New NAIC RMBS Ratings Could Give Insurers Flexibility: Moody's

NU Online News Service, Oct. 19, 3:20 p.m. EDT

National Association of Insurance Commissioners' moves to obtain revised ratings and reassessment of capital requirements for residential-backed mortgage securities (RMBS) could give insurers more financial flexibility, said Moody's Investors Service.

That assessment in Moody's Weekly Credit Outlook came after an NAIC committee and task force voted last week to seek a third-party vendor to examine the loss models for RMBS after a life insurers' trade group argued that nationally recognized rating firms like Moody's failed to distinguish between securities with a total loss and those projected for minor losses.

American Council of Life Insurers (ACLI) contended the NAIC, in relying on those ratings, has set excessive capital reserve requirements for them.

Moody's rating agency said some insurers' reinsurance agreements, bank lines, or other debt instruments may contain covenants based on minimum risk-based capital (RBC) ratios. "Therefore," Moody's said, "to the extent that the revised approach for determining RMBS capital charges adds more cushion in its reported RBC ratio, we believe an insurer's financial flexibility can benefit from this change."

Last Wednesday, the NAIC's Valuation Securities Task Force and Financial Conditions Committee voted to solicit third-party loss estimates for insurers' RMBS investments instead of applying standard loss factors based on credit ratings.

Some in the industry, including the ACLI, have contended that rating agencies only take into account the probability of a default and not the severity of the default, and so sudden downgrades on RMBS by rating agencies have resulted in massive increases in RBC requirements for insurers.

Moody's said the new proposed approach for RMBS required capital is based upon modeled expected losses–to be performed by an independent modeling firm–for the securities relative to their carrying value on the insurers' balance sheets. This could help alleviate some of the RBC requirements and thus provide financial flexibility for insurers, the firm advised.

However, Moody's said the proposal will not have a material rating impact on insurers since there is no real economic effect on capital.

"Although the proposal, if approved, is expected to improve reported RBC, the change will not increase companies' economic capital. Higher RBC ratios, then, will not lead to upgrades if the increases are due simply to this change in regulatory capital requirements," according to the rating agency.

Moody's explained that its analysis of insurers' capital strength considers RBC ratios as well as economic capital, which is defined as "the cushion available to the insurer to absorb unfavorable deviations in its results."

Moody's said it expects required capital for the insurance industry to increase substantially in 2009 due to deterioration in the credit quality of the fixed income sector broadly, but the rating agency acknowledged that proponents of the NAIC proposal believe the RMBS change alone will "noticeably mitigate the increase in capital requirements for the industry."

The NAIC proposal must still be voted on by the NAIC Executive Committee and Plenary, and implemented by individual states. But Moody's said the path for approval "seems almost certain."