1211. (a) For the purposes of this section the following
definitions shall apply:
(1) "Aggregate counterparty exposure" means the sum of the
aggregate statement value options, swaptions, caps, floors, and
warrants purchased, and the aggregate potential exposure of collars,
swaps, forwards, and futures entered into.
(2) "Cap" means an agreement obligating the seller to make
payments to the buyer with each payment based on the amount by which
a reference price or level or the performance or value of one or more
underlying interests exceeds a predetermined number, sometimes
referred to as the strike rate or strike price.
(3) "Collar" means an agreement to receive payments as the buyer
of an option, cap, or floor and to make payments as the seller of a
different option, cap, or floor.
(4) "Credit default swap" means an agreement obligating the buyer
to pay a periodic payment to the seller in return for the seller's
obligation to make a payment to the buyer if a credit event or events
occur with respect to underlying interests or an entity, as
specified in the documentation of the credit default swap.
(5) "Derivative instrument" means an agreement, option,
instrument, or a series or combination of those (A) to make or take
delivery of, or assume or relinquish, a specified amount of one or
more underlying interests, or to make a cash settlement in lieu
thereof, or (B) that has a price, performance, value, or cashflow
based primarily upon the actual or expected price, level,
performance, value, or cashflow of one or more underlying interests.
A derivative instrument includes all investment instruments or
contracts that derive all or almost all of their value from the
performance of an underlying market, index, or financial instruments.
The term includes options, warrants, caps, floors, collars, swaps,
credit default swaps, swaptions, forwards, and futures.
(6) "Derivative transaction" means a transaction involving the use
of one or more derivative instruments.
(7) "Floor" means an agreement obligating the seller to make
payments to the buyer in which each payment is based on the amount by
which a predetermined number, sometimes called the floor rate or
price, exceeds a reference price, level, performance, or value of one
or more underlying interests.
(8) "Forward" means an agreement, other than a future, to make or
take delivery in the future of one or more underlying interests, or
effect a cash settlement, based on the actual or expected price,
level, performance, or value of those underlying interests, but does
not mean or include spot transactions effected within customary
settlement periods, when issued purchases, or other similar cash
market transactions.
(9) "Future" means an agreement traded on an organized and
qualified futures exchange, to make or take delivery of, or effect a
cash settlement based on the actual or expected price, level,
performance, or value of, one or more underlying interests.
(10) "Hedging transaction" means a derivative transaction that is
entered into and at all times maintained to reduce (A) risk due to a
change in the value, yield, price, cashflow, or quantity of assets or
liabilities that the insurer has acquired or incurred or anticipates
acquiring or incurring or (B) risk due to changes in the currency
exchange rate or the degree of exposure as to assets or liabilities
denominated in a foreign currency that an insurer has acquired or
incurred or anticipates acquiring or incurring.
(11) "Option" means an agreement giving the buyer the right to buy
or receive, sell, or deliver, enter into, extend, or terminate or
effect a cash settlement based on the actual or expected price,
spread, level, performance, or value of one or more underlying
interests.
(A) For purposes of this paragraph, an agreement giving the buyer
the right to buy or receive may also be called a "call option."
(B) For purposes of this paragraph, an agreement giving the buyer
the right to sell or deliver may be called a "put option."
(12) "Potential exposure" means the amount determined in
accordance with the National Association of Insurance Commissioners
Annual Statement Instructions.
(13) "Qualified bank" means a bank or trust company that meets all
of the following:
(A) The bank or trust company is organized and existing, or in the
case of a branch or agency of a foreign banking organization is
licensed, under federal law or the law of any state.
(B) The bank or trust company is regulated, supervised, and
examined by the United States federal or state authorities having
regulatory authority over banks and trust companies.
(C) The bank or trust company has assets in excess of five billion
dollars ($5,000,000,000).
(D) The bank or trust company has senior obligations outstanding,
or has a parent corporation that has senior obligations outstanding,
rated AA or better, or the equivalent, by two independent nationally
recognized statistical rating organizations.
(E) The bank or trust company has a ratio of primary capital to
total assets of at least 5 1/2 percent and a ratio of total capital
to total assets of at least 6 percent.
(14) "Qualified counterparty" is a qualified broker or dealer or a
qualified bank or other counterparty rated AA- or Aa3 or higher by a
nationally recognized statistical rating organization.
(15) "Qualified broker or dealer" means a broker or dealer that is
organized under the laws of a state and is registered under the
Securities Exchange Act of 1934 (15 U.S.C. Sec. 78a et seq.), and has
net capital in excess of two hundred fifty million dollars
($250,000,000).
(16) "Replication transaction" means a derivative transaction or
combination of derivative transactions effected either separately or
in conjunction with cash market investments included in the insurer's
investment portfolio in order to replicate the investment
characteristic of another authorized transaction, investment, or
instrument or that may operate as a substitute for cash market
investments. A derivative transaction entered into by the insurer as
a hedging transaction authorized pursuant to this section shall not
be considered a replication transaction.
(17) "Swap" means an agreement to exchange or to net payments or
income streams at one or more times based on the actual or expected
price, yield, level, performance, or value of one or more underlying
interests.
