The process, if approved after an extensive public comment period, will be as follows:

*The FSOC will make each decision on a firm-specific basis, with the analysis encompassing both quantitative analysis and qualitative judgment.

* It will assess the potential impact of a company's financial distress on the broader economy based on size, substitutability and interconnectedness.

* It will assess the vulnerability of a company to financial distress based on leverage, liquidity risk and maturity mismatch, and existing regulatory scrutiny.

A three-stage process will be used to determine whether a non-bank such as an insurer will be designated:

1) Application of a uniform quantitative threshold (see details below) for identifying a non-bank financial company (NFC) that warrants further review.

2) An analysis of the NFCs identified in stage 1, based on available public and regulatory information.

3) Contacting individual NFCs that warrant further review to collect data not available in the earlier stages.

At the end of the third stage, the FSOC will hold a vote. At least two-thirds of voting members, including the chairperson, must vote in the affirmative for an NFC to be designated. A designated company may request a hearing, after which the FSOC must again vote by a two-thirds majority for designation.

The uniform quantitative thresholds the FSOC intends to apply in the first stage of evaluation to identify NFCs requiring further review are if a company has at least $50 billion in total consolidated assets and meets or exceeds any one of the following:

• $30 billion in gross notional credit-default swaps outstanding;
• $3.5 billion in derivative liabilities;
• $20 billion of outstanding loans borrowed and bonds issued;
• 15-to-1 leverage as measured by total consolidated assets to total equity;
• 10-percent ratio of short-term debt to total consolidated assets

The FSOC said it believes these thresholds will provide “meaningful initial assessments” regarding the likelihood that a NFC could pose a threat to U.S. financial stability; and that thresholds “add significant transparency to the designation process.”

In a note issued Oct. 11, Fitch Ratings said the clarification of the SIFI criteria would potentially be “significant” in differentiating the credit profiles of certain large insurers, particularly with respect to capital requirements and higher operating costs linked to tougher regulatory compliance requirements.

“While stronger capital ratios would in and of themselves represent a credit positive, they could also impose higher costs associated with carrying statutory capital,” Fitch Ratings said.

The potential need to carry higher capital against the same risk exposures could make an insurance company designated a SIFI less competitive than its non-SIFI peers, the statement said.

Currently, most large U.S. insurance organizations hold significant excess capital relative to statutory minimums, the Fitch statement said. “Therefore, the implementation of higher capitals standards may not be a major disadvantage from a practical perspective in the near term,” the report said.

In proposing the regulation, Treasury Secretary Timothy Geithner said subjecting financial firms outside “the formal banking system” should help ease “tension and trauma” created by the near failure of AIG, which was found in September 2008 to have issued $2.77 trillion in credit default swaps as insurance against losses on mortgage-backed securities.

The government, by its own account, provided AIG up to $120 billion in borrowing authority to save it from insolvency.

But insurers have argued AIG is unique and that their business model should not subject them to federal oversight in addition to its current state regulation.

In a comment letter urging caution in designating insurers as SIFI, for example, the American Insurance Association asked the FSOC to consider its industry “unique and fundamentally different than banking and other financial services.”

For its part, the National Association of Mutual Insurance Companies (NAMIC) had this to say: “NAMIC appreciates the work the FSOC has done to provide more transparency and clarity to the SIFI-designation process for non-bank financial institutions.

“While a clear statement that the FSOC did not intend to look at property/casualty insurers would have been preferable, we believe any analysis based on the proposed six-category framework for assessing both a company's vulnerability to financial distress and its potential impact on the broader economy will conclude that no P&C insurance company should be designated as a systemically significant financial institution.

“NAMIC has consistently argued,” the association continued, ”that no P&C insurer engaged in the traditional business of insurance poses a systemic risk to the economy. Subjecting an insurer to enhanced prudential standards established by the Federal Reserve's Board of Governors, which has little to no institutional knowledge or experience in regulating insurance, could create unintended market distortions that would ultimately harm consumers.”

In the proposal released today, the FSOC noted, “In the recent financial crisis, financial distress at certain non-bank financial companies contributed to a broad seizing up of financial markets. These non-bank companies were not subject to the type of regulation and consolidated supervision applied to bank holding companies, nor were there effective mechanism in place to resolve the largest and most interconnected of these non-bank companies without causing further instability.”