The average American couldn't pick the Financial Stability Board (FSB) out of a lineup. But every fall this shadowy group of international regulators makes decisions that have a crucial impact on their lives. This year's announcement on November 3rd added Aegon, the Dutch financial conglomerate and parent of U.S. insurer Transamerica, to the list of too big to fail financial companies. Formally, Aegon joins eight other insurance companies on the FSB's list of Global Systemically Important Insurers (G-SIIs).
Being named a G-SII launches a company into an entirely new realm of capital requirements, liquidity requirements, and other features of the regulatory web. This makes operations more costly, and products more expensive. Given that, you would think it would be clear who is, and who is not, a G-SII and why. But it has never been clear why the FSB and its U.S. arm, the Financial Stability Oversight Council (FSOC), make the decisions they do.
For example, the nine G-SIIs are all primary insurers. However, there are comparably large, global reinsurers like Berkshire Hathaway who are not designated (at least yet) as G-SIIs. What's the difference? Insurers sell insurance to primary customers. Reinsurers sell insurance to insurance companies. The U.S. Federal Insurance Office asserts that the business of insurance and reinsurance are so tightly intertwined that one could not exist without the other.
If the FSB and the FSOC were basing their decisions on the risks posed by the products and activities one would seemingly be led to the inevitable conclusion that either both are G-SIIs or both are not. The evidence supports the latter - insurance companies are not like too big to fail banks - but the inconsistency is troubling in either event. The FSB and FSOC have to get the analysis right and apply it consistently.
A lot is at stake. International regulators are struggling to justify their G-SII regime, but have no hesitation about proposing to make designated companies hold more capital. As a result, G-SIIs will need to raise prices or dial back the guarantees they offer to consumers, without any assurance that the financial system will be safer. The FSB does not have to justify its decisions because the process is carried out behind closed doors.
Similar concerns have been raised in the United States. The FSOC has come under criticism for designating insurance companies as Systemically Important Financial Institutions (SIFIs). Unfortunately, it is hard to make this case on the merits and the regulatory regime is being designed by banking regulators that do not understand the insurance business. Prudential, MetLife, and AIG appear to simply be big and for this transgression have been thrown into an ill-fitting, expensive regulatory morass.
In contrast, the FSOC stopped short of doing the same thing with comparably large asset managers. Instead, it requested an analysis of the risks posed by asset manager' activities and products. That is good, but its refusal to have the same treatment of insurers cries out for explanation. Good luck getting an answer from FSOC, whose designation process is every bit as opaque as the FSB's.
In the wake of the financial crisis, regulators have said their highest priority is to make sure that no "too big to fail" institution ever gets a taxpayer bailout. To do so requires that the regulatory process be transparent and founded on genuine, principled risk analysis. If it is not, it will provide fodder for suspicions of political influence and undercut the goal of building greater trust in the financial system.
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