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New Proposals Advanced To Settle Hybrid Securities Issue

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Regulators will discuss 2 additional proposals, and possibly a third, on reserving for hybrid securities at upcoming meetings.

In talks to be held Aug. 24-31 by the National Association of Insurance Commissioners, Kansas City, Mo., regulators hope to advance a short-term proposal on reserving for hybrids. The draft proposals would be presented at the fall national NAIC meeting in St. Louis Sept. 9-12.

Rating treatment of hybrid securities by the NAIC’s Securities Valuation Office raises concern among both insurers and Wall Street because of the potential impact on the market for these investment vehicles as well as the risk-based capital and reserving charges companies will face because of these ratings. Ratings would reflect the heavier charges for hybrids, which are more like common stocks than they are like bonds.

The goal of the effort is to “balance the potential additional capital in the short run with a clear message that will facilitate those changes without rattling the markets,” according to Lou Felice, a New York regulator chairing the working group.

Jim Renz, director-accounting policy with the American Council of Life Insurers, Washington, says if changes are made, then a “proper” rather than a “quick” solution is needed, even if that means holding off on a final decision until after the fall national meeting.

The new scenarios are in addition to 3 proposals submitted to the NAIC that are already available for comment. And the ACLI is promising to develop a scenario of its own to be considered during the exposure period.

The two new scenarios are:

Scenario 2A: the SVO classifies hybrids as preferred stock, including securities the SVO previously exempted from filing. The classification would be accompanied by a single rating notch to reflect regulators’ risk assessment of those securities. No additional notching would be done for securities with common stock characteristics. Insurers could still seek bond status for filing exempt hybrids.

Scenario 2B: Securities defined as hybrids would be considered preferred stock, including filing-exempt securities. The preferred stock classification and a single rating notch would apply to those securities but not to filing-exempt securities. Additional ratings of up to 2 notches may be considered for those preferreds with common stock characteristics. FE hybrids could still be considered for bond status.

The two new scenarios supplement three scenarios that were offered earlier:

Scenario 1: Bonds and preferred securities for life companies would receive the same factor based upon designation (0.4% to 20%.) Bonds and preferred securities for property-casualty and health insurers would receive the same factor based upon designation (0.3% to 30%.)

Scenario 2: No hybrids would be reported as bonds, and preferred securities would be treated the same as Scenario 1.

Scenario 3: Hybrids would receive the same treatment as Scenario 1 except that life unaffiliated common stock would receive a 30% default factor adjusted by an insurer’s beta or volatility measure to a minimum of 15%. Property-casualty and health unaffiliated common stock would receive a 15% factor. And all affiliated common stock would be a percentage of risk-based capital or other calculation by type of affiliate.