The leader of the National Association of Insurance Commissioners is siding with an NAIC investment-evaluation agency in a bitter dispute over the riskiness of securities that straddle the border separating debt from equity.

Alessandro Iuppa, president of the NAIC, Kansas City, Mo., has issued a letter stating that the decisions of the agency, the Securities Valuation Office, are “consistent with responsible regulation.”

The SVO “is not a rogue operation but functions under a set of guidelines established by regulators,” writes Iuppa, who is the Maine insurance superintendent as well as president of the NAIC.

The letter is dated June 19, and the NAIC today issued a press release emphasizing NAIC support for the SVO.

Iuppa and other NAIC officials have been responding to complaints by life insurers, bond issuers and industry groups about the SVO’s tendency to treat hybrid securities, or securities that combine equity features with bond features, as common stock rather than as debt.

The issue is important to life insurers because it affects how regulators calculate the insurers’ risk-based capital levels.

Because regulators assume that holding stock is riskier than owning debt, they use a discounting strategy, called a charge, to reduce the value of investments in stock when coming up with RBC figures.

The common stock charge is 30% for life companies and 15% for property-casualty companies.

In March, when the SVO reclassified $300 million in “Enhanced Capital Advantage Preferred Securities” or ECAPS, issued by Lehman Brothers Holding Inc., New York, as common stock rather than as preferred stock, that move caused spreads between ECAPS rates and Treasury rates to widen more than twice as much as spreads between corporate debt securities rates and Treasury rates, according to financial services industry groups.

Wider spreads on hybrid securities could sharply increase the issuers’ borrowing costs.

The NAIC addressed the issue earlier this month during its summer meeting in Washington, and it plans to hold a hearing on the issue this summer.

During the summer meeting, commissioners resisted industry calls for clear guidelines on the hybrid securities issue and instead decided to postpone making a final decision.

The American Council of Life Insurers, Washington, and the Bond Market Association, New York, have criticized the way regulators handled the hybrid securities issue at the summer meeting.

ACLI President Frank Keating says the way the NAIC handled the hybrid securities issue during the summer meeting was “extremely disturbing” to ACLI member companies.

“A clear disregard for the very legitimate concerns of the insurance industry and the capital markets was evidenced by the decisions that were made, as well as the decisions that were not made,” Keating writes in a letter dated June 15.

Issuing ratings on hybrid securities before the dispute has been resolved will make matters worse and hurt some companies, Keating writes.

But Iuppa argues that a preliminary NAIC analysis shows the hybrid securities decision will have little if any effect on the insurers that hold the securities.