How Will the Insurance Regulators React to the Subprime Mess?
Based upon historical behavior, the NAIC and other insurance regulators will react like generals fighting the last war.
First, they will wait to see if and how the overall repricing of risk impacts insurers. Amazingly, reductions in earnings and risk capital are not the biggest issue here. Potential insolvencies or rehabilitations are. Depending upon the ultimate impact on individual insurers, the NAIC will then slowly make changes, most likely, through the various model law vehicles.
But, what if the threat to common sense regulation of insurers is not the NAIC and others regulating with their eyes squarely on the rear view mirror?
What if the real threat comes from the Securities Valuation Office (SVO) of the NAIC?
Insurers must use pricing as noted by the SVO when filing statutory financials at year end. However, what if the craziness of pricing ABS, CMOs, CDOs, etc. that is occurring now, persists at year end? How will the SVO get accurate pricing for use by insurers? And, how realistic would those prices be? Of course, unrealistically low prices could feed into lower risk capital and increased pressure on insurer financial condition.
Also, as many of you know, the insurance industry worked for several years to convince the NAIC that the SVO should use the ratings of the rating agencies with a ‘look-up table’ to determine the SVO rating. (i.e. A- or higher meant SVO 1, BBB meant SVO 2, etc.). Before this change, one of the insurers holding a given rated security or tranche would have to pay a fee to the SVO for their imprimatur. (Non-rated securities have always required independent credit review by the SVO.) With many of the problems that have started with sub prime mortgages aided and abetted by the rating agencies to some degree, will the NAIC change its tune? Will the SVO now be required to rate all securities, irrespective of rating agency letter rating? And, how much more in resources (read: fees from insurers) will this require?
On top of this, the SVO has not exactly developed a reputation for accuracy and reasonableness in their rating process.
From a small acorn, a large oak can grow. It’s starting to look increasingly like the small acorn of sub prime mortgage problems will grow into a large oak of problems and challenges previously unimagined.