(18) "Swaption" means an option to purchase or sell a swap at a
given price and time or at a series of prices and times. A swaption
does not mean a swap with an embedded option.
(19) "Underlying interest" means the assets, liabilities, other
interests, or a combination thereof, underlying a derivative
instrument, such as any one or more securities, currencies, rates,
indices, commodities, or derivative instruments.
(20) "Warrant" means an instrument that gives the holder the right
to purchase or sell the underlying interest at a given price and
time or at a series of prices and times outlined in the warrant
agreement.
(b) Any domestic incorporated insurer having admitted assets, as
of the preceding December 31, of at least one billion dollars
($1,000,000,000) and capital and surplus of at least two hundred
million dollars ($200,000,000), after investing an amount equal to
its required minimum paid-in capital in securities specified in
Article 3 (commencing with Section 1170), may engage in derivative
transactions pursuant to, and in compliance with, this section.
(c) An insurer may only use derivative instruments under this
section to engage in hedging transactions and replication
transactions authorized pursuant to this section.
(d) An insurer that engages in hedging transactions or replication
transactions as authorized pursuant to this section shall do both of
the following:
(1) Maintain its position in any outstanding derivative instrument
used as part of a hedging transaction or replication transaction for
only as long as the hedging transaction or replication transaction,
as the case may be, continues to be effective in meeting the
objective and the rationale the insurer identifies at the point of
inception of the hedging or replication transaction.
(2) Be able to demonstrate to the commissioner, upon request, that
any hedging transaction or replication transaction continues to be
effective in meeting that objective and rationale.
(e) (1) The aggregate statement value, and potential exposure, of
all transactions held under the authority of this section at any one
time shall not be in excess of 7 1/2 percent of the insurer's
admitted assets, as of the preceding December 31.
(2) Hedging transactions under this section may only be made if,
as a result of, and after giving effect to the transaction, all of
the following is established:
(A) Excluding options acquired under Section 1212, the aggregate
statement value of options, swaptions, caps, floors, and warrants
purchased pursuant to this section does not exceed 7 1/2 percent of
its admitted assets as of the preceding December 31.
(B) Excluding options acquired under Section 1212, the aggregate
statement value of options, swaptions, caps, and floors written
pursuant to this section does not exceed 3 percent of its admitted
assets as of the preceding December 31.
(C) Excluding futures entered into under Section 1212, the
aggregate potential exposure of collars, swaps, forwards, and
futures, entered into and, except for options acquired under Section
1212, options, swaptions, caps, and floors written pursuant to this
section does not exceed 6 1/2 percent of its admitted assets as of
the preceding December 31.
(f) An insurer may purchase or sell one or more derivative
instruments to offset any derivative instrument previously purchased
or sold, as the case may be, without regard to the quantitative
limitations of this section, provided that the derivative instrument
is an exact offset to the original derivative instrument being
offset.
(g) (1) The board of directors of any domestic insurer that makes
investments pursuant to this section shall first adopt written
guidelines for the making of the investments. The guidelines shall
cover factors including concentration and diversification of
counterparty risk, quality, maturity, and diversification of
derivative investments, and other specifications, including
investment strategies, asset liability management practices, the
insurer's liquidity needs and its capital and surplus, and other
factors that the board of directors deems appropriate. The guidelines
shall also include processes and practices that will facilitate the
monitoring of derivative transactions through cashflow testing or
other methods to substantiate the effectiveness of the hedging
strategies and derivative transactions and provide the board of
directors of the committee thereof charged with the responsibility
for supervising investments the opportunity to assure itself of the
training, sufficient understanding, and competency of pertinent
personnel implementing the derivative transactions.
(2) In order to address the need for appropriate oversight by
senior management and by the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
and to provide for a comprehensive risk management process, an
insurer shall establish the following with respect to derivative
transactions:
(A) Appropriate limits for various identified risks relevant to
the derivative transactions used by the insurer.
(B) Procedures and practices that control the nature and amount of
those risks.
(C) Adequate systems or processes for identifying and measuring
those risks.
(D) Systems or processes for documenting, monitoring, and
reporting risk exposures on a timely basis.
(E) Systems or processes of internal review and audit to ensure
the integrity of the overall risk management process.
(3) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, shall receive and
review quarterly reports which shall include all of the following:
(A) Information to ascertain that all derivative transactions have
been made in accordance with delegations, standards, limitations,
and investment objectives contained in the derivative guidelines.
(B) The outstanding derivative positions.
(C) The unrealized gains or losses thereon.
(D) The derivative transactions closed during the report period.
(E) A performance review of the derivative transactions.
(F) An evaluation of the risks and benefits of the derivative
transactions.
(G) Other information necessary to ensure that the internal
control procedures are being followed.
(4) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, shall establish the
following management oversight standards for derivative transactions:
(A) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, has an affirmative
obligation to inform management of its desired risk tolerance levels.
Management shall appropriately translate these risk tolerance levels
into effective policies and procedures that address both individual
transactions and entire portfolios.
