The Federal Home Loan Bank (FHLB) System was at the centre of a regulatory maelstrom in the second half of 2014, causing widespread reaction and debate across a number of industries...
The Federal Home Loan Bank (FHLB) System was at the centre of a regulatory maelstrom in the second half of 2014, causing widespread reaction and debate across a number of industries. In particular, concerns over captive insurance entities’ membership of the FHLB System served to stop this growing sector in its tracks.
These concerns arose in earnest when Redwood Trust’s special purpose captive insurance subsidiary, RWT Financial, received approval as a member of the FHLB of Chicago on 6 June 2014. This led all 12 banks of the FHLB System to agree on a three-month moratorium on admitting captive insurers as members, following the mounting concerns of the Federal Housing Finance Agency (FHFA) regarding the risks of such memberships.
Initially, US Congress created the FHLB System to serve as a reliable source of funds for local lenders to finance housing, jobs and economic growth. The 12 banks that make up the system are cooperatives owned by more than 7,500 community financial institutions throughout the US. Prior to this unrest, a real estate investment trust (REIT), such as Redwood Trust, could gain access to financing offered by an FHLB for certain assets—provided its insurance subsidiary captive was a member. This use of the system became a particular concern for regulators as they became worried about the structure of, and capital invested in, such insurancers.
The FHFA proposed a rule change last year that, if adopted, will effectively exclude captive insurers from membership to any one of the 12 FHLBs. The definition of an acceptable ‘insurance company’, under the proposed rule, would mean a company that has as its primary business the underwriting of insurance for non-affiliated persons. This would continue to include traditional insurance companies but not captive insurers. As a result, existing membership of captive insurers would be ‘sunset’ over five years with defined limits on advances.
The comment period was originally set to close on 12 November 2014, which itself was 60 days after publication of the proposed rule in the Federal Register, though this was extended until 12 January 2015. The FHFA extended the comment period “in light of the importance of the issues addressed in the proposed rule, the high level of interest in the proposal and requests from multiple stakeholders for more time to evaluate the proposed rule”.
All told, the FHFA received 1,300 comments about the proposed rules. FHFA director Melvin Watt said in a statement before a Congress financial services committee in January that the agency is reviewing and considering the comments. “Getting input and feedback from stakeholders is a crucial part of FHFA’s policymaking process, and we will carefully consider comments made by members of this committee as well as the public in determining our final rule,” he explained.
“A captive insurance company provides benefits only for its parent company, which itself is often not eligible for FHLB membership. While captive insurers may in some cases be involved in housing finance, allowing them to have access to the FHLB system raises a number of policy issues that are discussed in the proposed rule.”
If it ain’t broke
The general feedback from the captive industry was as to be expected from a sector potentially facing the end of one of its newest opportunities. While the overwhelming majority, perhaps unsurprisingly, stood in opposition to the proposed rule change, a number of respondents also raised a few more specific concerns of their own.
Steve Kinion, speaking on behalf of Delaware insurance commissioner Karen Weldin Stewart, claimed that the proposed prohibition is the result of the FHFA’s “lack of understanding and knowledge” of the captive insurance industry.
Kinion suggested that, by collaborating with captive insurance regulators and others in the captive insurance industry, it could make an “informed decision” on whether to continue with the proposed rulemaking.
He also suggested that the FHFA should withdraw the its proposal and agree to form a joint task force consisting of the FHFA, insurance regulators, representatives of the commercial and captive insurance industry, and FHLB member banks. The first mission of this task force would be to enhance the FHFA’s knowledge about the captive insurance industry and illustrate why captives value FHLB membership.
The Risk and Insurance Management Society (RIMS) president Rick Roberts reiterated the point made by Kinion that, according to himself and Roberts at least, there is a feeling from the industry that the FHFA is in need of some education regarding the fundamentals of captive insurance.
Roberts said that, by carving out captives from the definition of insurance company because of “supervisory concerns”, the FHFA would also be questioning the ability of state insurance regulators to regulate a whole category of insurance companies.
In his letter, Roberts commented: “Insurance companies are permitted to be members of the banks as a way to diversity the membership base. Banning captive insurance companies from membership would lessen that diversity.”
Roberts was also at pains to point out the seemingly self-evident fact that captives are subject to “significant” state insurance regulation. He continues: “Captive insurance companies often underwrite the risks of both affiliated and unaffiliated companies.”
“Just like other types of insurance companies, captive insurance companies are subject to state regulatory requirements regarding supervision, solvency, receivership and liquidation. The fact that a captive insurance company insures affiliates does not mean that it is not subject to regulatory requirements designed to ensure that it is financially sound.”
David Weiser, general counsel and assistant secretary at RiverSource Life Insurance Company, also raised an important point in his letter to the FHFA. In the letter, he cited the long-standing nature of the arrangement as something to preserve and reminded the FHFA that the proposed rules could weaken a system that has “worked well for more than 80 years”.
Weiser said: “The FHFA has provided no data indicating that this hypothetical issue has created any actual systematic issues, but merely asserts the possibility of an issue as grounds for a new and more restrictive regulatory scheme.”
Even those companies that are not the targets of the captive prohibition, such as risk retention group ICI Mutual Insurance Company, have asked the FHFA to consider technical revisions to its proposal.
In his letter, ICI Mutual president David Steiner said: “We remain concerned that the proposed rule, in its current form, could create uncertainty as to ICI Mutual’s ability to continue its bank membership in years to come”. This again leads to the conclusion, as far as the captive insurance respondents are concerned, that the FHFA has not fully thought through this proposed rule.
While it is easy to sit back and simply observe that ‘time will tell’, that platitude is of little comfort to the masses waiting for the FHFA to take these comments on board and, ultimately, make a decision.
As far as captive insurers and those associated with the industry are concerned, state regulators should be more than capable of keeping an eye on any potential abuses of the FHLB System.
As Roberts said in his letter: “Captive insurance companies are regulated by the states, and the regulatory approach to assessing qualifications for an insurance company’s membership in a bank should remain intact.”
