivalent in quality and capacity to absorb losses to existing
instruments may be created to satisfy different market needs. Proposed
section 217.608(g) accommodates such instruments for inclusion in
available capital. Similar authority exists under the Board's banking
capital rule under section 217.20(e).\78\ In exercising its authority
under proposed section 217.608(g), the Board expects to consider, among
other things, the requirements for capital elements in the final rule;
the size, complexity, risk profile, and scope of operations of the
insurance depository institution holding company, and whether any
public benefits in approving the instrument would be outweighed by risk
to an IDI. Capital instruments already approved under the authority
under the Board's banking capital rule remain eligible for inclusion as
available capital under the BBA in accordance with this proposal. For
purposes of the BBA, proposed section 217.608(g) would apply going
forward.
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\78\ Proposed section 12 CFR 217.601(d)(1)(ii) parallels the
existing section 12 CFR 217.1(d)(2)(ii).
---------------------------------------------------------------------------
[[Page 57261]]
VIII. The BBA Ratio, Minimum Capital Requirement and Capital
Conservation Buffer
A. The BBA Ratio and Proposed Minimum Requirement
Under the BBA, the Board's minimum capital requirement for an
insurance depository institution holding company would be the ratio of
aggregated building block available capital to the aggregated building
block capital requirement (the BBA ratio):
[GRAPHIC] [TIFF OMITTED] TP24OC19.027
In light of the Board's supervisory objectives and authorities in
accordance with U.S. law, the Board proposes to require a minimum BBA
ratio of 250 percent. The Board determined this minimum threshold by
first translating the minimum total capital requirement of 8 percent of
risk-weighted assets under the Board's banking capital rule to its
equivalent under NAIC RBC. The Board then added a margin of safety to
account for factors including any potential data or model parameter
uncertainty in determining scaling parameters and an adequate degree of
confidence in the stringency of the requirement. The Board notes that
the proposed minimum ratio, 250 percent, aligns with the midpoint
between two prominent, existing state insurance supervisory
intervention points, the ``company action level'' and ``trend test
level'' under state insurance RBC requirements.\79\
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\79\ See footnote 16 for explanation of company action level and
trend-test level as used in the context of RBC.
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Question 32: The Board invites comment on the proposed minimum
capital requirement. What are the advantages and disadvantages of the
approach? What is the burden associated with the proposed approach?
As a simple illustration of this minimum requirement, consider the
example presented in Sections IV, V, and VII above. After aggregating
the subsidiary building block parents, the life insurance top-tier
parent had building block available capital of $487.5 million and
building block capital requirement of $99.6 million. Its BBA ratio is
thus 489 percent, above the required minimum 250 percent. A further
illustration of this step in applying the BBA is presented in Section
IX.H.
B. Proposed Capital Conservation Buffer
To encourage better capital conservation by supervised firms and
enhance the resiliency of the financial system, the proposed rule would
limit capital distributions and discretionary bonus payments for
insurance depository institution holding companies that do not hold a
specified amount of available capital at the level of a top-tier parent
or other depository institution holding company, in addition to the
amount that is necessary to meet the minimum risk-based capital
requirement proposed under the BBA. Insurance depository institution
holding companies would be subject only to the proposed capital
conservation buffer under the BBA, not the existing capital
conservation buffer codified at section 217.11 of the Board's banking
capital rule.
To determine the appropriate threshold for a capital conservation
buffer under the BBA, the Board took a similar approach to how it
determined the minimum requirement. The analysis began with the
threshold levels from the buffer under the Board's banking capital rule
and translated them to their equivalents under NAIC RBC.\80\ The full
amount of the buffer under the Board's banking capital rule, 2.5
percent, translates to 235 percent under the NAIC RBC framework. This
translated buffer threshold was applied in the BBA. An insurance
depository institution holding company would need to hold a capital
conservation buffer in an amount greater than 235 percent (which,
together with the minimum requirement of 250 percent, results in a
total requirement of at least 485 percent) to avoid limitations on
capital distributions and discretionary bonus payments to executive
officers. The proposal further provides for a maximum dollar amount
(calculated as a maximum payout ratio multiplied by eligible retained
income, as discussed below) that the insurance depository institution
holding company could pay out in the form of capital distributions or
discretionary bonus payments during the current calendar year. Under
the proposal, an insurance depository institution holding company with
a buffer of more than 235 percent would not be subject to a maximum
payout amount pursuant to the above-referenced proposed provision;
however, the Board would retain the ability to restrict capital
distributions under other authorities and limitations on distributions
under other regulatory frameworks would continue to apply.
---------------------------------------------------------------------------
\80\ Because the thresholds here are part of a capital
conservation buffer, which is inherently a provision to apply an
added margin of safety, no uplift or margin of safety was built into
the intervention points after translating those under the Board's
banking capital rule to NAIC RBC.
---------------------------------------------------------------------------
In order to tailor the capital conservation buffer to the insurance
business, the proposal introduces a number of technical adaptations to
the capital conservation buffer appearing in the Board's banking
capital rule to apply this in the context of an insurance depository
institution holding company. First, in light of the proposed annual
reporting cycle for the BBA, discussed below, the proposed rule would
apply the capital conservation buffer on a calendar year basis rather
than quarterly. Second, the proposed rule broadens ``distributions'' to
include discretionary dividends on participating insurance policies
because, for mutual insurance companies, these payments are the
equivalent of stock dividends. Third, rather than restrict the
composition of the capital conservation buffer to solely common equity
tier 1 capital, the proposal restricts the composition to building
block available capital excluding tier 2 instruments. Moreover, the
proposed rule replaces the thresholds appearing in 12 CFR 217.11, Table
1, with corresponding amounts that have been scaled from the Board's
banking capital rule to the common capital framework under the BBA.\81\
---------------------------------------------------------------------------
\81\ Note that, as defined in the proposed rule, tier 2 capital
instruments are those meeting the criteria for tier 2 capital under
the Board's banking capital rule, but failing the criteria for
common equity tier 1 capital.
---------------------------------------------------------------------------
In addition, the proposal defines ``eligible retained income'' as
``the annual change in building block available capital,'' excluding
certain changes resulting from capital markets
[[Page 57262]]
transactions. This change significantly reduces operational burden
because, unlike in the bank context, insurance depository institution
holding companies do not necessarily calculate a consolidated retained
earnings amount that could serve as the basis upon which to apply the
definition of ``eligible retained income'' without modification.
Question 33: The Board invites comment on the proposed minimum
capital buffer. What are the advantages and disadvantages of the
buffer? What is the burden associated with the buffer?
IX. Sample BBA Calculation
In order to better illustrate the steps and application of the BBA,
this NPR presents the example below based on a fictitious mutual life
insurance company.
A. Inventory
As described above in Section IV.C.1, the first step in applying
the BBA is identifying an inventory of companies within the insurance
depository institution holding company's enterprise. This would
generally be performed by identifying the companies on the Board's Y-10
and Y-6 forms together with companies on the Schedule Y, as prepared in
accordance with the NAIC's SSAP No. 25, included in the most recent
statutory annual statement for an operating insurer in the insurance
depository institution holding company's enterprise. The organizational
chart below illustrates the application of this step for the sample
insurance firm presented here, Mutual Life Insurance Company (Mutual
Life).
[GRAPHIC] [TIFF OMITTED] TP24OC19.028
As can be seen from this organizational chart, Mutual Life Ins. Co.
is the top-tier depository institution holding company of the insurance
depository institution holding company's enterprise. In addition to two
life insurance companies, this enterprise has two P&C insurance
companies, a life captive insurance company, and an IDI (assume it is a
nationally-chartered IDI), as well as a number of nonbank, non-
insurance companies, including life and P&C insurance agencies,
investment vehicles, an asset manager, a broker/dealer, and a midtier
holding company above the IDI.
B. Applicable Capital Frameworks
As described in Section IV.C.2, the second step in applying the BBA
is to determine the applicable capital frameworks for companies under
the insurance depository institution holding company. As proposed in
this rule, the applicable capital framework for a company other than
one engaged in insurance or reinsurance underwriting, except for an
IDI, is the Board's banking capital rule, while the applicable capital
framework for a nationally-chartered IDI is the banking capital rule as
set forth by the OCC. For companies engaged in insurance or reinsurance
underwriting, the applicable capital framework is generally the
regulatory capital framework under the laws or regulations to which
that company is subject. The applicable capital frameworks for
companies under Mutual Life Ins. Co. are presented below.
[[Page 57263]]
[GRAPHIC] [TIFF OMITTED] TP24OC19.029
In the illustration above, the applicable capital frameworks are
shown for certain key companies. For instance, the applicable capital
frameworks for Mutual Life Insurance Co., the top-tier depository
institution holding company, and P&C Insurance Co. are shown, but no
frameworks are shown for Life Insurance Agency or P&C Insurance
Agency--these two companies would be treated as they are under the
capital frameworks applicable to their immediate parents. Assume that
the life insurance captive was material in relation to the insurance
depository institution holding company through Mutual Life Insurance
Company guaranteeing the return on certain investments of the captive.
The life insurance captive would be treated as an MFE and the
applicable capital framework would be the NAIC's RBC applicable to life
insurance companies.
C. Identification of Building Block Parents and Building Blocks
As described in Section IV.C.3, the third step in applying the BBA
is to identify the building block parents. Most often, this will occur
as a result of having identified the applicable capital frameworks for
the companies under the insurance depository institution holding
company, where a capital-regulated company or MFE is assigned to a
building block when its applicable capital framework differs from that
of the next-upstream capital-regulated company, MFE, or DI holding
company.
As the top-tier depository institution holding company, Mutual Life
Insurance Company itself is the first candidate to be a building block
parent. Life Insurance Co. would fall under the same applicable capital
framework as the top-tier depository institution holding company (NAIC
life RBC), and therefore would not be identified as a building block
parent; rather, it would remain in the same building block as the block
for which Mutual Life Ins. Co. is building block parent. By contrast,
the BBA proposes (for purposes of identification of building blocks) to
treat NAIC RBC for life and P&C as distinct frameworks; thus, P&C
Insurance Company is identified as a building block parent from Mutual
Life Ins. Co. With it, the Subsidiary P&C Insurance Company, P&C
Insurance Agency, and two investment subsidiaries would be members of
this building block.
The life insurance captive would be subject to NAIC RBC for life
insurers. Because treatment of captives' risk can vary among insurers,
the life insurance captive may not be reflected in the RBC capital
calculations of its operating insurance parents. Assuming that, for
purposes of this illustration, the life insurance captive's risk is not
reflected in the RBC calculations of Mutual Life or Life Ins. Co., the
captive would be made its own building block parent. The other
subsidiaries of Life Insurance Co. would be assigned to the building
block for which Mutual Life Ins. Co. is building block parent.
Midtier Holdco is a depository institution holding company. Under
the proposed rule, this company would be identified as a building block
parent. Note that, as a non-insurance company, this company's
applicable capital framework under the proposed BBA would be the
Board's banking capital rule, which, in turn, would reflect the risks
of the IDI. Therefore, the IDI would not be identified as a building
block parent. The same would be the case for the broker/dealer, which,
together with the IDI, would be assigned as a member of Midtier
Holdco's building block.
Thus, the building block parents in Mutual Life Ins. Co.'s
enterprise are Mutual Life Ins. Co., P&C Ins. Co., Life Ins. Captive,
and Midtier Holdco. The demarcation of building blocks for Mutual Life
Ins. Co. is shown below:
[[Page 57264]]
[GRAPHIC] [TIFF OMITTED] TP24OC19.030
D. Identification of Available Capital and Capital Requirements Under
Applicable Capital Frameworks
Assume that, for the captive, an RBC calculation is performed and
reported to the state regulator even though the captive generally would
not be subject to the same generally applicable capital requirements as
primary insurers. Assume further that, for Mutual Life Ins. Co., the
available capital and capital requirement amounts for its four building
blocks are as shown below. Determination of available capital and
capital requirements would result as follows:
[GRAPHIC] [TIFF OMITTED] TP24OC19.031
[[Page 57265]]
E. Adjustments to Available Capital and Capital Requirements
1. Illustration of Adjustments to Capital Requirements
As described in Section VI.B above, the BBA, as proposed, includes
a number of possible adjustments to capital requirements at the level
of each building block. Assume that no adjustments to capital
requirements are applicable in the building block for which Mutual Life
Insurance Company is the building block parent.
The first possible adjustment is to reverse any permitted or
prescribed practices that affect capital requirements. Suppose that the
Life Ins. Captive benefits from a prescribed practice under its
domiciliary jurisdiction, specifically, that assets in the form of
conditional letters of credit are reported on the balance sheet without
corresponding liabilities. This prescribed practice would be adjusted
out of the capital requirement. Under the proposed BBA, these letters
of credit would not be treated as assets and, hence, would face no risk
weight. Additionally, the use of principles-based reserving from the
elimination of transitional measures would impact the RBC calculation
because reserves are used in different parts of the RBC calculation,
including the calculation of exposure to mortality risk. Assume that
the total impact on Life Insurance Company's RBC capital requirement
from these adjustments to captives is $3 million.
The second possible adjustment to capital requirements is an
optional elimination of intercompany credit risk weights. Suppose that
in Mutual Life Ins. Co., there is an inter-affiliate reinsurance
arrangement whereby P&C Ins. Co. reinsures a portion of Sub P&C Ins.
Co.'s book. Sub P&C Ins. Co. retains some risk, and faces a charge in
its RBC requirement for its receivables from its parent. Suppose that
this receivable is in the amount of $40 million, the RBC charge for Sub
P&C Ins. Co. is $2 million, and Mutual Life Ins. Co. elects to make
this adjustment.
An additional possible adjustment to capital requirements relates
to the insurance depository institution holding company's ability to
elect to not treat as an MFE a company that otherwise meets the
definition of this term, after which the insurance depository
institution holding company must correspondingly allocate the risks of
this company to other companies in the insurance depository institution
holding company with which the company engages in transactions. Assume
that Mutual Life Ins. Co. has no companies other than its Life
Insurance Captive that would constitute MFEs and that Mutual Life Ins.
Co opts to treat the Life Insurance Captive as an MFE. This adjustment
to capital requirements is therefore not applicable in this case.
Under the BBA as proposed, no adjustments would take place to total
risk-weighted assets for building block parents subject to the Board's
banking capital rule. Thus, the total impact of adjustments to capital
requirements for Mutual Life Ins. Co. can be shown as follows:
[GRAPHIC] [TIFF OMITTED] TP24OC19.032
[[Page 57266]]
2. Illustration of Adjustments to Available Capital
As described in Section VII.B above, the proposed BBA includes a
number of possible adjustments to available capital. In the example of
Mutual Life Ins. Co., assume that no adjustments to available capital
are applicable in the building block for which Mutual Life Insurance
Company is the building block parent.
However, suppose that the P&C Insurance Co. subsidiary benefits
from a permitted practice under its domiciliary jurisdiction. As
described in Section VII.B.3, permitted and prescribed practices would
be adjusted out of available capital, so that insurance companies are
presented on a consistent basis in the BBA. Suppose that, for P&C
Insurance Co., the increase to surplus arising from the permitted
practice is $15 million. This amount would be deducted in determining
building block available capital for P&C Insurance Co.
Captive reinsurers typically would have at least two related
adjustments. Suppose that, as noted above, the Life Ins. Captive has a
prescribed practice that allows holding undrawn contingent letters of
credit as assets without a corresponding liability. By application of
the adjustment to available capital to reverse prescribed practices,
described in Section VII.B.3, these letters of credit would not be
treated as assets and, hence, would not contribute to available capital
under the proposed BBA. Suppose that, for Life Ins. Captive, these
letters of credit are held at $240 million. This amount would be
deducted in determining building block available capital for Life Ins.
Captive. Somewhat offsetting this, captives would typically benefit
from the adjustment that removes transitional measures. Suppose that
application of principles-based reserving to business in the captive
results in reduced liabilities that increase surplus by $100 million.
This would be added to available capital.
Under the BBA, as proposed, the sole possible adjustment to
building block parents, or their building blocks, subject to the
Board's banking capital rule arises where the building block parent
owns an insurer. Under the Board's banking capital rule, this ownership
generally results in a deduction from qualifying capital in the amount
of the insurance subsidiary's capital requirement for insurance
underwriting risks.\82\ In the case of Mutual Life Ins. Co., neither
the Midtier Holdco nor IDI have insurance underwriting subsidiaries, so
no adjustment is needed to available capital for this building block.
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\82\ See 12 CFR 217.22(b)(3).
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The total impact of adjustments to available capital for Mutual
Life Ins. Co. can be shown as follows:
[GRAPHIC] [TIFF OMITTED] TP24OC19.033
F. Scaling Adjusted Available Capital and Capital Requirements
As described above in Section V, adjusted available capital and
adjusted capital requirement for each building block are scaled, using
the scaling approach proposed by the Board, to the applicable capital
framework of the building block parent most immediately upstream. No
scaling is proposed for translating between NAIC RBC as applicable to
life and P&C insurance. Thus, in the case of Mutual Life Ins. Co., for
the building blocks for which P&C Ins. Co. and Life Ins. Captive are
[[Page 57267]]
building block parents, no scaling is needed to translate to NAIC RBC
as applied to Mutual Life Ins. Co. For these building blocks, the
building block available capital are the adjusted available capital
amounts and the building block capital requirements are the adjusted
capital requirements.
For the building block for which Midtier Holdco is building block
parent, scaling is needed. This building block is under the Board's
banking capital rule. The building block parent most immediately
upstream, Mutual Life Ins. Co., is under NAIC RBC. Thus, scaling is
needed between the Board's banking capital rule and NAIC RBC according
to the equations set out in Section V.C above. The calculations are as
follows:
Building block available capital = $272M - ($2,264M * 6.3%) = $129
million
Building block capital requirements = $2,264M * 1.06% = $24 million
The total impact of scaling for Mutual Life Ins. Co. can be shown
as follows:
[GRAPHIC] [TIFF OMITTED] TP24OC19.034
G. Roll-Up and Aggregation of Building Blocks
As described in Sections IV.D, VI.C, and VII.A.2 above, building
block available capital and building block capital requirement,
reflecting adjustments and scaling, are rolled up through successive
upstream building blocks until the top-tier parent's building block is
reached.
At each step, when rolling up available capital, any downstreamed
capital from the upstream parent is deducted. Assume that Mutual Life
Ins. Co. provides no capital to P&C Ins. Co. or Midtier Holdco other
than its equity investment in the subsidiary, and that Mutual Life Ins.
Co. carries these subsidiaries at $698 million and $301 million,
respectively. Assume that Mutual Life Ins. Co. treats the Life Ins.
Captive as a nonadmitted asset. The total impact on Mutual Life Ins.
Co.'s surplus is thus $999 million, which would be deducted in the
roll-up prior to re-aggregating the building block available capital
for P&C Ins. Co., Midtier Holdco, and Life Ins. Captive.
