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IMPROVING TRANSPARENCY IN STATE

REGULATION OF INSURER INVESTMENTS

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE, AND 

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

SEPTEMBER 20, 2006

Printed for the use of the Committee on Financial Services

Serial No. 109–122

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED

ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair 

CHRISTOPHER SHAYS, Connecticut 

PAUL E. GILLMOR, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

SUE W. KELLY, New York 

ROBERT W. NEY, Ohio 

VITO FOSSELLA, New York, 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

MARK R. KENNEDY, Minnesota 

PATRICK J. TIBERI, Ohio 

J. GRESHAM BARRETT, South Carolina 

GINNY BROWN-WAITE, Florida 

TOM FEENEY, Florida 

JIM GERLACH, Pennsylvania 

KATHERINE HARRIS, Florida 

JEB HENSARLING, Texas 

RICK RENZI, Arizona 

GEOFF DAVIS, Kentucky 

MICHAEL G. FITZPATRICK, Pennsylvania 

JOHN CAMPBELL, California 

MICHAEL G. OXLEY, Ohio 

PAUL E. KANJORSKI, Pennsylvania 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

ARTUR DAVIS, Alabama 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

September 20, 2006 .......................................................................................... 1

Appendix: 

September 20, 2006 .......................................................................................... 17

WITNESSES 

WEDNESDAY, SEPTEMBER 20, 2006

Conery, Kevin J., Senior Director, Merrill Lynch, on behalf of the Bond 

Market Association .............................................................................................. 3

Hunter, Michael J., Executive Vice President and Chief Operating Officer, 

American Council of Life Insurers ...................................................................... 5

Iuppa, Alessandro, President, National Association of Insurance Commissioners ................................................................................................................... 7

APPENDIX 

Prepared statements: 

Conery, Kevin J. ............................................................................................... 18

Hunter, Michael J. ........................................................................................... 34

Iuppa, Alessandro ............................................................................................. 42

(1)

IMPROVING TRANSPARENCY IN STATE 

REGULATION OF INSURER INVESTMENTS 

Wednesday, September 20, 2006

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT-SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 10 a.m., in room 

2128, Rayburn House Office Building, Hon. Richard H. Baker 

[chairman of the subcommittee] presiding. 

Present: Representatives Baker, Kelly, Biggert, and Hensarling. 

Chairman BAKER. I’d like to call the Subcommittee on Capital 

Markets to order. On behalf of Mr. Kanjorski, I wish to announce 

that he intended to be here, but he had matters that required his 

attention, and he will not be here on time. His office has given us 

the agreement to proceed with the hearing in the absence of a minority member for the hearing this morning. The rules require two 

members in participation, and so I thank Mr. Hensarling for his 

willingness to participate. 

This morning the committee meets to consider the issues relative 

to State regulation of insurance products, improving transparency 

of the regulatory methodologies, and to better understand the work 

of the NAIC Securities Valuation Office. Created in 1907, the office 

was intended to provide oversight for securities issued in the insurance world, an important role, and a role which has value to the 

broader market. 

Recent events, however, have brought a tension to regulatory decisions which had the unintended consequence of devaluing particular securities in the market, and then subsequently that rating 

or opinion being reversed having significant adverse consequence in 

the confidence of holders of this particular structure of securities 

device. The observations that I make this morning come from a review of testimony provided to date and correspondence with the office, but it becomes clear that some revision in current processes 

are warranted. 

Today we will hear from stakeholders in the market, who will express their own views on the matter, as well as a representative 

of the NAIC, who has expressed a willingness and desire to work 

with the committee and others to ensure that the regulatory process is responsive to the identified problems. 

The NRSRO’s, which have the principal and primary duty for 

evaluations of securities in the broader market have a clearly-established process which is a stated methodology, and then an inforVerDate 0ct 09 2002 16:23 Apr 09, 2007 Jkt 031551 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\HBA263.160 HFIN PsN: TERRIE
2

mal process by which, before making public their ratings to the 

broader market, will engage in discussions with management of the 

rated company to determine if the factual assessment made by the 

rating entity is in fact the circumstances that management would 

agree as to the underlying facts, not as to the conclusion reached 

by the rating agency but only as to the factual material. 

Despite the fact that I have had my own views for need for reform of the NRSRO’s, those two basic elements of their rating process appear to be absent from the Securities Valuation Office. In 

fact, there are quotes attributable to members of the NAIC which 

indicate that the SVO does not consider outside opinions in reaching their rating conclusions. 

The result of this, I believe, has created unnecessary uncertainty 

in the markets about particular types of security structures. It is 

my hope today that we can reach some conclusions regrading disclosure of methodologies, as to the ability of the issuers of the rated 

securities to have an informal ability to communicate with the SVO 

prior to reaching a public stated position. 

