NAIC Advances Risk-Based Capital Plan Amid Concerns About Pimco

The NAIC recently selected Pimco Advisory, a unit of Allianz SE, as a third-party financial modeler to help state regulators determine the risk-based capital requirements that insurers face when they invest in residential mortgage-backed securities (BestWire, Nov. 20, 2009). The draft presents an analytical framework and economic assumptions for use in Pimco's models for the new designation process for RMBS.

Pimco Advisory will conduct a loan level analysis of U.S. RMBS using its own proprietary non-agency mortgage model, according to the discussion draft. This process will consist of a macroeconomic model, a mortgage loan credit model, a capital structure model and a final valuation. Home price appreciation and projected interest rates will be considered as key variables. Each security will be evaluated using a set of HPA projections representing moderate (base), aggressive and conservative expectations.

"We are acting carefully to make sure insurers hold adequate capital to meet their obligations to consumers, while moving quickly and openly to address an issue at the core of the financial meltdown," NAIC President and New Hampshire Insurance Commissioner Roger Sevigny said in a statement.

Consumer advocates objected to the proposal and to the selection of Pimco, citing conflict of interest concerns. Birny Birnbaum, executive director of the Center for Economic Justice, said the NAIC plan is a rush to provide capital relief to insurers.

"The potential for conflict of interest is as great or greater with Pimco as with credit rating agencies. Pimco is owned by an insurer whose securities will be rated by Pimco. Pimco manages investments for insurers. Pimco manages investments for others, including investments in insurers," said Birnbaum, a NAIC-designated consumer liaison.

Pimco spokesman Mark Porterfield referred all questions to the NAIC. NAIC spokesman Scott Holeman said, "We're trying to make this process as transparent as possible."

A.M. Best Co. does not rate RMBS but has relied upon the ratings of these securities by other credit rating agencies in assessing capital charges in its own capital model (BCAR), according to a company statement.

The proposal would result in the assignment of new NAIC rating designations for life insurer-owned RMBS for the credit risk assessment charges used in the calculation of risk-based capital. In an analysis, A.M. Best noted that the NAIC proposal attempts to focus on the severity or amount of loss to be experienced by the RMBS, rather than the probability of default, which is currently captured in credit rating agency ratings on these RMBS. In 2009, many non-agency RMBS were downgraded multiple rating levels. Under the NAIC's current RBC calculation, these lower rated securities would be assessed higher capital charges.

A.M. Best notes that any improvement in BCAR scores due solely to the NAIC change in methodology would not result in positive rating movement. In addition, "stressed" BCAR scores, which fall below ratings guidelines would serve as a basis for discussion with company management (BestWire, Nov. 23, 2009).

Pimco, of Newport Beach, Calif., is a global investment management firm that manages investments for an array of clients, including state, municipal and union pension and retirement plans, individual and investment saving accounts, and public sector reserve management. In 2000, Allianz SE, a large global financial services company based in Germany, acquired Pimco. Pimco said on its Web site that it operates as a separate and autonomous subsidiary of Allianz.

In a September NAIC hearing, a panel of insurance industry and ratings experts said the current use of ratings in insurance regulation and risk management is fundamentally flawed and in need of reform (BestWire, Sept. 25, 2009). The hearing closed with panelists urging more competition and the elimination of barriers to entry for new ratings agencies. The NAIC cited the failure of ratings agencies to note problems with mortgage-backed securities until late 2007, more than two years after the problems first began to appear. The association also cited concerns about the "inherent conflict" of the issuer-pays ratings model.

The NAIC's Valuation of Securities Task Force will hold a conference call public hearing on the discussion draft on Nov. 30 at 11 a.m. EST. The issue will also be the subject of a Dec. 7 hearing during the NAIC Winter Meeting in San Francisco. NAIC officials have set a target date of the end of 2009 for implementation.

(By Sean P. Carr, Washington Correspondent: sean.carr@ambest.com)

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