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State Insurance Regulators Approve New Rating Methodology Proposal for Home Debt

Source: WSJ

Posted on 06 Nov 2009

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State insurance regulators Thursday approved an insurance-industry proposal to adopt a new methodology for sizing up risk in insurers' big holdings of residential-mortgage bonds, eliminating for this year a longstanding use of ratings from the major ratings firms.

"We have a model in front of us that is basically broken," said Matti Peltonen, a regulator in New York. "We are under an obligation to fix something that is broken."

Consumer groups complained the move could weaken protections for policyholders, but just a handful of states voted against it.

The development, while expected, is a blow to ratings firms that have been criticized since the housing crisis; insurers are one of the biggest users of ratings.

The National Association of Insurance Commissioners, which voted Thursday, now will proceed to hire a consulting firm. The firm, in turn, will help the organization review bids from risk-advisory firms for the valuation work. The high-profile assignment involves assessing potential losses in about 18,000 different residential-mortgages securities held by insurers.

The assessments will be used in the insurers' financial filings for calendar year 2009, while regulators continue to discuss a longer-term solution to what they say is an overreliance on the major ratings firms for various types of assets.

The American Council of Life Insurers, an industry trade group, has estimated that the NAIC's existing ratings-based capital guidelines would require the industry to boost risk-based capital by $9 billion by year-end to back up residential-mortgage bonds that were downgraded in waves earlier this year from investment grade to "junk." The amount represents less than about 10% of the industry's risk-based capital, according to regulators.

One of the biggest concerns of the trade group and the regulators voting in favor of the proposal is that a junk rating signals probability of a default, but doesn't speak to the size of any potential loss. The current methodology also doesn't take into account whether insurers already have written down the bonds to reflect potential losses.

The regulators said they would use conservative assumptions in assessing the bonds. In their conference call Thursday, regulators supportive of the change noted it had been under discussion since the spring and, in NAIC hearings this fall, the ratings firms themselves said the ratings shouldn't be relied on exclusively as a tool to determine capital to back up the mortgage bonds.

Officials already have talked to analytical firms including BlackRock Inc., Promontory Financial Group; and Andrew Davidson & Co. to determine whether the job can be completed by year-end. Regulators declined to discuss the possible cost at this stage of the bidding process. Insurers will foot the bill.

The Center for Economic Justice, a consumer-advocacy group, complained the proposal "is being rushed through the NAIC" when the organization ought to develop "a comprehensive strategy to eliminate regulatory reliance" on the ratings in all asset categories.