Failing to decide on whether hybrid securities are debt or equity would cause investors to shy away from the insurance sector and could jeopardize some carriers’ financial stability, insurers and investment bankers warned the National Association of Insurance Commissioners during its summer meeting here.

But the remarks were countered by regulators who insisted that it was their duty to consider the complex issue carefully before reaching a decision.

Ultimately, n NAIC unit decided to defer a decision on the treatment of hybrid securities until regulators figure out how they should be treated in an insurer’s portfolio.

In a 9 to 5 vote, the Valuation of Securities “E” Task Force of the NAIC, Kansas City, Mo., deferred a compromise solution that would have grandfathered hybrid securities issued before June 11, 2006, and treated them as debt rather than as common stock. Hybrids issued after that date would have been treated as common stock under the shelved proposal, which was put forth during the NAIC’s summer meeting here.

The issue affects the risk-based capital charge that a company is assessed. The charge for common-stock treatment is higher than for securities categorized as debt or as preferred stock. That common stock charge is 30% for life companies and 15% for property-casualty companies.

The VOS decided to hold an interim meeting to get more input and make a careful decision on the issue. By press time, the date of the meeting had not been announced.

Howard Mills, New York Superintendent of Insurance, said he hoped the decision to give the issue a more careful examination would give the markets more clarity.

An investment banker in the audience who declined to be named said the lack of clarity had dried up the market because insurers had stopped buying the hybrids because of uncertainty over their treatment.

The market was put in flux when the NAIC’s Security Valuation Office in New York reclassified $300 million in ECAPs, a hybrid security issued by Lehman Brothers Holdings Inc. in New York on March 15, as common stock. As a result, the New York insurance department began to look at insurers’ holdings of hybrid securities.

The impact on how risky these securities are considered was explained in a joint letter from the American Council of Life Insurers, Washington, and the Bond Market Association, New York.

The letter said that from March 15 until May 14, 2006, spreads on ECAPs widened by around 5 basis points while spreads on corporate bonds in the same period widened by around 2 basis points. Because the Securities Valuation Office did not disclose specifics about the features of these ECAPs, hybrid securities with similar features “suffered from reduced prices and wider spreads as investors reasoned by analogy rather than insight,” the letter stated.

North Dakota Insurance Commissioner Jim Poolman said his compromise proposal for grandfathering hybrids issued before June 11 was an effort to give insurers a pass on existing holdings. It would also serve to show NAIC support for the decisions of the SVO as an “independent body whose constituency is the regulatory body and not the industry,” Poolman said. “The industry is not going to like every decision coming out of the SVO.”

Betty Patterson, a Texas regulator, urged that a decision on the issue be delayed for a brief time until both regulators and insurers could discuss the issue more fully. She said that risk-based capital is determined at the same time as annual statement filings and that there was a little time before regulators would have to make a decision.

Douglas Barnert, representing the National Alliance of Life Companies, Rosemont, Ill., said he supported the grandfathering proposal and delay on the treatment of securities until a determination could be made.