(B) Management and the board of directors, or a committee thereof
charged with the responsibility for supervising investments, shall
receive sufficient information to assess the strengths and
limitations of the insurer's risk measurement systems in order to
determine appropriate risk limits. The board of directors, or a
committee thereof charged with the responsibility for supervising
investments, shall also review management's response to strengths and
limitations identified through oversight processes such as stress
testing, independent validation, and back-testing of risk measurement
models. Management and the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
shall consider the information identified by the oversight processes,
including the potential for indirect effects of downside performance
beyond the insurer's finances, when they determine and communicate
their risk profile.
(C) When management or the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
identifies weaknesses in the risk management process, they shall
consider alternatives and take steps to strengthen that process and
maintain detailed documentation of steps and actions taken.
(D) Actions shall be taken to correct any deficiencies in internal
controls relative to derivative transactions, including any
deficiencies determined by the independent certified public
accountant in the evaluation of accounting procedures and internal
controls and maintain detailed documentation of steps and actions
taken.
(E) Personnel responsible for risk oversight functions shall
possess independence, authority, and expertise.
(F) Issuer and counterparty credit decisions for each transaction
shall be consistent with the overall credit standards of the insurer.
(G) In connection with each derivative transaction under this
section, insurers shall maintain a statement in their records listing
any member of the board of directors who is employed by, or a
partner in, a party involved in the derivative transaction.
(5) The board of directors or committee charged with the
responsibility of supervising investments shall determine at least
quarterly whether all derivative transactions have been made in
accordance with delegations, standards, limitations, and investment
objectives prescribed in the guidelines. If the determinations are
made by a committee of the board of directors, the minutes of the
committee reflecting the determinations shall be recorded and a
report thereon shall be submitted to the board for its review at the
board's next meeting.
(6) The commissioner shall require the guidelines to be submitted
and shall disapprove the guidelines if the insurer is unable to show
that the guidelines are found sufficient to prevent financially
unsound or hazardous transactions or practices.
(h) An insurer shall comply with applicable financial requirements
as promulgated by the commissioner and the National Association of
Insurance Commissioners included in the Purposes and Procedures
Manual of the National Association of Insurance Commissioners
Securities Valuation Office, the National Association of Insurance
Commissioners Accounting Practices and Procedures Manual, and the
National Association of Insurance Commissioners Annual Statement
Instructions, including, but not limited to, the reporting of
transfers, if any, of interests in the assets of the insurer pledged
as collateral or interests in the assets of counterparties received
as collateral in connection with derivative transactions.
(i) (1) The counterparty exposure under a derivative instrument
entered into by an insurer authorized to engage in derivative
transactions pursuant to this section shall be deemed to be an
obligation of the institution to which the insurer is exposed to
credit risk and shall be included in determining compliance with any
single or aggregate quantitative limitation on investments made by an
insurer under this section.
(2) An insurer shall only enter into derivative transactions with
counterparties that are rated one by the Securities Valuation Office.
(3) Notwithstanding any single or aggregate quantitative
limitation on investments made by an insurer under this section, the
aggregate counterparty exposure under one or more derivative
transactions to any single counterparty rated one by the Securities
Valuation Office, other than a "qualified counterparty," shall be
limited to one-half of 1 percent of an insurer's admitted assets, and
all counterparties rated one by the Securities Valuation Office,
other than qualified counterparties, shall be limited to 3 percent of
an insurer's admitted assets.
(j) Investments made pursuant to this section, and related
transactions, are deemed excess funds investments and shall be
subject to the provisions of Sections 1153.5, 1154, and 1210, and
Article 4 (commencing with Section 1190), provided that if an insurer
classifies an investment under Section 1210 that investment shall
continue to be subject to the limitations of paragraph (1) of
subdivision (e). Notwithstanding anything to the contrary, a
requirement providing that any derivative transaction be disposed of
by the insurer pursuant to Section 1202 shall be deemed conclusive
unless the insurer establishes that the derivative transaction or
transactions are financially sound and not hazardous. This section
shall only be deemed to permit replication of investments or
instruments, that are otherwise permitted in this code, and that are
reported in compliance with the requirements of the risk-based
capital and risk-based capital instructions required by Section
739.2.
(k) Except as permitted in this section, nothing in this section
shall be deemed to permit an investment, transaction, or practice
that is not authorized by another section of this code. Exposure to
risk by use of derivatives shall be consistent with the overall
investment guidelines. Insurers shall not enter into derivative
transactions in whole or in part with funds borrowed for that
purpose, including, but not limited to, on margin.
(l) The commissioner may adopt rules and issue guidelines
establishing standards and requirements relative to practices
authorized in this section. In connection with any of the actions
contemplated by this section to be taken by the commissioner,
including review of an insurer's written guidelines with respect to
derivative transactions and review of documentation maintained by an
insurer with respect to derivative transactions, the commissioner may
deem the actions to be an examination of an insurer subject to the
provisions of Sections 730 to 738, inclusive. The commissioner shall
issue regulations establishing requirements regarding the disclosure
of affiliations and conflicts of interest between an insurer and
persons contracted by the commissioner to perform services on behalf
of the commissioner in connection with the matters authorized by this
section.
