Insurance-linked securities: Insurance companies or issuers of asset-backed securities?

The U.S. Securities and Exchange Commission (SEC) has voted to propose new rules and amendments to the way ratings agencies conduct their business. The proposed rules, which the members of the SEC voted to put out for comments for sixty days to get feedback from interested parties, are intended to increase transparency and improve the integrity of credit ratings.

The proposition, which you can read in its 517 page entirety, if passed would implement certain provisions (relating to credit ratings and ratings agencies) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC say this would enhance their existing rules over the sector of credit ratings and Nationally Recognized Statistical Rating Organizations (NRSROs).

“In passing the Dodd-Frank Act, Congress noted that credit ratings applied to structured financial products proved inaccurate and contributed significantly to the mismanagement of risks by financial institutions and investors,” said SEC Chairman Mary L. Schapiro. “Our proposed rules are intended to strengthen the integrity and improve the transparency of credit ratings.”

How insurance-linked securities should be treated is one question within the report that the SEC is seeking feedback and comments on. Page 264 of the report asks whether insurance-linked securities should be classified as insurance companies or as issuers of asset-backed securities or something else? The exact text is below:

How should insurance-linked securities be classified? For example, should they be classified as: (1) insurance companies identified in Section 3(a)(62)(A)(ii) of the Exchange Act; or (2) issuers of asset-backed securities identified in Section 3(a)(62)(A)(iv) of the Exchange Act as broadened to include any rated security or money market instrument issued by an asset pool or as part of any asset-backed securities transaction? Is there another more appropriate classification? Commenters should provide explanations for their choices.

It’s an interesting question and perhaps they are actually serving as both to some degree. Although feedback we have received in the past from market outsiders suggests that many see them as issuers of securities as they don’t actually perform any underwriting. If you have a strong opinion on this topic we would highly recommend you making sure your voice is heard by submitting your comments on the SEC website (you can also let us know what you think in the comments below).

It seems likely that some discussion could arise from this as the request for comments could be worded better and it’s not particularly clear whether the SEC is distinguishing correctly between the classification of the special purpose reinsurance vehicle (SPRV) which issues catastrophe bonds and insurance-linked securities or the resulting ILS notes themselves. Rating agencies apply their credit ratings to the (sometimes multiple) tranches of notes that get issued by an insurance-linked security SPRV, not directly to the SPRV company itself.

This process of trying to make the rating agency world more transparent and accountable is unlikely to have any impact on the market. In fact the desire to increase transparency and to make it easier for users of credit ratings, such as investors, to understand and analyse them can only be a good thing and help encourage investors to ILS as an asset class.