There is one other element that I would like to raise, however, 

that I do not think has been raised by any others in the public domain, and that is in the securities world if a person has information and acts on that information prior to general disclosure of that 

set of facts to the broader market, that creates or triggers certain 

regulatory concerns, and that really is at the base of my difficulty 

with this matter. It appears that the unintended consequence of 

the current valuation effort is to disclose a rating to a particular 

subset of market participants not concurrent with all market participants at the same time—not that it would be necessarily called 

insider trading, because this is a regulatory function, but as a matter of disclosure policy all stakeholders in the market, whether 

there is action to be taken that either increases or decreases the 

value of a public security, there should be an absolute essential requirement to make that type of determination and disclosure simultaneous to all affected stakeholders. That does not now appear 

to be the case. 

I look forward to working with the superintendent going forward 

and to the NAIC and better understanding their concerns. I believe 

I do understand their stated purpose. I have actually gone to the 

Web site this morning and read through the Securities Valuation 

Office guidelines to make sure that I had an appropriate understanding, but there clearly is a need for modest reform here to provide for stability in market function, and I appreciate the panel’s 

willingness to participate this morning and look forward to hearing 

your statements. 

Mr. Hensarling, did you have an opening statement? 

Mr. HENSARLING. Mr. Chairman, I would like to note that rarely 

has my presence been so welcome here before— 

Chairman BAKER. I second that. 

Mr. HENSARLING. I would just like to thank you and Ranking 

Member Kanjorski for holding this hearing. I think it is a very important topic that we will be discussing today. Clearly these classification decisions made by the SVO are critical in determining the 

amount of risk-based capital that our state-regulated insurance 

companies must hold, which consequently, of course, has to help 

3

determine the asset base which these companies pay their claims 

as well as promoting a very efficient and transparent capital market. 

It is not a matter that has previously been on my radar screen, 

but clearly the March 2006 decision of the SVO in their classification of the Lehman Brothers ECAP hybrid securities as common 

stock has raised the issue. We saw the impact that had within our 

capital markets, and clearly I think that this committee needs to 

look into how the decisionmaking process works, and as we all 

know, sometimes a little bit of sunshine goes a very long way in 

helping solve a certain amount of challenges that we have, so I look 

forward to hearing from the witnesses. Mr. Chairman, I yield back. 

Chairman BAKER. I thank the gentleman for his statement and 

his presence this morning. 

We will now proceed to our panel of witness. Let me first express 

our appreciation. In our general platform of operation, we request 

that your statement be limited to 5 minutes, if possible. Your full 

formal statement will be made part of the official record. Make 

sure that the button is pushed on the bottom of the microphone, 

and we appreciate your being here. 

Our first witness is Mr. Kevin J. Conery, senior director of Merrill Lynch, but appearing here today on behalf of the Bond Market 

Association. Welcome, sir. 

STATEMENT OF KEVIN J. CONERY, SENIOR DIRECTOR, MERRILL LYNCH, ON BEHALF OF THE BOND MARKET ASSOCIATION 

Mr. CONERY. Good morning. Chairman Baker and committee 

members, thank you for holding this important hearing on transparency in the State regulation of insurer investments. My name 

is Kevin Conery, and I am a preferred securities strategist at Merrill Lynch. It is a pleasure for me to offer this statement today on 

behalf of the Bond Market Association, the trade association for the 

$46 trillion dollar global fixed income markets. 

BMA members have high regard for the role of the NAIC, which 

is the primary focus of this hearing. The NAIC and its members, 

the State insurance regulars, play a critical role in assuring the 

solvency of the Nation’s insurance industry. Recently, however, the 

NAIC Securities Valuation Office, or the SVO, put a chill in the 

market for hybrid securities by classifying as common equity a financial instrument well established as fixed income security. Insurance companies are an important source of demand for hybrid 

securities. The common equity classification from the NAIC would 

require a significantly higher capital charge against these securities for insurers. This caused both issuers and investors to retreat 

for a full 6 weeks in March and April of this year. 

The price of the securities fell as insurance companies were faced 

with the prospect of higher capital charges. Always seeking the 

lowest cost of capital, issuers shied away from the uncertain U.S. 

markets and looked abroad. With tens of billions of dollars of hybrid securities in the pipeline, issuers are right to ask themselves 

a key question—which country offers the best environment to bring 

hybrid securities to market? As long as the threat of regulatory unVerDate 0ct 09 2002 16:23 Apr 09, 2007 Jkt 031551 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\HBA263.160 HFIN PsN: TERRIE
4

certainty exists in the United States, issuers will consider the option of going to capital markets of the other countries. 

Regulatory clarity is critical to maintaining the competitiveness 

of U.S. capital markets. We are pleased that the NAIC adopted an 

interim definition of hybrid securities at a meeting last week. The 

definition expires January 1, 2008, unless a permanent definition 

is crafted prior to that date. This development has encouraged insurance companies to return to the hybrid market in the near term 

at least. The overall experience, however, illustrates a fundamental 

problem with the SVO classification process. It lacks transparency. 

A chief goal of BMA members is the development of policies and 

practices that promote efficient and transparent capital markets. A 

lack of transparency distorts prices, can cause a misallocation of 

capital, and generally leads to market inefficiency. Similar to what 

happened in March, if the NAIC without explanation classifies as 

common equity hybrid securities of the type long considered debt 

instruments, insurance companies have no choice but to withdraw 

from the marketplace. The loss of this key source of demand in 

turn would distort prices and lead to a less efficient allocation of 

capital. 

