NAIC classifies hybrid E-CAPS as equities

Moody’s Investors Service says the recent classification of E-CAPS in the United States as an equity security, rather than a bond or preferred stock, will have capital requirement implications for insurers holding the security.
The Securities Valuation Office of the NAIC recently made the ruling on Enhanced Capital Advantage Preferred Securities (E-CAPS), which are a “hybrid” form of security.
“Hybrid securities, which combine the benefits of equity and tax-deductible debt, have taken off because they are partly treated as equity by credit rating agencies and they do not weigh on credit ratings as traditional debt issuance (such as stocks or bonds) can,” according to Professor Ian Giddy from New York University.
“It is more expensive for insurers to hold securities classified as common equity because they are required to pay a 15% capital charge against the security, which is significantly higher than charges for holding preferred stock or debt. Insurers are estimated to hold roughly between 10% and one-third of hybrids sold.”
Estimates suggest US$30 billion worth of hybrid securities will be issued in 2006 against $4 billion in 2005.
Moody’s notes in a recent report that: “some market participants claim that the [NAIC] ruling may have a dampening impact on the market for hybrids in the U.S.”
At the very least, Moody’s notes in a press release, “the SVO’s ruling has triggered a healthy debate about the investment characteristics of hybrid securities and how they should be treated within the risk management frameworks of insurance company holders.”