State insurance regulators approve new way to value residential-mortgage bonds

Nov 6, 2009 @ 11:51 am

By Darla Mercado

State insurance regulators yesterday voted in favor of using a new method to evaluate residential mortgage-backed securities that would allow them to reduce the capital requirements related to these investments.

The proposal was pitched by the American Council of Life Insurers, which sought to change the way state regulators evaluate insurance carriers’ holdings of the bundled mortgages, said Jeremy Wilkinson, a spokesman for the National Association of Insurance Commissioners.

Currently, the regulators rely on ratings agencies’ judgments of the securities to determine how much capital insurers should hold against the investments.

The life insurance industry has argued that ratings agencies focus on the probability of a loss inside of a residential-mortgage-backed security. That method fails to account for the severity of the loss and thus requires insurers to add more capital each time the investments are downgraded.

Instead of using the ratings agencies’ judgment when evaluating how much capital insurers need to back the securities, the NAIC will search for an independent third-party firm to estimate the size of the losses within the residential-mortgage-backed securities.

The American Council of Life Insurers applauded the decision. “The NAIC’s action is a step toward correcting a flaw in the way residential-mortgage-backed securities are rated for risk-based-capital purposes,” ACLI spokesman Whit Cornman wrote in an e-mail. “The new methodology will align better with the NAIC’s model for determining RBC [risk-based capital], which accounts for probability as well as severity of loss.”

Ratings agency Moody’s Investors Service determined last month that the change would improve financial flexibility for carriers

However, the proposal and the prospect of regulators adjusting their methodology bothers consumer advocates and advisers.

Birny Birnbaum, a consumer advocate and executive director of the Center for Economic Justice, protested the decision yesterday, urging regulators not to change their evaluations of the securities.

“There has not been improvement in the experience of home mortgages,” he wrote in a letter to regulators. “Rather, mortgage delinquencies, defaults and foreclosures are at record highs. It makes no sense to reduce capital requirements related to risk RMBS at this time.”

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