1 Rating Agency (E) Working Group of the Financial Conditions (E) Committee A Public Hearing – The Role of Ratings in Insurance Regulation September 24,

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Rating Agency (E) Working Group of the Financial

Conditions (E) Committee A Public Hearing –

The Role of Ratings in Insurance Regulation September 24, 2009

Panel 1 – NAIC Use of Ratings In Regulation Chris Evangel, Managing Director, SVO

[email protected]

212 386-1920

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The Securities Valuation Office (SVO) • Is the professional staff of the VOS Task Force• Does the day-to-day work of analyzing, classifying, and pricing

securities• Insurers are required to report all securities not rated by an

NRSRO• Conducts Investment Research• Investment experts for State Insurance Regulators• Located at 48 Wall Street, NYC • Provides a number of services to state insurance regulators.

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StaffingFTE 2008 – 48• Average Tenured SVO Analyst

– Work Experience: 25+ years– Financial Services Experience: 20+ Years

• Example of Prior work experience:– Standard & Poor’s, Moody’s, FitchRatings, Citibank, JP

Morgan Chase, Merrill Lynch, Credit Suisse, NY State Department of Insurance

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Purposes and Procedures Manual of the NAIC SVO

• Instructions of the Task Force to the SVO and the Industry

• Administrative Instructions of SVO to Industry

• Explains analytical methodologies

• Official NAIC communication

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Operational Comparison of Transparency

NRSRO and SVO Existing Business Model NRSROs

• Capital market pre-purchase focus

• Capital allocation function

• Global/national coverage

• Credit ratings only

• Obtains information from the issuer

• Structures trans. w issuer advisors

• Sells subscriber services

• Monitors all markets & developments

• Regulatory objectives do not inflect analysis

• Benefits from federal securities laws exemption

• Enjoys 1st Amendment privileges – shields from tort liability

• Regulatory framework in transition

SVO• Regulatory post-purchase focus• Limited state insurance financial

solvency role• Ratings, classification, valuations,

portfolio analysis, other• Information provided by insurer –

including its own analysis • Distribution to NAIC community• No monitoring of capital markets• State regulatory objectives are relevant

to and inflect analytics• Never positioned and not structured as

financial newspaper• Not in legal relationship with insurer

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SVO Designations and NRSRO Rating Equivalents

External Rating NAIC DesignationAAA to A- 1

BBB+ to BBB- 2

BB+ to BB- 3

B+ to B- 4

CCC+ to CCC- 5

CC+ to D 6

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Risk Based Capital Reserve Requirements (Percent)

Class Life P/CTax-Adjusted %

Difference

NAIC 1 0.4% 0.3% 0%

NAIC 2 1.3% 1.0% 0%

NAIC 3 4.6% 2.0% 70%

NAIC 4 10.0% 4.5% 64%

NAIC 5 23.0% 10.0% 70%

NAIC 6 30.0% 30.0% -27%

Source: NAIC Life Risk Based Capital Report: Overview and Instructions for Companies, 11/8/2007; NAIC Property/Casualty Risk Based Capital Report: Overview and Instructions for Companies, 11/8/2007

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Distribution Of Issuers by Designation Filing Exempts (FEs) - All

12/31/2007 12/31/2008 2007 vs. 2008

Designation Total Total Change 1FE 90.8% 82.3% -9.7%

2FE 5.1% 11.6% 125.9%

3FE 1.6% 1.9% 14.6%

4FE 1.3% 1.5% 10.1%

5FE 0.7% 1.2% 61.2%

6FE 0.4% 1.6% 290.4%

Overall Totals 100% 100% -0.4%

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Distribution Of Issuers by Designation Filing Exempts (FEs) – Municipals Excluded

12/31/2007 12/31/2008 2007 vs. 2008

Designation Total Total Change 1FE 73.8% 64.8% - 11.3%

2FE 13.5% 15.7% 17.0%

3FE 5.0% 5.7% 15.2%

4FE 4.3% 4.8% 11.1%

5FE 2.0% 3.8% 91.6%

6FE 1.3% 5.3% 312.4%

Overall Totals 100% 100% 1.0%

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Default Rate Assumptions of Risk-Based Capital

Excluded

Excluded

Stress Test Captures Increased

Present vs. Past Corporate

Default Rates

Stress Test Does Not Capture Structured Finance

Default Rates

Source: Corporate Default and Recovery Rates, 1920 – 2007, Moody’s, February 2008

Source: Default and Loss Rates of Structured Finance Securities, 1993 – 2007, Moody’s, July 2008

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Insurers’ Securities Held Year-End 2008

• Value of Securities Rated by NRSROs –Filing Exempt (FE)• Industry Corporate Municipal Structured Total• $ Millions:• Life $1,090,414.4 $ 37,432.6 $336,198.2 $1,464,045.3• P&C $ 292,981.7 $ 375,723.3 $ 63,362.8 $ 732,067.7• F,H&T $ 60,508.8 $ 14,335.8 $ 12,803.8 $ 87,668.0• FE Total: $1,443,904.9 $ 427,491.7 $412,364.8 $2,283,781.0

• Value of Securities Rated by NAIC/SVO – VOS• Corporate Municipal Structured Total• Life $ 350,979.2 $ 728.5 $ 9,815.7 $ 361,523.5• P&C $ 96,462.5 $ 4,398.0 $ 63,362.8 $ 101,584.6• F,H&T $ 16,914.6 $ 82.8 $ 12,803.8 $ 29,801.2• SVO Total: $ 464,356.3 $ 5,208.7 $412,364.8 $ 480,388.8

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Percentage of Insurer Fixed Income Assets Rated by NRSROs

