Raising more questions than answers
by Timothy BernsteinMr. Bernstein is NewOak, an independent financial services company providing strategic counsel and services around structured credit, complex asset valuation, enterprise risk, and regulatory compliance. Reprinted with permission. Visit newoak.com.
The March 30th ruling on the MetLife case—in which a federal judge struck down the insurance giant’s designation as a systemically important financial institution (SIFI)—raised more questions than it answered.
To date, we still do not know what the full details of the sealed decision are, or what effect those details will have on the divestment plans of MetLife or the regulatory status of the other insurance SIFIs, Prudential and AIG. As we wait for more information, it is worthwhile to take stock of where the case stands today and where the potential paths forward would take us.
For those catching up: After the financial crisis, the Treasury-led Financial Stability Oversight Council (FSOC) sought to identify which institutions would create a plausible threat to the stability of the U.S. economy if they failed.
It then designated those institutions with the SIFI tag. Although the precise regulations behind the SIFI designation have yet to be written for non-banks like MetLife, the overarching idea is to subject SIFIs to stricter oversight from the Federal Reserve, and potentially require them to hold more capital in reserve in the case of an emergency.
In addition to a number of large investment banks, MetLife, Prudential and AIG were the three large insurance firms that the FSOC tagged with the SIFI label. In January of 2015, a month after it received the designation, MetLife sued the government on the grounds that the label was a) arbitrary and b) harmful to its business, and on March 30th Judge Rosemary Collyer ruled in its favor. Barring a reversal on appeal, MetLife will no longer be designated a SIFI, and will no longer need to concern itself with the extra requirements that accompany that classification.
What surprised many observers was the news that, even after the ruling in its favor, MetLife still intended to move forward with the plan to divest a domestic retail operation, a plan it originally announced in January.
However, it is important to remember that the consequences of the judge’s ruling, as beneficial as they appear to be to MetLife, are not yet fully apparent. For one thing, the decision itself from MetLife’s trial is still sealed—possibly until May—which means that MetLife does not have as much information at its disposal as it might want before reversing a big initiative. Additionally, the government is likely to appeal the court’s verdict, which would keep MetLife under close government watch until the appeal would conclude, which could take years.
Reducing Met’s risk-profile
There is also the possibility, as MetLife executives implied in January, that the divestiture would bring strategic benefits in addition to regulatory ones.
The unit that MetLife targeted for separation is a provider of variable annuities, a retirement vehicle whose payout is often tied to the volatile movements of stock indices; divesting might reduce the risk profile of MetLife, whether or not it is under SIFI regulations. As MetLife CEO Steven Kandarian put it in a February conference call, the spun-off U.S. life insurer would be “more nimble and competitive, benefiting from greater focus, more flexibility in products and operations, and a reduced capital and compliance burden.” If that is the path MetLife plans to take, however, then the court’s ruling may actually help them; Sean Dargan, an analyst at Macquarie Group Ltd., recently told Insurance Journal that, in the immediate aftermath of the ruling, the reduced time pressure on MetLife to get the deal done could allow it to divest at a better price.
Going forward, the most pressing question for anyone with a vested interest in the insurance industry will be what Prudential and AIG decide to do about their own SIFI designations. There is certainly little debate over what Wall Street wants them to do: shares of both firms jumped in the hours following the MetLife verdict’s announcement, in a sign that investors saw a clearer path to all three firms eventually shedding the label. To this point, however, neither firm has indicated any definitive plans to move forward.
Pru looking on with interest
In the case of Prudential, The Wall Street Journal reported last June that the company was monitoring the MetLife case closely, an implication that it was considering a similar attempt to discard the SIFI designation. In the immediate aftermath of the ruling, Prudential has released a statement that strenuously avoided divulging much of anything (“we continuously review developments that impact our company, and we are evaluating what is in the best interests of the company and our stakeholders”).
One potential factor to monitor, however, would be the size of the adjustments Prudential has had to make under the SIFI tag compared to MetLife. New York, where MetLife is based, already imposes some of the strictest insurance regulations in the country.
By comparison, in a report released last June, an analyst at KBW estimated that Prudential, whose domestic units are based in New Jersey, Arizona and California, would be holding $7.2 billion less in adjusted capital if it were based in New York. MetLife, in other words, appeared to have had less to lose from transitioning to the stricter SIFI rules, and it still sued the government to try to evade them. Will Prudential, now that a precedent has been created, follow (and file) suit?
Cloudy picture for AIG?
For AIG, the picture is slightly murkier. There is the unique perception of AIG, among the insurance giants, as particularly integral to the causes of the financial crisis, which could deter a judge from actively aiding it in avoiding regulatory scrutiny.
CEO Peter Hancock, for his part, has maintained that the designation “provided little to no additional expense,” nor has it “prevented the return of capital to shareholders.” On the other hand, the company has faced increasing pressure from activist investors to separate into at least three separate entities—life insurance, property/ casualty coverage, mortgage insurance—and recently announced a fourth-quarter net loss of $1.8 billion. If Hancock and the rest of the C-suite believe that they too can get off the SIFI list, AIG might decide to mount a legal challenge of its own.
Until Judge Collyer’s decision is unsealed, the full impact of MetLife’s victory will remain unknown. What the early fallout indicates, however, is that MetLife has pried open a window for Prudential and AIG that had very recently seemed shut. What effect that has on any plans to divest or separate or go to court remains to be seen. For the rest of us? This should only get more interesting before it is over.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any other person or entity. The information contained in this article is for general information purposes only and, while it is based on sources the authors believe to be reliable and current, neither the authors nor NewOak Capital LLC make any representations or warranties of any kind, express or implied, about the completeness, accuracy or reliability of such information for any purpose, upon which any person may rely. In particular, nothing herein shall be construed as legal, accounting, tax or investment advice of any nature. This article is also subject to the disclaimers set forth at http://newoak.com/disclaimers/