Lingering confusion about the risk classification of hybrid securities could scare investors away from the insurance sector and threaten some companies’ financial stability, insurers and investment banks say.

Representatives for the insurance and investment banking industry called for quick action on the treatment of hybrid securities here at the summer meeting of the National Association of Insurance Commissioners, Kansas City, Mo., during a meeting of the NAIC’s Financial Condition Committee.

But regulators said they have a duty to study such a complicated topic carefully before making a decision.

The Financial Condition Committee decided to hold a joint public interim hearing on the topic with the Valuation of Securities Task Force and the Capital Adequacy Task Force.

The committee also decided that the decision of the Securities Valuation Office, a New York-based securities rating arm of the NAIC, will stand at least for now and that securities classified as equity will still be classified as equity while the matter is under review.

At press time, North Dakota Insurance Commissioner Jim Poolman reportedly was still trying to implement a compromise that would let insurers continue to classify hybrid securities they already own as debt but require them to classify newly purchased hybrid securities as stock.

Hybrid securities are securities that combine characteristics of both debt securities and equity securities. They may include features such as notes that can be converted into common stock or warrants that give holders the right to buy stock.

The Securities Valuation Office stunned the hybrid securities market March 15, by reclassifying $300 million in “Enhanced Capital Advantage Preferred Securities,” or ECAPS, issued by Lehman Brothers Holdings Inc., New York, as common stock, rather than as preferred stock.

Insurers and investment bankers had assumed that the SVO would treat ECAPS and other hybrid securities as the equivalent of preferred stock.

Between March 15 and May 14, market confusion about the SVO assessment of ECAPS caused spreads on ECAPS to widen by 0.05 percentage points, while spreads on corporate bonds widened by just 0.02 percentage points, officials at the American Council of Life Insurers, Washington, and the Bond Market Association, New York, have written in a joint letter about the reclassification.

If the NAIC fails to make a decision by September and clarify its position on hybrid securities, that could hurt the insurance sector, according to Chris Anderson, an investment analyst with Merrill Lynch, New York.

Investors say they are concerned about being in the insurance market because of the “regulatory event risk” that regulators are creating, Anderson reported.

“If I were an insurance company investor, I’d be selling now because of the lack of clarity,” Anderson said.

Tom Considine, an executive in the Long Island City, N.Y., office of MetLife Inc., said regulators are “not grasping the market implications here.” He said the additional risk-based capital charge could cause the industry to take a $3 billion hit in the marketplace because of the additional risk-based capital requirement.

The additional risk-based capital charge could jeopardize the financial security of smaller companies, Considine added.

Al Gross, chair of the Financial Condition Committee and Virginia insurance commissioner, said regulators need to focus on their work.

“Our responsibility is to respond as regulators,” Gross said. “This motion [to hold an interim meeting] addresses what we need to be worried about.”

Regulators need to focus on their responsibility because if they do something, that is construed to be a message to the market, and if they don’t do something, that also is construed to be a message to the market, Gross said.

Poolman said the Financial Condition Committee’s decision to hold an interim meeting “affirms the process that we abide by SVO and NAIC decisions.”