The New York State Insurance Department wants insurers to be careful with the collateral backing their securities lending operations.

The New York department recommends in Circular Letter Number 16 (2008) that insurers that have securities lending operations make sure that they have identified all risks and established strategies for managing those risks.

“The department will place more emphasis on securities lending activity by evaluating how well insurers are managing these risks in upcoming examinations and inquiries,” Matti Peltonen, capital markets bureau chief, writes in the letter.

Matti also urges insurers with securities lending operations to make sure they are complying with new securities lending reporting rules that will take effect when insurers prepare their 2008 annual statements.

Insurers with securities lending operations try to squeeze higher returns from their portfolios by lending securities to broker-dealers, hedge funds and other parties that are “shorting” those securities, or conducting financial transactions based on the assumption that the prices of the securities involved will fall.

Traditionally, insurers have parked the cash they are using as collateral for the securities in what were viewed as conservative investments, such as insured and high-rated mortgage-backed securities.

In the past 6 to 12 months, however, market turmoil has hurt the value of securities that once appeared to be safe. Insurers have found that the value of securities lending collateral invested in those securities has declined significantly, Peltonen writes.