If the SVO classification process were transparent, the rationale 

behind its March decision would have been made public, but far 

from being made public, this information was provided only to certain parties compelled to maintain confidentiality. 

The SVO’s reasoning still has not been publicly revealed. The 

BMA believes that the NAIC needs to acknowledge that SVO decisions can have a broad impact on the hybrid securities market. The 

NAIC should develop a system similar to that employed by other 

capital regulators, such as the Federal Reserve Board or the Securities and Exchange Commission, those that make clear what criteria are involved in evaluating securities in addition to publiclyannouncing the valuation decision. 

Such an announcement can come in the form of Web site postings or press releases, so long as the information is freely accessible to all market participants. Consider that rating agencies, 

while not a capital regulator, do make decisions and provide information that have broad effects on the market, including the market 

for hybrid securities. Rating agencies’ decisions are always publicly 

available and their methodologies clearly disclosed. 

We acknowledge that the NAIC has made some efforts to become 

more transparent at the industry’s request. Since May the SVO has 

posted classification notices on its Web site. The reasons for these 

classifications unfortunately are still not made public. We hope to 

continue a dialogue with the NAIC as it moves towards consideration of how to create a more transparent classification process. 

Changes that lead to increased transparency, including the conveyance of information about decisions in policy, are best for all markets and all investors. 

Mr. Chairman, thank you again for the opportunity to testify 

here today. I look forward to any questions that the committee may 

have. 

[The prepared statement of Mr. Conery can be found on page 18 

of the appendix.] 

Chairman BAKER. Thank you for your statement, sir. 

5

Our next witness is Mr. Michael J. Hunter, the executive vice 

president and chief operating officer for the American Council of 

Life Insurers. 

Welcome. 

STATEMENT OF MICHAEL J. HUNTER, EXECUTIVE VICE PRESIDENT AND CHIEF OPERATING OFFICER, AMERICAN COUNCIL OF LIFE INSURERS 

Mr. HUNTER. Thank you, Mr. Chairman, and members of the 

committee. I am here today on behalf of ACLI’s 377 members, 

which account for 91 percent of the industry’s total U.S. assets. 

ACLI members offer life insurance, annuities, pensions including 

401(k)s, long-term care insurance, disability income insurance, reinsurance, and other retirement and financial protection products. As investors holding approximately $4.2 trillion of securities, or 

approximately 12 percent of the total investments in the United 

States capital market, actions and decisions regarding the regulatory oversight of our investments are critical to the business operations of ACLI member companies, the customers we serve, and 

arguably our Nation’s economic stability. 

As you know, the insurance industry is state-regulated. Companies operate under the supervision of each State in which they are 

licensed. The Securities Valuation Office is an instrumentality of 

the NAIC, which is an association of State insurance commissioners and is charged with examining the credit quality and value 

of insurers’ investment portfolios. 

We understand that one reason that this committee has called 

for this hearing is to better understand the decisions made earlier 

this year by the SVO regarding hybrid securities. These decisions 

created such a level of uncertainty in the capital markets that 

holders of these securities experienced a substantial decrease in 

market value as well as a limited ability to trade in the securities. 

I believe a fundamental issue for the subcommittee to consider 

is what role the SVO should play in the ratings and valuations of 

securities held by insurers and exactly how that role should be carried out. 

Before moving on, I want to acknowledge that as of today it appears that a very workable short-term solution to the hybrid securities situation has been reached. This was accomplished thanks to 

extraordinary efforts of both the industry and NAIC leadership 

over the last few months. I want to particularly compliment and 

commend Superintendent Iuppa on the vital leadership role he 

played to help us get to this positive outcome. 

A bit of history. The SVO was formed by the NAIC in 1942 to 

value investments made in private and public companies. In the 

late 1990’s, the NAIC realized that a more effective way of valuing 

securities would be to rely on the values provided by nationally-recognized statistical rating organizations—NRSRO’s. So today insurers rely on NRSRO’s to determine the value and classification of 

their securities. In the event that a security is not rated by an 

NRSRO or a State regulator requests the review of a previouslyrated security, the SVO will value and classify that security. 

To understand the importance of the classification of securities to 

an insurer, one must understand the NAIC’s risk-based capital sysVerDate 0ct 09 2002 16:23 Apr 09, 2007 Jkt 031551 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\HBA263.160 HFIN PsN: TERRIE
6

tem, or RBC. This system uses a formula to establish the minimum 

amount of capital necessary for an insurance company to support 

its business operations. Computing risk-based capital helps determine when and what actions regulators should take in the event 

a company’s actual capital and surplus falls below its calculated 

minimum. 

All securities are classified as either debt/preferred stock or common stock. A highly-rated debt instrument or preferred stock with 

a market value of a million dollars would require a company to allocate $3,000 for risk-based capital, while a common stock of equal 

market value would require that $300,000 be allocated. 

