A short term solution for regulatory rating of hybrid securities was reached during the fall meeting of the National Association of Insurance Commissioners here.

In a 6-month turnaround, the Hybrid Risk-Based Capital working group adopted 1 of 5 scenarios considered by the working group to establish rating guidelines that would be ready by year-end 2006. The working group, under the direction of Lou Felice, the group’s chair, will also develop a long-term approach for rating hybrid securities. That effort will involve the American Academy of Actuaries, Washington, and investment professionals in the industry.

The short term solution was advanced to the Financial Condition “E” Committee, adopted by that committee on Sept. 12, and will be taken up by the NAIC’s executive committee and plenary by the NAIC winter meeting in December.

According to the NAIC, the short term solution is as follows:

“The short-term solution that was adopted, effective at the earlier of Jan. 1, 2008 or adoption of a long-term proposal by the NAIC, would report all defined hybrid securities as preferred stock. The proposal also calls for all hybrid securities issued after Aug. 18, 2005, and those hybrids classified in 2006 by the SVO as common stock to be notched down by one NAIC rating designation. Those hybrid securities classified by the SVO as preferred stock in 2006 will not be notched. Those hybrid securities classified by the SVO as debt in 2006 will be reported as debt. All future hybrids will be reported as preferred stock and notched down one NAIC designation unless they are classified as debt by the SVO.

“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.”

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.

During the discussion with the working group, Jim Renz, accounting director with the American Council of Life Insurers, Washington, requested that trust preferred securities be excluded from the definition of hybrid securities, noting that as recently as the end of August they had been defined as preferred stock.

Mike Moriarity, a New York regulator responded that as part of the long-term solution, trust preferred securities will be looked at.

Renz and other interested parties including Tom Considine of MetLife, New York, said that the decision by the working group represented a fair compromise. Mary Kuan, a representative with the Bond Market Association, New York, said that while her organization could support the compromise, they still preferred another scenario that had been examined by regulators. That scenario, according to Kuan, would define all hybrids as a bond or preferred stock according to the debt/equity guidelines of the SVO. Under that scenario, all defined hybrids would receive a single downward notch to the nationally recognized securities rating organization (NRSRO), for statutory reporting purposes.

Steve Broadie, a representative with the Property Casualty Insurers Association of America, Des Plaines, Ill., said that the decision represented a compromise. He said that the decision of the NAIC’s Valuation of Securities Task Force to hold ratings in abeyance until the issue was researched was one that PCI supported. At the June NAIC meeting in Washington, the VOS voted to hold a decision on hybrid securities in abeyance until the matter was discussed further. The VOS’ parent, the “E” Committee, overruled that decision, initiating a hearing which resulted in the formation of a hybrid securities working group which was charged with coming up with both a short-term and a long-term decision.