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NAIC May Change SVO Designations Use Rules

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Regulators should find a new way to keep insurers from using the Securities Valuation Office as a borrower stability monitor, an SVO official says.

The Valuation of Securities Task Force at the NAIC, Kansas City, Mo., has posted a copy of a memorandum about the topic on its section of the NAIC website.

Robert Carcano, SVO senior counsel, wrote the memo and addressed it to Matti Peltonen, chair of the task force, and to other task force members and other interested persons.

The SVO is an arm of the NAIC that helps regulators evaluate insurance company investments by classifying the riskiness of many investment vehicles.

The NAIC lets insurers decide whether to use the ratings issued by credit rating agencies as “triggers” for changes in the terms of private contracts.

But the NAIC prohibits insurers that are acting as lenders from using changes in SVO risk classification designations of the borrowers as triggers for renegotiating loan terms.

If an insurer uses information about an SVO designation change against a borrower, that “would have the effect of transforming an analytical decision with regulatory implications made by the SVO on behalf of regulators into the catalyst for an economic impact on a private party,” Carcano writes. “This, in turn, would increase the potential for NAIC legal liability, given that an issuer might allege that a credit opinion expressed by the SVO, or indeed the failure of the SVO to update a credit opinion, precipitated, either independently or in tandem with other events, funding issues that caused it financial harm.”

As the NAIC sees it, “the SVO is not obligated and is also not organized to bear primary responsibility for monitoring the financial condition of issuers,” Carcano writes.

Today, SVO analysts try to enforce the prohibition on use of SVO designation rating triggers – and on risk-based capital levels, which are usually related to SVO designations – by asking insurer-lenders from removing SVO designation trigger provisions from transaction filings.

In practice, insurers find removing the trigger provisions to be difficult and expensive, Carcano writes.

“In addition, depending on the transaction and how many insurers hold it, it could be destabilizing to markets,” Carcano writes. “In other instances, the language is found so close to the year-end process that enforcement of the prohibition against assessing its risk carries with it the potential for the disruption of reporting processes for major insurers.”

The SVO staff has decided that, instead of the SVO continuing to try to get insurers to remove the designation-related provisions, a better approach would be to “place all practical and legal responsibility for engaging in this prohibited practice clearly and squarely on the insurer,” Carcano writes.

The NAIC could put the responsibility on the shoulders of the insurers by replacing the effort to root out the designation-related provisions with a disclaimer, Carcano writes.

Carcano provides suggested language for the disclaimer.

Insurers would be advised in the disclaimer that, “The NAIC disclaims any and all responsibility whatsoever for surveillance of insurance company investments for purposes of identifying when a deterioration of the borrower’s credit quality or other risk attribute suggests that the insurance company should adjust the financial terms of the original transaction to obtain a different overall investment return or compensation for the risks involved.”

The SVO designations “are not published as investment advice to insurance companies and might lack necessary attributes that would make them suitable for use as investment advice,” according to the proposed disclaimer text.


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