The National Association of Insurance Commissioners yesterday approved guidelines on how insurers' bond holdings should be evaluated.

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.

The memo offers the following reporting instructions:

o Bonds insured by ACA and rated only by S&P should report an NAIC-5 designation for those bonds, while those rated by more than one NAIC-approved rating organization should report the second lowest of the two or more ratings.

o However, if the credit quality of specific bonds is higher than NAIC 5, as measured by a SPUR (Standard & Poor's underlying rating) or other underlying rating, the insurer may translate the S&P SPUR rating into its equivalent NAIC designation and report that designation.

o Insurers can also opt to file the ACA guaranteed bonds with the SVO for a rating and apply the rating that is received for the 2007 annual statement filing.

For 2008, the memo offers the following guidance:

o Noting that S&P has withdrawn ratings on ACA guaranteed bonds, the memo said that to the extent another rating is not available, ACA insured bonds will no longer be eligible for an SVO filing exemption. These bonds will have to be filed with the SVO for credit quality assessment.

o Bonds with SPUR ratings will report an NAIC-3 designation until assigned a designation by the SVO.

o But, if the issuer of a bond with a SPUR converts the SPUR into an S&P rating, the security is again eligible for a filing exemption.

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