NRSRO Total Securities

NRSRO Only Rated Issues & Issuer

Exposure

NRSRO Only

%Rating Total / Sole Rater

Moody’s 183,182 33,272/7,998 $66.4 Billion 77.4% /14.1%

S&P 154,788 13,503/5,441 $88.0 Billion 65.4% / 5.7%

Fitch 100,573 4,526/1,408 $19.1 Billion 42.5% / 1.9%

DBRS 8,451 1,317/287 $5.6 Billion 3.6% / 0.5%

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Surveillance Report on Rating Migration Changes from YE 2007 to YE 2008

Corporate Industrial Bonds

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Surveillance Report on Rating Migration Changes from YE 2007 to YE 2008

Structured Securities

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Surveillance Report on Rating Migration Changes from YE 2007 to YE 2008

Corporate Industrial Bonds

Structured Securities

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Surveillance Report on Rating Migration Changes from YE 2007 to YE 2008

Structured Securities

Corporate Industrial Bonds

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Report on Rating Migration % of # IssuesFrom / To 1 2 3 4 5 6

1 70.78% 8.42% 5.63% 5.15% 7.49% 2.53% 100.00%2 0.96% 46.66% 9.23% 13.76% 17.76% 11.64% 100.00%3 0.10% 0.76% 33.75% 11.69% 22.24% 31.46% 100.00%4 0.12% 0.12% 0.36% 26.02% 29.26% 44.12% 100.00%5 0.00% 0.00% 0.00% 0.00% 24.27% 75.73% 100.00%6 0.00% 0.00% 0.11% 0.00% 0.22% 99.67% 100.00%

2008 YE $From / To 1 2 3 4 5 6 Total

1 $345,923.1 $26,539.6 $17,524.3 $16,273.9 $25,442.1 $4,792.3 $436,495.42 $1,082.7 $33,653.3 $2,540.8 $5,188.9 $7,360.1 $2,374.0 $52,199.93 $4.2 $64.5 $2,630.0 $948.4 $2,748.7 $2,541.5 $8,937.34 $41.0 $69.8 $0.7 $1,184.3 $2,388.9 $2,325.1 $6,009.65 $0.0 $0.0 $0.0 $0.0 $1,132.0 $2,064.8 $3,196.86 $0.0 $0.0 $23.9 $0.0 $4.9 $659.9 $688.7

$14,763.6 $507,527.6

Structured Securities YE ‘’08 to September ‘09

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Designation No. of

CompaniesAs % of

Total EBITDA/

IntEBIT/

IntFFO/Debt

%Debt/EB

ITDAROC

%Debt/Capital

%

NAIC-1 60 8.6% 13.0x 10.4x 61.8% 1.4x 16.4% 26.2%AAA 6 0.6% 31.0x 27.3x 174.2% 0.5x 25.2% 12.6%AA 15 1.5% 21.4x 18.0x 74.3% 1.0x 25.4% 36.1%A 118 11.5% 12.8x 10.4x 50.7% 1.6x 19.7% 38.4%

Subtotal 139 13.5%

NAIC-2 315 45.3% 8.2x 5.6x 34.9% 2.3x 14.7% 44.6%BBB 213 20.8% 7.6x 5.9x 35.9% 2.2x 15.1% 43.7%NAIC-3 127 18.2% 5.3x 3.4x 25.5% 3.0x 12.0% 54.4%BB 297 28.9% 4.6x 3.4x 24.9% 3.2x 12.5% 51.9%NAIC-4 111 15.9% 2.8x 2.0x 14.4% 4.4x 10.8% 67.2%B 345 33.6% 2.3x 1.5x 12.0% 5.4x 8.8% 74.9%NAIC-5 83 11.9% 1.6x 0.9x 7.2% 5.6x 7.1% 75.4%CCC 32 3.1% 1.2x 0.5x 4.5% 7.7x 5.2% 100.6% Total # of Companies NAIC Rated 696 100.0% S&P Rated 1026 100.0%

2004-2006 Industrial Median AveragesNAIC Rated vs. S&P Rated

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Designation No. of

CompaniesAs % of Total

EBITDA / Int

EBIT / Int

FFO/Debt %

Debt / EBITDA

ROC %

Debt/Capital %

NAIC-1 60 6.5% 12.9x 10.0x 61.7% 1.4x 17.1% 32.7%AAA 6 0.6% 32.0x 26.2x 155.5% 0.4x 27.0% 12.3%AA 14 1.3% 19.5x 16.4x 79.2% 0.9x 28.4% 35.2%A 111 10.2% 13.5x 11.2x 54.5% 1.5x 21.8% 36.8%

Subtotal 131 12.1%

NAIC-2 352 37.8% 8.1x 5.9x 39.4% 2.1x 14.8% 42.2%BBB 213 19.6% 7.8x 5.8x 35.5% 2.2x 15.2% 44.5%NAIC-3 161 17.3% 5.3x 3.5x 26.2% 3.1x 12.8% 55.0%BB 306 28.2% 4.8x 3.4x 25.7% 3.1x 12.4% 52.5%NAIC-4 189 20.3% 3.0x 1.9x 14.1% 4.8x 9.8% 65.8%B 354 32.6% 2.3x 1.4x 11.5% 5.5x 8.7% 73.2%NAIC-5 168 18.1% 1.5x 0.8x 6.3% 5.7x 6.2% 75.6%CCC 22 2.0% 1.1x 0.4x 2.5% 8.6x 2.7% 98.9%Total # of Companies NAIC Rated 930 100% S&P Rated 1086 100%

2005-2007 Industrial Median Averages (NAIC rated vs. S&P Rated)