(m) An insurer that is not engaged in the issuance of new policies
of insurance and that is formed for the purpose of facilitating the
rehabilitation of an insolvent insurer under Article 14 (commencing
with Section 1010) of Chapter 1, shall, prior to engaging in any
derivative transaction, obtain approval for each transaction from the
commissioner, and shall otherwise comply with the requirements of
this section. However, the insurer may, upon request to the
commissioner, and upon showing satisfactory to the commissioner that
prior approval of each transaction would not be in the best interests
of the policyholders, request that the commissioner waive the
requirement of prior approval and the insurer shall, in addition to
complying with the requirements of this section, submit monthly
written reports of all derivative transactions to the commissioner in
the form required by the commissioner within 30 days of the prior
month's end.
1212. (a) Any domestic incorporated insurer having aggregate
capital and surplus as of the preceding December 31 of at least
twenty-five million dollars ($25,000,000), after investing an amount
equal to its required minimum paid-in capital in securities specified
in Article 3 (commencing with Section 1170), may purchase insurance
futures contracts, purchase call options on insurance futures
contracts, and sell put options on insurance futures contracts in
bona fide hedging transactions, subject to the limitations set forth
in this section.
Domestic insurers may sell insurance futures contracts, sell call
options on insurance futures contracts, and purchase put options on
insurance futures contracts only for the purpose of a closing
transaction. No other sales of insurance futures contracts, sales of
call options on insurance futures contracts, or purchases of put
options on insurance futures contracts are authorized under this
section.
(b) For purposes of this section, "insurance futures contracts"
mean contracts based on indices of loss performance of insurance
contracts and traded in accordance with the rules and procedures of a
board of trade regulated by the Commodity Futures Trading
Commission, or any successor agency, and subject to the terms and
conditions of the Commodity Exchange Act (7 U.S.C. Sec. 1 et seq.),
as amended. For purposes of this section, "put and call options on
insurance futures contracts" mean put or call options, regulated in
accordance with the rules of the board of trade on which the options
are traded, on insurance futures contracts.
(c) No domestic insurer may purchase insurance futures contracts,
purchase call options on insurance futures contracts, or sell put
options on insurance futures contracts unless the insurance futures
contracts are required to be settled in cash within nine months after
the end of the loss period underlying the insurance futures
contracts, and the relevant type of insurance futures contracts have
attained an average daily trading volume of at least 250 contracts
and an open interest of 1,000 contracts as reported by the relevant
board of trade for the one-month period prior to the insurer
initiating the transaction.
(d) A transaction will be considered a bona fide hedging
transaction only if, upon execution, (1) the insurance futures
contract or option is specifically identified with a group of
insurance policies issued or reasonably expected to be issued by the
insurer in the ordinary course of business and (2) the insurer's
relevant underwriting or insurance-related risk exposures bear a
correlation to the risk exposures of the index underlying the
insurance futures contracts or options thereon entered into as part
of the hedging transaction. For purposes of this section,
"correlation" means that the loss experience of the policies hedged
is, at the date of purchase of the insurance futures contracts,
expected to develop similarly to the loss experience of the policies
underlying the insurance futures contract when exposed to similar
occurrences and conditions. The insurer shall identify this hedging
transaction and the policies and written premiums hedged on its books
and records and any insurance futures contract or option position
shall be terminated as soon as possible after this correlation does
not exist.
(e) Notwithstanding other limitations of this section, an insurer
may hold open insurance futures contracts and put and call options on
insurance futures contracts which do not exceed the equivalent of 75
percent of the insurer's written premium for each line of business,
as designated in the annual statement required by Section 923, being
hedged pursuant to this section. For purposes of this subdivision,
equivalence shall be based on the par dollar value of the insurance
futures contracts and an insurer's written premium shall be measured
based on the loss period reflected in the underlying futures
contracts.
(f) A domestic insurer shall not enter into hedging transactions
in insurance futures contracts or options on insurance futures
contracts unless the transaction is authorized or approved by the
insurer's board of directors or a committee designated by the board.
This authorization or approval shall be entered on the records or
minutes of the domestic insurer and, if made upon the authority of a
committee of directors, shall be submitted to the full board of
directors for ratification at their next meeting. The entry of
approval shall show the fact of entering into the hedging
transaction, the specific policies hedged, the size of the hedge as
measured pursuant to subdivision (e), and the name of each director
voting to approve the hedging transaction.
(g) The commissioner may, in his or her discretion, by written
order require the disposal of any insurance futures contracts or
options on insurance futures contracts made in violation of this
section. Pending a disposal pursuant to an order by the commissioner,
the insurance futures contracts or options on insurance futures
contracts shall not be given any effect on any statement required by
this code purporting to show the financial condition of the domestic
insurer or in measuring the financial condition of the domestic
insurer for the purpose of determining whether the domestic insurer
is solvent or insolvent. The commissioner may also, for good cause
shown, order the disposal of any insurance futures contract or option
on insurance futures contracts.
