The National Association of Insurance Commissioners (NAIC) over the past several months has been considering making changes to its methodology of calculating risk-based capital requirements on insurance company-held legacy RMBS and CMBS positions.
Specifically, the NAIC has thought about applying a more conservative bias in its RMBS and CMBS valuation process at the end of 2012 to better capture tail risks in these investments.
According to a Barclays Capital report this morning, the NAIC recently released documents offering added data about its proposed changes.
The Valuation of Securities Task Force (VOSTF), which is a part of NAIC assigned to make recommendations that regulate investment risk, has proposed that the economic scenarios used in the 2012 yearend modelling process should stay similar to 2011.
This would entail less stringent assumptions in some of the CMBS conservative scenarios considering the trajectory of CRE prices to date. But, the group also suggested that probability weights assigned to each scenario be changed to more heavily weight pessimistic tail scenarios.
For instance, Barclays analysts cited the probability weight for the most conservative or pessimistic scenario for CMBS positions will rise to 10% from 5%, while the probability weight for an aggressive or optimistic scenario will dip to 10% from 20%. Likewise, the most aggressive scenario for RMBS positions will be dropped altogether while the probability weight assigned to the most conservative scenario will triple to 15% from 5%.
Barclays said it is important to consider that the proposed changes have not yet been finalized. The NAIC will hold a public conference call on Oct. 4 to discuss the changes with the industry and will seek feedback on the proposals at that time.
The VOSTF will then meet again on Oct. 11 to finalize the assumptions, scenarios, and probability weights that will be used in the 2012 yearend valuation model.
Capital Requirements Impact
For RMBS, since the assumptions behind the scenarios themselves will not change considerably, bonds that were not expected to incur any writedowns or "zero-loss designation bonds" under the old method will probably not be impacted, Barclays said.
They should still be classified as NAIC 1. As such, these bonds will probably still carry the lowest risk-based capital requirements.
On the other hand, there might be a rise in the number of CMBS bonds that can be classified as NAIC 1 with a zero-loss designation in the new method considering the lesser CRE price drops assumed in the conservative and most conservative scenarios.
For bonds that should have write-downs in some of the economic scenarios, intrinsic prices are probably going to dip, Barclays said. This might potentially force some insurance firms to hold them at higher NAIC designations and increasing the capital required to be held against the positions.
According to updated numbers from the NAIC, the VOSTF projects that industry-wide risk-based capital requirements will rise to 1.0% from 0.9% on CMBS holdings, while capital requirements will rise to 3.2% from 2.7% on insurance company RMBS holdings.
If analysts make use 2011 yearend industry-wide carrying values, this would mean roughly $160 million on CMBS and $620 million on RMBS added capital required.
Considering that the projected changes in capital requirements are less severe versus what was shown in previous NAIC documents, analysts think that these figures use PIMCO’s updated credit model. The average on which results in lower write-downs on RMBS bonds.