When rolling up capital requirements, the amount of the upstream
parent's capital requirement attributable to each downstream building
block parent is deducted. Mutual Life Ins. Co.'s RBC required capital
amount would include the unadjusted P&C RBC requirement for P&C Ins.
Co., assumed to be $166 million, in its C0 component, but would include
no amount attributable to Life Ins. Captive. Mutual Life Ins. Co.'s
holding of Midtier Holdco would affect its life RBC calculation through
the C1cs component, deriving from the carrying value of $301 million
but also may reflect the impact of asset concentration charges, taxes,
and the covariance adjustment as reflected in the life RBC calculation.
Assume that extracting Midtier Holdco from Mutual Life Ins. Co.'s RBC
calculation would reduce the amount (on the basis of the authorized
control level of RBC) by $24 million. Assume that the total impact on
Mutual Life Ins. Co.'s RBC requirement is thus $190 million, which
would be deducted in the roll-up prior to re-aggregating the building
block capital requirement for P&C Ins. Co., Life Ins. Captive, and
Midtier Holdco.
In each case, the roll-up is also done taking into account the
upstream parent's allocation share of the downstream building block
parent. For purposes of Mutual Life Ins. Co., assume
[[Page 57268]]
all subsidiaries are wholly owned, so that all allocation shares are
100 percent.
Taking into account the building block available capital amounts,
building block capital requirements, and deductions of downstreamed
capital and contributions to Mutual Life Ins. Co.'s RBC related to P&C
Ins. Co., Life Ins. Captive, and Midtier Holdco, the resulting building
block available capital and building block capital requirement amounts
for Mutual Life Ins. Co. are as follows:
Building block available capital = $4,311 + (999) + 626 + 105 + 129
= $4,172 million
Building block capital requirement = $454 + (190) + 164 + 37 + 24 =
$489 million
This can be shown as follows:
[GRAPHIC] [TIFF OMITTED] TP24OC19.035
As described in Section VII.C above, there is a remaining
adjustment at the level of the top-tier depository institution holding
company to determine whether capital instruments that meet the criteria
set out in Section VII.B.1 above, but not the criteria in Section
VII.C, exceed 62.5 percent of capital requirements. Assume that Mutual
Life Ins. Co. has outstanding surplus notes that are grandfathered as
proposed in the BBA, and thus are deemed to satisfy the criteria set
out in Section VII.B.1 above. These surplus notes may not meet the
criteria set out in Section VII.C above, but as proposed in the BBA,
would be grandfathered such that the BBA would not limit the insurance
depository institution holding company from treating all of these
instruments as available capital under the BBA. Going forward, the
unretired portion of these surplus notes would continue to be
grandfathered, and Mutual Life Ins. Co. would treat as available
capital any instruments meeting the criteria from Section VII.B.1, but
not meeting the criteria in Section VII.C, not exceeding the greater of
62.5 percent of capital requirements and the outstanding grandfathered
surplus notes.
H. Calculation of BBA Ratio and Application of Minimum Requirement and
Buffer
As described in Sections III.A above, the ratio of building block
available capital to building block capital requirements is the
calculated BBA Ratio. This ratio is reviewed relative to the minimum
requirement set out in the proposed BBA. In the example presented
above, the ratio of building block available capital to building block
capital requirements for Mutual Life Ins. Co. is $4,172 million/$489
million = 853 percent. This can be shown as follows:
BILLING CODE 6210-01-P
[[Page 57269]]
[GRAPHIC] [TIFF OMITTED] TP24OC19.036
BILLING CODE 6210-01-C
Relative to the minimum capital requirement proposed in the BBA, 250
percent, and the 235 percent buffer atop this minimum, Mutual Life Ins.
Co. would be considered to have met the minimum requirement and buffer
with a BBA ratio of 853 percent.
X. Reporting Form and Disclosure Requirements
In connection with this proposed rule, the Board proposes to
implement a new reporting form for use in the BBA. The proposed
reporting form, titled ``Capital Requirements for Board-Regulated
Institutions Significantly Engaged in Insurance Activities'' (Form FR
Q-1), and instructions focus on information needed to carry out the BBA
calculations.\83\ The proposed Form FR Q-1 is not intended to be
exhaustive in terms of addressing supervisory needs other than the
needs for the BBA.
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\83\ The proposed Form FR Q-1 and instructions are available at
https://www.federalreserve.gov/apps/reportforms/review.aspx.
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The vast majority of the information reported to the Board through
the proposed reporting form would not be public. The information that
the Board proposes to make public would consist of the building block
available capital, building block capital requirement, and BBA ratio
for the top-tier parent of an insurance depository institution holding
company's enterprise. The Board has long supported meaningful public
disclosure by supervised firms with the objective of improving market
discipline and encouraging sound risk management practices. The Board
is also aware that a sizable amount of information is publicly
disclosed by insurance firms pursuant to state laws and that IDIs
disclose their Call Reports. At this stage, the Board does not see the
need for the proposed BBA to require more detailed disclosure of
information by an insurance depository institution holding company. The
Board's consideration of market discipline is also informed by the fact
that the current population of insurance depository institution holding
companies represents a minority of the U.S. insurance market.
Furthermore, the Board believes that the proposed disclosure
requirements strike an appropriate balance between the need for
meaningful disclosure and the protection of proprietary and
confidential information.\84\ The Board has tailored the proposed
disclosure requirements under the BBA so as to enable insurance
depository institution holding companies to provide the disclosures
without revealing proprietary and confidential information.
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\84\ Proprietary information encompasses information that, if
shared with competitors, would render a supervised firm's investment
in these products/systems less valuable, and, hence, could undermine
its competitive position. Information about customers is often
confidential, in that it is provided under the terms of a legal
agreement or counterparty relationship.
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As set out in the proposed reporting form and instructions, the
form would be sent to the Board annually by March 15 of each year. The
Board may also choose to require reporting more frequently than
annually if needed for the Board to fulfill its supervisory objectives.
Instances calling for such more frequent reporting may include, among
others, a significant change such that the most recent reported amounts
are no longer reflective of the supervised firm's capital adequacy and
risk profile, or a significant change in qualitative attributes (for
example, the firm's risk management objectives and policies, nature of
reporting system, and definitions).
Question 34: What should the Board consider in determining the
reporting cycle for the BBA?
Question 35: Aside from what is currently proposed for public
disclosure under the BBA and associated reporting form, should
additional information submitted to the Board pursuant to the BBA be
made public?
[[Page 57270]]
To be transparent, gather additional input, and provide a valuable
test of the proposed approach, the Board intends to conduct a
quantitative impact study (QIS) of the BBA as part of its rulemaking
process. The data collected through this QIS will be used to analyze
the impact of various aspects of the proposed BBA. For instance,
information collected through the QIS will allow further exploration of
areas of thought and concern raised by commenters in response to the
Board's ANPR of June 2016. In addition, the Board's analysis of the QIS
results may inform its advocacy of positions in international insurance
standard setting, including an aggregation method, akin to the BBA,
that may be deemed comparable to the ICS. The analysis of QIS results
may also assist in the Board's continued engagement with the NAIC and
the NAIC's development of the GCC so as to minimize burden and achieve
efficiencies with regard to firms that may be subject to more than one
of these approaches.
XI. Impact Assessment of Proposed Rule
This section presents a preliminary assessment of anticipated
benefits and costs of the proposed BBA, were it to be adopted as
proposed. The Board's review of potential costs and benefits of this
proposal remains ongoing as the Board proceeds towards a final rule
implementing the BBA. This assessment will be informed by a QIS.
Furthermore, the Board remains mindful of the assistance commenters can
provide in bringing to light anticipated costs and benefits. The Board
has already reached a more informed preliminary assessment of benefits
and costs because of the comments submitted in response to the ANPR.
This preliminary analysis indicates that the proposed BBA achieves the
statutory requirement to establish a consolidated capital requirement
for insurance depository institution holding companies in a manner that
streamlines burden such that the benefits should more than outweigh any
initial or ongoing implementation costs. The Board invites comments on
all potential benefits and costs, as well as balance between the two,
arising from the BBA as proposed.
To the greatest extent possible, the Board attempts to minimize
regulatory burden in its rulemakings, consistent with the effective
implementation of its statutory responsibilities. Moreover, the Board
remains committed to transparency in this and all of its rulemaking
processes, including engagement with interested parties and an
appropriate balancing of benefits, costs, and economic impacts.
A. Analysis of Potential Benefits
1. A Capital Requirement for the Board's Consolidated Supervision
One of the main elements of a program of supervision of financial
institutions is a robust and risk-sensitive capital requirement, a key
benefit provided by the BBA with respect to insurance depository
institution holding companies. Maintaining sufficient capital is
central to a financial institution's ability to absorb unexpected
losses and continue to engage in financial intermediation. Ensuring the
adequacy of a supervised firm's capital levels and a robust capital
planning process for managing and allocating its capital resources are
primary objectives of the Board's consolidated supervision, including
supervision of insurance depository institution holding companies. In
the absence of a capital rule for insurance depository institution
holding companies, the Board's supervision of these firms has focused
on the second of these objectives, evaluation of the supervised firms'
capital planning. The Federal Reserve System's supervisory teams
conduct capital adequacy inspections at insurance depository
institution holding companies, evaluating processes and policies for
capital planning including methodologies and controls. A more complete
supervisory program includes a capital requirement, a need that this
proposal aims to fill and a principal benefit it is intended to
achieve.
2. Going Concern Safety and Soundness of the Supervised Institution
With a capital requirement for insurance depository institution
holding companies, the Board as a consolidated supervisor will have a
risk-sensitive framework to assess going-concern safety and soundness
for each insurance depository institution holding company and the
population of these firms overall. This enables firm-specific capital
adequacy review and horizontal reviews across firms. The Board remains
cognizant that state insurance supervisors regulate the types of
insurance products offered by insurance companies that are part of
organizations that the Board supervises, as well as the manner in which
the insurance is provided, and the capital adequacy of licensed
insurers. The Board's consolidated supervision is complementary to, and
in coordination with, existing legal-entity supervision by the states
by providing a perspective that considers the risks across the entire
firm.
As a result, the Board's supervision will have the ability to
consider risks at the enterprise level arising from an array of
sources, including companies subject and not subject to a capital
requirement, and insurance and non-insurance companies, under an
insurance depository institution holding company. The BBA therefore has
the benefit of not only providing a capital requirement for the Board's
consolidated supervision, but also providing the Board with additional
supervisory insights.
3. Protection of the Subsidiary Insured Depository Institution
The Board believes that it is important that any company that owns
and operates a depository institution be held to appropriate standards
of capitalization. The Board's consolidated supervision of an insurance
depository institution holding company encompasses the parent company
and its subsidiaries, and allows the Board to understand the
organization's structure, activities, resources, and risks, and to
address financial, managerial, operational, or other deficiencies
before they pose a danger to the insurance depository institution
holding companies' subsidiary depository institutions. Using its
authority, the Board proposes a consolidated capital requirement for
insurance depository institution holding companies, helping to ensure
that these institutions maintain adequate capital to support their
group-wide activities and do not endanger the safety and soundness of
their depository institution subsidiaries.
The proposed BBA brings the benefit of contributing to the
protection of the insurance depository institution holding companies'
IDIs and, consequently, the FDIC and the U.S. system of deposit
insurance. Deposit insurance has provided a safe and secure place for
those households and small businesses with relatively modest amounts of
financial assets to hold their transactional and other balances, and
Congress designed deposit insurance mainly to protect the modest
savings of unsophisticated depositors with limited financial assets.
4. Improved Efficiencies Resulting From Better Capital Management
The proposed BBA brings the benefit of potential efficiencies at
insurance depository institution holding companies through improved
capital management practices by providing an enterprise-wide capital
requirement and associated framework. For example, the application of a
consolidated capital
[[Page 57271]]
requirement in the form of the BBA could result in an insurance
depository institution holding company discovering that its aggregate,
enterprise-wide capital position is different than previously
estimated, resulting in the insurance depository institution holding
company being able to manage and allocate its capital in a way that
more accurately reflects its risks. If insurance depository institution
holding companies are better able to manage risk, then over the long
term, the proposed rule may result in decreased losses and related
costs to insurance depository institution holding companies and their
IDIs.
5. Fulfillment of a Statutory Requirement
As noted above, the Board is charged by Congress to promulgate
rules in accordance with statutory mandates, which reflect a
deliberation of costs and benefits first performed by Congress. The
framework proposed in this NPR fulfills a statutory mandate under
Section 171 of the Dodd-Frank Act.
B. Analysis of Potential Costs
1. Initial and Ongoing Costs To Comply
While insurers typically have internal capital planning processes,
calculations, and metrics, insurance depository institution holding
companies do not presently perform an enterprise-wide capital
calculation mandated by a federal regulator. Compliance with the BBA
will thus require some upfront setup and attendant maintenance to
collect the requisite information, perform the calculations, and submit
the required reports, as well as opportunity cost of management's time
to undertake this setup. However, the BBA builds on existing legal
entity capital requirements and, as a result, minimizes the amount of
additional systems infrastructure development beyond what is already
done by the insurance depository institution holding company to comply
with its entity-level regulatory requirements. Implementation costs are
thereby notably less relative to a ground-up capital requirement.
Under the proposal, the BBA would require certain calculations of,
and information pertaining to, the RBC requirements for certain
operating insurance companies in the insurance depository institution
holding company's enterprise. Generally, RBC reports that insurers file
with state regulators are confidential under the applicable state laws.
The proposed reporting form FR Q-1 aims to reflect this treatment under
state law while still serving the Board's supervisory objectives.
The attributes of the BBA as proposed are not anticipated to give
rise to significant initial or ongoing implementation costs. Generally,
compliance with the BBA may entail initial costs for an insurance
depository institution holding company. In particular, the firm may
need to set up certain systems for information collection and
processing and, on an ongoing basis, maintain these systems, conduct
certain review, and submit the regulatory reports required under the
proposal. The analysis suggests that these costs will not be unduly
burdensome.
The BBA's proposed approach to grouping an insurance depository
institution holding company's legal entities into building blocks is
not anticipated to be unduly burdensome. Under the proposal, the
insurance depository institution holding company would be required to
inventory its legal entities, then review each capital-regulated
company and material financial entity and ascertain whether each should
be treated as a building block parent. The proposed BBA would use an
insurance depository institution holding company's Schedule Y, as
prepared in the institution's lead insurer's most recent statutory
annual statement, together with its Forms Y-6 and Y-10 prepared for the
Board, as the basis for the inventory. By leveraging information that
the insurance depository institution holding company already prepares
under current regulatory requirements, the proposed BBA would
streamline implementation burden. The burden of evaluating each company
against the BBA's proposed provisions on determining building block
parents is anticipated to be minimal.
The proposed rule also sets out a method and formula for scaling
between Federal banking capital rules and NAIC RBC. Implementing this
provision entails calculations that are not anticipated to be
burdensome.
Under the proposed rule, a material financial entity not engaged in
insurance or reinsurance underwriting would be subject to the Board's
banking capital rule prior to aggregation, unless the insurance
depository institution holding company elects to not treat such a
company as an MFE. While the burden of identifying a material financial
entity is not expected to be sizable, an insurance depository
institution holding company may face some initial implementation costs
in preparing financial statement data for MFEs in accordance with U.S.
GAAP, to the extent such data is not already prepared. Were the
insurance depository institution holding company to decline to treat
any such company as an MFE, the firm would be required to allocate the
risks faced by the company to relevant affiliates. However, a financial
report for an MFE, or allocation of an MFE's risks to affiliates with
which it engages in certain transactions, would build on financial data
anticipated to be already captured, thereby minimizing additional
implementation burden. The costs associated with initial setup to
produce financial statement data for MFEs, or allocating the risks of
the MFE to relevant affiliates with any attendant recalculations of
required capital amounts, could include, but may not be limited to, the
opportunity cost of personnel and management's time to establish and
oversee processes to generate this data, and the more direct costs of
establishing or improving new management information systems to assure
the timely and accurate presentation of information. Ongoing costs in
either case may include system maintenance and additional staffing to
produce the statements, potentially entailing ongoing payroll costs and
the opportunity cost of the time spent operating the systems to produce
MFEs' financial data or allocating its risks and potential constraints
on flexibility in financial or corporate structure. However, none of
these initial and ongoing costs is expected to be substantial.
Under the proposal, an insurance depository institution holding
company would be required to conform all permitted and prescribed
practices, for any insurer in its enterprise, that depart from
statutory accounting treatment as set out by the NAIC. An insurance
depository institution holding company would also be required to remove
the impact of any transitional measures available under applicable
capital frameworks. The initial implementation costs of administering
these adjustments are anticipated to be comparable to such ongoing
costs since reviewing and making these adjustments would generally be
done on an annual basis when performing the BBA's calculations. When
permitted or prescribed accounting practices impact capital, surplus
and/or net income, they are generally required to be disclosed in
statutory annual statements prepared by regulated insurers. The
identification of these and the remaining such practices is not
anticipated to involve significant time beyond what is incurred by the
insurance depository institution holding company in preparing its
regulatory
[[Page 57272]]
filings for state supervisors. Conforming these accounting practices to
the NAIC's SAP, and producing revised accounting and RBC information,
may entail some implementation costs. The costs associated with these
adjustments are expected to be modest within the context of the
organizations and could include, but may not be limited to, the costs
to recruit and hire staff, including ongoing payroll and benefits
costs, and the costs of development and implementation of management
information systems.
Under the proposal, the insurance depository institution holding
company would have the option to eliminate credit risk weights on
intercompany transactions, including loans, guarantees, reinsurance,
and derivatives transactions. Because this adjustment is at the option
of the insurance depository institution holding company, the Board
considers that the supervised institution would only elect for such
adjustments if the benefits outweighed the costs. In any event, the
costs associated with running entity-level capital requirements,
including RBC, excluding intercompany credit risk weights are expected
to be minimal, where such costs could include, but may not be limited
to, changes in accounting or management information systems and costs
of potentially rerunning certain capital calculations, with any
attendant costs to recruit and hire staff, including ongoing payroll
and benefits costs, to revise accounting treatment as needed.
2. Review of Impacts Resulting From the BBA
Any capital requirement has the potential to influence a subject
firm's actions. With regard to the BBA, the Board notes that it is
generally less likely for an insurance depository institution holding
company to fail an aggregation-based approach if it already meets each
of its entity-level regulatory requirements. In concept, this outcome
may not always hold after reflecting an aggregation-based approach's
adjustments, inclusion of entities not subject to a regulatory capital
framework, and the intervention levels used by the supervisor applying
the aggregation-based approach. However, based on the Board's
preliminary review, the Board does not presently anticipate that any
currently supervised insurance depository institution holding company
will initially need to raise capital to meet the requirements of the
proposed BBA.
