A key member of the House says the National Association of Insurance Commissioners should be more open about how it values securities.
Rep. Richard Baker, R-La., chairman of the Capital Markets Subcommittee of the House Financial Services Committee, made that point here today at a hearing on “Improving Transparency in State Regulation of Insurer Investments.”
Baker held the hearing to review how the Securities Valuation Office of the NAIC, Kansas City, Mo., has gone about rating hybrid securities, or securities that have characteristics both of debt and of equity.
The NAIC is like an “elephant’s foot” because of its potential effect on U.S. competitiveness in the global securities market, Baker said at the hearing. “[The foot] has a major impact when it hits the ground.”
Baker joined with Michael Hunter, chief operating officer of the American Council of Life Insurers, Washington, and Kevin Conery, a representative of the Bond Market Association, New York, in complaining about the SVO approach to explaining risk-classification decisions.
Because the SVO gives specific information about risk-classification decisions only to holders of the securities, the current system allows some parts of the market to learn of SVO decisions before other parts do, Baker, Hunter and Conery said.
“Key securities valuation information is discovered by certain parties randomly and at different times,” Conery said.
In the past, insurers and hybrid securities issuers have assumed that the SVO would see the securities as safe equivalents to ordinary bonds, but the SVO said in March that it believed some hybrid securities were more like equity securities.
Because regulators assume that stock prices are more volatile than bond values, they require life insurers to apply a substantial discount when including equity investments in risk-based capital calculations.
Securities firms have complained that confusion about hybrid risk classification has hurt their ability to issue the securities.
State officials are taking concerns about the SVO seriously, NAIC President Alessandro Iuppa, the Maine insurance superintendent, said at the hearing.
“The NAIC is continuously evolving and improving to keep up with the changing markets, and I am confident in the integrity of our open and transparent process,” Iuppa said. “Nonetheless, like any effective organization working in a dynamic market, we have initiated a review with respect to the issue of disclosure and transparency of our classification process covering hybrid securities in order to identify any improvements that should be made.”
Iuppa told the Capital Markets Subcommittee that a task force led by the New York State Department of Insurance will give commissioners a report on hybrid securities valuation and valuation disclosure by Dec. 12.
Meanwhile, the NAIC likely will be adopting an interim solution proposal that was endorsed last week by an NAIC working group. Under the provisions of the interim solution, a typical hybrid security would either be treated as if it were a debt security or else receive a rating only 1 notch lower than the rating that might be given to a comparable debt security issued by the same company.
Another proposed interim solution could allow some parts of the market limited but free access to the SVO Web site, Iuppa said.
Iuppa said SVO risk classification decisions are aimed at insurance regulators, not issuers or the general investing public. The SVO process is transparent for regulators and insurers, Iuppa said.
Forcing the SVO to behave like an ordinary rating agency would hurt its ability to act as a centralized regulatory advisor, Iuppa said.
Regulators need to be able to talk to insurers about the insurers’ portfolios without the issuers and broker-dealers listening in, Iuppa said.
Iuppa defended the NAIC’s decision not to accept the hybrid securities rating decisions of the national credit rating agencies.
The rating agencies do not always account in their ratings for all of the investment risks considered by the SVO, Iuppa said.
Iuppa also defended the SVO’s March decision.
“Although some asserted that our reclassification of a relatively small number of securities would have dire consequences, we have uncovered no insurer that would become financially impaired or unable to meet the minimum capital and surplus level required by our risk-based capital formula as a result of these decisions,” Iuppa said.
Hunter, the ACLI representative, estimated the SVO decision led to a total decrease in market value in the hybrid securities market of about $1 billion.
But the NAIC’s interim solution does appear to be working, Hunter testified.
“We anticipate a favorable response to this solution by the capital markets and expect to experience a recovery of some of the market value and liquidity in the market for hybrids,” Hunter said.
Links to copies of the written testimony are on the Web at Document Link