Due to the extremely-high capital requirement for common stocks 

and the risk-averse nature of life insurers, ACLI member portfolios 

contain substantially more debt securities than common stock. 

The SVO’s recent actions on hybrid securities illustrate the effect 

its decisions can have on both insurers and the capital markets. We 

are concerned with the process and lack of transparency at the 

SVO and we call on the SVO to adopt and apply a more transparent, open process by which it classifies securities, disseminates 

those decisions to market participants, and provides clarity as to 

why and how these classifications are made. 

When the SVO reclassified several securities from debt to common stock in March, investors were left to wonder what prompted 

the change. Industry immediately requested that the SVO communicate the additional risks it perceived the securities contained that 

are not considered in the rating process of the NRSRO’s. As of 

today, the SVO has yet to respond to this request. 

When the SVO acts on a request to rate a security, only the entity that made the request will receive the decision. Other insurers 

holding the security, issuers of securities, dealers and investors are 

not notified of the decision. We are at a loss to understand the public policy purpose behind this. 

The SVO should disclose the basis for its decisions by public dissemination as such information is material to the market and information disclosed unevenly can certainly erode investor confidence. 

Additionally, the entity receiving this information is prohibited 

from sharing the information with other investors or issuers. As insurers or other investors learn eventually of an SVO classification, 

they are unable to obtain a clarification as to what factors led to 

this decision. We do not see that a legitimate public policy purpose 

is served by this confidentiality. 

In the case of hybrid securities, the SVO began a process by 

which all classification decisions are posted in a report on the 

NAIC Web site. We want to applaud this move and we strongly 

support it. However, the system is not in place for other SVO rated 

securities, and, as previously noted, the empirical basis for these 

ratings is not disclosed. 

SVO staff has stated publicly that their designations are not 

suitable for use by anyone other than regulators. This is a completely unrealistic and impractical position to take, as we have recently seen SVO actions do have an immediate and significant impact on capital markets. This stance does nothing more than foster 

7

a lack of confidence in the integrity of the process within the industry and the marketplace. 

In summary, we would like to leave the subcommittee with three 

main points: 

(1) Buyers and sellers of securities must know in advance when 

the SVO is analyzing a particular security or class of securities. 

This will provide stakeholders the opportunity to provide input to 

the SVO to ensure that a fully-informed decision will be made; 

(2) The SVO must publicly communicate the empirical basis for 

all ratings decisions so that issuers of securities can understand 

what risk characteristics the SVO has identified that could lead to 

a different rating than that of the NRSRO’s. Investors will then be 

in a position to assess their investment portfolios and make an informed decision as to whether they wish to continue to hold the security or securities in question; and 

(3) The NAIC has shown a willingness to allow the use of 

NRSRO ratings and expanding that system is one option for consideration, leaving the SVO to focus solely on solvency issues. However, should regulators not be willing to cede all rating and classifications decisions to the NRSRO’s, it is imperative that an open, 

transparent system for SVO action be implemented. 

I thank the subcommittee and you, Mr. Chairman, for inviting 

ACLI to participate in the hearing, and I would be happy to answer 

any questions. Thank you. 

[The prepared statement of Mr. Hunter can be found on page 34 

of the appendix.] 

Chairman BAKER. Thank you for your statement, sir. 

Our next witness is the Honorable Superintendent Alessandro 

Iuppa, who appears here today in his capacity as president of the 

National Association of Insurance Commissioners. 

Welcome, sir. 

STATEMENT OF ALESSANDRO IUPPA, PRESIDENT, NATIONAL 

ASSOCIATION OF INSURANCE COMMISSIONERS 

Mr. IUPPA. Chairman Baker, and members of the committee, 

thank you very much for providing me with the opportunity to 

present the views of the NAIC on transparency in the regulation 

of insurer investments. I also want to thank you for making the 

committee staff available to discuss some of the issues in preparation for this hearing. 

The financial regulation of insurance is essential to consumer 

protection, and we do this job well. Without consumer protection afforded by financial regulation, an insurance policy may not be 

worth the paper it is written on. We serve the public by means of 

independent and honest financial oversight, safeguarding insurers’ 

capacity to pay claims, and we welcome the chance to dialogue with 

Congress and the subcommittee on this complex issue. 

I am confident that we would not be here today if not for recent 

NAIC decisions related to hybrid securities—highly complex, often 

customized, nonconventional financial instruments that are constantly evolving. 

We stand by our recent analysis, both on substance and the process, and I will be happy to respond to your questions on those aspects. Nonetheless, like any effective organization working in a dyVerDate 0ct 09 2002 16:23 Apr 09, 2007 Jkt 031551 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\HBA263.160 HFIN PsN: TERRIE
8

namic market, the NAIC membership has initiated a review with 

respect to the issues of disclosure and transparency of our classification process covering hybrid securities. 

Following the concerns raised by the ACLI and the Bond Market 

Association about a complex product that in fact represents a small 

portion of the overall financial market, the NAIC responded by 

holding a public hearing in New York City to gather the perspectives of rating agencies, insurers, trade associations, and other interested parties. That particular hearing attracted over 200 

attendees. 

