MetLife, AIG spinoffs of U.S. insurance units show “disruptive” fiduciary rules, not just capital needs

February 3, 2016

By Richard Satran, Regulatory Intelligence

(Thomson Reuters Regulatory Intelligence) – The American insurance industry is being rapidly reshaped from a state-regulated backwater by what an industry group calls the “disruptive” impact of government regulation — and it is not just the often-cited capital demands placed on them by regulators who want bank-like systemic risk protection and activist investors who want quick returns on their investments.

The broker-dealer units of MetLife and AIG have been caught in the middle of the fray over how the insurance business sells products through broker dealers as looming fiduciary-duty rules reshape the role of financial advisers.

In short order, both No. 1 insurer MetLife and AIG, the No. 3, have announced plans to get out of retail business units via spinoffs or sales. The rationale for downsizing and spinning off their U.S. retail insurance operations was the much-cited demand for new capital requirements from the U.S. Treasury Department. The two were tagged in late 2014 as systemically important financial institutions (SIFIs) that put them into the same “too-big-to-fail” regulatory sphere as the largest banks. AIG said on Tuesday it would sell its AIG Advisor Group, a network of independent broker-dealers, to Lightyear Capital and PSP Investments, only days after MetLife said it will spin off its U.S. retail unit.

While capital concerns were blamed for the restructurings, another regulatory worry — the proposed uniform financial industry fiduciary standard and new rules on conflict of interest and fee disclosures — may have been an even larger and less advertised reason behind the decisions of both to exit retail insurance after decades in the business, said industry and legal sources.

MetLife faces “significant” regulatory action

MetLife, the first to move on an insurance brokerage spinoff plan earlier this month, made its decision two months after learning that it faces a significant fine from the Financial Industry Regulatory Authority for its variable annuity sales practices in the use of incentives for clients and brokers switching clients to new policies. FINRA had no comment on the pending case. Metlife said there had been no additional notification on how the enforcement will play out.

“All of the regulatory issues facing our business were considered in the decision” to spit up the company, said MetLife spokesman John Calagna. “We looked at all parts of our business and the value of each going forward.” The company previously said that it was comfortable that it had provisions to pay the cost of any penalty.

The pending FINRA action marked a setback for MetLife after it and the rest of the industry appeared to be recovering from a crisis in loss-making investment insurance products after the stock market crash ushered in an era of low interest rates that made it difficult to pay out guaranteed returns. The new problems surfacing over its sales network practices stems from more recent history, and comes at a difficult turning point for MetLife and other insurers.

“This is a big concern, with the fiduciary rules being decided,” said an industry risk expert, who asked not to be named. “It really raises questions for the how the insurance industry advisers will fare under the new rules.”

The looming FINRA enforcement action came after a recent period in which MetLife and AIG reported progress in balancing the risks associated with their insurance investment products. In its outlook a year ago MetLife said it expected its variable annuities results to benefit from rising rates, which it saw boosting its profit margins and lowering capital requirements over time. It had said it was ready to stay the course toward gradual improvement. But in shifting its strategy it cited the push of new regulation that highlighted the capital requirements of being too big. But it played down the impact of new regulations hitting is broker network it has ended up deciding to sell.

Too-big-to-fail not yet a factor yet

To be sure, both MetLife and AIG also face potentially onerous new capital requirements that contributed to the urgency of their new restructuring plans. In MetLife’s case, the potential impact of having to meet the capital standard of banks would require a doubling of its reserves, the company has said.

Insurers have pushed back against the systemically-important tag by arguing that their risk profile is fundamentally different than deposit banks, since the clients are beneficial owners of securities linked to insurance contracts. But because the operating income for variables shows up on earnings under accounting standards, they are treated as the insurers’ assets that must be offset by capital, just as banks must list their loans. MetLife’s CEO Steven Kandarian, a former top U.S. regulator who served as executive director of the Pension Benefit Guaranty Corp, has been vocal in making the case that insurers need flexibility.

The effort has gathered momentum with strong support from the influential National Association of Insurance Commissioners in opposing the too-big-too-fail designation. The U.S. Federal Reserve, meanwhile, has considered a proposal for new nationwide insurance capital standards that would rely heavily on the current system of state-based regulations, according to a copy of the plan seen by Reuters and people familiar with the deliberations last July. The final ruling on the capital plan has not been made.

