Regulators have come up with a short-term method for evaluating the riskiness of the hybrid securities held in insurers’ investment portfolios.

Members of the hybrid risk-based capital working group at the National Association of Insurance Commissioners, Kansas City, Mo., endorsed the short-term measure here at the NAIC’s fall meeting.

Members of the working group endorsed 1 of 5 methods proposed, and advocates of the approach that was recommended hope it will be the basis for short-term rating guidelines that will win approval from the full NAIC membership by the end of the year.

The NAIC’s Financial Condition Committee and its executive committee must approve the short-term hybrid securities proposal before the full NAIC membership can vote on it.

The hybrid RBC working group also is teaming with the American Academy of Actuaries, Washington, and insurance industry representatives to develop a long-term approach to rating hybrid securities.

Hybrid securities are securities that combine features of stock with features of debt securities. Financial experts say efforts to grapple with the issue will affect the way insurers value tens of billions of dollars in portfolio assets.

According to the NAIC, the short-term hybrid risk rating approach endorsed by the hybrid RBC working group would:

- Take effect at the earlier of Jan. 1, 2008, or after adoption of a long-term proposal by the NAIC.

- Treat all defined hybrid securities as preferred stock.

- Cut 1 NAIC rating designation, or notch, from the ratings of all hybrid securities issued after Aug. 18, 2005, and from those hybrids classified in 2006 by the NAIC’s Securities Valuation Office as common stock.

- Not notch hybrid securities classified by the SVO as preferred stock in 2006.

- Treat hybrid securities classified by the SVO as debt in 2006 as debt.

- Treat all future hybrids as preferred stock and notch them down by 1 NAIC designation, unless those hybrids are classified as debt by the SVO.

Under the terms of the short-term hybrid rating measure, “an insurer holding a notched hybrid security issued subsequent to the effective date of this proposal may request an SVO review of the security in an attempt to eliminate the notch,” the NAIC says.

In the long run, there will be an attempt to determine the risk associated with hybrid securities and to come up with a factor that will reflect those risks, according to Lou Felice, the New York insurance regulator who is chair of the hybrid RBC working group.

During the discussion of the hybrid rating issue, Jim Renz, a representative from the American Council of Life Insurers, Washington, and Tom Considine of MetLife Inc., New York, said the measure that the hybrid RBC working group endorsed was a fair compromise.

Mary Kuan, a representative from the Bond Market Association, New York, said her organization could support the compromise but prefers 1 of the other proposals that the working group considered.

That proposal would define each hybrid as a bond or preferred stock according to the debt-equity guidelines of the SVO, Kuan said.

Under the terms of that proposal, the SVO would take the rating issued to each hybrid by the major securities rating agencies and lower that rating 1 notch for statutory reporting purposes.

In the long-term, according to Felice, there will be an attempt to determine the risk associated with hybrid securities and to define a factor to those risks.