At that meeting, the NAIC leadership appointed a special working group led by the New York Department of Insurance to evaluate the appropriate risk-based capital treatment of hybrid securities and to develop both short and long term resolutions. 

During our most recent national meeting at St. Louis, which was 

held last week, the NAIC adopted the short-term resolution for the 

year-end financial statement filing. That resolution essentially provides for the classification and reporting of recently issued hybrid 

securities as preferred stock and the regulatory with some adjustment to account for investment risks not accounted for by national 

credit rating agencies. 

Going forward, the special hybrid Risk Based Capital Working 

Group will further study the characteristics of hybrid securities 

and develop a permanent solution. I hope you will agree that we 

have made good progress on a substantial financial issue in a short 

timeframe with the support of both the ACLI and the BMA. 

In the interim 3 months, while the working group completes our 

review, there are other actions that market participants can take 

to improve the current situation within the existing regulatory 

framework. 

First, I would strongly encourage insurers to use the SVO’s Advance Rating Service. By using the ARS insurance companies and 

their financial advisors, you can eliminate most, if not all, surprises 

by learning in advance how these programs will be classified by the 

SVO. I would also encourage insurers and producers of hybrids to 

take advantage of the Automated Valuation Service, the AVS. Like 

federally-regulated rating organizations the NAIC offers a subscription service that allows subscribers to access SVO determinations 

as they are issued. 

In response to the concerns of the Bond Market Association and 

others, we took the unusual step of posting a number of our rulings 

on hybrid securities on the SVO homepage and we did this without 

the normal subscription fee. 

Finally, I would encourage the interested parties to continue 

their active engagement with the NAIC membership through our 

open and transparent process for establishing and amending policies and regulatory practices including those related to the SVO. 

Together we can make improvements that contain consumer protections and a dynamic market. 

With respect to the issue of disclosure and transparency of the 

SVO’s classification process covering hybrid securities, the NAIC’s 

Valuation of Securities Task Force, which is comprised of financial 

solvency and investment experts, is evaluating the guidance provided through SVO analysts, as well as the communications pracVerDate 0ct 09 2002 16:23 Apr 09, 2007 Jkt 031551 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\HBA263.160 HFIN PsN: TERRIE
9

tices revolving around those SVO classification decisions. I think it 

is safe to say that as a result of ongoing discussions, we better understand that the range of interested parties may very well extend 

beyond insurers, their financial advisors, and the regulatory community, and we look forward to reporting back to the subcommittee 

once the NAIC has reached its final decision on the regulatory 

treatment of hybrid securities. 

I thank you and look forward to your questions. 

[The prepared statement of Mr. Iuppa can be found on page 42 

of the appendix.] 

Chairman BAKER. Thank you very much, Mr. Iuppa. 

Mr. Conery and Mr. Hunter, let me try to get a framework of the 

market effect of this decision, and then the ultimate reversal of the 

decision. 

At the point at which it did become public, what is your assessment of the financial consequences in the broader market? 

There’s been references made to devaluation of these particular 

class of assets. Do either or both have some view as to what the 

broad market consequence was of this instability? 

Mr. CONERY. If I may go first, Mr. Chairman, yes, there was 

clearly market instability, market confusion, because once again 

there was not any transparency as to why this decision was made. 

Broadly speaking, any security that looked approximately like 

the Lehman ECAP structure also had its value decline. With the 

rationale being unclear, the market entered a phase, as I noted 

earlier, that it was largely shut down and there was very little 

trading volume going on for awhile because people were uncertain, 

so valuations were pretty wide, as often happens when liquidity becomes less in a marketplace. But I think that most people are 

thinking that the average cost for anything that looked to be similar to a Lehman ECAP structure was approximately at that time 

30 to 40 basis points from most issues. 

Chairman BAKER. And what in your estimate is the notional 

amount of this class of securities in the market? Any way to know 

that? 

Mr. CONERY. Well, one of the things that became interesting, and 

this also goes back to the transparency issue as well, because it 

was unclear what they were specifically targeting, and initially 

when the market assumed, as did I individually, that it was the 

ECAP structure that was the problem that they were having, the 

market viewed it as a much more narrow problem, okay? 

As time went on, and more classifications came out and became 

more apparent, especially into May and into June, and people recognized it was structures well beyond the Lehman ECAP structure, 

the market became much more concerned. So I would say initially 

we’re talking about a market size that was probably only about $15 

billion. By the time June was coming around, you were talking 

about in market size that I would conservatively estimate at about 

$100 billion. 

Chairman BAKER. Mr. Hunter, can you add or expand on that 

view? 

Mr. HUNTER. Yes. I think that nobody would challenge the proposition that markets respond negatively to two things, bad news and 

10

uncertainty. And there was a mixture of both with regard to the 

SVO decision. 

I think our research indicates that at the nadir of the activity 

with respect to these securities during the summer that portfolios 

decreased by about a billion dollars industry-wide. Portfolios have 

certainly rebounded but there were negative impacts on companies 

that haven’t been remedied by the positive developments of recent 

weeks. 

Chairman BAKER. Are we back to the pre-April market conditions? 