In light of the Board's supervisory objectives in designing the
BBA, the Board proposes in this NPR to subject capital instruments that
may be included in the BBA to the criteria for tier 2 capital under the
Board's banking capital rule. It is possible that, to the extent that a
state's criteria for inclusion of capital instruments differs from the
criteria in the Board's banking capital rule, instruments that qualify
under legal entities' RBC requirements would not qualify under the BBA,
which could result in an insurance depository institution holding
company incurring costs (e.g., issuance costs and required interest or
dividend payments) to raise capital resources meeting requirements
under the BBA. However, it is relevant that insurance depository
institution holding companies in many cases hold capital, in forms
other than instruments that may not meet the criteria for tier 2
capital under the Board's banking capital rule, already sufficient to
meet the requirements under the BBA.
Moreover, in order to mitigate any burdens arising from these
proposed requirements applicable to capital resources, the Board
proposes to grandfather existing surplus notes and treat them as
available capital under the BBA, and treat as capital, on a going-
forward basis, newly issued surplus notes meeting the criteria set out
in the BBA.
The proposed BBA would also deduct any investments that an
insurance depository institution holding company has in its own capital
instruments, including upstream investments by subsidiaries in parents
and any reciprocal cross-holdings in the capital of financial
institutions. In the Board's supervisory experience, insurance
depository institution holding companies tend to have few such
investments, if any. The proposed BBA also includes a limitation on the
investment by a top-tier parent or other depository institution holding
company in instruments recognized as capital of unconsolidated
financial institutions. The Board's supervisory experience suggests
that insurance depository institution holding companies do not tend to
hold such instruments. The Board therefore anticipates any costs or
burden arising from these proposed provisions to be minimal or
nonexistent.
Under the proposal, the minimum capital requirement applied under
the BBA would be the minimum requirement under the Board's banking
capital rule, scaled to the BBA's common capital framework, plus a
margin of safety. The proposal further includes the capital
conservation buffer requirement under the Board's banking capital rule,
tailored and scaled to the BBA's common capital framework. To minimize
any burden and tailor the BBA to be an insurance-centric standard, the
Board proposes to use, as the common capital framework for aggregation,
the NAIC RBC framework. Based on the Board's preliminary review, the
Board does not presently anticipate that any insurance depository
institution holding company would immediately fail to meet the proposed
BBA's minimum capital requirement or this requirement together with the
BBA's proposed capital conservation buffer.
The proposed BBA would limit the inclusion in the BBA of
instruments meeting the criteria for tier 2 instruments under the
Board's banking capital rule, but not meeting the banking capital
rule's criteria for common equity tier 1, to 62.5 percent of required
capital after aggregating to the level of the top-tier parent of the
insurance depository institution holding company's enterprise. An
insurance depository institution holding company may have issued
instruments that would qualify as tier 2 capital under the banking
capital rule, but would not qualify as common equity tier 1 under the
same, exceeding 62.5 percent of required capital. In such a case,
absent grandfathering, the firm would not be able to count the
instruments in excess of 62.5 percent of required capital towards its
BBA requirement.\85\ In concept, this could result in an insurance
depository institution holding company needing to modify its capital
structure to comply with this proposed provision. However, based on the
Board's preliminary review, and the current insurance depository
institution holding companies' overall capital positions, the Board
does not anticipate any substantial burden arising from this
limitation. Moreover, the proposed grandfathering of outstanding
surplus notes issued by any company within an insurance depository
institution holding company's enterprise, with the proposed BBA
applying the limit on tier 2 instruments to only newly issued surplus
notes, will reduce implementation burden.
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\85\ The supervised insurance institution, including the issuer
within its enterprise, would remain able to count such instruments
towards any other capital requirements.
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This proposal also includes the Section 171 calculation, as
described above. The Board continues to deliberate the potential
implementation costs of this calculation. In light of this, the Board
has proposed two options by which subject DI holding companies can
exclude certain insurance subsidiaries.
[[Page 57273]]
3. Impact on Premiums and Fees
Any initial and ongoing costs of complying with the standard, if
adopted as proposed, could nominally affect the premiums and fees that
the insurance depository institution holding companies charge, since
insurance products are priced to allow insurers to recover their costs
and earn a fair rate of return on their capital. A capital requirement
like the BBA, if adopted as proposed, could also affect the cost of
capital borne by the insurance depository institution holding company,
which in turn could affect premiums and an insurer's borrowing cost. In
the long run, costs of providing a policy may be borne by
policyholders.
Because the expected costs associated with implementing the
proposal, if adopted, are not expected to be substantial within the
context of the insurance depository institution holding companies'
existing budgets, there is not expected to be a substantial change in
the pricing of insurance depository institution holding companies'
products resulting from the proposed standards. In addition, because
the Board does not presently anticipate that any supervised insurance
depository institution holding company will need to initially raise
capital to meet the requirements of the BBA, there is not expected to
be a substantial change in the cost of capital faced by insurance
depository institution holding companies. Moreover, the better
identification of risk to the safety and soundness of the consolidated
enterprise, as well as the subsidiary IDI, that is expected to result
from the proposal may lead to improved efficiencies, fewer losses, and
lower costs in the long term, which may offset any effects on premiums
of any compliance costs.
4. Impact on Financial Intermediation
The possibility of reduced financial intermediation or economic
output in the United States related to the proposed BBA appears
unlikely. In this regard, the Board recalls that capital requirements
under the BBA are taken as they are under the jurisdictional capital
frameworks, including NAIC RBC, subject to adjustment and scaling that
does not alter the underlying capital charges. As a result, the BBA is
not expected to operate to influence insurance depository institution
holding companies' aggregate investment allocations among asset
classes, or more generally affect insurance depository institution
holding companies' role in risk assumption or other financial
intermediation.
C. Assessment of Benefits and Costs
Based on an initial assessment of available information, the
benefits of the proposed BBA are expected to outweigh any costs. Most
significantly, the intent of the proposed rule is to ensure the safety
and soundness of the insurance depository institution holding company
and protect the subsidiary IDI, in fulfillment of the Board's statutory
mandate. The Board believes this objective would be accomplished, in
accordance with the Board's supervisory goals, through the proposed BBA
in a manner that is minimally burdensome and appropriately tailored.
Question 36: The Board invites comment on all aspects of the
foregoing evaluation of the costs and benefits of the proposed rule.
Are there additional costs or benefits that the Board should consider?
Would the magnitude of costs or benefits be different than as described
above?
XII. Administrative Law Matters
A. Solicitation of Comments on the Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act (Pub. L. 106-102, 113
Stat. 1338, 1471, 12 U.S.C. 4809) requires the Federal banking agencies
to use plain language in all proposed and final rules published after
January 1, 2000. The Board has sought to present the proposed rule in a
simple and straightforward manner, and invites comment on the use of
plain language.
B. Paperwork Reduction Act
In connection with the proposed rule, the Board proposes to
implement a new reporting form that would constitute a ``collection of
information'' within the meaning of the Paperwork Reduction Act (PRA)
of 1995 (44 U.S.C. 3501-3521). In accordance with the requirements of
the PRA, the Board may not conduct or sponsor, and a respondent is not
required to respond to, an information collection unless it displays a
currently valid Office of Management and Budget (OMB) control number.
The OMB control number is 7100-NEW. The Board reviewed the proposed
information collection under the authority delegated to the Board by
the OMB.
The proposed reporting form is subject to the PRA. The form would
be implemented pursuant to section 171 of the Dodd-Frank Act and
section 10 of HOLA for insurance depository institution holding
companies.
Comments are invited on:
(a) Whether the collections of information are necessary for the
proper performance of the Board's functions, including whether the
information has practical utility;
(b) The accuracy of the Board's estimate of the burden of the
information collections, including the validity of the methodology and
assumptions used;
(c) Ways to enhance the quality, utility, and clarity of the
information to be collected;
(d) Ways to minimize the burden of the information collections on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
(e) Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
All comments will become a matter of public record. Comments on
aspects of this notice that may affect reporting, recordkeeping, or
disclosure requirements and burden estimates should be sent to the
addresses listed in the ADDRESSES section. A copy of the comments may
also be submitted to the OMB desk officer: By mail to U.S. Office of
Management and Budget, 725 17th Street NW, #10235, Washington, DC 20503
or by facsimile to (202) 395-5806.
Proposed Information Collection
Title of Information Collection: Reporting Form for the Capital
Requirements for Board-regulated Institutions Significantly Engaged in
Insurance Activities.
Agency Form Number: FR Q-1.
OMB Control Number: 7100-NEW.
Frequency of Response: Annual.
Affected Public: Businesses or other for-profit.
Respondents: Insurance depository institution holding companies.
Abstract: Section 171 of the Dodd-Frank Act requires, and section
10 of the Home Owners' Loan Act authorizes, the Board to implement
risk-based capital requirements for depository institution holding
companies, including those that are significantly engaged in insurance
activities.
Current Actions: Pursuant to section 171 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act and section 10 of HOLA, the
Board is proposing the application of risk-based capital requirements
to certain depository institution holding companies. The Board is
proposing an aggregation-based approach, the Building Block Approach,
that would aggregate capital resources and capital requirements across
the different legal entities under an insurance depository institution
holding company to calculate consolidated, enterprise-wide
[[Page 57274]]
qualifying and required capital. The proposed BBA utilizes, to the
greatest extent possible, capital frameworks already in place for the
entities in the enterprise of a depository institution holding company
significantly engaged in insurance activities and is tailored to the
supervised firm's business model, capital structure, and risk profile.
The new reporting form FR Q-1 would require a depository institution
holding company to produce certain information required for the
application of the BBA. The proposed reporting form and instructions
are available on the Board's public website at https://www.federalreserve.gov/apps/reportforms/review.aspx.
Estimated Paperwork Burden
Estimated number of respondents: 8.
Estimated average hours per response: 40 (Initial set-up 160).
Estimated annual burden hours: 1,600 (1,280 for initial set-up and
320 for ongoing compliance).
C. Regulatory Flexibility Act
In accordance with section 3(a) of the Regulatory Flexibility Act
\86\ (RFA), the Board is publishing an initial regulatory flexibility
analysis of the proposed rule. The RFA requires an agency to either
provide an initial regulatory flexibility analysis with a proposed rule
for which a general notice of proposed rulemaking is required, or
certify that the proposed rule will not have a significant economic
impact on a substantial number of small entities. Based on its analysis
and for the reasons stated below, the Board believes that this proposed
rule will not have a significant economic impact on a substantial
number of small entities. Nevertheless, the Board is publishing an
initial regulatory flexibility analysis. A final regulatory flexibility
analysis will be conducted after comments received during the public
comment period have been considered.
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\86\ 5 U.S.C. 601 et seq.
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In accordance with section 171 of the Dodd-Frank Act and section 10
of HOLA, the Board is proposing to adopt subpart J to 12 CFR part 217
(Regulation Q) to establish risk-based capital requirements for
insurance depository institution holding companies.\87\ An insurance
depository institution holding company's aggregate capital requirements
generally would be the sum of the capital requirements applicable to
the top-tier parent and certain subsidiaries of the insurance
depository institution holding company, where the capital requirements
for regulated financial subsidiaries would generally be based on the
regulatory capital rules of the subsidiaries' functional regulators--
whether a state or foreign insurance regulator for insurance
subsidiaries or a Federal banking regulator for IDIs. The BBA would
then build upon and aggregate capital resources and requirements across
groups of legal entities in the insurance depository institution
holding company's enterprise (insurance, non-insurance financial, non-
financial, and holding company), subject to adjustments.
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\87\ See 12 U.S.C. 1467a and 5371.
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Under Small Business Administration (SBA) regulations, the finance
and insurance sector includes direct life insurance carriers, direct
title insurance carriers, and direct P&C insurance carriers, which
generally are considered ``small'' for the purposes of the RFA if a
life insurance carrier or title insurance carrier has assets of $38.5
million or less or if a P&C insurance carrier has less than 1,500
employees.\88\ The Board believes that the finance and insurance sector
constitutes a reasonable universe of firms for these purposes because
this proposal would only apply to depository institution holding
companies significantly engaged in insurance activities, as discussed
in the SUPPLEMENTARY INFORMATION.
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\88\ 13 CFR 121.201.
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Life insurance companies and title insurance companies that would
be subject to the proposed rule all substantially exceed the $38.5
million asset threshold at which they would be considered a ``small
entity'' under SBA regulations. P&C insurance companies subject to the
proposed rule exceed the less than 1,500 employee threshold at which a
P&C entity is considered a ``small entity'' under SBA regulations.
Because the proposed rule is not likely to apply to any life
insurance carrier or title insurance carrier with assets of $38.5
million, or P&C carrier with less than 1,500 employees, if adopted in
final form, it is not expected to apply to a substantial number of
small entities for purposes of the RFA. The Board does not believe that
the proposed rule duplicates, overlaps, or conflicts with any other
federal rules. In light of the foregoing, the Board does not believe
that the proposed rule, if adopted in final form, would have a
significant economic impact on a substantial number of small entities
supervised. Nonetheless, the Board seeks comment on whether the
proposed rule would impose undue burdens on, or have unintended
consequences for, small organizations, and whether there are ways such
potential burdens or consequences could be minimized in a manner
consistent with section 171 of the Dodd-Frank Act and section 10 of
HOLA.
List of Subjects
12 CFR Part 217
Administrative practice and procedure, Banks, Banking, Capital,
Federal Reserve System, Holding companies, Reporting and recordkeeping
requirements, Risk, Securities.
12 CFR Part 252
Administrative practice and procedure, Banks, banking, Credit,
Federal Reserve System, Holding companies, Investments, Qualified
financial contracts, Reporting and recordkeeping requirements,
Securities.
Authority and Issuance
For the reasons set forth in the preamble, the Board of Governors
of the Federal Reserve System proposes to amend chapter II of title 12
of the Code of Federal Regulations as follows:
PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)
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1. The authority citation for part 217 continues to read as follows:
Authority: 12 U.S.C. 248(a), 321-338a, 481-486, 1462a, 1467a,
1818, 1828, 1831n, 1831o, 1831p-1, 1831w, 1835, 1844(b), 1851, 3904,
3906-3909, 4808, 5365, 5368, 5371.
Subpart A--General Provisions
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2. Section 217.1 is amended by:
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a. Revising paragraphs (c)(1)(ii) and (iii);
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b. Redesignating paragraphs (c)(2) through (5) as paragraphs (c)(3)
through (6); and
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c. Adding new paragraph (c)(2).
The revisions and additions read as follows:
Sec. 217.1 Purpose, applicability, reservations of authority, and
timing.
* * * * *
(c) * * *
(1) * * *
(ii) A bank holding company domiciled in the United States that is
not subject to the Small Bank Holding Company and Savings and Loan
Holding Company Policy Statement (part 225, appendix C of this
chapter), provided that the Board may by order apply any or all of this
part to any bank holding company, based on the institution's size,
level of complexity,
[[Page 57275]]
risk profile, scope of operations, or financial condition; or
(iii) A covered savings and loan holding company domiciled in the
United States that is not subject to the Small Bank Holding Company and
Savings and Loan Holding Company Policy Statement (part 225, appendix C
of this chapter). For purposes of compliance with the capital adequacy
requirements and calculations in this part, savings and loan holding
companies that do not file the FR Y-9C should follow the instructions
to the FR Y-9C.
(2) Insurance Savings and Loan Holding Companies. (i) In the case
of a covered savings and loan holding company that does not calculate
consolidated capital requirements under subpart B of this part because
it is a state regulated insurer, subpart B of this part applies to a
savings and loan holding company that is a subsidiary of such covered
savings and loan holding company, provided:
(A) The subsidiary savings and loan holding company is an insurance
SLHC mid-tier holding company; and
(B) The subsidiary savings and loan holding company's assets and
liabilities are not consolidated with those of a savings and loan
holding company that controls the subsidiary for purposes of
determining the parent savings and loan holding company's capital
requirements and capital ratios under subparts B through F of this
part.
(ii) Insurance savings and loan holding companies and treatment of
subsidiary state regulated insurers, regulated foreign subsidiaries and
regulated foreign affiliates.
(A) In complying with the capital adequacy requirements of this
part (except for the requirements and calculations of subpart J of this
part), including any determination of applicability under Sec. 217.100
or Sec. 217.201, an insurance savings and loan holding company, or an
insurance SLHC mid-tier holding company, may elect to:
Option 1: Deduction
(1) Not consolidate the assets and liabilities of its subsidiary
state-regulated insurers, regulated foreign subsidiaries and regulated
foreign affiliates; and
(2) Deduct the aggregate amount of its outstanding equity
investment, including retained earnings, in such subsidiaries and
affiliates.
Option 2: Risk-Weight
(1) Not consolidate the assets and liabilities of its subsidiary
state-regulated insurers, regulated foreign subsidiaries and regulated
foreign affiliates;
(2) Include in the risk-weighted assets of the Board-regulated
institution the aggregate amount of its outstanding equity investment,
including retained earnings, in such subsidiaries and affiliates and
assign to these assets a 400 percent risk weight in accordance with
Sec. 217.52.
(B) Nonconsolidation election for state regulated insurers,
regulated foreign subsidiaries and regulated foreign affiliates. (1) An
insurance savings and loan holding company or insurance SLHC mid-tier
holding company may elect not to consolidate the assets and liabilities
of all of its subsidiary state regulated insurers, regulated foreign
subsidiaries and regulated foreign affiliates by indicating that it has
made this election on the applicable regulatory report, filed by the
insurance savings and loan holding company or insurance SLHC mid-tier
holding company for the first reporting period in which it is an
insurance savings and loan holding company or insurance SLHC mid-tier
holding company.
(2) An insurance savings and loan holding company or insurance SLHC
mid-tier holding company that has not made an effective election
pursuant to paragraph (C)(2)(B)(1) of this section, or that seeks to
change its election due to a change in control, business combination,
or other legitimate business purpose, may do so only with the prior
approval of the Board, effective as of the reporting date of the first
reporting period after the period in which the Board approves the
election, or such other date specified in the approval.
* * * * *
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3. In Sec. 217.2,
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a. Revising the definition of ``Covered savings and loan holding
company, '' and
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b. Adding the definitions of ``Capacity as a regulated insurance
entity'', ``Insurance savings and loan holding company'', ``Insurance
SLHC mid-tier holding company'', ``Regulated foreign subsidiary and
regulated foreign affiliate'', and ``State regulated insurer''.
The revision and additions read as follows:
Sec. 217.2 Definitions.
* * * * *
Capacity as a regulated insurance entity has the meaning in section
171(a)(7) of the Dodd-Frank Act (12 U.S.C. 5371(a)(7)).
* * * * *
Covered savings and loan holding company means a top-tier savings
and loan holding company other than:
(1) An institution that meets the requirements of section
10(c)(9)(C) of HOLA (12 U.S.C. 1467a(c)(9)(C)); and
(2) As of June 30 of the previous calendar year, derived 50 percent
or more of its total consolidated assets or 50 percent of its total
revenues on an enterprise-wide basis (as calculated under GAAP) from
activities that are not financial in nature under section 4(k) of the
Bank Holding Company Act of 1956 (12 U.S.C. 1843(k)).
