Insurers’ concern over the classification of hybrid securities as common stock in their portfolios has them asking state insurance regulators about what a recent decision will mean for the amount of capital they need to hold.

The concern prompted state insurance regulators to hold an informational call on April 19.

Hybrid securities have features of both equity and debt but can vary greatly, depending on the features of the individual security.

The concern is that the classification as common stock rather than as debt will increase the risk-based capital that companies are required to hold to ensure that they are financially strong.

“RBC charges will flow from the classification of the SVO [Securities Valuation Office],” explains Scott Holeman, a spokesperson for the National Association of Insurance Commissioners, Kansas City, Mo. The SVO, a unit of the NAIC based in New York, held the call along with the New York insurance department. “Thus, if common stock, it flows through to RBC as common stock and gets a common stock RBC charge.

“The investment limitation statutes in the states would be based upon the SVO decision. If the SVO classified it as common stock, then that would become part of the total common stock portfolio of the insurer, which would be subject to the investment statute limitation for common stock in the domiciliary state,” Holeman continues.

Capital and trust preferred securities held by life insurers in 2005 totaled $35 billion in 2005 compared with $29 billion in 2004, said Robert Carcano, SVO senior counsel and senior vice president.

Institutions on the call included: Aegon, Credit Suisse, Genworth Financial, HSBC, John Hancock, Merrill Lynch, Prudential Financial and TIIA-CREF.

“We are looking at the issue and trying to get some clarity of what this means for companies,” Whit Cornman, a spokesperson for the American Council of Life Insurers, Washington, responded when National Underwriter asked what it could mean for the industry.

The issue was first raised when a Lehman E-Capital Trust I security purchased by a New York domiciled insurer in August 2005 was required by the New York department to be filed with the SVO for analysis.

The required review was made in the fall of 2005, and in early March 2006 the SVO notified the department that the security should be classified as common equity. An appeal was filed March 24.

But the security is also owned by 9 other insurers, according to the SVO. And, in mid-March, following the determination, the New York department requested other insurers to file various hybrid securities with the SVO for analysis.

Howard Mills, New York Superintendent, opened the call by noting that concern about the decision and the impact on pricing of these securities in the marketplace and new securities currently in the pipeline led to a decision to hold an informational call.

During the call, Mike Moriarty, director of the New York department’s capital markets bureau, noted that the significance of hybrid securities among insurers has increased.

A change in classification of these securities should not affect a company’s risk-based capital ratio, he continued.

“If it did impact a company’s RBC ratio, the company is probably already stressed or the portfolio of hybrids is already significant,” Moriarty said.

The NAIC’s RBC requirements do not indicate financial strength, he said. Rather, Moriarty continued, it is a formula-driven standard.

It was noted during the discussion that the fact that risk-based capital is used as a financial strength indicator or to measure financial performance is a factor outside of regulators’ control.

“If it is used for financial strength, it is not what it was intended for or what it was validated to do,” Carcano said.

“There is a need to recognize that there is a different model that the market is using. We have been trying to demonstrate since 1994 that we wanted a model in addition to the credit rating. It is very important to keep that in perspective,” Carcano noted in trying to explain the difference between regulators’ and rating agencies’ responsibilities.

During the dialogue, Carcano noted there has been no change in the method for evaluating any security.