Mr. HUNTER. It’s not my belief that we have returned to preApril. I’ll let Mr. Conery opine on that as well. 

Mr. CONERY. Right now it depends upon which segment of the 

market you are speaking about. I would say broadly you have 

largely recovered as of today, this morning, and for the past few 

days, pretty much where we were prior to April. However, certain 

segments of the market have not responded as favorably, basically, 

those that have more to lose by the interim solution, for example. 

The way the interim solution works, if you still got classified as 

common equity initially and you had a Triple B rating, you would 

get hit harder, so consequently those issues have only recovered 

about half of what they lost, so they may have recovered 20 of 

those 40 basis points. 

Chairman BAKER. Thank you. Mr. Iuppa, my reason for asking 

that line of questions of the other two witnesses is just to establish 

the market consequence of this regulatory action by the NAIC, that 

many years ago the scope of influence and residual effect in the 

market may in fact have been very minor, but today market consequences are quite different. 

As you indicated, these are sophisticated and technical issues 

that require a level of sophistication in their assessment. That also 

leads me to conclude that the inter-related financial network that 

may be beyond the scope of the insurance regulatory purview was 

adversely affected, although unintentionally, by the rating for some 

duration in the market, and even today there are certain classifications that have not fully recovered. 

I don’t believe this is insoluable. I believe that the model that 

has been created by the actions of the NRSRO’s generally is a blueprint for continuing this rating responsibility and engaging in it in 

a manner which would not necessarily roil the markets—primarily, 

the two issues being simultaneous disclosure of ratings to all affected parties and certainly not requiring confidentiality to those 

who benefit from the information, and secondly, some disclosure of 

empirical standards or methodology so that issuers can understand 

when we go out into the regulatory world here is what they are 

going to look at and here’s the expectation so we can structure our 

deal to meet those regulatory expectations. 

I know you have made a statement in your comment today that 

the NAIC is working toward resolution perhaps on both those ends. 

Can you represent to us today when you think that the regulatory 

revisions that you have described would actually be made effective 

or will there be some interim report? 

I come to this with some trepidation. We have not always had 

a date certain target for other NAIC goals, and I just want to make 

11

sure that this one of particular importance is targeted and is described for the broader market in a way where there can be a little 

more certainty about when this will be resolved. 

Can you respond? 

Mr. IUPPA. Yes, I think I can. As I noted, we have asked the VOS 

Task Force to come back to the broader membership with a report. 

Chairman BAKER. Is there a deadline for that report? 

Mr. IUPPA. I am getting to that. 

Chairman BAKER. Okay. Thank you. 

Mr. IUPPA. I believe the last day for the NAIC meeting in December is December 12th, so that NAIC leadership is expecting to have 

that by December 12th, so that if we can’t take action in December, 

we can arrange to take action subsequent to that, but I think the 

key is the NAIC leadership and there is a commitment from the 

New York Department with regard to their role as chairing this 

group to deliver to the broader membership a report, and hopefully 

a recommendation, as to how to address some of these concerns. 

As I noted in my commentary, as a regulator it is difficult at 

times to see beyond the regulatory blinders, if you will, and I think 

we have drawn some inferences and some conclusions that our actions do have a broader impact, and can have a broader impact, in 

the broader marketplace, and we have to take that into consideration as we look at the transparency and disclosure issues going 

forward. 

Chairman BAKER. And I don’t know the charge that the committee has been given for the issuance of the December report, but 

in the ‘‘for what it’s worth’’ category, this simultaneous disclosure 

and disclosure of empirical methodologies is extremely important in 

order to have the SVO’s mission and operations consistent with 

other securities regulators. 

I hope that will be at the forefront of the committee’s effort—and 

my time has long expired. 

Mrs. Biggert? 

Mrs. BIGGERT. Thank you, Mr. Chairman. While we heard that 

NAIC doesn’t announce when the classifications are made and that 

parties that are interested in determining a current designation 

pay a fee to actively monitor a NAIC database, this materially 

makes material information non-public, which—can this benefit 

some of the market participants to the detriment of others then, 

the way that this was set up? 

Mr. IUPPA. Would you like me— 

Mrs. BIGGERT. Yes, Mr. Iuppa. 

Mr. IUPPA. Well, I guess on a purely analytical response, I guess 

the answer is probably yes, because if some segment of the market 

doesn’t have information that is available to others, those that 

have the information can be perceived to have been advantaged. 

Mrs. BIGGERT. And you said that some of the classification 

changes have been put up on the Web site about some securities 

and not others. Does this make a difference then? How do you 

choose which one you are going to put up on the Web site? 

Mr. IUPPA. Well, a couple of things. I want to clear up what may 

be one misconception. I have heard several times today that the 

NAIC reversed its initial analysis on some of the hybrids. That is 

not really what happened. We did not necessarily reverse those rulVerDate 0ct 09 2002 16:23 Apr 09, 2007 Jkt 031551 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\HBA263.160 HFIN PsN: TERRIE
12

ings but we have worked towards a sort of interim solution with 

them. 

