Hybrid Securities Command Industry's Attention

With the uncertainty surrounding these securities, Kandarian said, the brokerage community has “seized up,” and a market that used to be able to move $50 million in these securities now has trouble moving $10 million transactions. Spreads have widened by 30 basis points, which means that on $45 billion in securities held by the industry, the value is down by $1 billion.

If the matter is not addressed, he says, insurers will have to sell these securities, and in an illiquid market, hedge funds will purchase them at greatly reduced prices. Consequently, according to Kandarian, “there will be a wealth transfer from insurers to others.”

Eric Goodman, president and CIO of AEGON USA Investment Management L.L.C., Cedar Rapids, Iowa, said hybrids are fixed income securities and are issued by high-quality financial institutions, even though he did acknowledge that they can be highly subordinated and have features specific to an issue that can increase risk. Capital treatment as equity is punitive, he said. One potential solution would be for the SVO to use a notching system that would reflect the actual risk in an issue, he said.

Speaking about the impact on small companies, Robert Peterson, representing Shenandoah Life Insurance Company, Roanoke, Va., said the RBC impact can be even more severe. For instance, he said if a higher RBC charge is assessed, that percentage is multiplied by a factor in rating processes such as with A.M. Best & Co., Oldwick, N.J. So, in Shenandoah’s case, a 30% RBC charge would be multiplied by 1.95 for a capital charge of 58.5%. Such a charge could result in a downgrade, which, he said, makes it more difficult to operate given the competitive life insurance selling environment.

Trade groups also weighed in. Transparency of both a classification decision and the specific reason for the decision was argued by Mary Kuan, vice president and assistant general counsel with the Bond Market Association, New York.

Jim Renz, director of accounting policy with the American Council of Life Insurers, Washington, said the option to get an advance rating review from the SVO will result in hundreds of such requests. A recent request took 34 calendar days after filing for a determination to be made, he continued.

Procedure as outlined in the SVO’s purposes and procedures manual either has not been understood or has been ignored, according to Ed Stephenson for Barnert Associates, New York. Stephenson was representing the National Alliance of Life Companies, Rosemont, Ill., and the National Association of Mutual Insurance Companies, Indianapolis.

The proper procedure when there is a major policy question, according to Stephenson, is to bring the issue to the SVO task force for consideration, he said.

His remarks were greeted by spontaneous applause from hearing attendees.

Regulators, for their part, tried to put the issue in perspective. During the hearing, Roger Sevigny, New Hampshire insurance commissioner and NAIC Secretary Treasurer, noted that hybrids had different terms and call features and could not just be classified in one way.

North Dakota Insurance Commissioner Jim Poolman asked whether the advance rating option was used often and was told by Chris Evangel, SVO managing director, that there might be about six to eight requests annually. However, since the issue over hybrids began, there have been 10 requests, he said.

After the hearing, the NAIC’s Iuppa disputed the assertion that SVO policy had disrupted the market. “Market disruption is something that happened after Enron” and not as a result of an SVO classification decision, he said. He noted that regulators’ primary responsibility was to ensure the solvency of companies and consumer protection. And, Iuppa disputed the assertion that the SVO had disregarded procedure, noting it had followed procedure and had acted at the request of a state insurance department.