Officials at the National Association of Insurance Commissioners will be looking at a wide range of strategies for handling concerns about risk classification of hybrid securities.

Alessandro Iuppa, Maine insurance superintendent and president of the National Association of Insurance Commissioners, Kansas City, Mo., talked about the options here Thursday during a hearing on the hybrid securities issue.

The NAIC could create a separate risk classification category for hybrid securities, or it could follow the example of the rating agencies and assign hybrid securities somewhat lower debt ratings than pure debt securities would receive, Iuppa said.

The details of any proposals will depend on technical input, Iuppa said.

Insurers will not be part of the group of regulators working on the issue, but they will be able to contribute ideas as a solution is developed, Iuppa said.

New York Superintendent Howard Mills, who was chairman of the hearing, said the first step will be to address questions about risk-based capital treatment for hybrids and to have an absolute resolution to concerns about transparency by the end of the year.

The NAIC’s Valuation of Securities Task Force and the Capital Adequacy Task Force held the hybrid securities hearing because of insurers’ complaints about a recent risk classification decision made by the NAIC’s Securities Valuation Office.

The SVO, the NAIC’s securities rating arm, reviewed hybrid securities issues at the request of New York insurance regulators.

The SVO concluded that the NAIC should treat the hybrid securities reviewed as equity rather than as debt.

If the SVO and the NAIC stick with that position, large insurers might have to subtract 30% from the value of hybrid securities holdings when computing risk-based capital ratios.

Small insurers might have to discount hybrid securities holdings by almost 60%, and that change could be enough to lead to credit rating downgrades, according to according to Robert Peterson, who spoke for Shenandoah Life Insurance Company, Roanoke, Va.

Hybrid securities issued by high-grade issuers offer a very low risk of insolvency and trade like high-quality bonds, said Stephen Kandarian, chief investment officer of MetLife Inc., New York.

Instead of protecting insurers’ finances, treating hybrid securities as if they were equities would hurt insurers, by forcing insurers to sell otherwise low-risk securities to hedge funds at greatly reduced prices, Kandarian said.

“There will be a wealth transfer from insurers to others,” Kandarian warned.

Kandarian gave Yankee Tier I hybrids as an example of the effect of the SVO rating decision.

Insurers hold 60% of the $75 billion in Yankee Tier I hybrids, Kandarian estimated.

Brokers that once had an easy time selling $50 million in Yankee Tier I hybrids at a time now have trouble moving $10 million, Kandarian reported.

The new uncertainty about hybrids’ risk classification already has cut the value of insurers’ $45 billion in hybrid securities holdings about $1 billion, Kandarian said.

Also at the SVO hearing:

- Mary Kuan, assistant general counsel of the Bond Market Association, New York, said her group’s members want more information about classification decisions and specific reasons for classification decisions.

- Eric Goodman, president of AEGON USA Investment Management L.L.C., Cedar Rapids, Iowa, supported the idea of using “notching,” or reductions in credit ratings, to reflect any concerns about hybrid securities’ level of risk. That would be far less punitive than treating hybrid securities as stock, Goodman said.

- Ed Stephenson said the SVO either misunderstood or ignored the provisions of the SVO purposes and procedures manual.

The SVO should have brought the hybrid securities risk issue classification issue to the SVO Task Force for its consideration, according to Stephenson, who spoke for the National Alliance of Life Companies, Chicago, and the National Association of Mutual Insurance Companies, Indianapolis.

After the hearing, Iuppa said the SVO had followed NAIC procedures, and he noted that the SVO had acted at the request of a state insurance department.

- Some speakers suggested that insurers and hybrid securities issuers could cope with any concerns about risk classification by asking the SVO for an advance rating review before doing a hybrid securities deal.

But getting an advance rating can already take more than 30 days, and issuers could end up making hundreds of requests each year, said Jim Renz, director of accounting policy at the American Council of Life Insurers, Washington.

SVO Managing Director Chris Evangel reported that the SVO has gotten 10 advance rating requests since the current hybrid securities controversy erupted. In the past, the SVO got about 6 to 8 requests for advance reviews per year, Evangel said.