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Regulators unanimously adopted guidance in a Jan. 14 memo issued by Mike Moriarty, Valuation of
Securities (VOS) Task Force chair and a New York regulator, during a conference call discussion.
NAIC through its Securities Valuation Office (SVO) in New York rates the securities holdings of
carriers to ensure they are operating on a sound financial basis.
The memo provides guidance for both 2007 filing requirements and guidelines for 2008. Guidance
for how to classify these bonds in 2007 is considered important because filing must be completed by
March.
For both life and property-casualty insurers, the possibility of a bond's SVO rating being dropped to
an NAIC-5 rating is a big consideration. An NAIC-1 rating is considered the highest rating by the
SVO.
Bond insurers' recent rating declines and threats of downgrades by rating agencies as a result of the
ongoing mortgage market crisis have concerned insurers who have part of their portfolios
guaranteed by these bond carriers. As a result, they turned to state insurance regulators for guidance
on how they should rate the bonds they hold in their portfolios.
Chris Anderson, a representative with Merrill Lynch, New York, thanked regulators on behalf of
insurers for their quick action in approving the memo.
For 2007 year-end reporting, the memo addresses all ACA bonds rated 'CCC' by Standard and Poor's,
the equivalent of an NAIC-5 rating.
During the call it was noted that the S&P underlying rating was being used as a reference to
underlying ratings available through all rating agencies.
Alan Close, who represented the American Council of Life Insurers, Washington, during the
discussion, said that how large an impact there is on insurers is difficult to determine because there
is really no analysis of the extent of the holdings of these guaranteed bonds in insurers' portfolios.
However, he said that in many cases, these bonds are not publicly traded. Still, Mr. Close said the
issue remains one of credit risk more than liquidity.
The impact is potentially different for life insurers and property-casualty insurers, according to Mr.
Close. Property-casualty insurers could be required to measure a bond at fair value, but for life
insurers, it would not necessarily result in marking the security to fair value, he explained. However,
for life insurers, Mr. Close continued, it could result in a change in risk-based capital requirements.
He compared the inability of a guarantee from a bond insurer to maintain the rating of a bond to a
reinsurer going into default and creating a loss of reinsurance coverage to the ceding company.
However, Mr. Close noted that the debt issuer is still liable for payments on the security.
He said the decision by regulators to approve the memo "gives companies some clarity regarding
reporting for 2007" as well as guidance for 2008.
By Andrew Ackerman
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WASHINGTON - A group of state insurance regulators next month will begin providing substitute credit ratings for
some of the municipal bonds held by insurers, to prevent a possible sell-off of those bonds due to the credit
crunch.
The ratings, to be issued by the securities valuation office of the National Association of Insurance Commissioners,
could be used as a substitute for the ratings provided by credit rating agencies on bonds backed by downgraded
insurers, to determine so-called risk capital assessments. These assessments determine how much capital insurers
must set aside based on the risk associated with each of their investments.
NAIC is taking action because many of the insured bonds held by insurance companies had their ratings withdrawn
after the bond insurer guaranteeing the security was downgraded to junk status and had no underlying rating to
fall back on. So far, only three insurers - Financial Guaranty Insurance Co., CIFG Assurance NA, and ACA Financial
GuarantyCorp. - have had at least one of their ratings downgraded to junk status, but NAIC is concerned that more
bond insurers could follow suit.
"This change puts us in a position to address proactively any issues if there is further degeneration in the overall
bond insurance market," said Wisconsin state insurance commissioner Sean Dilweg, who introduced the proposal.
Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC, said
the NAIC's proposal is "very significant" for insurance companies who have investment-grade standards for their
holdings. When the bond insurers were downgraded, it left many insurers who own munis in a "very exposed place"
because of the expectation that they may have to post additional capital, he said.
"Rather than be forced to allocate capital at levels that might not reflect their true credit quality, they're going to
step in and provide a substitute rating," he said.
Collectively, the insurance industry holds about $420 billion of municipal bonds, about $145 billion of which are
wrapped by insurance, according to the NAIC. The biggest holders of munis are life and casualty insurance
companies, which are taxed at rates that make munis favorable investments for them.
An analyst at an insurance company that is one of the largest purchasers of municipal bonds in the industry said
that munis are popular tools used to offset more risky investments in an insurers' portfolio. The analyst, who did
not want to be identified, said munis provide the best after-tax, risk-adjusted return for the credit quality the
insurance companies take on when they purchase them.
