UPDATE 2-US insurance group moves ahead with new rating plan

(Adds rating company comment)

By Al Yoon

NEW YORK Nov 6 (Reuters) - U.S. insurance regulators on Friday approved development of a new model for sizing up risks in mortgage bonds held by insurers that cuts reliance on traditional credit rating companies.

The National Association of Insurance Commissioners, a group of state insurance regulators, said its plan reflects a loss of confidence in the rating companies.

The ratings agencies, such as Standard & Poor's, Moody's Investors Service and Fitch Ratings, have been blamed with contributing to the financial crisis by assigning top ratings to the securities linked to mortgages at the heart of the crisis.

The NAIC's change would rely on a new third-party designation of the risk in holding mortgage bonds, instead of only ratings handed out by the rating companies.

But while criticizing the rating companies, the new model may result in more liberal treatment of mortgages.

"This is a big story as it involves a regulatory body moving away from a pure ratings-based approach to assessing risk and assigning capital requirements," said Scott Buchta, a strategist at Guggenheim Capital Markets in Chicago.

The new model would address regulators' concern that mortgage losses are not treated appropriately in current ratings, inasmuch as they determine the capital that insurance companies must hold against the securities, the NAIC said in a statement.

In many cases, that could free insurers from the impact of harsh downgrades on securities where losses are deemed minimal, traders said. The prospects of holding more capital against downgraded securities has forced insurers to sell holdings, or has kept them from buying cheap securities, they said.

Rating companies treat small partial losses on mortgage bonds with hundreds of creditors similar to losses on corporate bonds, which have one creditor, traders said. Since credit ratings can be triggered by the first dollar of loss, the mortgage bond can thus get hit much harder, Buchta said.

"This is something that would be very beneficial to insurance companies," said William Bemis, a portfolio manager at Aviva Investors in Des Moines, Iowa.

"Instead of rating them as first dollar of loss, you would rate them more on the severity of that loss," he said.

The NAIC said it will partner with an independent party to develop the model. It has discussed the model with Blackrock Inc, Promontory Financial Group and Andrew Davidson & Co, according to The Wall Street Journal.

The model will produce ratings for about 18,000 mortgage bonds owned by insurers at the end of 2009, the NAIC said.

A Moody's Investors Service (MCO.N) spokesman said the company has always encouraged users of ratings to consider if its work meets their needs. Moody's ratings are a "well-considered evaluation of the likely severity of loss and do not overstate credit risk," he said.

Standard & Poor's, a unit of McGraw-Hill Cos (MHP.N) declined to comment. Fimilac SA's (LBCP.PA) Fitch Ratings also declined to comment.

Rating companies are also under fire in Congress, where proposed legislation would give the Securities and Exchange Commission a new oversight role. The bill would open the door for lawsuits against the companies over flawed ratings. (Additional reporting by Nancy Leinfuss and Walden Siew; Editing by Leslie Adler)