With regard to the availability, like most of the rating agencies 

you can subscribe to get access to the information as it is issued, 

and that has been our general practice with regard to the ratings 

and classifications on securities. 

In this particular case, as a result of some of the discussions we 

have had since I will say early June—in fact, I can recall sitting 

down with some of the CEOs and investment people at a meeting 

that ACLI organized here in Washington, talking about this early 

in June, we decided to go ahead and put some of that classification 

information regarding the segment of hybrids out on the Web site. 

Typically, in the past, we would not have done that. That would 

have been available to those who subscribed to the service, so that 

that may ultimately be one of the ways to disseminate this information. 

Mr. CONERY. If I may— 

Mrs. BIGGERT. Mr. Conery. 

Mr. CONERY.—just one point, just regarding fact. Thank you. We 

note very clearly it was a significant improvement to have the postings on the Web site, but we not only would challenge the point 

that some of the decisions regarding the actual classifications of 

certain issues were not reversed. I would agree with that point 

with respect to newer issues, but in some cases some of the classifications they were posting in fact were on securities that were 

issued 7, 8, 9 years ago that previously had been classified as either preferred stock or, in some cases, debt. So clearly there was 

a change in this whole methodology, which in part has created this 

whole concern about what is their methodology and lack of transparency. 

Mrs. BIGGERT. Was there anything negative when something was 

not put on the Web site or was left off? Did people have concerns 

about the value of those hybrids? 

Mr. CONERY. Well, it would be people who tried to make conjecture, and I would emphasize it was conjecture or market best estimate in terms of what other securities were likely to be impacted. 

I can say that most investors as well as most broker dealers have 

their own internally generated set of lists that they thought were 

likely suspects to be classified. But clearly everybody’s list differed 

slightly. 

Mrs. BIGGERT. Mr. Iuppa, you said that you had the special 

working group and asked for it. This was in July. Was this the 

time that you asked for a comment period, or was this earlier that 

there was a comment period open for people to talk about the hybrid securities and the classification? 

Mr. IUPPA. It was actually earlier than the meeting itself, because we were getting comments broadly from interested parties 

subsequent to our June meeting, which was held here in Washington. But it was at that June meeting that we decided the need 

to have a special interim meeting of the VOS Task Force to air out 

and in a formal way obtain comments and input from interested 

parties. At that hearing on July 17th, I believe it was, is when the 

NAIC leadership directed that a special working group be put together that was tasked with what I would describe as financial and 

13

investment experts within the regulatory community to work with 

the interested parties to develop a solution. 

We didn’t say develop a short and a long term. We said come to 

us with a solution. The consensus was the best way to deal with 

it is to deal in the short term with the financial reporting for riskbased capital and also to put together a long term solution as well. 

Mrs. BIGGERT. Did you hear from a large number of the industry? 

Mr. IUPPA. I estimated, and I believe it is conservative, that 

there were over 200 people at that meeting in New York. The real 

number was probably considerably higher than that. 

Mrs. BIGGERT. I see. 

Mr. IUPPA. The answer is yes. 

Mrs. BIGGERT. Okay. I have one more question. 

Mr. Hunter, it appears from the testimony that life insurers are 

major investors in hybrid securities. These securities seem to be 

very attractive to your member companies, but did this change, 

then, with—what effect did these regulations—or the reclassification, did that cause real angst that suddenly something that people 

thought was valued for a period of time—you know, the length of 

time that they would be held, how did that affect your companies? 

Mr. HUNTER. Well, clearly insurers are significant consumers of 

hybrid securities. They are uniquely suited to the challenge that insurance companies have to comply and be in compliance with the 

risk-based capital systems that monitor reserves and because of the 

fact that so much uncertainty developed around these decisions, 

there was clearly a withdrawal from insurers investing in this marketplace and it—you know, capital flows freely, and I guess one of 

the unfortunate elements that maybe is of national concern is that 

you have these investments flowing into other parts of the world. 

So there’s clearly a very thoughtful and well-established mechanism and routine that was placed in some degree of disarray this 

past summer. As I said earlier, Congresswoman, we really want to 

give a lot of credit to the leadership of Superintendent Iuppa and 

others who have taken steps to provide a solution that provides 

more certainty in the marketplace with the hybrids. 

Mrs. BIGGERT. So you think that the short-term proposal then 

will send the right message to the capital markets? 

Mr. HUNTER. Well, it’s been very helpful. You know, where we 

go from here, however, is critical. You know, my experience in government and the analog that I think is most applicable is that of 

a rulemaking or the promulgation of a regulation. You have adequate notice that’s provided to stakeholders of regard to what’s at 

issue. There is an opportunity for comment, possibly for hearings. 

And then you have a decision that is public and the rationale 

therefore is provided as a part of that decision. We think that very 

basic framework is one that will address concerns of our companies. 

ACLI is every bit as committed to State regulation as they are 

to an initiative for an optional Federal regulator. We don’t support 

an EFC, an Exclusive Federal Charter, just to make that record. 

