Insurers’ New Capital Rules Near Finish Line

After more than three years of work, regulators are close to approving a new formula for calculating how much capital insurers must hold to protect against possible losses in their commercial mortgages.

The National Association of Insurance Commissioners rolled out the proposal for industry input Oct. 26, and comments were due Wednesday. A conference call is scheduled for today to discuss the comments. The NAIC’s Life Risk-Based Capital Working Group could vote on the measure in two weeks, during the association’s fall meeting in Washington.

The proposed formula has drawn widespread industry support because it is based on the quality of each commercial mortgage. It would replace a standard that compares the performance of each company’s portfolio to the industry average. That long-standing rule, last updated in 2010, has been criticized by insurers for effectively grading their portfolios on a curve.

If approved by the working group on Nov. 30, the new risk-based capital guidelines would likely take effect next year. They would still have to go through a series of steps before being finalized, but that would be largely a formality.

The proposal represents the latest version of a plan submitted last year by the American Council of Life Insurers, using commercial-mortgage modeling data from Moody’s Analytics. It’s “similar to the approach used to assess regulatory capital requirements in the banking industry for similar assets,” according to the NAIC, the standard-setting organization for state insurance commissioners.

Under the current rule, the basic capital charge is equal to 2.6% of the face amount of an insurer’s commercial mortgage holdings. That benchmark is then adjusted to reflect how the quality of that company’s portfolio compares to those of other insurers. That’s done by multiplying the 2.6% benchmark by a Mortgage Experience Adjustment Factor, or “MEAF,” that can range from 80% to 175%.

The Mortgage Bankers Association strongly favors the change. “The fundamental concern with the MEAF formulation is that it is based on how a life company’s commercial real estate loan portfolio is performing relative to its peers, which is not an objective measure,” the MBA wrote in its four-page comment letter.

“With the MEAF, you didn’t have to outrun the bear. You had to outrun the guy next to you,” added George Green, an associate vice president at the MBA. In an interview, he said the proposed formula would be more accurate and reflective of changing market conditions.

The formula devised by the insurers’ trade group would rank portfolio loans in seven categories, with capital charges ranging from 0.9% for the highest-quality mortgages to 18% for loans 90 days past due and 23% for those backed by properties in foreclosure. The categories in between would require set-asides of 1.75%, 3%, 5% and 7.5%.

For a mortgage to incur the lowest capital charge, the loan-to-value couldn’t exceed 80% and the debt-service-coverage ratio would have to be at least 1.6 to 1. Those metrics would be adjusted as necessary to reflect a 25-year amortization schedule.

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