* * * * *
Insurance savings and loan holding company means:
(1) A top-tier savings and loan holding company that is an
insurance underwriting company; or
(2)(i) A top-tier savings and loan holding company that, as of June
30 of the previous calendar year, held 25 percent or more of its total
consolidated assets in subsidiaries that are insurance underwriting
companies (other than assets associated with insurance underwriting for
credit risk); and
(ii) For purposes of this definition, the company must calculate
its total consolidated assets in accordance with GAAP, or if the
company does not calculate its total consolidated assets under GAAP for
any regulatory purpose (including compliance with applicable securities
laws), the company may estimate its total consolidated assets, subject
to review and adjustment by the Board.
Insurance SLHC mid-tier holding company means a savings and loan
holding company domiciled in the United States that:
(1) Is a subsidiary of an insurance savings and loan holding
company to which subpart J applies; and
(2) Is not an insurance underwriting company that is subject to
state-law capital requirements.
Regulated foreign subsidiary and regulated foreign affiliate has
the meaning in section 171(a)(6) of the Dodd-Frank Act (12 U.S.C.
5371(a)(6)) and any subsidiary of such a person other than a state
regulated insurer.
* * * * *
State regulated insurer means a person regulated by a state
insurance regulator as defined in section 1002(22) of the Dodd-Frank
Act (12 U.S.C. 5481(22)), and any subsidiary of such a person, other
than a regulated foreign subsidiary and regulated foreign affiliate.
* * * * *
[[Page 57276]]
Subpart B--Capital Ratio Requirements and Buffers
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4. Section 217.10 is amended by adding paragraphs (a)(4), (6) and (7),
to read as follows:
Sec. 217.10 Minimum capital requirements.
* * * * *
(a) * * *
(4) For a Board-regulated institution other than an insurance
savings and loan holding company or insurance SLHC mid-tier holding
company, a leverage ratio of 4 percent.
* * * * *
(6) An insurance savings and loan holding company that is a state
regulated insurer is not required to meet the minimum capital ratio
requirements in paragraphs (a)(1) through (5) of this section, if the
company uses subpart J of this part for purposes of compliance with the
capital adequacy requirements and calculations in this part.
(7) An insurance savings and loan holding company is not required
to meet the buffer in Sec. 217.11, if the company uses subpart J of
this part for purposes of compliance with the calculation of its
capital conservation buffer.
* * * * *
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5. Section 217.11 is amended by revising paragraph (a)(3) to read as
follows:
Sec. 217.11 Capital conservation buffer, countercyclical capital
buffer amount, and GSIB surcharge.
(a) * * *
* * * * *
(3) Calculation of Capital Conservation Buffer. (i) For a Board-
regulated institution (other than an insurance savings and loan holding
company that uses subpart J of this part for the purpose of calculating
its capital conservation buffer) the capital conservation buffer is
equal to the lowest of the following ratios, calculated as of the last
day of the previous calendar quarter based on the Board-regulated
institution's most recent Call Report, for a state member bank, or FR
Y-9C, for a bank holding company or savings and loan holding company,
as applicable:
* * * * *
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6. In part 217, add subpart J, to read as follows:
Subpart J--Capital Requirements for Board-regulated Institutions
Significantly Engaged in Insurance Activities
Sec.
207.601 Purpose, applicability, reservations of authority, and scope
207.602 Definitions
207.603 Capital Requirements
207.604 Capital Conservation Buffer
217.605 Determination of Building Blocks
217.606 Scaling Parameters
217.607 Capital Requirements under the Building Block Approach
217.608 Available Capital Resources under the Building Block
Approach
Subpart J--Capital Requirements for Board-regulated Institutions
Significantly Engaged in Insurance Activities
Sec. 217.601 Purpose, applicability, reservations of authority, and
scope
(a) Purpose. This subpart establishes a framework for assessing
overall risk-based capital for Board-regulated institutions that are
significantly engaged in insurance activities. The framework in this
subpart is used to measure available capital resources and capital
requirements across a Board-regulated institution and its subsidiaries
that are subject to diverse applicable capital frameworks, aggregate
available capital resources and capital requirements, and calculate a
ratio that reflects the overall capital adequacy of the Board-regulated
institution. This subpart includes minimum BBA ratio and capital buffer
requirements, public disclosure requirements, and transition provisions
for the application of this subpart.
(b) Applicability. This section applies to every Board-regulated
institution that is:
(1) (i) A top-tier depository institution holding company that is
an insurance underwriting company; or
(ii) A top-tier depository institution holding company, that, as of
June 30 of the previous calendar year, held 25 percent or more of its
total consolidated assets in insurance underwriting companies (other
than assets associated with insurance underwriting for credit risk).
For purposes of this subparagraph (b)(ii), the Board-regulated
institution must calculate its total consolidated assets in accordance
with U.S. GAAP, or if the Board-regulated institution does not
calculate its total consolidated assets under U.S. GAAP for any
regulatory purpose (including compliance with applicable securities
laws), the company may estimate its total consolidated assets, subject
to review and adjustment by the Board; or
(2) An institution that is otherwise subject to this subpart, as
determined by the Board.
(c) Exclusion of certain SLHCs. This subpart shall not apply to a
top-tier depository institution holding company that
(i) Exclusively files financial statements in accordance with SAP;
(ii) Is not subject to a State insurance capital requirement; and
(iii) Has no subsidiary depository institution holding company that
(A) Is subject to a capital requirement; or
(B) Does not exclusively file financial statements in accordance
with SAP.
(d) Reservation of authority.
(1) Regulatory capital resources.
(i) If the Board determines that a particular company capital
element has characteristics or terms that diminish its ability to
absorb losses, or otherwise present safety and soundness concerns, the
Board may require the supervised insurance organization to exclude all
or a portion of such element from building block available capital for
a depository institution holding company in the supervised insurance
organization.
(ii) Notwithstanding the provisions set forth in Sec. 217.608, the
Board may find that a capital resource may be included in the building
block available capital of a depository institution holding company on
a permanent or temporary basis consistent with the loss absorption
capacity of the capital resource and in accordance with Sec.
217.608(g).
(2) Required capital amounts. If the Board determines that the
building block capital requirement for any depository institution
holding company is not commensurate with the risks of the depository
institution holding company, the Board may adjust the building block
capital requirement and building block available capital for the
supervised insurance organization.
(3) Structural requirements. In order to achieve the appropriate
application of this subpart, the Board may require a supervised
insurance organization to take any of the following actions with
respect to the application of this subpart, if the Board determines
that such action would better reflect the risk profile of an inventory
company or the supervised insurance organization:
(i) Identify an inventory company that is a depository institution
holding company as a top-tier depository institution holding company,
or vice versa;
(ii) Identify any company as an inventory company, material
financial entity, or building block parent;
(iii) Reverse the identification of a building block parent; or
(iv) Set a building block parent's allocation share of a downstream
building block parent equal to 100 percent.
(e) Other reservation of authority. With respect to any treatment
required under this subpart, the Board may require a different
treatment, provided
[[Page 57277]]
that such alternative treatment is commensurate with the supervised
insurance organization's risk and consistent with safety and soundness.
(f) Notice and response procedures. In making any determinations
under this subpart, the Board will apply notice and response procedures
in the same manner as the notice and response procedures in section
263.202 of this chapter.
Sec. 217.602 Definitions
(a) Terms that are set forth in Sec. 217.2 and used in this
subpart have the definitions assigned thereto in Sec. 217.2.
(b) For the purposes of this subpart, the following terms are
defined as follows:
Allocation share means the portion of a downstream building block's
available capital or building block capital requirement that a building
block parent must aggregate in calculating its own building block
available capital or building block capital requirement, as applicable.
Applicable capital framework is defined in Sec. 217.605, provided
that for purposes of Sec. 217.605(b)(2), the NAIC RBC frameworks for
life insurance, fraternal insurers, property and casualty insurance,
and health insurance companies are different applicable capital
frameworks.
Assignment means the process of associating an inventory company
with one or more building block parents for purposes of inclusion in
the building block parents' building blocks.
BBA ratio is defined in Sec. 217.603.
Building block means a building block parent and all downstream
companies and subsidiaries assigned to the building block parent.
Building block available capital has the meaning set out in Sec.
217.608.
Building block capital requirement has the meaning set out in Sec.
217.607.
Building block parent means the lead company of a building block
whose applicable capital framework must be applied to all members of a
building block for purposes of determining building block available
capital and the building block capital requirement.
Capital-regulated company means a company in a supervised insurance
organization that is directly subject to a regulatory capital
framework.
Common capital framework means NAIC RBC.
Company available capital means, for a company, the amount of its
company capital elements, net of any adjustments and deductions, as
determined in accordance with the company's applicable capital
framework.
Company capital element means, for purposes of this subpart, any
part, item, component, balance sheet account, instrument, or other
element qualifying as regulatory capital under a company's applicable
capital framework prior to any adjustments and deductions under that
framework.
Company capital requirement means:
(1) For a company whose applicable capital framework is NAIC RBC,
the Authorized Control Level risk-based capital requirement;
(2) For a company whose applicable capital framework is a U.S.
federal banking capital rule, the total risk-weighted assets; and
(3) For any other company, a risk-sensitive measure of required
capital used to determine the jurisdictional intervention point
applicable to that company.
Downstream building block parent means a building block parent that
is a downstream company of another building block parent.
Downstream company means a company whose company capital element is
directly or indirectly owned, in whole or in part by, another company
in the supervised insurance organization.
Downstreamed capital means direct ownership of a downstream
company's company capital element that is accretive to a downstream
building block parent's building block available capital.
Engaged in insurance or reinsurance underwriting means, for a
company, to be regulated as an insurance or reinsurance underwriting
company, other than insurance underwriting companies that primarily
underwrite title insurance or insurance for credit risk.
Financial entity means:
(1) A bank holding company; a savings and loan holding company as
defined in section 10(n) of the Home Owners' Loan Act (12 U.S.C.
1467a(n)); a U.S. intermediate holding company established or
designated for purposes of compliance with this part;
(2) A depository institution as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c)); an organization that
is organized under the laws of a foreign country and that engages
directly in the business of banking outside the United States; a
federal credit union or state credit union as defined in section 2 of
the Federal Credit Union Act (12 U.S.C. 1752(1) and (6)); a national
association, state member bank, or state nonmember bank that is not a
depository institution; an institution that functions solely in a trust
or fiduciary capacity as described in section 2(c)(2)(D) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(c)(2)(D)); an industrial
loan company, an industrial bank, or other similar institution
described in section 2(c)(2)(H) of the Bank Holding Company Act of 1956
(12 U.S.C. 1841(c)(2)(H));
(3) An entity that is state-licensed or registered as:
(i) A credit or lending entity, including a finance company; money
lender; installment lender; consumer lender or lending company;
mortgage lender, broker, or bank; motor vehicle title pledge lender;
payday or deferred deposit lender; premium finance company; commercial
finance or lending company; or commercial mortgage company; except
entities registered or licensed solely on account of financing the
entity's direct sales of goods or services to customers;
(ii) A money services business, including a check casher; money
transmitter; currency dealer or exchange; or money order or traveler's
check issuer;
(4) Any person registered with the Commodity Futures Trading
Commission as a swap dealer or major swap participant pursuant to the
Commodity Exchange Act of 1936 (7 U.S.C. 1 et seq.), or an entity that
is registered with the U.S. Securities and Exchange Commission as a
security-based swap dealer or a major security-based swap participant
pursuant to the Securities Exchange Act of 1934 (15 U.S.C. 78a et
seq.);
(5) A securities holding company as defined in section 618 of the
Dodd-Frank Act (12 U.S.C. 1850a); a broker or dealer as defined in
sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(4)-(5)); an investment company registered with the U.S.
Securities and Exchange Commission under the Investment Company Act of
1940 (15 U.S.C. 80a-1 et seq.); or a company that has elected to be
regulated as a business development company pursuant to section 54(a)
of the Investment Company Act of 1940 (15 U.S.C. 80a-53(a));
(6) A private fund as defined in section 202(a) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an entity that would be an
investment company under section 3 of the Investment Company Act of
1940 (15 U.S.C. 80a-3) but for section 3(c)(5)(C); or an entity that is
deemed not to be an investment company under section 3 of the
Investment Company Act of 1940 pursuant to Investment Company Act Rule
3a-7 (17 CFR 270.3a-7) of the U.S. Securities and Exchange Commission;
(7) A commodity pool, a commodity pool operator, or a commodity
trading
[[Page 57278]]
advisor as defined, respectively, in sections 1a(10), 1a(11), and
1a(12) of the Commodity Exchange Act (7 U.S.C. 1a(10), 1a(11), and
1a(12)); a floor broker, a floor trader, or introducing broker as
defined, respectively, in sections 1a(22), 1a(23) and 1a(31) of the
Commodity Exchange Act (7 U.S.C. 1a(22), 1a(23), and 1a(31)); or a
futures commission merchant as defined in section 1a(28) of the
Commodity Exchange Act (7 U.S.C. 1a(28));
(8) An entity that is organized as an insurance company, primarily
engaged in underwriting insurance or reinsuring risks underwritten by
insurance companies;
(9) Any designated financial market utility, as defined in section
803 of the Dodd-Frank Act (12 U.S.C. 5462); and
(10) An entity that would be a financial entity described in
paragraphs (1) through (9) of this definition, if it were organized
under the laws of the United States or any State thereof.
Inventory has the meaning set out in paragraph (a) of Sec.
217.602(b)(2).
Material means, for a company in the supervised insurance
organization:
(1) Where the top-tier depository institution holding company's
total exposure exceeds 1 percent of total consolidated assets of the
top-tier depository institution holding company. The supervised firm
must calculate its total consolidated assets in accordance with U.S.
GAAP, or if the firm does not calculate its total consolidated assets
under U.S. GAAP for any regulatory purpose (including compliance with
applicable securities laws), the company may estimate its total
consolidated assets, subject to review and adjustment by the Board. For
purposes of this definition, total exposure includes:
(a) The absolute value of the top-tier depository institution
holding company's direct or indirect interest in the company capital
elements of the company;
(b) The top-tier depository institution holding company or any
other company in the supervised insurance organization providing an
explicit or implicit guarantee for the benefit of the company; and
(c) Potential counterparty credit risk to the top-tier depository
institution holding company or any other company in the supervised
insurance organization arising from any derivative or similar
instrument, reinsurance or similar arrangement, or other contractual
agreement; or
(2) The company is otherwise significant in assessing the building
block available capital or building block capital requirement of the
top-tier depository institution holding company based on factors
including risk exposure, activities, organizational structure,
complexity, affiliate guarantees or recourse rights, and size.
Material financial entity means a financial entity that, together
with its subsidiaries, but excluding any subsidiary capital-regulated
company (or subsidiary thereof), is material, provided that an
inventory company is not eligible to be a material financial entity if:
(1) The supervised insurance organization has elected pursuant to
Sec. 217.605(c) to not treat the company as a material financial
entity.
(2) The inventory company is a financial subsidiary, as defined in
section 121 of the Gramm-Leach-Bliley Act;
(3) The inventory company is properly registered as an investment
adviser under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1 et
seq.), or with any state.
Member means, with respect to a building block, the building block
parent or any of its downstream companies or subsidiaries that have
been assigned to a building block.
NAIC means the National Association of Insurance Commissioners.
NAIC RBC means the most recent version of the Risk-Based Capital
(RBC) For Insurers Model Act, together with the RBC instructions, as
adopted in a substantially similar manner by an NAIC member and
published in the NAIC's Model Regulation Service.
Permitted Accounting Practice means an accounting practice
specifically requested by a state regulated insurer that departs from
SAP and state prescribed accounting practices, and has received
approval from the state regulated insurer's domiciliary state
regulatory authority.
Prescribed Accounting Practice means an accounting practice that is
incorporated directly or by reference to state laws, regulations and
general administrative rules applicable to all insurance enterprises
domiciled in a particular state.
Recalculated building block capital requirement means, for a
downstream building block parent and an upstream building block parent,
the downstream building block parent's building block capital
requirement recalculated assuming that the downstream building block
parent had no upstream investment in the upstream building block
parent.
Regulatory capital framework means, with respect to a company, the
applicable legal requirements, excluding this subpart, specifying the
minimum amount of total regulatory capital the company must hold to
avoid restrictions on distributions and discretionary bonus payments,
regulatory intervention on the basis of capital adequacy levels for the
company, or equivalent standards; provided that for purposes of this
subpart, the NAIC RBC frameworks for life insurance, fraternal
insurance, property and casualty insurance, and health insurance
companies are different regulatory capital frameworks.
SAP means Statutory Accounting Principles as promulgated by the
NAIC and adopted by a jurisdiction for purposes of financial reporting
by insurance companies.
Scaling means the translation of building block available capital
and building block capital requirement from one applicable capital
framework to another by application of Sec. 217.606.
Scalar-compatible means a capital framework:
(1) For which the Board has determined scalars; or
(2) That is an insurance capital regulatory framework, and exhibits
each of the following three attributes:
(a) the framework is clearly defined and broadly applicable;
(b) The framework has an identifiable intervention point that can
be used to calibrate a scalar; and
(c) The framework provides a risk-sensitive measure of required
capital reflecting material risks to a company's financial strength.
Submission date means the date as of which Form FR Q-1 is filed
with the Board.
Supervised insurance organization means:
(1) In the case of a depository institution holding company, the
set of companies consisting of:
(i) A top-tier depository institution holding company that is an
insurance underwriting company, together with its inventory companies;
or
(ii) A top-tier depository institution holding company, together
with its inventory companies, that, as of June 30 of the previous
calendar year, held 25 percent or more of its total consolidated assets
in insurance underwriting companies (other than assets associated with
insurance underwriting for credit risk). For purposes of this paragraph
(1)(ii) of this definition, the supervised firm must calculate its
total consolidated assets in accordance with U.S. GAAP, or if the firm
does not calculate its total consolidated assets under U.S. GAAP for
any regulatory purpose (including compliance with applicable securities
laws), the company may estimate its total consolidated assets, subject
to review and adjustment by the Board; or
[[Page 57279]]
(2) An institution that is otherwise subject to this subpart, as
determined by the Board.
Tier 2 capital instruments, for purposes of this subpart, has the
meaning set out in Sec. 217.608(a).
Top-tier depository institution holding company means a savings and
loan holding company that is not controlled by another savings and loan
holding company.
Upstream building block parent means an upstream company that is a
building block parent.
Upstream company means a company within a supervised insurance
organization that directly or indirectly controls a downstream company,
or directly or indirectly owns part or all of a downstream company's
company capital elements.
Upstream investment means any direct or indirect investment by a
downstream building block parent in an upstream building block parent.
