New RMBS Calculation to Save Life Insurers $5 Billion

A new evaluation of the risk-based capital requirements that life insurers face when they invest in residential mortgage-backed securities will free up approximately $5 billion in capital industrywide.

A determination by Pimco Advisory, contracted by the National Association of Insurance Commissioners to determine the economic assumptions regulators will use to evaluate RMBS, will require life insurers to allocate approximately $8.75 billion to backstop the investments. The estimation is some $5 billion less than it would have been under previous determinations, which relied on assessments made by rating agencies, according to Deputy New York State Insurance Superintendent Michael Moriarty.

Pimco modeled more than 20,000 RMBS held by insurance companies and assessed capital charges, said Moriarty, who has worked with NAIC staff and state regulators on this issue. The calculations are technically preliminary figures, but will be reflected in year-end 2009 annual statements insurers must file with state regulators by March 1, he said; actual needed capital reserves will likely be even less once all data is evaluated.

"We know what will be generated from the RMBS," Moriarty said.

Whit Cornman, spokesman for the American Council of Life Insurers, said the capital determination made by state regulators and Pimco is appropriate."The proposal was ours, but they were driving the process," he said.

The NAIC selected Pimco Advisory, a unit of Allianz SE, as a third-party financial modeler to help state regulators determine the risk-based capital requirements (BestWire, Nov. 25, 2009). Pimco is conducting a loan level analysis of U.S. RMBS using its own proprietary non-agency mortgage model, according to NAIC documents.

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 NAIC cited the failure of ratings agencies to note problems with mortgage-backed securities until late 2007, more than two years after the problems began to appear. The association also cited concerns about the "inherent conflict" of the issuer-pays ratings model.

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 (BestWire, Nov. 25, 2009).

Birny Birnbaum, executive director of the Center for Economic Justice, said the positive outcome for the industry was "a predetermined result" from a methodological "black box." Consumer advocates had objected to the NAIC's selection of Pimco, citing conflict of interest concerns and a perceived lack of transparency.

"If the housing market doesn't recover, the life insurers are going to be in real trouble," Birnbaum said.

The Pimco determination is the latest in a series of regulatory steps that benefited life insurers, he said. In December, the NAIC approved accounting changes long sought by life insurers that the industry expects to provide an $11 billion capital boost for 2009. Opposed by some consumer organizations as an industry giveaway, the changes generated extensive debate among regulators gathered at the NAIC's winter national meeting (BestWire, Dec. 8, 2009).

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.