(h) Insurance futures contracts and put and call options on
insurance futures contracts shall not be deemed to be investments for
purposes of any investment limitations or authorizations contained
in this code.
(i) The commissioner may adopt rules and guidelines establishing
standards and requirements relative to practices authorized in this
section. The commissioner shall issue a bulletin by June 30, 1994,
setting forth the accounting, reporting, and valuation practices and
procedures for insurance futures contracts. However, a bulletin shall
not be required if, prior to June 30, 1994, accounting practices and
procedures are officially promulgated by the National Association of
Insurance Commissioners. The bulletin issued pursuant to this
subdivision shall not be superseded by any action of the National
Association of Insurance Commissioners that conflicts with or that
fails to address matters addressed by the bulletin. No insurer shall
engage in hedging transactions with respect to insurance futures
contracts or put and call options on insurance futures contracts
until the earlier of the date a bulletin is issued or the date
accounting practices and procedures are officially promulgated by the
National Association of Insurance Commissioners and except pursuant
to this section.
1211. (a) For the purposes of this section the following
definitions shall apply:
(1) "Aggregate counterparty exposure" means the sum of the
aggregate statement value options, swaptions, caps, floors, and
warrants purchased, and the aggregate potential exposure of collars,
swaps, forwards, and futures entered into.
(2) "Cap" means an agreement obligating the seller to make
payments to the buyer with each payment based on the amount by which
a reference price or level or the performance or value of one or more
underlying interests exceeds a predetermined number, sometimes
referred to as the strike rate or strike price.
(3) "Collar" means an agreement to receive payments as the buyer
of an option, cap, or floor and to make payments as the seller of a
different option, cap, or floor.
(4) "Credit default swap" means an agreement obligating the buyer
to pay a periodic payment to the seller in return for the seller's
obligation to make a payment to the buyer if a credit event or events
occur with respect to underlying interests or an entity, as
specified in the documentation of the credit default swap.
(5) "Derivative instrument" means an agreement, option,
instrument, or a series or combination of those (A) to make or take
delivery of, or assume or relinquish, a specified amount of one or
more underlying interests, or to make a cash settlement in lieu
thereof, or (B) that has a price, performance, value, or cashflow
based primarily upon the actual or expected price, level,
performance, value, or cashflow of one or more underlying interests.
A derivative instrument includes all investment instruments or
contracts that derive all or almost all of their value from the
performance of an underlying market, index, or financial instruments.
The term includes options, warrants, caps, floors, collars, swaps,
credit default swaps, swaptions, forwards, and futures.
(6) "Derivative transaction" means a transaction involving the use
of one or more derivative instruments.
(7) "Floor" means an agreement obligating the seller to make
payments to the buyer in which each payment is based on the amount by
which a predetermined number, sometimes called the floor rate or
price, exceeds a reference price, level, performance, or value of one
or more underlying interests.
(8) "Forward" means an agreement, other than a future, to make or
take delivery in the future of one or more underlying interests, or
effect a cash settlement, based on the actual or expected price,
level, performance, or value of those underlying interests, but does
not mean or include spot transactions effected within customary
settlement periods, when issued purchases, or other similar cash
market transactions.
(9) "Future" means an agreement traded on an organized and
qualified futures exchange, to make or take delivery of, or effect a
cash settlement based on the actual or expected price, level,
performance, or value of, one or more underlying interests.
(10) "Hedging transaction" means a derivative transaction that is
entered into and at all times maintained to reduce (A) risk due to a
change in the value, yield, price, cashflow, or quantity of assets or
liabilities that the insurer has acquired or incurred or anticipates
acquiring or incurring or (B) risk due to changes in the currency
exchange rate or the degree of exposure as to assets or liabilities
denominated in a foreign currency that an insurer has acquired or
incurred or anticipates acquiring or incurring.
(11) "Option" means an agreement giving the buyer the right to buy
or receive, sell, or deliver, enter into, extend, or terminate or
effect a cash settlement based on the actual or expected price,
spread, level, performance, or value of one or more underlying
interests.
(A) For purposes of this paragraph, an agreement giving the buyer
the right to buy or receive may also be called a "call option."
(B) For purposes of this paragraph, an agreement giving the buyer
the right to sell or deliver may be called a "put option."
(12) "Potential exposure" means the amount determined in
accordance with the National Association of Insurance Commissioners
Annual Statement Instructions.
(13) "Qualified bank" means a bank or trust company that meets all
of the following:
(A) The bank or trust company is organized and existing, or in the
case of a branch or agency of a foreign banking organization is
licensed, under federal law or the law of any state.
(B) The bank or trust company is regulated, supervised, and
examined by the United States federal or state authorities having
regulatory authority over banks and trust companies.
(C) The bank or trust company has assets in excess of five billion
dollars ($5,000,000,000).
(D) The bank or trust company has senior obligations outstanding,
or has a parent corporation that has senior obligations outstanding,
rated AA or better, or the equivalent, by two independent nationally
recognized statistical rating organizations.
(E) The bank or trust company has a ratio of primary capital to
total assets of at least 5 1/2 percent and a ratio of total capital
to total assets of at least 6 percent.