U.S. federal banking capital rules mean this part, other than this
subpart, and the regulatory capital rules promulgated by the Federal
Deposit Insurance Corporation and the Office of the Comptroller of the
Currency.
Sec. 217.603 Capital Requirements
(a) Generally. A supervised insurance organization must determine
its BBA ratio, subject to the minimum requirement set out in this
section and buffer set out in Sec. 217.604, for each depository
institution holding company within its enterprise by:
(1) Establishing an inventory that includes the supervised
insurance organization and every company that meets the requirements of
Sec. 217.605(b)(1);
(2) Identifying all building block parents as required under Sec.
217.605(b)(3);
(3) Determining the available capital and capital requirement for
each building block parent in accordance with its applicable capital
framework;
(4) Determining the building block available capital and building
block capital requirement for each building block, reflecting
adjustments and scaling as set out in this subpart;
(5) Rolling up building block available capital and building block
capital requirement amounts across all building blocks in the
supervised insurance organization's enterprise to determine the same
for any depository institution holding companies in the enterprise; and
(6) Determining the ratio of building block available capital to
building block capital requirement for each depository institution
holding company in the supervised insurance organization.
(b) Determination of BBA ratio. For a depository institution
holding company in a supervised insurance organization, the BBA ratio
is the ratio of the company's building block available capital to the
company's building block capital requirement, each scaled to the common
capital framework in accordance with Sec. 217.606. Expressed
formulaically:
[GRAPHIC] [TIFF OMITTED] TP24OC19.037
(c) Minimum capital requirement. A depository institution holding
company in a supervised insurance organization must maintain a BBA
ratio of at least 250 percent.
(d) Capital adequacy. (1) Notwithstanding the minimum requirement
in this subpart, a depository institution holding company in a
supervised insurance organization must maintain capital commensurate
with the level and nature of all risks to which the supervised
insurance organization is exposed. The supervisory evaluation of the
depository institution holding company's capital adequacy is based on
an individual assessment of numerous factors, including the character
and condition of the company's assets and its existing and prospective
liabilities and other corporate responsibilities.
(2) A depository institution holding company in a supervised
insurance organization must have a process for assessing its overall
capital adequacy in relation to its risk profile and a comprehensive
strategy for maintaining an appropriate level of capital.
Sec. 217.604 Capital Conservation Buffer
(a) Application of Sec. 217.11(a). A top-tier depository
institution holding company in a supervised insurance organization must
comply with Sec. 217.11(a) as modified solely for application in this
subpart by:
(1) Replacing the term ``calendar quarter'' with ``calendar year;''
(2) Including in the definition of ``distribution'' discretionary
dividend payments on participating insurance policies;
(3) In Sec. 217.11(a)(1), replacing ``common equity tier 1
capital'' with ``building block available capital excluding tier 2
instruments;''
(4) Replacing Sec. 217.11(a)(2)(i) in its entirety with the
following: ``Eligible retained income. The eligible retained income of
a depository institution holding company in a supervised insurance
organization is the annual change in the company's building block
available capital, calculated as of the last day of the current and
immediately preceding calendar years based on the supervised insurance
organization's most recent Form FR Q-1, net of any distributions and
accretion to building block available capital from capital instruments
issued in the current or immediately preceding calendar year, excluding
issuances corresponding with retirement of capital instruments under
paragraph (1) of this section of the definition of distribution;
(5) Replacing Sec. 217.11(a)(3) in its entirety with the
following: ``The capital conservation buffer for a depository
institution holding company in a supervised insurance organization is
the greater of its BBA ratio, calculated as of the last day of the
previous calendar year based on the supervised insurance organization's
most recent Form FR Q-1, minus the minimum capital requirement under
Sec. 217.603(c), and zero;''
(6) Replacing Sec. 217.11(a)(4)(ii) in its entirety with the
following: ``A depository institution holding company in a supervised
insurance organization with a capital conservation buffer that is
greater than 235 percent is not subject to a maximum payout amount
under this section;
(7) In Sec. 217.11(a)(4)(iii)(B), replacing ``2.5 percent'' with
``235 percent;''
(8) Replacing Table 1 to Sec. 217.11 in its entirety with the
following:
Table 1 to Sec. 217.604--Calculation of Maximum Payout Amount
------------------------------------------------------------------------
Maximum payout ratio (as a
Capital conservation buffer percentage of eligible
retained income)
------------------------------------------------------------------------
Greater than 235 percent.................. No payout ratio limitation
applies.
Less than or equal to 235 percent, and 60 percent.
greater than 177 percent.
[[Page 57280]]
Less than or equal to 177 percent, and 40 percent.
greater than 118 percent.
Less than or equal to 118 percent, and 20 percent.
greater than 59 percent.
Less than or equal to 59 percent.......... 0 percent.
------------------------------------------------------------------------
Sec. 217.605 Determination of Building Blocks
(a) General. A supervised insurance organization must identify each
building block parent and its allocation share of any downstream
building block parent, as applicable.
(b) Operation. To identify building block parents and determine
allocation shares, a supervised insurance organization must take the
following steps in the following order:
(1) Inventory of companies. A supervised insurance organization
must identify as inventory companies: (i) All companies that are
(A) Required to be reported on the FR Y-6;
(B) Required to be reported on the FR Y-10; or
(C) Classified as affiliates in accordance with NAIC Statement of
Statutory Accounting Principles (SSAP) No. 25 and the preparation of
Schedule Y;
(ii) Any company, special purpose entity, variable interest entity,
or similar entity that:
(A) Enters into one or more reinsurance or derivative transactions
with inventory companies identified pursuant to paragraph (b)(1)(i) of
this section;
(B) Is material;
(C) Is engaged in activities such that one or more inventory
companies identified pursuant to paragraph (b)(1)(i) of this section
are expected to absorb more than 50 percent of its expected losses; and
(D) Is not otherwise identified as an inventory company; and
(iii) Any other company that the Board determines must be
identified as an inventory company.
(2) Determination of applicable capital framework. (i) A supervised
insurance organization must:
(A) Determine the applicable capital framework for each inventory
company; and
(B) Identify inventory companies that are subject to a regulatory
capital framework.
(ii) The applicable capital framework for an inventory company is:
(A) If the inventory company is not engaged in insurance or
reinsurance underwriting, the U.S. federal banking capital rules, in
particular:
(1) If the inventory company is not a depository institution,
subparts A through F of this part; and
(2) If the inventory company is a depository institution, the
regulatory capital framework applied to the depository institution by
the appropriate primary federal regulator, i.e., subparts A through F
of this part (Board), parts 3 of this title (Office of the Comptroller
of the Currency), or part 324 of this title (Federal Deposit Insurance
Corporation), as applicable;
(B) If the inventory company is engaged in insurance or reinsurance
underwriting and subject to a regulatory capital framework that is
scalar-compatible, the regulatory capital framework; and
(C) If the inventory company is engaged in insurance or reinsurance
underwriting and not subject to a regulatory capital framework that is
scalar-compatible, then NAIC RBC for life insurers, fraternal insurers,
health insurers, or property & casualty insurers based on the company's
primary source of premium revenue.
(3) Identification of building block parents. A supervised
insurance organization must identify all building block parents
according to the following procedure:
(i) (A) Identify all top-tier depository institution holding
companies in the supervised insurance organization.
(B) Any top-tier depository institution holding company is a
building block parent
(ii) (A) Identify any inventory company that is a depository
institution holding company;
(B) An inventory company identified in paragraph (b)(3)(ii)(A) of
this section is a building block parent.
(iii) Identify all inventory companies that are capital-regulated
companies (i.e., inventory companies that are subject to a regulatory
capital framework) or material financial entities.
(iv) (A) Of the inventory companies identified in paragraph
(b)(3)(iii) of this section, identify any inventory company that:
(1) Is assigned an applicable capital framework that is different
from the applicable capital framework of any next upstream inventory
company identified in paragraphs (b)(3)(i) through (iii) of this
section; \1\ and
---------------------------------------------------------------------------
\1\ In a simple structure, an inventory company would compare
its applicable capital framework to the applicable capital framework
of its parent company. However, if the parent company does not meet
the criteria to be identified as a building block parent, the
inventory company must compare its capital framework to the next
upstream company that is eligible to be identified as a building
block parent. For purposes of this paragraph (b)(3)(iv) of this
section, a company is ``next upstream'' to a downstream company if
it owns, in whole or in part, the downstream company either
directly, or indirectly other than through a company identified in
paragraphs (b)(3)(ii) through (iii) of this section.
---------------------------------------------------------------------------
(2) Is assigned an applicable capital framework for which the Board
has determined a scalar or, if the company in aggregate with all other
companies subject to the same applicable capital framework are
material, a provisional scalar;
(B) Of the inventory companies identified in paragraph (b)(3)(iii)
of this section, identify any inventory company that:
(1) Is assigned an applicable capital framework that is the same as
the applicable capital framework of each next upstream inventory
company identified in paragraphs (b)(3)(i) through (iii) of this
section;
(2) Is assigned an applicable capital framework for which the Board
has determined a scalar or, if the company in aggregate with all other
companies subject to the same applicable capital framework are
material, a provisional scalar; and
(3) Is owned, in whole or part, by an inventory company that is
subject to the same regulatory capital framework and the owner:
(i) Applies a charge on the inventory company's equity value in
calculating its company capital requirement; or
(ii) Deducts all or a portion of its investment in the inventory
company in calculating its company available capital.
(C) An inventory company identified in paragraph (b)(3)(iv)(A)
through (B) of this section is a building block parent.
(v) Include any inventory company identified in paragraph
(b)(1)(ii) of this section as a building block parent.
(vi) (A) Identify any inventory company
(1) For which more than one building block parent, as identified
pursuant to paragraphs (b)(3)(i) through (v) of this section, owns a
company capital element either directly or indirectly other than
through another such building block parent; and
(2) (i) Is consolidated under any such building block parent's
applicable capital framework; or
[[Page 57281]]
(ii) Owns downstreamed capital.
(B) An inventory company identified in paragraph (b)(3)(vi)(A) of
this section is a building block parent.
(4) Building blocks. (A) Except as provided in paragraph (b)(4)(B)
of this section, a supervised insurance organization must assign an
inventory company to the building block of any building block parent
that owns a company capital element of the inventory company, or of
which the inventory company is a subsidiary,\2\ directly or indirectly
through any company other than a building block parent, unless the
inventory company is a building block parent.
---------------------------------------------------------------------------
\2\ For purposes of this section, subsidiary includes a company
that is required to be reported on the FR Y-6, FR Y-10, or NAIC's
Schedule Y, as applicable.
---------------------------------------------------------------------------
(B) A supervised insurance organization is not required to assign
to a building block any inventory company that is not a downstream
company or subsidiary of a top-tier depository institution holding
company.
(5) Financial Statements. The supervised insurance organization
must:
(i) For any inventory company whose applicable capital framework is
NAIC RBC, prepare financial statements in accordance with SAP; and
(ii) For any building block parent whose applicable capital
framework is subparts A through F of this part:
(A) Apply the same elections and treatment of exposures as are
applied to the subsidiary depository institution;
(B) Apply subparts A through F of this part, to the members of the
building block of which the building block parent is a member, on a
consolidated basis, to the same extent as if the building block parent
were a Board-regulated institution; and
(C) Where the building block parent is not the top-tier depository
institution holding company, not deduct investments in capital of
unconsolidated financial institutions, nor exclude these investments
from the calculation of risk-weighted assets.
(6) Allocation share. A supervised insurance organization must, for
each building block parent, identify any downstream building block
parent owned directly or indirectly through any company other than a
building block parent, and determine the building block parent's
allocation share of these downstream building block parents pursuant to
paragraph (d) of this section.
(c) Material financial entity election. (1) A supervised insurance
organization may elect to not treat an inventory company meeting the
criteria in paragraph (c)(2) of this section as a material financial
entity. An election under this section must be included with the first
financial statements submitted to the Board after the company is
included in the supervised insurance organization's inventory.
(2) The election in paragraph (c)(1) of this section is available
as to an inventory company if:
(i) That company engages in transactions consisting solely of
either (A) transactions for the purpose of transferring risk from one
or more affiliates within the supervised insurance organization to one
or more third parties; or (B) transactions to invest assets contributed
to the company by one or more affiliates within the supervised
insurance organization, where the company is established for purposes
of limiting tax obligation or legal liability; and
(ii) The supervised insurance organization is able to calculate the
adjustment required in Sec. 217.607(b)(4).
(d) Allocation share. (1) Except as provided in paragraph (d)(2) of
this section, a building block parent's allocation share of a
downstream building block parent is calculated as Allocation Share
UpBBP =
[GRAPHIC] [TIFF OMITTED] TP24OC19.038
(i) UpBBP = The building block parent that owns a company capital
element of DownBBP directly or indirectly through a member of
UpBBP's building block.
(ii) DownBBP = The building block parent whose company capital
element is owned by UpBBP directly or indirectly through a member of
UpBBP's building block.
(iii) Tier2 = The value of tier 2 instruments issued by DownBBP,
where Tier2UpBBP is the amount that is owned by any
member of UpBBP's building block and Tier2Total is the
total amount issued by DownBBP.\3\
---------------------------------------------------------------------------
\3\ The amounts of Tier2 should be valued consistently with how
the instruments are reported in DownBBP's financial statements.
---------------------------------------------------------------------------
(iv) UpInvestment = Any upstream investment by DownBBP in UpBBP.\4\
---------------------------------------------------------------------------
\4\ The amount of the upstream investment is calculated as the
impact, excluding any impact on taxes, on DownBBP's company
available capital if DownBBP were to deduct the investment.
---------------------------------------------------------------------------
(v) ProRataAllocationUpBBP = UpBBP's share of DownBBP
based on equity ownership of DownBBP, including associated paid-in
capital.
(vi) DownAC = Total building block available capital of DownBBP.
(2) The top-tier depository institution's allocation share of a
building block parent identified under paragraph (b)(3)(v) of this
section is 100 percent. Any other building block parent's allocation
share of such building block parent is zero.
Sec. 217.606 Scaling Parameters
(a) Scaling specified by the Board.
(1) Scaling between the U.S. federal banking capital rules and NAIC
RBC.
(i) Scaling capital requirement. When calculating (in accordance
with Sec. 217.607) the building block capital requirement for a
building block parent, the applicable capital framework which is NAIC
RBC or the U.S. federal banking capital rules, and where the applicable
capital framework of the appropriate downstream building block parent
is NAIC RBC or the U.S. federal banking capital rules, the capital
requirement scaling modifier is provided by Table 1 to Sec. 217.606.
Table 1 to Sec. 217.606--Capital Requirement Scaling Modifiers for
NAIC RBC and the U.S. Federal Banking Capital Rules
------------------------------------------------------------------------
Upstream building block parent's
applicable capital framework:
Downstream building block ---------------------------------------
parent's applicable capital U.S. federal
framework: NAIC RBC banking capital
rules
------------------------------------------------------------------------
U.S. federal banking capital 1.06 percent 1.
rules. (i.e., 0.0106).
[[Page 57282]]
NAIC RBC........................ 1................. 94.3.
------------------------------------------------------------------------
(ii) Scaling available capital. When calculating (in accordance
with Sec. 217.608) the building block available capital for a building
block parent, the applicable capital framework which is NAIC RBC or the
U.S. federal banking capital rules, and where the applicable capital
framework of the appropriate downstream building block parent is NAIC
RBC or the U.S. federal banking capital rules, the available capital
scaling modifier is provided by Table 2 to Sec. 217.606.
Table 2 to Sec. 217.606--Available Capital Scaling Modifiers for NAIC
RBC and the U.S. Federal Banking Capital Rules
------------------------------------------------------------------------
Upstream building block parent's
applicable capital framework:
Downstream building block ---------------------------------------
parent's applicable capital U.S. federal
framework: NAIC RBC banking capital
rules
------------------------------------------------------------------------
U.S. federal banking capital Recalculated 0.
rules. building block
capital
requirement * -
6.3 percent
(i.e., -0.063).
NAIC RBC........................ 0................. Recalculated
building block
capital
requirement *
5.9.
------------------------------------------------------------------------
(2) [Reserved]
(b) Scaling not specified by the Board but framework is scalar-
compatible. Where scaling modifier to be used in Sec. 217.607 or Sec.
217.608 is not specified in paragraph (a) of this section, and the
building block parent's applicable capital framework is scalar-
compatible, the scaling modifier is determined as follows:
(1) Definitions. For purposes of this section, the following
definitions apply:
(i) Jurisdictional intervention point. The jurisdictional
intervention point is the capital level, under the laws of the
jurisdiction, at which the supervisory authority in the jurisdiction
may intervene as to a company subject to the applicable capital
framework by imposing restrictions on distributions and discretionary
bonus payments by the company or, if no such intervention may occur in
a jurisdiction, then the capital level at which the supervisory
authority would first have the authority to take action against a
company based on its capital level; and
(ii) Jurisdiction adjustment. The jurisdictional adjustment is the
risk adjustment set forth in Table 3 to Sec. 217.606, based on the
country risk classification set by the Organization for Economic
Cooperation and Development for the jurisdiction.
Table 3 to Sec. 217.606--Jurisdictional Adjustments by OECD Country
Risk Classification
------------------------------------------------------------------------
Jurisdictional
OECD CRC Adjustment
(percent)
------------------------------------------------------------------------
0-1, including jurisdictions with no OECD country 0
risk classification.................................
2.................................................... 20
3.................................................... 50
4-6.................................................. 100
7.................................................... 150
------------------------------------------------------------------------
(2) Scaling capital requirement. When calculating (in accordance
with Sec. 217.607) the building block capital requirement for a
building block parent, where the applicable capital framework of the
appropriate downstream building block parent is a scalar-compatible
framework for which the Board has not specified a capital requirement
scaling modifier, the capital requirement scaling modifier is equal to:
[GRAPHIC] [TIFF OMITTED] TP24OC19.039
Where:
Adjustmentscaling from is equal to the jurisdictional adjustment of
the downstream building block parent;
Requirementscaling from is equal to the jurisdictional intervention
point of the downstream building block parent; and
Requirementscaling to is equal to the jurisdictional intervention
point of the upstream building block parent.
(3) Scaling available capital. When calculating (in accordance with
Sec. 217.608) the building block available capital for a building
block parent, where the applicable capital framework of the appropriate
downstream building block parent is a scalar-compatible framework for
which the Board has not specified an available capital scaling
modifier, the available capital scaling modifier is equal to zero.
