Most insurers want regulators to treat the hybrid securities they buy as debt, but many of the issuers would prefer to treat the capital they raise through the sale of hybrid securities as equity.
Rating agency insurance analysts talked about that conflict this week as they and regulators prepared for a July 13 public hearing in New York on risk classification of hybrid securities.
The Valuation of Securities Task Force and the Capital Adequacy Task Force of the National Association of Insurance Commissioners, Kansas City, Mo., plan to hold the hearing to give state insurance regulators a chance to hear more about the issue.
Regulators hope to get a better understanding of what hybrid securities are as well as the risks associated with hybrids, Michael Moriarty, a New York regulator, said during a recent NAIC conference call.
One topic to be discussed will be the economic impact changes in securities risk classification could have on “companies and players in the capital markets,” Moriarty said.
Lou Felice, a New York regulator and chair of the Capital Adequacy task force, says regulators need to come up with a long-term solution.
Options could include assigning a hybrid securities issue a lower class than a comparable debt issue might earn; simply treating some or all hybrids as equity; or finding some other solution, Felice says.
The NAIC’s New York-based Securities Valuation Office, an organization that values and assesses the credit quality of securities owned by state-regulated insurance companies, tends to assume that stock will be riskier than high-grade bonds and other high-grade debt securities. Because of that assumption, insurers must apply a discount, or “charge,” of 15% to 30% to the current market value of stock holdings when including stock holdings in risk-based capital calculations.
Traditionally, the SVO has treated hybrid securities, or securities that combine features of stock with features of debt securities, as if they were preferred stock.
But in March, the SVO reclassified $300 million in “Enhanced Capital Advantage Preferred Securities” or ECAPS, issued by Lehman Brothers Holding Inc., New York, as common stock.
The March reclassification caused spreads between ECAPS rates and Treasury rates to widen more than twice as much over the following 2 months as spreads between corporate debt securities rates and Treasury rates, according to financial services industry groups.
Insurers and industry groups are saying classifying hybrid securities as equity could hurt both insurers and the hybrid securities market.
Insurers and industry groups also are complaining about what they say is lack of information about how the SVO rates securities.
NAIC officials have left the SVO ruling in place while taking time to review the issue.