When I was named treasurer, and later chief financial officer, of State Farm Mutual Automobile Insurance Co. in June 2009, I thought I knew what was coming. I've been with State Farm for almost 25 years, working in financial operations for most of that time. But there have been a few surprises. One big one is the amount of time I find myself spending in Washington D.C.
Now, I have nothing against Washington. It's just that, primarily a property/casualty and life insurer, State Farm has historically dealt with state regulators. But all that changed with the passage of the Dodd-Frank Act.
You see, State Farm has a bank (technically, a thrift). Not a huge bank, right at $14.2 billion in assets. We've been in the business of originating auto loans since 1936: first for other institutions and then, starting in 1999, for our own subsidiary. Our over 18,000 agents serve the middle market of America with simple deposit and loan products, and our mutual structure allows us to do so at very competitive prices.
Back in 2009, the country was still reeling from the financial crisis and Congress was responding with a massive overhaul of the financial regulatory system. The fact that another large insurance company was at the heart of the financial crisis—albeit for a business that has absolutely nothing to do with insurance—meant we'd be facing some regulatory changes.
It's been nearly three years since the Dodd-Frank Act was enacted, yet many of the rules and regulations necessary to enable the Act have yet to be written or implemented. In the meantime, financial services companies are tasked with making decisions that impact the success of the business without knowing the rules.
As an example, the insurance industry could suffer from implementation of the Volcker Rule. This rule was included in the Dodd-Frank Act to ensure federally insured depositories did not put their organization at risk by investing in hedge funds or private equity, trading on their own account.
While the Act includes a Volcker rule exemption for insurance companies, the final rule has yet to be implemented and there remains uncertainty, as some regulators appear to have interpreted that exemption in a limited fashion.
Insurance is a completely different business than banking. Banks' liabilities are primarily demand deposits, so it is crucial that assets be of a quality and nature to meet the liquidity depositor's need. Insurance companies' liabilities are unearned premiums and loss reserves. These are predictable and for life Insurance, longer term.
Insurance companies, by our nature, trade on our own account on behalf of our customers. State insurance rules have always recognized that and allowed a variety of investments subject to stringent limits.
In this extremely low yield environment, insurance products—particularly life Insurance—come under great pressure. These are so-called spread products, where a company collects premiums and invests them in a way to cover the investment income credited to an account, plus any operating costs and profit.
When there is no yield in the market, life Insurance is a tough business. Having a broad array of investment options is important to the success of an insurance company.
Also as a result of the Dodd-Frank Act, federal regulators are considering more uniform capital and liquidity standards for companies owning depository institutions.
In doing so, these regulators are following an approach that would apply the same standards and requirements on all of these companies—regardless of the activities, size of the bank within the company's structure or how extensively the company's capital is already regulated.
For insurers with depository institutions, this would create an added layer of regulation. More importantly, Dodd-Frank regulations need to provide for the differences between banks and insurance companies. As I mentioned earlier, banks and insurers have very different capital and liquidity structures because of fundamental dissimilarities in their capital needs.
Regulation could also create reporting requirements that would be burdensome, costly and provide very little—if any—benefit.
As regulators look to finalize new regulations under Dodd-Frank, I hope they consider the differences between banks and insurers. I am encouraged by the initial interactions with the Fed team reviewing State Farm. I am also encouraged that members of Congress—on a bipartisan basis—have been engaged on this issue.
Congress didn't intend to supplant existing state-based capital regulation with a bank-centric approach. This should be sufficient to drive good regulatory policy.
And, for many reasons, I hope for a calm, rationally productive and storm-free 2013 in Washington.
—By Paul Smith, CFO, State Farm