Sec. 217.607 Capital Requirements under the Building Block Approach
(a) Determination of building block capital requirement. For each
building block parent, building block capital requirement means the sum
of the items
[[Page 57283]]
in paragraphs (a)(1) through (2) of this section:
(1) The company capital requirement of the building block parent;
(i) Recalculated under the assumption that members of the building
block parent's building block had no investment in any downstream
building block parent; and
(ii) Adjusted pursuant to paragraph (b) of this section;
(2) For each downstream building block parent, the adjusted
downstream building block capital requirement (BBCRADJ), which equals:
BBCRADJ = BBCRDS [middot] CRSM [middot] AS
Where:
(i) BBCRDS = The building block capital requirement of the
downstream building block parent recalculated under the assumption
that the downstream building block parent had no upstream investment
in the building block parent;
(ii) CRSM = The appropriate capital requirement scaling modifier
under Sec. 217.606; and
(iii) AS = The building block parent's allocation share of the
downstream building block parent.
(b) Adjustments in determining the building block capital
requirement. A supervised insurance organization subject to this
subpart must adjust the company capital requirement for any building
block parent as follows:
(1) Internal credit risk charges. A supervised insurance
organization must deduct from the building block parent's company
capital requirement any difference between:
(i) The building block parent's company capital requirement; and
(ii) The building block parent's company capital requirement
recalculated excluding capital requirements related to potential for
the possibility of default of any company in the supervised insurance
organization.
(2) Permitted accounting practices and prescribed accounting
practices. A supervised insurance organization must deduct from the
building block parent's company capital requirement any difference
between:
(i) The building block parent's company capital requirement, after
making any adjustment in accordance with paragraph (b)(1) of this
section; and
(ii) The building block parent's company capital requirement, after
making any adjustment in accordance with paragraph (b)(1) of this
section, recalculated under the assumption that neither the building
block parent, nor any company that is a member of that building block
parent's building block, had prepared its financial statements with the
application of any permitted accounting practice, prescribed accounting
practice, or other practice, including legal, regulatory, or accounting
procedures or standards, that departs from a solvency framework as
promulgated for application in a jurisdiction.
(3) Transitional measures in applicable capital frameworks. A
supervised institution must deduct from the building block parent's
company capital requirement any difference between:
(i) The building block parent's company capital requirement; and
(ii) The building block parent's company capital requirement
recalculated under the assumption that neither the building block
parent, nor any company that is a member of the building block parent's
building block, had prepared its financial statements with the
application of any grandfathering or transitional measures under the
building block parent's applicable capital framework, unless the
application of these measures has been approved by the Board.
(4) Risks of certain intermediary entities. Where a supervised
insurance organization has made an election with respect to a company
not to treat that company as a material financial entity pursuant to
Sec. 217.605(c), the supervised insurance organization must add to the
company capital requirement of any building block parent, whose
building block contains a member, with which the company engages in one
or more transactions, and for which the company engages in one or more
transactions described in Sec. 217.605(c)(2) with a third party, any
difference between:
(i) The building block parent's company capital requirement; and
(ii) The building block parent's company capital requirement
recalculated with the risks of the company, excluding internal credit
risks described in paragraph (b)(1) of this section, allocated to the
building block parent, reflecting the transaction(s) that the company
engages in with any member of the building block parent's building
block.\1\
---------------------------------------------------------------------------
\1\ The total allocation of the risks of the intermediary entity
to building block parents must capture all material risks and avoid
double counting.
---------------------------------------------------------------------------
(5) Investments in own capital instruments.
(i) A supervised insurance organization must deduct from the
building block parent's company capital requirement any difference
between:
(A) The building block parent's company capital requirement; and
(B) The building block parent's company capital requirement
recalculated after assuming that neither the building block parent, nor
any company that is a member of the building block parent's building
block, held any investment in the building block parent's own capital
instrument(s), including any net long position determined in accordance
with paragraph (b)(5)(ii) of this section.
(ii) Net long position. For purposes of calculating an investment
in a building block parent's own capital instrument under this section,
the net long position is determined in accordance with Sec. 217.22(h),
provided that a separate account asset or associated guarantee is not
regarded as an indirect exposure unless the net long position of the
fund underlying the separate account asset (determined in accordance
with Sec. 217.22(h) without regard to this paragraph) equals or
exceeds 5 percent of the value of the fund.
(6) Risks relating to title insurance. A supervised insurance
organization must add to the building block parent's company capital
requirement the amount of the building block parent's reserves for
claims pertaining to title insurance, multiplied by 300 percent.
Sec. 217.608 Available Capital Resources under the Building Block
Approach
(a) Qualifying capital instruments.
(1) Under this subpart, a qualifying capital instrument with
respect to a building block parent is a capital instrument that meets
the following criteria:
(i) The instrument is issued and paid-in;
(ii) The instrument is subordinated to depositors and general
creditors of the building block parent;
(iii) The instrument is not secured, not covered by a guarantee of
the building block parent or of an affiliate of the building block
parent, and not subject to any other arrangement that legally or
economically enhances the seniority of the instrument in relation to
more senior claims;
(iv) The instrument has a minimum original maturity of at least
five years. At the beginning of each of the last five years of the life
of the instrument, the amount that is eligible to be included in
building block available capital is reduced by 20 percent of the
original amount of the instrument (net of redemptions), and is excluded
from building block available capital when the remaining maturity is
less than one year. In addition, the instrument must not have any terms
or features that require, or create significant incentives
[[Page 57284]]
for, the building block parent to redeem the instrument prior to
maturity.\1\
---------------------------------------------------------------------------
\1\ An instrument that by its terms automatically converts into
a qualifying capital instrument prior to five years after issuance
complies with the five-year maturity requirement of this criterion.
---------------------------------------------------------------------------
(v) The instrument, by its terms, may be called by the building
block parent only after a minimum of five years following issuance,
except that the terms of the instrument may allow it to be called
sooner upon the occurrence of an event that would preclude the
instrument from being included in the building block parent's company
available capital or building block available capital, a tax event, or
if the issuing entity is required to register as an investment company
pursuant to the Investment Company Act of 1940 (15 U.S.C. 80a-1 et
seq.). In addition:
(A) The top-tier depository institution holding company must
receive the prior approval of the Board to exercise a call option on
the instrument.
(B) The building block parent does not create at issuance, through
action or communication, an expectation the call option will be
exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the Board-regulated institution must either: Replace any amount called
with an equivalent amount of an instrument that meets the criteria for
regulatory capital under this section; \2\ or demonstrate to the
satisfaction of the Board that following redemption, the Board-
regulated institution would continue to hold an amount of capital that
is commensurate with its risk.
---------------------------------------------------------------------------
\2\ A building block parent may replace qualifying capital
instruments concurrent with the redemption of existing qualifying
capital instruments.
---------------------------------------------------------------------------
(vi) Redemption of the instrument prior to maturity or repurchase
requires the prior approval of the Board.
(vii) The instrument meets the criteria in Sec. 217.20(d)(1)(vi)
through (ix) and Sec. 217.20(d)(1)(xi), except that each instance of
``Board-regulated institution'' is replaced with ``building block
parent'' and, in Sec. 217.20(d)(1)(ix), ``tier 2 capital instruments''
is replaced with ``qualifying capital instruments''.
(2) Differentiation of tier 2 capital instruments. For purposes of
this subpart, tier 2 capital instruments of a top-tier depository
institution holding company are instruments issued by any inventory
company that are qualifying capital instruments under paragraph (a)(1)
of this section,\3\ other than those qualifying capital instruments
that meet all of the following criteria:
---------------------------------------------------------------------------
\3\ For purposes of this paragraph (a)(2) of this section, the
supervised insurance organization evaluates the criteria in
paragraph (a)(1) of this section with regard to the building block
in which the issuing inventory company is a member.
---------------------------------------------------------------------------
(i) The holders of the instrument bear losses as they occur
equally, proportionately, and simultaneously with the holders of all
other qualifying capital instruments (other than tier 2 capital
instruments) before any losses are borne by holders of claims on the
top-tier depository institution holding company with greater priority
in a receivership, insolvency, liquidation, or similar proceeding.
(ii) The paid-in amount would be classified as equity under GAAP.
(iii) The instrument meets the criteria in Sec. 217.20(b)(1)(i)
through (vii) and in Sec. 217.20(b)(1)(x) through (xiii).
(b) Determination of building block available capital. (1) For each
building block parent, building block available capital means the sum
of the items described in paragraphs (b)(1)(i) and (b)(1)(ii) of this
section:
(i) The company available capital of the building block parent:
(A) Less the amount of downstreamed capital owned by any member of
the building block parent's building block; \4\ and
---------------------------------------------------------------------------
\4\ The amount of the downstreamed capital is calculated as the
impact, excluding any impact on taxes, on the company available
capital of the building block parent of the building block of which
the owner is a member, if the owner were to deduct the downstreamed
capital.
---------------------------------------------------------------------------
(B) Adjusted pursuant to paragraph (c) of this section;
(ii) For each downstream building block parent, the adjusted
downstream building block available capital (BBACADJ), which equals:
BBACADJ = (BBACDS - UpInv + ACSM) [middot] AS
Where:
(A) BBACDS = The building block available capital of the downstream
building block parent;
(B) UpInv = the amount of any upstream investment held by that
downstream building block parent in the building block parent; \5\
---------------------------------------------------------------------------
\5\ The amount of the upstream investment is calculated as the
impact, excluding any impact on taxes, on the downstream building
block parent's building block available capital if the owner were to
deduct the investment.
---------------------------------------------------------------------------
(C) ACSM = The appropriate available capital scaling modifier under
Sec. 217.606; and
(D) AS = The building block parent's allocation share of the
downstream building block parent.
(2) Single tier of capital. If there is more than one tier of
company available capital under a building block parent's applicable
capital framework, the amounts of company available capital from all
tiers are combined in calculating building block available capital in
accordance with paragraph (b) of this section.
(c) Adjustments in determining building block available capital.
For purposes of the calculations required in paragraph (b) of this
section, a supervised insurance organization must adjust the company
available capital for any building block parent as follows:
(1) Non-qualifying capital instruments. A supervised insurance
organization must deduct from the building block parent's company
available capital any accretion arising from any instrument issued by
any company that is a member of the building block parent's building
block, where the instrument is not a qualifying capital instrument.
(2) Insurance underwriting RBC. When applying the U.S. federal
banking capital rules as the applicable capital framework for a
building block parent, a supervised insurance organization must add
back into the building block parent's company available capital any
amounts deducted pursuant to section _.22(b)(3) of those rules.
(3) Permitted accounting practices and prescribed accounting
practices. A supervised insurance organization must deduct from the
building block parent's company available capital any difference
between:
(i) The building block parent's company available capital; and
(ii) The building block parent's company available capital
recalculated under the assumption that neither the building block
parent, nor any company that is a member of that building block
parent's building block, had prepared its financial statements with the
application of any permitted accounting practice, prescribed accounting
practice, or other practice, including legal, regulatory, or accounting
procedures or standards, that departs from a solvency framework as
promulgated for application in a jurisdiction.
(4) Transitional measures in applicable capital frameworks. A
supervised institution must deduct from the building block parent's
company available capital any difference between:
(i) The building block parent's company available capital; and
(ii) The building block parent's company available capital
recalculated under the assumption that neither the building block
parent, nor any company that is a member of the building block parent's
building block, had prepared its financial statements with the
application of any grandfathering or transitional measures under the
building block parent's applicable capital framework, unless the
[[Page 57285]]
application of these measures has been approved by the Board.
(5) Deduction of investments in own capital instruments.
(i) A supervised insurance organization must deduct from the
building block parent's company available capital any investment by the
building block parent in its own capital instrument(s), or any
investment by any member of the building block parent's building block
in capital instruments of the building block parent, including any net
long position determined in accordance with paragraph (c)(5)(ii) of
this section, to the extent that such investment(s) would otherwise be
accretive to the building block parent's building block available
capital.
(ii) Net long position. For purposes of calculating an investment
in a building block parent's own capital instrument under this section,
the net long position is determined in accordance with Sec. 217.22(h),
provided that a separate account asset or associated guarantee is not
regarded as an indirect exposure unless the net long position of the
fund underlying the separate account asset (determined in accordance
with Sec. 217.22(h) without regard to this paragraph) equals or
exceeds 5 percent of the value of the fund.
(6) Reciprocal cross holdings in the capital of financial
institutions. A supervised insurance organization must deduct from the
building block parent's company available capital any investment(s) by
the building block parent in the capital of unaffiliated financial
institutions that it holds reciprocally, where such reciprocal cross
holdings result from a formal or informal arrangement to swap,
exchange, or otherwise intend to hold each other's capital instruments,
to the extent that such investment(s) would otherwise be accretive to
the building block parent's building block available capital.
(d) Limits on certain elements in building block available capital
of top-tier depository institution holding companies.
(1) Investment in capital of unconsolidated financial institutions.
(A) A top-tier depository institution holding company must deduct, from
its building block available capital, any accreted capital from an
investment in the capital of an unconsolidated financial institution
that is not an inventory company, that exceeds twenty-five percent of
the amount of its building block available capital, prior to
application of this adjustment, excluding tier 2 capital instruments.
For purposes of this paragraph, the amount of an investment in the
capital of an unconsolidated financial institution is calculated in
accordance with Sec. 217.22(h), except that a separate account asset
or associated guarantee is not an indirect exposure.
(B) The deductions described in paragraph (d)(1)(A) of this section
are net of associated deferred tax liabilities in accordance with Sec.
217.22(e).
(2) Limitation on tier 2 capital instruments. A top-tier depository
institution holding company must deduct any accretions from tier 2
capital instruments that, in the aggregate, exceed the greater of:
(i) 62.5 percent of the amount of its building block capital
requirement; and
(ii) The amount of instruments subject to paragraphs (e) or (f) of
this section that are outstanding as of the submission date.
(e) Treatment of outstanding surplus notes. A surplus note issued
by any company in a supervised insurance organization prior to November
1, 2019, is deemed to meet the criteria in paragraphs (a)(1)(iii) and
(vi) of this section if:
(1) The surplus note is a company capital element for the issuing
company;
(2) The surplus note is not owned by an affiliate of the issuer;
and
(3) The surplus note is outstanding as of the submission date.
(f) Treatment of certain callable instruments. Notwithstanding the
criteria under paragraph (a)(1) of this section, an instrument with
terms that provide that the instrument may be called earlier than five
years upon the occurrence of a rating event does not violate the
criterion in paragraph (a)(1)(v) of this section, provided that the
instrument was a company capital element issued prior to January 1,
2014, and that such instrument satisfies all other criteria under
paragraph (a)(1) of this section.
(g) Board approval of a capital instrument.
(1) A supervised insurance organization must receive Board prior
approval to include in its building block available capital for any
building block an instrument (as listed in this section), issued by any
company in the supervised insurance organization, unless the
instrument:
(i) Was a company capital element for the issuer prior to May 19,
2010, in accordance with the applicable capital framework that was
effective as of that date and the underlying instrument meets the
criteria to be a qualifying capital instrument (as defined in paragraph
(a) of this section); or
(ii) Is equivalent, in terms of capital quality and ability to
absorb losses with respect to all material terms, to a company capital
element that the Board determined may be included in regulatory capital
under this subpart pursuant to paragraph (g)(2) of this section, or may
be included in the regulatory capital of a Board-regulated institution
pursuant to Sec. 217.20(e)(3).
(2) After determining that an instrument may be included in a
supervised insurance organization's regulatory capital under this
subpart, the Board will make its decision publicly available, including
a brief description of the material terms of the instrument and the
rationale for the determination.
* * * * *
PART 252--ENHANCED PRUDENTIAL STANDARDS (REGULATION YY)
0
7. The authority citation to part 252 continues to read as follows:
Authority: 12 U.S.C. 321-338a, 481-486, 1467a, 1818, 1828,
1831n, 1831o, 1831p-l, 1831w, 1835, 1844(b), 1844(c), 3101 et seq.,
3101 note, 3904, 3906-3909, 4808, 5361, 5362, 5365, 5366, 5367,
5368, 5371.
Subpart B--Company-Run Stress Test Requirements for Certain U.S.
Banking Organizations with Total Consolidated Assets over $10
Billion and Less Than $50 Billion
0
8. Section 252.13 is amended by revising paragraphs (b)(1)(ii) to read
as follows:
Sec. 252.13 Applicability.
* * * * *
(b) * * *
* * * * *
(ii) Any savings and loan holding company with average total
consolidated assets (as defined in Sec. 252.12(d)) of greater than $10
billion, excluding companies subject to part 217, subpart J of this
chapter; and''
* * * * *
Editorial Note: The following Exhibit will not publish in the
Code of Federal Regulations.
Exhibit
Editorial Note: This section will not publish in the Code of
Federal Regulations.
Capital Requirements for Insurance Depository Institution Holding
Companies Comparing Capital Requirements in Different Regulatory
Frameworks
Preface
The Board of Governors of the Federal Reserve System is responsible
for protecting the safety and soundness of depository institutions
affiliated with
[[Page 57286]]
holding companies. This responsibility requires regulating the capital
of holding companies of groups that conduct both depository and
insurance operations.\1\ Unfortunately, the insurance and banking
sectors do not share any common capital assessment methodology.
Existing capital assessment methodologies are tailored to either
banking or insurance and unsuitable for application to the other
sector.\2\
---------------------------------------------------------------------------
\1\ 12 U.S.C. 5371.
\2\ Insurance methodologies are also generally country specific.
---------------------------------------------------------------------------
The Board proposes relying on these existing sectoral capital
assessment methodologies to assess capital for most holding companies
that own both insured depository institutions and insurers. In this
proposed approach, capital requirements would be aggregated across
sectors to calculate a group-wide capital requirement. Just as adding
money denominated in different currencies requires exchange rates,
meaningfully aggregating capital resources and requirements calculated
under different regulatory frameworks requires some translation
mechanism between them. We refer to this process of translating capital
measures between regulatory frameworks as ``scaling.''
Executive Summary
This white paper examines scaling. Scaling has not previously been
the subject of academic research, and industry practitioners don't
agree on the best methodology.
This paper introduces a scaling method based on historical
probability of default (PD) and explains why the Board's proposal uses
this approach. This method uses historical default rates as a shared
economic language to enable translation. Concretely, scalars pair
solvency ratios that have identical estimated historical insolvency
rates. An analysis of U.S. data produces the simple scaling formulas
below.
NAIC Authorized Control Level Risk Based Capital = .0106 * Risk
Weighted Assets
NAIC Total Adjusted Capital = Bank Tier 1 Capital + Bank Tier 2
Capital-.063 * Risk Weighted Assets
This paper also compares the PD method and alternatives, including
those suggested by commenters in response to the Board's advance notice
of proposed rulemaking (ANPR).\3\ While other implementable methods
make broad assumptions regarding equivalence, the historical PD method
only assumes that companies have equivalent financial strength when
defaulting.\4\ The major disadvantage of the PD approach is that it
needs extensive data. Plentiful data exists on U.S. markets but not
many international markets. Because of this and because the Board's
current population of supervised insurance groups has immaterial
international insurance operations, scalars for other jurisdictions
were not developed.
---------------------------------------------------------------------------
\3\ Capital Requirements for Supervised Institutions
Significantly Engaged in Insurance Activities, 81 FR 38,631 (June
14, 2016), https://www.gpo.gov/fdsys/pkg/FR-2016-06-14/pdf/2016-14004.pdf.
