The NAIC’s Valuation of Securities (VOS) Task Force decided it was good to hope for the best but prepare for the worst when it voted today 11-2, with abstentions to adopt a controversial proposal that will likely result in life insurances having to increase their risk-based capital for their mortgage backed securities.
Life insurers are concerned that with the VOS Task Force, in targeting a higher capital number rather than retaining the fundamentals-based capital system for RMBS and CMBS, will make it very hard for insurance companies to plan for capital or to purchase securities with predictable capital impacts.
The proposal took a more conservative path than some regulators and the life insurance industry had wanted. The proposal, if and when adopted by the NAIC, affects the assignment of particular RMBS/CMBS securities to rating categories.
The NAIC has been looking into the potential for volatility in U.S. insurer holdings of RMBS.
According to the NAIC’s Capital markets Bureau special report, Potential for Volatility in U.S. Insurer Holdings of Residential Mortgage-Backed Securities, total RMBS exposure as of the end of 2011 was $123.2 billion. This is compared with a total par value of $151.5 billion for a weighted average price of $81.30.
The NAIC found that, though it is a relatively small percentage of the industry’s holdings, there are bonds within the group of 18,459 that were modeled by the NAIC that have profiles that are potentially problematic. These bonds demonstrate a substantial amount of downside risk if the market environment turns negative relative to those assumptions used in the year-end modeling, without a significant amount of upside potential.
An issue worth considering, according to the report, is whether the current framework properly addresses the additional volatility that is represented in those securities. The current formula applies the same weighting and approach to all RMBS, regardless of their volatility characteristics.
Perhaps this paved the way for the VOS Task Force decision to introduce a more conservative bias into the modeling, despite protests from the life insurers that the housing market has been recovering, by changing the weighting of the pessimistic housing percentages from 25 percent to 40 percent, creating an increase in risk-based capital required to be held for the RMBS and CMBS securities once the measure is adopted by the NAIC.