(14) "Qualified counterparty" is a qualified broker or dealer or a
qualified bank or other counterparty rated AA- or Aa3 or higher by a
nationally recognized statistical rating organization.
(15) "Qualified broker or dealer" means a broker or dealer that is
organized under the laws of a state and is registered under the
Securities Exchange Act of 1934 (15 U.S.C. Sec. 78a et seq.), and has
net capital in excess of two hundred fifty million dollars
($250,000,000).
(16) "Replication transaction" means a derivative transaction or
combination of derivative transactions effected either separately or
in conjunction with cash market investments included in the insurer's
investment portfolio in order to replicate the investment
characteristic of another authorized transaction, investment, or
instrument or that may operate as a substitute for cash market
investments. A derivative transaction entered into by the insurer as
a hedging transaction authorized pursuant to this section shall not
be considered a replication transaction.
(17) "Swap" means an agreement to exchange or to net payments or
income streams at one or more times based on the actual or expected
price, yield, level, performance, or value of one or more underlying
interests.
(18) "Swaption" means an option to purchase or sell a swap at a
given price and time or at a series of prices and times. A swaption
does not mean a swap with an embedded option.
(19) "Underlying interest" means the assets, liabilities, other
interests, or a combination thereof, underlying a derivative
instrument, such as any one or more securities, currencies, rates,
indices, commodities, or derivative instruments.
(20) "Warrant" means an instrument that gives the holder the right
to purchase or sell the underlying interest at a given price and
time or at a series of prices and times outlined in the warrant
agreement.
(b) Any domestic incorporated insurer having admitted assets, as
of the preceding December 31, of at least one billion dollars
($1,000,000,000) and capital and surplus of at least two hundred
million dollars ($200,000,000), after investing an amount equal to
its required minimum paid-in capital in securities specified in
Article 3 (commencing with Section 1170), may engage in derivative
transactions pursuant to, and in compliance with, this section.
(c) An insurer may only use derivative instruments under this
section to engage in hedging transactions and replication
transactions authorized pursuant to this section.
(d) An insurer that engages in hedging transactions or replication
transactions as authorized pursuant to this section shall do both of
the following:
(1) Maintain its position in any outstanding derivative instrument
used as part of a hedging transaction or replication transaction for
only as long as the hedging transaction or replication transaction,
as the case may be, continues to be effective in meeting the
objective and the rationale the insurer identifies at the point of
inception of the hedging or replication transaction.
(2) Be able to demonstrate to the commissioner, upon request, that
any hedging transaction or replication transaction continues to be
effective in meeting that objective and rationale.
(e) (1) The aggregate statement value, and potential exposure, of
all transactions held under the authority of this section at any one
time shall not be in excess of 7 1/2 percent of the insurer's
admitted assets, as of the preceding December 31.
(2) Hedging transactions under this section may only be made if,
as a result of, and after giving effect to the transaction, all of
the following is established:
(A) Excluding options acquired under Section 1212, the aggregate
statement value of options, swaptions, caps, floors, and warrants
purchased pursuant to this section does not exceed 7 1/2 percent of
its admitted assets as of the preceding December 31.
(B) Excluding options acquired under Section 1212, the aggregate
statement value of options, swaptions, caps, and floors written
pursuant to this section does not exceed 3 percent of its admitted
assets as of the preceding December 31.
(C) Excluding futures entered into under Section 1212, the
aggregate potential exposure of collars, swaps, forwards, and
futures, entered into and, except for options acquired under Section
1212, options, swaptions, caps, and floors written pursuant to this
section does not exceed 6 1/2 percent of its admitted assets as of
the preceding December 31.
(f) An insurer may purchase or sell one or more derivative
instruments to offset any derivative instrument previously purchased
or sold, as the case may be, without regard to the quantitative
limitations of this section, provided that the derivative instrument
is an exact offset to the original derivative instrument being
offset.
(g) (1) The board of directors of any domestic insurer that makes
investments pursuant to this section shall first adopt written
guidelines for the making of the investments. The guidelines shall
cover factors including concentration and diversification of
counterparty risk, quality, maturity, and diversification of
derivative investments, and other specifications, including
investment strategies, asset liability management practices, the
insurer's liquidity needs and its capital and surplus, and other
factors that the board of directors deems appropriate. The guidelines
shall also include processes and practices that will facilitate the
monitoring of derivative transactions through cashflow testing or
other methods to substantiate the effectiveness of the hedging
strategies and derivative transactions and provide the board of
directors of the committee thereof charged with the responsibility
for supervising investments the opportunity to assure itself of the
training, sufficient understanding, and competency of pertinent
personnel implementing the derivative transactions.
(2) In order to address the need for appropriate oversight by
senior management and by the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
and to provide for a comprehensive risk management process, an
insurer shall establish the following with respect to derivative
transactions:
(A) Appropriate limits for various identified risks relevant to
the derivative transactions used by the insurer.
(B) Procedures and practices that control the nature and amount of
those risks.
(C) Adequate systems or processes for identifying and measuring
those risks.