\4\ See the Historical Probability of Default Section for
details of this method. An empirical check on the assumption
regarding companies defaulting at similar levels of financial
strength can be found at [reasonableness of assumptions discussion].
---------------------------------------------------------------------------
Key Concepts
Scaling can be simplified into the calculation of two
parameters: (1) A required capital scalar and (2) an available capital
scalar.
There are at least three considerations of importance in
assessing the scaling methods: (1) Reasonableness of the assumptions,
(2) ease of implementation, and (3) stability of the parameterization.
Our analysis identifies a trade-off between the
reasonableness of a methodology's assumptions and the easiness of its
implementation. Easily producing stable results generally requires bold
assumptions about the comparability of regulatory frameworks.
The Board's recommended scaling approach (PD method)
relies on an analysis of historical default rates in the different
regulatory frameworks.
Introduction
In its ANPR of June 2016, the Board proposed a building block
approach (BBA) for regulating the capital of banking organizations with
substantial insurance operations.\5\ For these institutions, the
building block approach would first calculate the capital resources and
requirements of its subsidiary institutions in different sectors. After
making adjustments that provide consistency on key items and ensure
risks are not excluded or double counted, the building blocks would be
scaled to a standard basis and then aggregated to calculate enterprise-
level available capital and required capital.
---------------------------------------------------------------------------
\5\ This approach is expanded upon in the Board's proposed rule.
---------------------------------------------------------------------------
Building blocks originate in regulatory frameworks, referred to as
``regimes,'' with different metrics and scales. They need to be
standardized before they can be stacked together. We refer to the
process of translating capital measures from different regimes into a
common standard as ``scaling.'' Based on the firms that would be
subject to the proposed rule currently, only two regimes would be
material: the regime applicable to U.S. banks and the regime applicable
to U.S. insurers, which is the National Association of Insurance
Commissioner (NAIC) Risk-Based Capital (RBC) requirements.\6\ These
regimes use starkly different rules, accounting standards, and risk
measures. While both the banking and insurance risk-based capital
standards use risk factors or weights to derive their capital
requirements, they differ in the risks captured, the risk factors used,
and the base measurement that is multiplied by these factors. In
banking, the regulatory risk measure applies risk weights to assets and
off-balance-sheet activities. This produces risk-weighted assets (RWA).
In insurance, the reported risk metric--``Authorized Control Level Risk
Based Capital Requirement (ACL RBC)''--uses a different methodology.
Among other differences, this methodology emphasizes risks on
liabilities and gives credit for diversification between assets and
liabilities.
---------------------------------------------------------------------------
\6\ Where material, unregulated financial activity would also be
assessed under one of those regimes and aggregated.
---------------------------------------------------------------------------
Scaling Framework and Assessment Criteria
Scaling translates available capital (AC) and required capital (RC)
between two different regimes. We refer to the original regime as the
applicable regime and the output regime--under which comparisons are
ultimately made--as the common regime. The Board's proposal uses NAIC
RBC as the common regime.
The scaling formulas below provide a generalized scaling framework
with two parameters and enough flexibility to represent our proposal
and all scaling methods suggested by commenters. One parameter, which
we refer to as the required capital or SRC, applies to RC in
the applicable regime and captures the average difference in the
``stringency'' of the regimes' RC calculations and the units used to
express the RC. We assume that differences in stringency between
regimes' risk measurements can be modeled by a single multiplicative
factor. The second parameter, which we refer to as the available
capital scalar or SAC, adjusts for the relative conservatism
of the AC. This parameter represents the additional amount of
conservatism in the calculation of AC in the applicable regime relative
to the common regime. Unlike the multiplicative scaling of
[[Page 57287]]
required capital, we assume available capital is an additive adjustment
that varies based on a company's risk. This allows the issuance of
additional capital instruments, such as common stock, to increase
available capital equally in both regimes, while still allowing for the
regimes to value risky assets and liabilities with differing degrees of
conservatism.
RCcommon = SRC * RCapplicable
ACcommon = ACapplicable + SAC
RCapplicable
These scaling parameters also have graphical interpretations that
illustrate their meaning. An equivalency line between the solvency
ratios of regimes (AC divided by RC) has a slope of SRC and
intercept of -SACwhen plotted with the common regime as the
x-axis. Figure 1 depicts this relationship, and appendix 1 shows a full
derivation of this graphical interpretation.
[GRAPHIC] [TIFF OMITTED] TP24OC19.040
In this two-parameter framework, a scaling methodology represents a
way of calculating SRC and SAC. Possible scaling
methodologies range from making very simple assumptions about
equivalence to using complex methods involving data to estimate these
relationships. There are at least three considerations of importance in
assessing the scaling methods. We identify these as the reasonableness
of the assumptions, ease of implementation, and stability of the
parameterization.
The first of these is the reasonableness of the assumptions.
Methodologies that make crude assumptions likely won't produce accurate
translations. Accurate translations between regimes enable a more
meaningful aggregation of metrics, thus allowing the Board to better
assess the safety and soundness of institutions and ultimately to
better mitigate unsafe or unsound conditions.
Another important consideration is the method's ease of
implementation. The most theoretically sound methodology would lack
practical value if it cannot be parameterized.
A final consideration is the stability of their parameterization--
the extent to which changes in assumptions or data affect the value of
the scalars. Scaling should be robust across time unless the underlying
regimes change. This stability provides predictability to firms and
facilities planning.
Historical Probability of Default
A sensible economic benchmark for solvency ratios is the insolvency
or default rates associated with them, and this method uses these rates
as a Rosetta stone for translating ratios between regimes. For example,
under this method a bank solvency ratio that has historically resulted
in a 5 percent PD translates to the insurance solvency ratio with an
estimated 5 percent PD.\7\
---------------------------------------------------------------------------
\7\ We need the PD to be monotonic on the financial strength
ratios for this approach to produce a single mapping.
---------------------------------------------------------------------------
Mechanically, this calculation uses (logistic) regressions to
estimate the relationship between the solvency ratios and default
probability.\8\ Setting the logit of PD in both regimes equal to each
other gives an equation that relates the solvency ratios in the two
regimes as shown below.
---------------------------------------------------------------------------
\8\ The logistic transformation is used because the regression
involves probabilities. If ordinary least squares were used instead,
estimated probabilities of default could be lower than 0 percent or
higher than 100 percent for some solvency ratios.
[GRAPHIC] [TIFF OMITTED] TP24OC19.041
In these formulas, ``b'' represents the slope of the estimated
relationship between a regime's solvency ratio and (logistic) default
probability and ``a'' represents the intercept. Simplifying this
equation produces the equations below, as demonstrated in appendix 2.
[[Page 57288]]
[GRAPHIC] [TIFF OMITTED] TP24OC19.042
This section will illustrate the approach and describe how it was
used to derive the proposed scalars for U.S. banking and U.S.
insurance. The approach will then be discussed in terms of the three
identified considerations for scaling methods. This analysis reveals
that the method generally can provide an accurate and stable
translation of regimes for which robust data are available, which is
why the Board has proposed to rely on the method for setting the scalar
between the U.S. banking regime and the U.S. insurance regime.
Application to U.S. Banking and Insurance
To apply this approach, we obtained financial data on depository
institutions and insurers. Insurance financial data came from statutory
financial statements. Bank data came from year-end Call Reports.\9\ The
Call Report, which is filed by the operating depository institutions,
provides the best match for the insurance data, which is only for the
operating insurance companies as of year end. The usage of operating
company data also comports with the Board's proposed grouping scheme,
which would be at a level below the holding company. For the solvency
ratios, we used ACL RBC for insurers because it can easily be
calculated from reported information and serves as the basis for state
regulatory interventions in the NAIC's Risk-Based Capital for Insurer's
Model Act.\10\ Many different solvency ratios are calculated for banks.
We used the total capitalization ratio. This broad regulatory capital
ratio is the closest match in banking for ACL RBC for insurance in
terms of which instruments are included.\11\
---------------------------------------------------------------------------
\9\ Call report data were downloaded from the publicly available
Federal Financial Institutions Examination Council database and
supplemented with internal data. See ``Bulk Data Download,'' Federal
Financial Institutions Examination Council, https://cdr.ffiec.gov/public/PWS/DownloadBulkData.aspx.
\10\ The BBA would not be impacted by using different multiples
of these amounts because the required capital scalar is
multiplicative. For instance, Company Action Level (CAL) RBC is two
times ACL RBC. If this were used in the scaling regressions, all
insurance solvency ratios would be cut in half. This would produce
corresponding changes to the scaling equations and required capital
ratios, but the overall capital requirement would remain constant
when expressed in terms of dollars. Similarly, the rule would not be
impacted by using some fraction of risk-weighted assets (for
example, 8 percent) for banks.
\11\ The proposed rule uses limits and other adjustments to
further align the definition of regulatory capital between the two
regimes and ensure sufficient quality of capital.
---------------------------------------------------------------------------
Several filters were applied to the data. Only data after 1998 and
before 2015 were used based on data availability, state adoption of
insurance risk-based capital laws, and the three-year default horizon
discussed below.\12\ Very small entities--those with less than $5
million in assets--were excluded from both sectors. These firms had
total asset size only sufficient to pay a handful of claims or large
loan losses; their default data appeared unreliable and could not
generally be corroborated by news articles or other sources.
Organizations with very high and low capital ratios were also excluded
(insurance ratios 1500% ACL RBC; banks with total
capitalization 20% RWA). Additionally, carriers not subject to
capital regulation and those that fundamentally differ from other
insurers were excluded. These included captive insurers (for example,
an insurer owned by a manufacturer that insures only that
manufacturer); government-sponsored enterprises (for example, workers
compensation state funds); and monoline group health or medical
malpractice insurers. P&C fronting companies were also removed. Summary
statistics showing the magnitude of these exclusions can be seen in
appendix 3
---------------------------------------------------------------------------
\12\ For state adoption dates, see ``Risk Based Capital (RBC)
for Insurers Model Act,'' National Association of Insurance
Commissioners, http://www.naic.org/store/free/MDL-312.pdf, 15-20.
---------------------------------------------------------------------------
We also obtained default data for the banking and insurance
sectors. A three-year time horizon for defaults was used in both
regimes to balance the competing considerations of wanting to observe a
reasonable number of defaults beyond the most weakly capitalized
companies and maximizing the number of data points that could be used
in the regression.\13\ Because of the Board's supervisory mission,
``default'' was defined as ceasing to function as a going concern due
to financial distress. This definition did not always align with the
point of regulatory intervention or commonly available data.
Consequently, existing regulatory default data sets were supplemented
to best align with the default definition.\14\
---------------------------------------------------------------------------
\13\ The impact of this assumption was analyzed and is discussed
in the context of the stability of the method's parameterization at
in the subsection Stability of Parameterization.
\14\ An empirical check on the reasonableness of these
assumptions and alignment can be found on in the section below on
reasonableness of assumptions.
---------------------------------------------------------------------------
Insurance default data were obtained from the NAIC's Global
Insurance Receivership Information Database (GRID).\15\ Because some
insurers cease to function as going concerns without being reported in
this data set, which is voluntary and impacted by confidentiality, a
supplemental analysis was also performed.\16\ An insurer was also
considered to be in default if it fell below the minimum capital
requirement and (1) had its license suspended in any state, (2) was
acquired, or (3) discontinued underwriting new businesses. Extensive
checks were performed on random companies as well as all outliers
(those with high RBC ratios that default and low RBC ratios that do not
default). This resulted in the development of criteria above and the
identification of some additional defaults based on news articles and
other data sources.\17\
---------------------------------------------------------------------------
\15\ The NAIC's GRID database can be accessed at https://i-site.naic.org/grid/gridPA.jsp.
\16\ The NAIC describes GRID as ``a voluntary database provided
by the state insurance departments to report information on insurer
receiverships for consumers, claimants, and guaranty funds'' at
https://eapps.naic.org/cis/. See also NAIC, GRID FAQs, available at
https://i-site.naic.org/help/html/GRID%20FAQs.html (``In some states
a court ordered conservation may be confidential.'')
\17\ A handful of companies were identified as no longer being
going concerns based on qualitative sources such as news articles,
rating agency publications, or in notes to the financial statements
that could not easily be applied to all companies. Additionally,
several companies were removed who appear to have ceased functioning
as going concerns at a time prior to the sample based on the volume
of premiums written. Two companies were dropped from the data set
for having aberrant data.
---------------------------------------------------------------------------
For banking organizations, default data were extracted from the
FDIC list of failures.\18\ For this analysis, banking organizations
were also considered to be
[[Page 57289]]
in default if they were significantly undercapitalized (total
capitalization below 6 percent of RWA) and did not recover, which might
occur in a voluntary liquidation. Additionally, banking organizations
with total capitalization ratios under 6 percent of RWA for multiple
years were manually checked for indications that operations ceased. The
different default rates by industry are shown in table 1 and figure 2.
---------------------------------------------------------------------------
\18\ See https://www.fdic.gov/bank/individual/failed/banklist.csv.
Table 1--Default Rates by Industry
------------------------------------------------------------------------
Insurance Bank
Year defaults defaults
------------------------------------------------------------------------
2000............................................ 23 4
2001............................................ 23 3
2002............................................ 27 6
2003............................................ 28 3
2004............................................ 17 3
2005............................................ 10 0
2006............................................ 8 0
2007............................................ 5 1
2008............................................ 6 19
2009............................................ 12 112
2010............................................ 10 122
2011............................................ 9 80
2012............................................ 11 40
2013............................................ 9 12
2014............................................ 8 11
2015............................................ 3 5
2016............................................ 2 6
2017............................................ 2 3
------------------------------------------------------------------------
[GRAPHIC] [TIFF OMITTED] TP24OC19.043
To estimate the probabilities of default from these data, we used a
logistic regression, which is commonly used with binary data, to
estimate the parameters a and b in the equation below. The regression
used cluster-robust standard errors with clustering by company.
Additional details about these regressions can be found in table 2 with
a discussion of their goodness of fit and robustness following in the
sections below.
[GRAPHIC] [TIFF OMITTED] TP24OC19.044
The parameters on the P&C and life insurance regressions were
analyzed separately because the regimes are distinct; however, the
regression results were very close to each other with no significant
statistical difference..\19\ The results of the combined insurance and
banking regressions are displayed in table 2.
---------------------------------------------------------------------------
\19\ Because the two slope values are very close (-.662 and
-.714), the p value of a test of differences is close to 50
percent). The constant terms show larger differences (-.402 vs.
-.602) and could indicate that P&C companies have slightly less
balance sheet conservatism compared with life insurers; however, the
difference is not statistically significant either (p ~ .44).
Table 2--Insurance and Banking Regressions
----------------------------------------------------------------------------------------------------------------
Life Combined
Banking P&C insurance insurance insurance
----------------------------------------------------------------------------------------------------------------
Slope (b)....................................... -66.392 -0.714 -0.662 -0.704
Robust Std. Err................................. (1.854) (0.052) (0.102) (0.046)
Intercept (a)................................... 3.723 -0.402 -0.602 -0.432
Robust Std. Err................................. (0.201) (0.178) (0.440) (0.164)
Observations.................................... 92,215 21,031 6,862 27,893
Pseudo R\2\..................................... 24.9% 23.3% 20.3% 23.3%
----------------------------------------------------------------------------------------------------------------
Using the formulas from the start of this section that relate
logistic regression output to scaling parameters, SRC =
1.06% and SAC = 6.3%.
These results appear reasonable and suggest that the banking
capital requirement is approximately equivalent to the insurance
capital requirement but that the regimes differ in their structure. The
insurance regime's conservative accounting rules lead to a conservative
calculation of
[[Page 57290]]
available capital. These rules set life insurance reserves at above the
best-estimate level, don't allow P&C carriers to defer acquisition
expenses on policies, and don't give any credit for certain types of
assets. Because of this conservative calculation of available capital,
the required capital calculation is relatively lower with ACLR RBC
translating to only about 1 percent of RWA.
Reasonableness of Assumptions
Because regulators design solvency ratios to identify companies in
danger of failing, default rates are a natural benchmark for assessing
them economically. Comparing solvency ratios based on this benchmark is
more reasonable than the alternatives, but it does have limitations.
One important limitation is that definitions of default across
sectors may be difficult to compare. To some extent, defaults are
influenced by regulatory actions, which are entwined with the
underlying regime itself. Although adjustments can be made (as we do
with our default definition in the U.S. markets), there is likely still
some endogeneity. However, defaults still provide a more objective
assessment of the regime than the alternatives discussed in the Review
of Other Scaling Methods under which these differences would be assumed
not to exist. For instance, one primary alternative would be to scale
by assuming the equivalency of regulatory intervention points. Another
would assume that the accounting is comparable.
As a test of the comparability of the default definitions, we
estimated each sector's loss given default. If the default definitions
in both sectors were equivalent economically, then the cost of these
defaults should also be close. Based on data from the FDIC, the average
bank insolvency in the period studied was approximately 10.7% of assets
with a median of 22.4%. The median is significantly higher than the
mean because of the very large Washington Mutual failure. Excluding
Washington Mutual, the mean insolvency cost was 18.7%. We estimated the
cost of insurance insolvencies by comparing the cost to insurance
guarantee fund assessments during the sample period with the assets of
insurers that defaulted using our definition. This produced an estimate
of insolvency costs of 16.9% of net admitted assets. This is between
the median and mean of the bank distribution and close to the bank mean
when Washington Mutual is excluded. This supports our assumption that
institutions identified as defaulting can be considered to have
comparable financial strength.
Historical insolvency rates also do not reflect regime changes and
can be influenced by government support. In the application to U.S.
banking and insurance, no adjustment was made for these factors, which
are difficult to quantify and would likely offset each other to some
extent over the period studied. Banking organizations have been more
affected by past government support, which might imply the regressions
underestimate PD, but there has recently been a significant tightening
of the regime after the 2008 financial crisis, which would have an
opposite effect.\20\ Additionally, support from the major government
programs during the financial crisis depended on the firm being able to
survive without it. On the insurance side, government support during
the crisis was much less extensive, but there has also not been a
similar recent strengthening of the regime.\21\ To the extent the
regimes were to have material, directional changes, this assumption
would be less reasonable and likely need to be revisited in a future
study.
---------------------------------------------------------------------------
\20\ Since the crisis, a number of reforms have been made to the
banking capital requirements in the United States, including a
reduction in the importance of internal models and additional
regulation of liquidity. These reforms would make banks less likely
to default at a given total capitalization ratio.
\21\ The major changes to insurance regulation following the
crisis have been the introduction of an Own Risk and Solvency
Assessment along with some enterprise-wide monitoring. These would
make insurers safer at a given capital ratio. The recently passed
principle-based reserving requirements, which generally lowered
reserves on many insurance products, would have the opposite effect.
