Lower capital requirements for RMBS would mean more flexibility for insurers, Moody's says

U.S. insurers may improve their financial flexibility as state insurance regulators change the way they evaluate capital requirements for residential-mortgage-backed securities, according to a report from Moody’s Investors Service. Last week, the National Association of Insurance Commissioners’ Valuation of Securities Task Force and Financial Condition Committee approved a proposal that would change the way that regulators determined how much capital insurers should post against their holdings of such securities. Currently, regulators use the ratings agencies’ metrics as a way to determine how much capital insurers should hold against RMBS. That method came under fire by the American Council of Life Insurers, which argued that the agencies focused on the likelihood of a loss inside a residential-mortgage-backed security rather than the magnitude of that loss, thus requiring insurers to post more capital. But the newly proposed method would instead have an independent third-party firm assess the loss estimates inside the securities themselves. Wallace Enman, vice president and senior accounting analyst at Moody’s, concluded that the proposal wouldn’t have any real economic effect on capital, so it wouldn’t have a material ratings impact on the insurers. But the agency also said in its report that in some cases, carriers’ financial flexibility could benefit. Mr. Enman wrote that he expects required capital to rise substantially at the end of this year because of how the credit quality in the fixed-income sector has deteriorated. Although the proposal would likely improve risk-based-capital ratios, it wouldn’t result in better ratings for the carriers if the increases in RBC were due simply to the changes in capital requirements. Still, some carriers have debt covenants and other agreements that require them to hold minimum RBC ratios, so to the extent that the new method could add more cushion to a company’s RBC ratio, that company could be improving its financial flexibility, Mr. Enman wrote. The proposal is still awaiting approval from the NAIC’s executive committee and plenary, and it could become effective in time for year-end reporting.