In his latest agenda, the head of the Financial Stability Board said that global regulators intend not only to finish total loss-absorption capacity (TLAC) standards for giant banks, but also to trot out TLAC for systemic insurers. TLAC has far-reaching strategic implications for G-SIBs already beleaguered by an array of redefining reforms. I said as much to Bloomberg, which laid out a helpful analysis of TLAC’s costs and benefits for big banks. But, for global systemically-important insurers (G-SIIs), TLAC could be more than a major strategic challenge; it could so fundamentally alter them as to force them out of critical, traditional insurance operations.
TLAC for big banks is problematic in part because it’s a pre-built buffer for a global resolution framework that’s still largely conceptual and, thus, uncertain. For global insurance companies, where the resolution construct is even more hypothetical, layering in TLAC ahead of finalizing the premises on which it is based is even less well-founded. It isn’t that TLAC for G-SIBs or G-SIIs is wrong — its point is to ensure orderly resolution via insolvency – not bail-outs. But, without knowing how the new resolution framework would actually work – and for all the talking about it, we don’t – TLAC’s benefits are unknowable even as its costs are clear and real.
TLAC is problematic for G-SIIs not only due to the absence of a clear resolution framework, but also because insurance companies are different than banks. Even if TLAC works for G-SIBs – TBD – insurance companies fund themselves very differently than banks. TLAC would force G-SIBs to issue as much as $1.6 trillion in long-term, high-risk debt to a limited pool of eligible investors who might or might not want it. Since all this debt has to go somewhere, banks that hope still to make a buck or two would need either to bulk up on trillions in long-term, high-yielding assets and/or curtail traditional deposit-taking in hopes of funding intermediation with TLAC debt. Good luck.
In their basic business lines, insurance companies neither gather deposits nor make loans. They do, for sure, engage in all sorts of non-traditional activities (securities lending, asset management) that isn’t insurance and warrants a far closer look. But, even the most far reaching G-SII is still at its heart an insurance company issuing policies for life, health, property, reinsurance or specialty coverage. To ensure they can pay claims, G-SIIs, like smaller insurance companies, hold big books of low-risk assets with longevities geared to anticipated actuarial risk. Earnings on these assets go not only to the bottom line, as is the case for banks, but also and in large amounts to fund premium reserves to ensure claims-paying capacity under stress. Since these proved fragile in the crisis, insurance companies are now facing a new regime requiring them to bulk up their holdings of low risk assets to buttress claims-paying capacity.
How to fund these low-risk assets? The liability side of an insurance company is principally debt issued to fund assets that can be liquidated to pay claims if reserves run dry. Like G-SIBs, G-SIIs would need to put TLAC debt somewhere. Banks can reduce deposits and go into fee-based activities – maybe – or substitute deposits with TLAC and make some higher-yielding loans (uh-uh), but at least this is theoretically possible.
How, though, could a G-SII promise robust claims-paying capacity in its insurance operations and still issue billions more in parent-company debt? At the least, all this debt would threaten the rating on which its other debt is premised and on which insurance company franchise value is particularly dependent. Markets already burdened by big books of TLAC debt from G-SIBs might have difficulty swallowing still more from GSIIs, raising not only the amount of debt, but also its cost. Are there enough long-term, low-risk assets with high enough coupons to make it possible for G-SIIs to fight G-SIBs for the scarce supply of remaining assets they could hold to ensure claims-paying capacity without either a big hike in premiums or a large drop in coverage offerings?
Maybe, but more likely maybe not. One of the most trenchant comments filed on TLAC with the FSB comes from Sir John Vickers, the architect of sweeping structural U.K. bank reform. Sir John makes one of those simple, yet profound statements that forces one back to basics: by virtue of trying to be total, TLAC has transformed itself from the “gone-concern” resolution buffer it was supposed to be when this entire effort started two years ago. If TLAC’s goal now is indeed to make G-SIBs immortal, it will make the biggest banks bullet-proof utilities, not profit-making financial institutions. Maybe that’s what regulators want, but if so, they should say so and, then, reckon with what this means not only for taxpayer-resolution risk, but also efficient market functioning when it comes both to banking and insurance