The NAIC has provided numerical "designations" for muni bonds for insurers for about a century, but previously was
unable to provide designations that were higher than the ratings provided by a credit rating agency. Essentially,
the proposal, which the NAIC plans to implement before final approval it in September, will "decouple" the NAIC
rating from the rating agency process, said Michael Moriarty, deputy superintendant in the New York State
Insurance Department. And instead of rating the security for insurers, NAIC will be assessing the creditworthiness
of the municipality or authority that issued the debt, he said.
Under the proposal, the NAIC will provide numerical ratings on a scale of 1 to 6. Munis rated "1" or "2" will be
considered investment grade, with "1" equivalent to A-minus, A3, or better, while "2" will be equivalent to triple-B.
Meanwhile, ratings 3 through 6 will be considered below investment grade, with a "6" being considered a "near
default bond," according to Mikaela Reck, public information officer for Dilweg.
Moriarty said that the NAIC's securities valuation office will review public records and financial statements to come
up with a rating in about a week's time, depending on the size of the municipality or authority, stressing that it will
not be as in depth as a review by a credit rating agency.
"It would be kind of a 'light' rating agency type of review, but we feel it would give a fairly accurate assessment of
the creditworthiness for the calculation of the risk-based capital that the company is required to hold," he said.
Market participants said yesterday that the NAIC's proposal was a step in the right direction.
But the analyst at the insurance company had mixed feelings about the proposal. He said many research analysts
have been laid off in recent years as the market has come to rely more heavily on ratings from the nationally
recognized credit rating agencies and fewer buy-side firms are performing their own analysis of underlying muni
credits, he said.
"NAIC needed to do something and they'll probably do an okay job, but the bottom line is the marketplace needs to
step up and begin to evaluate assets again," he said
NAIC evaluates the holdings of insurers, and based on how the NRSROs rate the carriers' securities,
the NAIC sets a minimum required amount of capital reserves that the insurer most hold against
possible equity losses, Mr. Finer said.
Mr. Finer said there was a "view that there's been an overreliance on rating agencies," mentioning
recommendations by the U.S. Treasury and the Group of 20 Finance Ministers and Central Bank
Governors.
He said the NAIC Rating Agency Working Group, which has invited insurance companies, pension
funds and others to testify on the NAIC reliance on NRSRO ratings, will among other things ask
about ratings of "structured securities where there's been a problem."
As an example, he mentioned residential- mortgage backed securities that plunged in value after
receiving satisfactory ratings from the NRSROs.
Mr. Finer said the Working Group has sent the NRSROs questionnaires and have received
"voluminous responses that were quite helpful," but he said the NAIC wants clarification of some
questions that were not answered completely.
NAIC, he said, does not believe the NRSROs have a monopoly on good rating models for securities,
and the organization may perhaps use "another vendor to do some calculations and use those to
develop and appropriate capital charge" for insurers.
The organization wants to "see if anybody else has a better mousetrap that can provide better
warnings and more transparency," noting that there "are a lot of folks that have very advanced
models that are quite state of the art.
He mentioned Black Rock, Risk Metrics and Andrew Davidson among other firms.
Rating firms that were contacted had no immediate comment.
In its announcement of the hearing, which will be held at Gaylord Convention Center in National
Harbor Md., the NAIC noted that insurance companies hold nearly $3 trillion in rated bonds, and
the insurance industry constitutes the largest sector of the financial services industry to rely on credit
ratings to supervise capital asset adequacy.
Insurance regulators, it noted, currently mandate the use of credit ratings to determine capital
reserves and other regulatory requirements for insurance companies.
The Working Group is co-chaired by Acting New York Insurance Superintendent James J. Wrynn
and Illinois Insurance Director Michael T. McRaith.
According to the announcement, the hearing will examine the historical reliance of insurance
regulators on ratings and the impact of this reliance.
Issues concerning ratings, particularly related to structured securities and municipal bonds, recent
systemic remedies or procedural changes enacted by NRSROs, recommendations and alternatives to
NRSROs for prudential regulation, will also be looked at.
Following the hearing, the Working Group said it will develop and present a final report
documenting the findings and any recommendations for corrective action available to the NAIC and
its members, as well as recommendations to the federal government on NRSRO regulation.
organization of the chief insurance regulatory officials of the 50 states, the District of Columbia and five
U.S. territories. The NAIC has three offices: Executive Office, Washington, D.C.; Central Office,
Kansas City, Mo.; and Securities Valuation Office, New York City. The NAIC serves the needs of
consumers and the industry, with an overriding objective of supporting state insurance regulators as
they protect consumers and maintain the financial stability of the insurance marketplace. For more
information, visit www.naic.org.