---------------------------------------------------------------------------
An additional limitation is the assumption of linearity in the
relationship between solvency ratios and default probabilities after
the logistic transformation. Figure 3 shows the goodness of fit of the
PD estimation for U.S. banking and insurance. The blue dots represent
actual observed default rates. The light red line represents the output
from the regressions discussed above. The figures on the left are the
same as those on the right after the logistic transformation.
BILLING CODE 6210-01-P
[[Page 57291]]
[GRAPHIC] [TIFF OMITTED] TP24OC19.045
The regressions produce a reasonably good fit to the available
data, but the linear fit breaks down for very highly capitalized
companies in both sectors (see blue circles). Consistent with other
research, beyond a certain point, capital does not appear to have a
large impact on the probability of a company defaulting. We considered
a piece-wise fit to address this issue, but decided against it for
three reasons. First, this issue has little practical impact because it
only affects very strongly capitalized companies. Differentiating
between these companies is not the focus of the capital rule. Second, a
piece-wise function would drastically increase the complexity of the
process. Simple scaling formulas can be derived if a single logistic
regression is used for each.\22\ Translating piece-wise regressions
into workable scaling formulas would require simplifications that could
outweigh any otherwise improved accuracy. Third, the required number of
parameters needed to fit a piece-wise model would more than double and
introduce additional uncertainty about the parameters.
---------------------------------------------------------------------------
\22\ See appendix 2 for the derivation of the simple formulas if
no piece-wise regression is used.
---------------------------------------------------------------------------
Ease of Implementation
The biggest disadvantage of this approach is data availability. The
approach requires a large number of default events to calibrate the
impact of the solvency ratio accurately. Although these data are
available on the currently needed regimes, they may not be available in
other regimes for which scalars could be needed in the future.
Stability of Parameterization
The parameter estimates appear stable and robust. As one basic
measure of stability and robustness, we estimated the standard error of
the scaling estimates by simulating from normal distributions with the
mean of the underlying regression parameters and standard deviation of
their standard error. This measure indicated a 95 percent confidence
interval of between .010 and .013 for SRC and between -.054
and -.071 for SAC. This confidence interval is a fairly
tight range given the spread of other methods.
We also tested the robustness of the methodology on out of sample
data. To do this, we split the sample at the year
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2010. Data from prior to 2010 was used to parameterize the model while
data from 2010 and subsequent years was used to assess the goodness of
fit. Figure 4 displays the results of this test. The model performs
fairly well on this test. The goodness of fit on the out of sample data
appears comparable to those within the entire data set.
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We also tested the parameterization for sensitivity to key
assumptions, which would not be captured by the estimated standard
errors. A description of these tests and the resulting scalars are
displayed in table 3. We also attempted to test the impact of the
exclusion of some data, including companies with very high or very low
solvency ratios, but we found that the regression showed little
relationship between the capital ratios and default probabilities in
both regimes when outlier entities that have ratios that are orders of
magnitude apart from typical companies are included.
[[Page 57293]]
Table 3--Results of Robustness Tests of Historical PD Method
----------------------------------------------------------------------------------------------------------------
AC scalar RC scalar
Name Description (percent) (percent)
----------------------------------------------------------------------------------------------------------------
Baseline................................... Assumptions used in the proposal... -6.26 1.06
Excluding firms under $100 million......... Firms with a largest size of less -6.51 1.17
than $100 million in assets are
excluded.
Wider solvency ratio bounds................ Insurance bounds are to allow -6.06 1.10
ratios between -300% to 2000% of
ACL RBC to be used in the
regression. Banking bounds are
similarly moved to 2% and 30% of
RWA.
Largest half of companies.................. The smallest 50% of companies as -5.72 2.21
measured by their peak total asset
size are excluded from both the
banking and insurance samples.
1 year default definition.................. A one year default horizon is used -6.15 0.96
in place of the baseline three
year window.
No crisis.................................. The financial crisis (2009-2010) is -5.60 0.91
excluded from the sample by using
a one-year default horizon and
excluding observations from year
end 2008 and year-end 2009.
----------------------------------------------------------------------------------------------------------------
Summary and Conclusion
The use of historical default probabilities can produce a
reasonable scalar for U.S. banking and insurance. The primary
disadvantage is the data required, which may not be available for other
jurisdictions. Because this method has a relatively robust
parameterization, the parameters would not need to be updated on a set
schedule and could be instead be revisited if new data or conditions
suggest a change is warranted.
Review of Other Scaling Methods
Other methods exist for calibrating the scaling parameters. This
section gives a description of these methods and compares them to the
historical PD method based on the desired characteristics described
before. The methods are arranged roughly in order of their ease of
parameterization. At one end of the spectrum, not scaling is very
simple, but it is not likely to produce an accurate translation. At the
other end of the spectrum, scaling based on market-derived
probabilities of default and scaling based on a granular analysis of
each regime's methodologies have theoretical advantages but cannot be
parameterized even for U.S. banking and U.S. insurance. Between these
extremes, some methods can be parameterized but generally have less
reasonable assumptions than the historical PD method.
Not Scaling
One scaling method would be to assume that no scaling is required,
as might be tempting for solvency ratios of the same order of
magnitude. This method would be equivalent to assuming that
Sac were equal to zero and Src were equal to one.
Although this approach would be very stable and not require
parameterization, the assumption generally appears unreasonable because
of the many differences between regimes. A typical ACL RBC ratio would
be hundreds of percent. The average bank operates with an RWA ratio
near 16 percent. Furthermore, although the numerators in these ratios
might be deemed as comparable under certain circumstances, the
denominators are conceptually very different. The denominator in
insurance is required capital; the denominator in banking is risk-
weighted assets.
Scaling by Interpolating Between Assumed Equivalent Points
This category of methods would take two assumed equivalent solvency
ratios and use interpolation between these to produce an assumed
equivalence line and the implied scaling parameters. The methods in
this category would vary primarily in terms of how they derive the
assumed equivalency points.
Table 4--Analysis of Potential Simple Equivalency Assumptions
----------------------------------------------------------------------------------------------------------------
Reasonableness of Ease of Stability of
Assumed equivalence assumptions parameterization parameterization
----------------------------------------------------------------------------------------------------------------
Available capital calculations.... Regimes are known to Parameterized by Very stable by
differ materially in how assumption. assumption.
they compute key aspects
of available capital
including insurance
reserves.
Regulatory intervention levels.... Regulatory objectives Very easy............ Very stable because
vary, which could justify regulatory intervention
intervening at different points do not frequently
levels. change.
Industry average capital levels... Corporate structure Easy................. Least stable--the
considerations in each of industry's capital ratio
these industries are very frequently changes and
different, and the the ratio of U.S.
average financial industry averages has
strength is unlikely varied by almost 50%
going to be comparable. between 2002 and 2007.
----------------------------------------------------------------------------------------------------------------
It is possible to mix and match from these assumptions to produce a
scaling methodology as illustrated in figure 5. In this figure, each of
the three assumptions is plotted as an assumed equivalence point. For
example, an 8 percent level of bank capital and 200 percent of ACL RBC
translate to comparable regulatory interventions so (200 percent, 8
percent) is shown as the regulatory intervention equivalence point. An
assumption that scaling is not required on available capital translates
to equivalence at (0 percent, 0 percent) because a company with no
available capital in one regime would also have no available capital
after scaling. Three different lines are illustrated which show the
three different ways these assumptions could be combined to produce
scaling methodology.
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Most commenters on the ANPR suggested one of these methods, but
commenters were split as to which assumption was better. A plurality of
commenters suggested not assuming equivalence in available capital
calculations because, as the Board noted in the ANPR, regimes do differ
significantly in how they calculate available capital. However, one
disadvantage of this method is that the average capital levels in a
regime may not always be available, so it might not be possible to
parameterize it for all regimes.
It is also possible to add different adjustments to these methods.
For instance, rather than directly using the regulatory intervention
points, one could first adjust these to make them more comparable. To
the extent that one knew that the regulatory intervention point was set
at a given level (for example, 99.9 percent over 1 year vs. 99.5
percent over one year) then it would be possible to adjust the
intervention point in one regime to move it to a targeted confidence
level that aligns with another regime. However, given that these
targeted calibration levels are more aspiration than likely to
ultimately be supported by empirical data, this adjustment does not
significantly improve the reasonableness of the underlying assumptions.
Some other adjustments could marginally improve the analysis. For
instance, although it is plausible that industries in similarly
developed economies could be similar, assuming equivalence across
starkly different economies is less reasonable. In particular, the
level of general country risk within a jurisdiction is likely to affect
both insurance companies and insurance regulators, and some adjustment
for this could improve the method.
Although these adjustments do marginally improve the methods,
methods in this category would still not be making as reasonable of
assumptions as the historical PD method. We do not consider it
appropriate to use any method in this category in setting the scalar
between the Board's bank capital rule and NAIC RBC. This category of
methods could, however, have utility where simple assumptions are
needed to support calibration.
Scaling Based on Accounting Analysis
A different data-based method that was considered would use
accounting data in place of default data. Under this method, the
distribution of companies' income and surplus changes would be analyzed
similarly to how the Board calibrated the surcharge on systemically
important banks.\23\ If companies routinely lost multiples of the
regulatory capital requirement, the regulatory capital requirement
likely is not stringent.
---------------------------------------------------------------------------
\23\ Board of Governors of the Federal Reserve System,
Calibrating the GSIB Surcharge, (Washington: Board of Governors,
July 20, 2015), https://www.federalreserve.gov/aboutthefed/boardmeetings/gsib-methodology-paper-20150720.pdf.
---------------------------------------------------------------------------
Turning this intuition into a scaling methodology requires an
additional assumption about equivalent ratios.\24\ Numbers can be
scaled to preserve the probability of having this ratio (or worse)
after a given time horizon. For example, if we define insolvency as
having assets equal to liabilities and assume this definition is
comparable in both regimes, then we can scale capital ratios based on
the probability of a loss larger than the capital ratio being observed.
If historically x percent of banks have experienced losses larger than
their current capital ratio over a given time horizon, then this ratio
would be scaled to the insurance solvency ratio that x percent of
insurers have observed losses larger than. A derivation of scaling
formulas from these assumptions is contained in appendix 4.
---------------------------------------------------------------------------
\24\ This parameter and assumption were not necessary in
calibrating the surcharge on systemically important banks because
that only depended on the change in default probability as capital
changes, rather than the absolute magnitude of the default
probability.
---------------------------------------------------------------------------
Although this method appears more reasonable than the simple
interpolation methods, the assumptions are not as sound as for the
historical PD method. Although there is some endogeneity with defaults,
there is much more with accounting data. Regimes differ greatly in how
they calculate net income and surplus changes such that benchmarking
against a distribution of these values may not bring the desired
comparability. The additional assumption required on equivalence is
also problematic as it would essentially require incorporating one of
the
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problematic assumptions discussed in the previous section on
interpolation.
In terms of the ease of parameterization, the method ranks
somewhere between the historical PD method and the simple methods based
on interpolation. Income data are plentiful relative to both historical
default data and market-derived default data. This ubiquity of the data
could allow for calibration of additional regimes and allow changes in
regimes to be picked up before default experience emerges.
To parameterize this method for U.S. banking and insurance, we
started with the distribution of bank losses discussed in the
calibration of the systemic risk charge for banks (see figure 6).
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To apply this method to insurance, historical data on statutory net
income relative to a company's authorized control level were extracted
from SNL. Data were collected on the 95 insurance groups with the
relevant available data in SNL and over $10 billion in assets as of
2006.\26\ Quarterly data points were used over the period of time for
which they were available (2002 to 2016). A regression was then run on
the estimated percentiles and log of the net income values to smooth
the distribution and allow extrapolation. Figure 7 shows the
distribution of ACL RBC returns resulting from this analysis.
---------------------------------------------------------------------------
\25\ Federal Reserve, GSIB Surcharge, at 8
\26\ Ninety-five groups met the size criteria, but three of
these groups did not have RBC or income data and produced errors
when attempting to pull the data. Two of these companies were
financial guarantors.
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Unlike with historical PD, an analysis of the top 50 life and P&C
groups based on year-end 2006 assets under this method strongly
suggested a different calibration. Historically, P&C carriers are
significantly less likely than life carriers to experience large losses
relative to their risk-based capital requirements. In 2008, nearly half
the largest life insurance groups experienced losses that were above
their authorized control level regulatory capital requirement. P&C
insurers were much less likely to experience comparable losses. Table 5
shows the scalars produced when the NAIC RBC life regime is used as the
base.
Table 5--Scalars Based on Accounting Analysis Results
------------------------------------------------------------------------
AC scalar RC scalar
(percent) (percent)
------------------------------------------------------------------------
P&C NAIC RBC............................ -12.82 20.5
Bank Capital............................ -.7 1.6
------------------------------------------------------------------------
Scaling Based on a Sample of Companies in Both Regimes
Another scaling method would be to analyze a group of companies in
both regimes. From a sample of companies in both regimes, it would be
possible to run a regression to parameterize an equivalency line that
represents the expected value in the common regime based on their
information in the applicable regime.
Although analyzing a single group of companies under both regimes
would provide a solid foundation for assuming equivalence
theoretically, there are problems with this method under the stated
criteria.
One issue is that calculating a given company's ratio under both
regimes would likely not be appropriate because it would involve
applying the regime outside of its intended domain. Applying the bank
capital rules to insurers or the insurance capital rules to banks for
calculating the scalar will not necessarily give comparable results.
Although a result for a bank could be calculated under the insurance
capital rules, this result may not really be comparable to insurers
scoring similarly because their risk profiles differ. Indeed, the lack
of a suitable regime for companies in both sectors is the primary
reason the Board is proposing the BBA rather than applying one of the
existing sectoral methodologies to the consolidated group.
Another disadvantage of this method is the difficulty of
implementation. Companies typically do not calculate their results
under multiple regimes. The limited available data, including the data
from the Board's prior QIS, do not statistically represent the
situations where a scalar is needed. Barriers to obtaining a
representative sample of companies make this method very difficult to
parameterize.\27\
---------------------------------------------------------------------------
\27\ The limitations of this method may not apply in the
international insurance context where the development of an
appropriate international capital standard for insurance companies
might make it possible to benchmark various insurance regimes.
---------------------------------------------------------------------------
Because of these problems, we do not recommend using this
methodology as a basis for scaling under the proposal.
Scaling Based on Market-Derived PDs
The intuition of this method is similar to the historical
probability of default method, but it would use market data to
calibrate the relationship between solvency ratios and expected
defaults. Market data can be used to calculate implied default
probabilities with some additional assumptions. Credit default swap
(CDS) prices or bond spreads depend heavily on default probabilities,
and a Merton model can translate equity prices and volatilities into
default probabilities.
Using market-derived default probabilities in place of historical
data would have theoretical advantages over the recommended method.
Because market signals are forward looking, this method could better
capture changes in regimes. It might also be better able to address
issues with past government support if the market no longer perceives
institutions as likely to be rescued.
Although theoretically appealing, the data limitations prevent this
method from being used. Bonds are heterogenous and not frequently
traded; equity prices are difficult to translate into default
probabilities. Even in the largest markets where CDS data exists, only
on a handful of companies have CDS information, and these companies
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are not necessarily representative of the broader market. For US
insurance, an additional issue is that regulatory ratios are not
available at the holding company level and market data are unavailable
at the operating company level.\28\
---------------------------------------------------------------------------
\28\ Although in some cases a sum of the capital of subsidiaries
may be a reasonable proxy for the capital of the group, this
approach would not be true for many entities including those with
large foreign operations or using affiliated reinsurance
transactions (captives). Only a handful of companies have reasonable
proxies available for both NAIC RBC and the market-implied default
rate of the company.
---------------------------------------------------------------------------
We attempted to parameterize the scalar for the U.S. market using
CDS data from Bloomberg and simple assumptions on recovery rates, but
were unable to produce sensible results. Although the historical data
show a strong relationship between capital levels and default
probabilities, the strong relationship did not hold in our CDS
analysis.
Several data restrictions might explain this issue. Only a small
number of issuers have observable credit default spreads. Additionally,
these are generally at the holding company level, which necessitated
making assumptions for insurers as no group solvency ratio exists.
Additionally, only relatively well-capitalized banking organizations
appear to have CDSs traded currently, potentially creating a section
bias. The historical PD data demonstrates that beyond a certain point,
capital does not strongly affect default probability.
Other potential explanations of this result exist. Changes in risk
aversion and liquidity premiums across the panel period could also
explain the results. Time-fixed effects were included in some
specifications of the regressions, but they did not improve the outcome
of this method. Endogeneity between banks' held capital and their
stress testing results may also contribute to the lack of sensible
results. Because of the lack of sensible results, we do not recommend
using this method to set the scalars.
Scaling Based on Regime Methodology Analysis
Another method would be to try to derive the appropriate scalars
from a bottom-up analysis of the regimes, including the factors applied
to specific risks and the components of available capital.
Unfortunately, the differences between the regimes can be inventoried,
but such an inventory cannot theoretically or practically be turned
into a scaling methodology. In each regime, the risks captured are
tailored to those present in the sector. The insurance methodology has
complex rules around the calculation of natural catastrophe losses, and
the bank regime has complex rules that apply for institutions that have
significant market-making operations. Deriving an appropriate scaling
methodology from the bottom up based on these differences would require
quantifying each of them and then weighting to these differences to
calculate an average. This calculation would be infeasible between
banking and insurance regimes given the number of differences.
Additionally, there are theoretical problems with trying to derive a
weighting methodology from the differences that appropriately reflects
the risk profiles of both banks and insurers.
Conclusion
This white paper describes our attempt to identify and evaluate
different scaling methodologies. We find the PD approach based on
historical data could be used to translate information between regimes
in a way that preserves the economic meaning of solvency ratios. This
method, however, requires data that are not currently available for
some regimes outside of the United States. The election of the scaling
approach is therefore a choice between using a single simple approach
to scaling in all economies or differentiating the scaling approach by
country and using the historical PD domestically. We recommend the
latter. Although this approach will involve more work and some
uncertainty for companies operating in countries with limited data, it
should allow for scaling that is more accurate and aid comparability.
Scalars for non-U.S. regimes are not specified in the proposed rule
given the Board's supervisory population. These may be set through
individual rulemakings as needed. For the scalar between Regulation Q
and NAIC RBC, the Board's proposal relies on the historical probability
of default method.
We believe that the historical PD method derived in this paper will
produce the most faithful translation of financial information between
the U.S. banking and insurance regimes. Historical insolvency rates are
currently the most credible economic benchmark to assess regimes
against, and the long track record and excellent data on both the
insurance and the bank U.S. regimes make this analysis feasible.
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By order of the Board of Governors of the Federal Reserve
System, October 2, 2019.
Ann Misback,
Secretary of the Board.
[FR Doc. 2019-21978 Filed 10-23-19; 8:45 am]
BILLING CODE 6210-01-C