Roots of regulation in financial crisis

Regulators have cited AIG’s near failure during the financial crisis as a reason for SIFI status, but the industry counters that the cause of its troubles was rooted in the mortgage securities issued by banks and government-backed agencies and derivatives of those securities. The industry has argued that its own operations never posed a systemic threat.

While MetLife cited the heightened capital requirements in explaining the need for the spinoff, shedding the assets does not guarantee that it will rid itself of its too-big-to fail status. A Reuters BreakingViews article noted that its remaining $640 billion of assets “would fit between Prudential Financial and AIG, the two other U.S. insurance SIFIs” and it “would still be big enough to merit the systemic designation.”

While the potential need to raise capital to meet new SIFI requirements surfaced repeatedly for AIG and MetLife, in AIG’s case the restructuring plan included a $25 billion return of capital to shareholders from the proceeds of shedding units and cutting costs. Those efforts were spurred by activist shareholder Carl Icahn and others whose investment strategies focus on vulnerable companies seen having potential to raise more capital for shareholders. MetLife and AIG had both been engaged in long-term strategies to boost reserves but the activist interest pushed them to act more quickly.

Fiduciary rule’s “disruptive” threat

Potential changes in the fiduciary rule, by comparison, posed a more certain and imminent threat to insurers than long-term capital building. The insurers sell about 20 percent of variable annuities through their own networks and the rest through brokers and fund managers, according to a Cerulli Associates research report, “The Cerulli Edge – Retirement Edition.” Independent broker dealers have picked up much of the business as insurers have downsized their in-house networks. The largest diversified investment houses and fund management firms also sell for insurers, but with their wide range of offerings in highly supervised compliance settings they are seen as more able to meet the new regulatory demands.

The independents face a steeper challenge in adopting to any new uniform standard. The Dodd-Frank regulatory reform act mandated a study of a a uniform financial services fiduciary standard. The final form any standard is still under debate, but the Department of Labor, which plays an influential rule as the regulator of U.S. pensions and employee retirement savings plans, is likely to impose a new code of conduct and disclosures for the retirement industry under whatever universal standard is adopted. Such requirements could impose new compliance and technology burdens on firms. A final Labor Department proposal is expected soon.

Insurance brokers’ regulatory risk

Insurance brokers are at the greatest risk from the proposed conflict-of-interest rule due to their heavy use of commissions and reliance on proprietary insurance products, said Cerulli Associates. The broker dealers will be required to win new business while having to comply with new rules that require them to get clients to sign a contract that discloses all fees and commissions to assure them that “the interests of the client are placed first and any potential conflicts of interest are disclosed,” Cerulli said.

Variable annuities pay higher commissions than most other financial products, which the industry says is due to their greater complexity and longer holding period. But industry critics and regulators say that the incentives reflect the difficulty of convincing customers due to the industry’s image problems. Securities regulators have taken hundreds of regulatory actions for alleged overselling of insurance products such as variables, the largest selling type of contract, which are complex products that invest premiums in securities to include capital and income gains for holders. Regulators have often take high profile actions over hidden fees and account churning, often involving allegations of pushing variables that are unsuitable for tax sheltered retirement accounts.

Variables’ hard sell in regulated world

While the insurance industry has remained largely state regulated, FINRA and the Securities and Exchange Commission have long acted on cases of broker dealers or registered advisers accused of wrongdoing. Dozens of cases of alleged abuses in the sales of variables are settled each year, and plaintiff’s lawyers account for scores of cases of alleged churning and aggressive sales tactics.

“It’s hard as a fiduciary to sell someone into a variable annuity and still comply with the rules. A large portion of sales are inappropriate,” said Erwin Shustak, managing partner of Shustak Reynolds & Partners. “There really are some very negative connotations surrounding the products and many lawsuits over unsuitable sales of variable annuities.”

New rules will add even more regulatory and legal compliance challenges for those who attempt to sell insurance products “as the sales forces come could come under scrutiny in a period of heightened regulation,” said Cerulli in its report. For AIG and MetLife, the solution has been to jettison its units involved in direct sales. The result could be a continued reshaping of firms ranging from broker dealer independents to the entire range of firms that include insurance products in their mix, including major wire houses and investment managers.

In the regulatory world, the “DOL’s Fiduciary Rule is the most significant and proximate policy shift on the horizon,” said the Insured Retirement Institute. “It also may be, depending on the final form of the rule, the most disruptive to the industry. All eyes across the industry will be watching as a final rule comes forward in 2016.”

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Jan. 27. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters)

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