A team at the American Academy of Actuaries is taking an in-depth, “blank sheet” look at risk assessment of hybrid securities.

Nancy Bennett, chair of the invested asset working group at the AAA, Washington, gave a rundown of the working group’s efforts recently during a conference call organized by the hybrid risk-based capital working group at the National Associational Association of Insurance Commissioners, Kansas City, Mo.

Bennett, a vice president with Ameriprise Financial Inc., Minneapolis, said the working group has developed a set of questions for insurers to help it get a better understanding of the hybrid market.

The questionnaire includes general questions about the nature of the hybrid market and specific questions about how the responding companies manage their own hybrids.

The working group will look at the concerns facing the interested parties, including the NAIC’s Securities Valuation Office, Bennett said.

If all goes well, the working group could have a preliminary report available in time for the NAIC’s summer meeting in June, Bennett said.

The working group could end up reviewing the RBC factors for assets as well as for liabilities, or even considering ways to apply a “principles-based” approach to actuarial analysis to the asset side of RBC calculations, Bennett said.

“Many of the asset factors have not been looked at in a long time,” Bennett said.

The practicality of taking a principles-based approach to RBC asset calculations still needs to be explored, Bennett said.

During the conference call, Mary Kuan, a vice president with the Securities Industry and Financial Markets Association, New York, repeated arguments previously made by SIFMA and the American Council of Life Insurers, Washington, that rating agencies’ hybrid ratings already capture any risks that hybrid securities might pose for insurer-investors.

The SVO has argued that rating agency ratings of hybrids may not reflect all relevant risks.

The AAA working group members already operate under the assumption that the rating agency ratings may not capture certain risks, such as the risk that a slowdown in prepayments will extend the life of a hybrid security, but the question is to determine how important that risk is, Bennett said.

In other hybrid rating news:

- Principal Financial Group Inc., Des Moines, Iowa, already has started answering the AAA’s questions about hybrids.

Julia Lawler, chief investment officer at Principal, writes in a response to the questions that “extension risk” can be an opportunity as well as a risk. The shift can create an income bonus when coupon payments suddenly become floating-rate payments, Lawler writes.

In an answer to a question about risk and experience studies, Lawler writes that deferred hybrid payments are correlated with debt default.

Analysts at a Principal affiliate have found that 14 of the 19 issuers that have deferred hybrid payments since 1993 have also defaulted on ordinary debt and filed for Chapter 11 bankruptcy court protection, Lawler writes.

- The London office of Standard & Poor’s Ratings Services has commented on its criteria for rating European hybrid capital issues that include mandatory deferral language.

S&P looks in the comment at when it could make hybrid ratings just 2 notches lower than ratings for a company’s other securities and when it would make the hybrid rating 3 or more notches lower.

A notching difference of 3 or more would reflect a realistic possibility of an issuer being forced to defer on a given issue against its will while it continues to service its other, discretionary hybrid issues on time and in full, according to S&P.

But a notching decision would reflect whether the particular issue’s mandatory deferral mechanism had real substance, S&P says.