(D) Systems or processes for documenting, monitoring, and
reporting risk exposures on a timely basis.
(E) Systems or processes of internal review and audit to ensure
the integrity of the overall risk management process.
(3) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, shall receive and
review quarterly reports which shall include all of the following:
(A) Information to ascertain that all derivative transactions have
been made in accordance with delegations, standards, limitations,
and investment objectives contained in the derivative guidelines.
(B) The outstanding derivative positions.
(C) The unrealized gains or losses thereon.
(D) The derivative transactions closed during the report period.
(E) A performance review of the derivative transactions.
(F) An evaluation of the risks and benefits of the derivative
transactions.
(G) Other information necessary to ensure that the internal
control procedures are being followed.
(4) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, shall establish the
following management oversight standards for derivative transactions:
(A) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, has an affirmative
obligation to inform management of its desired risk tolerance levels.
Management shall appropriately translate these risk tolerance levels
into effective policies and procedures that address both individual
transactions and entire portfolios.
(B) Management and the board of directors, or a committee thereof
charged with the responsibility for supervising investments, shall
receive sufficient information to assess the strengths and
limitations of the insurer's risk measurement systems in order to
determine appropriate risk limits. The board of directors, or a
committee thereof charged with the responsibility for supervising
investments, shall also review management's response to strengths and
limitations identified through oversight processes such as stress
testing, independent validation, and back-testing of risk measurement
models. Management and the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
shall consider the information identified by the oversight processes,
including the potential for indirect effects of downside performance
beyond the insurer's finances, when they determine and communicate
their risk profile.
(C) When management or the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
identifies weaknesses in the risk management process, they shall
consider alternatives and take steps to strengthen that process and
maintain detailed documentation of steps and actions taken.
(D) Actions shall be taken to correct any deficiencies in internal
controls relative to derivative transactions, including any
deficiencies determined by the independent certified public
accountant in the evaluation of accounting procedures and internal
controls and maintain detailed documentation of steps and actions
taken.
(E) Personnel responsible for risk oversight functions shall
possess independence, authority, and expertise.
(F) Issuer and counterparty credit decisions for each transaction
shall be consistent with the overall credit standards of the insurer.
(G) In connection with each derivative transaction under this
section, insurers shall maintain a statement in their records listing
any member of the board of directors who is employed by, or a
partner in, a party involved in the derivative transaction.
(5) The board of directors or committee charged with the
responsibility of supervising investments shall determine at least
quarterly whether all derivative transactions have been made in
accordance with delegations, standards, limitations, and investment
objectives prescribed in the guidelines. If the determinations are
made by a committee of the board of directors, the minutes of the
committee reflecting the determinations shall be recorded and a
report thereon shall be submitted to the board for its review at the
board's next meeting.
(6) The commissioner shall require the guidelines to be submitted
and shall disapprove the guidelines if the insurer is unable to show
that the guidelines are found sufficient to prevent financially
unsound or hazardous transactions or practices.
(h) An insurer shall comply with applicable financial requirements
as promulgated by the commissioner and the National Association of
Insurance Commissioners included in the Purposes and Procedures
Manual of the National Association of Insurance Commissioners
Securities Valuation Office, the National Association of Insurance
Commissioners Accounting Practices and Procedures Manual, and the
National Association of Insurance Commissioners Annual Statement
Instructions, including, but not limited to, the reporting of
transfers, if any, of interests in the assets of the insurer pledged
as collateral or interests in the assets of counterparties received
as collateral in connection with derivative transactions.
(i) (1) The counterparty exposure under a derivative instrument
entered into by an insurer authorized to engage in derivative
transactions pursuant to this section shall be deemed to be an
obligation of the institution to which the insurer is exposed to
credit risk and shall be included in determining compliance with any
single or aggregate quantitative limitation on investments made by an
insurer under this section.
(2) An insurer shall only enter into derivative transactions with
counterparties that are rated one by the Securities Valuation Office.
(3) Notwithstanding any single or aggregate quantitative
limitation on investments made by an insurer under this section, the
aggregate counterparty exposure under one or more derivative
transactions to any single counterparty rated one by the Securities
Valuation Office, other than a "qualified counterparty," shall be
limited to one-half of 1 percent of an insurer's admitted assets, and
all counterparties rated one by the Securities Valuation Office,
other than qualified counterparties, shall be limited to 3 percent of
an insurer's admitted assets.
(j) Investments made pursuant to this section, and related
transactions, are deemed excess funds investments and shall be
subject to the provisions of Sections 1153.5, 1154, and 1210, and
Article 4 (commencing with Section 1190), provided that if an insurer
classifies an investment under Section 1210 that investment shall
continue to be subject to the limitations of paragraph (1) of
subdivision (e). Notwithstanding anything to the contrary, a
requirement providing that any derivative transaction be disposed of
by the insurer pursuant to Section 1202 shall be deemed conclusive
unless the insurer establishes that the derivative transaction or
transactions are financially sound and not hazardous. This section
shall only be deemed to permit replication of investments or
instruments, that are otherwise permitted in this code, and that are
reported in compliance with the requirements of the risk-based
capital and risk-based capital instructions required by Section
739.2.
