NAIC Discusses AIG's Securities Lending

National Underwriter News
December 10, 2008

GRAPEVINE, TEXAS -- Securities lending programs by insurers and the way that they are conducted need to be examined, New York's insurance superintendent told other state regulators meeting here.

The issue has not been addressed by the National Association of Insurance Commissioners as a group, Superintendent Eric Dinallo said at a session of the NAIC's Life & Annuities "A" Committee.

The programs can be a "wonderfully smart use of assets but also [can leave companies] vulnerable to extreme stress," Mr. Dinallo explained as part of a discussion that mentioned problems at American International Group.

In July Mr. Dinallo sent out a Circular Letter to the industry mentioning a concern that cash received as collateral in securities lending programs had been reinvested into securities whose value had significantly declined. He said he was worried some insurers might have maintained inadequate collateral and mismanaged the risks involved with the securities lending function.

Companies that participate in securities lending programs offer securities they own to other institutions in return for borrowed cash. The securities lender then receives payments equal to dividends and interest from the borrower of the securities and invests those funds. At the end of the agreement, the securities lender returns the cash with a payment for the use of that cash and receives the securities back.

In the case of AIG in New York, the carrier came up short when the time came to return collateral on such deals when much of the cash it received was used to invest in mortgage-backed securities which took a hit when the real estate market faltered.

Regulators said the AIG securities lending transactions were kept off the company's balance sheet and were not transparent.

Mr. Dinallo and other state insurance commissioners are now trying to right the company which accepted federal control when a liquidity crisis forced it to borrow $150 billion from taxpayers.

The regulatory accounting for these programs is not sufficient, according to Mr. Dinallo. Regulators, he said, are able to examine assets which the insurer still owns but do not get to see what happens to the cash.

During a regulator-only session at the meeting, according to Connecticut Insurance Commissioner Tom Sullivan, "the lack of consistency around these vehicles" was described as "deeply alarming."

Mr. Dinallo added that "one could have a reasonable discussion over whether insurers should be involved in this activity." He said that if regulators are trying to build a "regulatory moat" around insurance companies, then these programs can be likened to a "drawbridge" that bridges insurers to other financial services areas.

Tom Hampton, commissioner of the District of Columbia, said that he understood the concern over these programs but also urged caution. "We want to be careful. We don't want to disadvantage insurance companies in the financial marketplace."

The discussion focused on how regulators at the NAIC will approach the potential new project and which committees will be involved in taking a look into how these programs are regulated.

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