We are going to have a number of companies chartered at both the 

State and Federal level, whatever happens going into the future, 

14

so we are committed to this process and committed to working with 

the other commissioners in the States to improve it. 

Mrs. BIGGERT. Thank you. Mr. Conery, do you think the proposal 

sent the right message to the capital markets? 

Mr. CONERY. Well, clearly the insurance companies have begun 

to return to most areas of the market, so in that sense it has sent 

the right message, but people need to recall that it is an interim 

solution. It is a temporary solution. They have not yet said what 

that permanent solution will be relative to the temporary solution. 

All along their dialogue has been saying that they are looking for 

a risk-based solution, which we are not sure exactly what that 

means, because they haven’t chosen to define what risks they are 

talking about at this point in time, so it’s certainly a move in the 

right direction relative to where we were back in May and June of 

this year, we’re cautiously optimistic that it is the right solution for 

the interim, but we have a note of concern that it is a temporary 

solution. 

If I could just make two quick clarifications on the characterization from the side of the BMA. 

The BMA’s position on the interim solution was not that we supported it, because we had our own proposal out there to the NAIC 

and to the working group. We did not object to the interim solution. 

I would say the same is still true. It is not that we support it as 

a solid risk-based solution, but we do not object to it, as we acknowledge that it is the least harmful of the other solutions that 

were out there. 

I would also note, too, that while we have been open to talking 

with the NAIC, I would also recommend, too, that as we go forward 

and down this road with the NAIC, that probably it should be 

noted that working together should include less of a monologue and 

more of a dialogue. 

Mrs. BIGGERT. Thank you. Thank you, Mr. Chairman. I yield 

back. 

Chairman BAKER. I thank the gentlelady. 

Mr. Iuppa, I want to return to an observation I made earlier, and 

didn’t cover with you, and I believe I am understanding the existing process that constrains the disclosure methodology to a subscription base with the NAIC. Those are people to whom they pay 

a fee to which you give this opinion about financial quality, as contrasted with an NRSRO, who assesses a fee directly—in this case 

it would be on the insurance company, perhaps on the issuer—and 

there is no subscription base. 

And so in looking at the model and potential revisions, if the 

NAIC was to move away from a subscription-based system to a feebased system on the company and/or issuers, then there would not 

be this self-imposed constraint on who gets access to that data, and 

then the work would occur with the rated entity or rated product 

and prior to public disclosure some discussion takes place about 

how these conclusions were reached, not that that affects the ultimate decision by the SVO. 

But then when the ‘‘final final’’ is made, it goes to everybody. 

That really is the NRSRO model and the only other addition would 

be just the disclosure of the empirical data that goes into the underlying assessment. 

15

I may be well beyond my expertise on the subject, but that appears to be at least operationally what is causing this differential 

set of disclosure standards. So as you go forward, I would love to 

visit with your team better understand, and I did not request but 

would do so on the committee’s behalf that at such time as you are 

final filed report is in receipt that the committee be given the opportunity to read and understand that set of findings as well. 

We want to make sure going forward that we are working toward 

a mutual end goal that doesn’t impair the NAIC’s ability to protect 

the public interest, but we have a view toward stability in the capital markets. I have extreme concern about global competitiveness 

issues and particularly where I believe it to be a regulatory set of 

standards that causes people to make investment judgments elsewhere. We certainly want to do our best to mitigate those wherever 

possible. 

But, as others have said, I want to express to you our appreciation for your courtesies, your staff meeting with ours was most 

helpful, we believe. We would like to continue in that manner going 

forward and to try to get resolution on this by the end of the year 

at the latest. 

Unless there is anyone who has further comment—yes, sir? 

Mr. IUPPA. If I may just a clarification. When I said that we 

hadn’t reversed any of the decisions, I do want to point out that 

I, too, I guess may be in over my head a little bit, but there were 

about eight securities that were revised as a result, and these were 

older securities that have previously been in place. 

I certainly appreciate, you know, the guidance that you are giving us with regard to moving forward. As I noted in my oral comments, I think that our definition of interested parties is probably 

a bit narrower than what may really be out there, and I think one 

of the challenges for us to reconcile our regulatory responsibilities 

with the broader responsibilities we have as financial regulators. 

I certainly want to acknowledge and look forward to State insurance regulators being compared commensurately with the Federal 

Reserve and the SEC when we come before the committee in the 

future. 

Chairman BAKER. Well, I would say that in the past some have 

described the ‘‘butterfly wing effect’’ that takes place somewhere 

around the world. What has happened to the SVO? They have now 

become the ‘‘elephant’s foot’’ and they really have a direct and 

meaningful impact when that foot hits the ground, and we just 

want to make sure that we know where the elephant is, and where 

he is going, and we only want to feed it and make it happy. We 

don’t want to cause people to take their capital and go elsewhere, 

perhaps to a less threatening environment, so we can get there, I 

think, and I appreciate the willingness to consider these proposals 

and to make whatever you think is the best regulatory judgment. 

I thank our witnesses and our meeting stands adjourned. 

[Whereupon, at 10:58 a.m., the hearing was adjourned.] 

(17)

A P P E N D I X

September 20, 2006

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