(k) Except as permitted in this section, nothing in this section
shall be deemed to permit an investment, transaction, or practice
that is not authorized by another section of this code. Exposure to
risk by use of derivatives shall be consistent with the overall
investment guidelines. Insurers shall not enter into derivative
transactions in whole or in part with funds borrowed for that
purpose, including, but not limited to, on margin.
(l) The commissioner may adopt rules and issue guidelines
establishing standards and requirements relative to practices
authorized in this section. In connection with any of the actions
contemplated by this section to be taken by the commissioner,
including review of an insurer's written guidelines with respect to
derivative transactions and review of documentation maintained by an
insurer with respect to derivative transactions, the commissioner may
deem the actions to be an examination of an insurer subject to the
provisions of Sections 730 to 738, inclusive. The commissioner shall
issue regulations establishing requirements regarding the disclosure
of affiliations and conflicts of interest between an insurer and
persons contracted by the commissioner to perform services on behalf
of the commissioner in connection with the matters authorized by this
section.
(m) An insurer that is not engaged in the issuance of new policies
of insurance and that is formed for the purpose of facilitating the
rehabilitation of an insolvent insurer under Article 14 (commencing
with Section 1010) of Chapter 1, shall, prior to engaging in any
derivative transaction, obtain approval for each transaction from the
commissioner, and shall otherwise comply with the requirements of
this section. However, the insurer may, upon request to the
commissioner, and upon showing satisfactory to the commissioner that
prior approval of each transaction would not be in the best interests
of the policyholders, request that the commissioner waive the
requirement of prior approval and the insurer shall, in addition to
complying with the requirements of this section, submit monthly
written reports of all derivative transactions to the commissioner in
the form required by the commissioner within 30 days of the prior
month's end.
1212. (a) Any domestic incorporated insurer having aggregate
capital and surplus as of the preceding December 31 of at least
twenty-five million dollars ($25,000,000), after investing an amount
equal to its required minimum paid-in capital in securities specified
in Article 3 (commencing with Section 1170), may purchase insurance
futures contracts, purchase call options on insurance futures
contracts, and sell put options on insurance futures contracts in
bona fide hedging transactions, subject to the limitations set forth
in this section.
Domestic insurers may sell insurance futures contracts, sell call
options on insurance futures contracts, and purchase put options on
insurance futures contracts only for the purpose of a closing
transaction. No other sales of insurance futures contracts, sales of
call options on insurance futures contracts, or purchases of put
options on insurance futures contracts are authorized under this
section.
(b) For purposes of this section, "insurance futures contracts"
mean contracts based on indices of loss performance of insurance
contracts and traded in accordance with the rules and procedures of a
board of trade regulated by the Commodity Futures Trading
Commission, or any successor agency, and subject to the terms and
conditions of the Commodity Exchange Act (7 U.S.C. Sec. 1 et seq.),
as amended. For purposes of this section, "put and call options on
insurance futures contracts" mean put or call options, regulated in
accordance with the rules of the board of trade on which the options
are traded, on insurance futures contracts.
(c) No domestic insurer may purchase insurance futures contracts,
purchase call options on insurance futures contracts, or sell put
options on insurance futures contracts unless the insurance futures
contracts are required to be settled in cash within nine months after
the end of the loss period underlying the insurance futures
contracts, and the relevant type of insurance futures contracts have
attained an average daily trading volume of at least 250 contracts
and an open interest of 1,000 contracts as reported by the relevant
board of trade for the one-month period prior to the insurer
initiating the transaction.
(d) A transaction will be considered a bona fide hedging
transaction only if, upon execution, (1) the insurance futures
contract or option is specifically identified with a group of
insurance policies issued or reasonably expected to be issued by the
insurer in the ordinary course of business and (2) the insurer's
relevant underwriting or insurance-related risk exposures bear a
correlation to the risk exposures of the index underlying the
insurance futures contracts or options thereon entered into as part
of the hedging transaction. For purposes of this section,
"correlation" means that the loss experience of the policies hedged
is, at the date of purchase of the insurance futures contracts,
expected to develop similarly to the loss experience of the policies
underlying the insurance futures contract when exposed to similar
occurrences and conditions. The insurer shall identify this hedging
transaction and the policies and written premiums hedged on its books
and records and any insurance futures contract or option position
shall be terminated as soon as possible after this correlation does
not exist.
(e) Notwithstanding other limitations of this section, an insurer
may hold open insurance futures contracts and put and call options on
insurance futures contracts which do not exceed the equivalent of 75
percent of the insurer's written premium for each line of business,
as designated in the annual statement required by Section 923, being
hedged pursuant to this section. For purposes of this subdivision,
equivalence shall be based on the par dollar value of the insurance
futures contracts and an insurer's written premium shall be measured
based on the loss period reflected in the underlying futures
contracts.
(f) A domestic insurer shall not enter into hedging transactions
in insurance futures contracts or options on insurance futures
contracts unless the transaction is authorized or approved by the
insurer's board of directors or a committee designated by the board.
This authorization or approval shall be entered on the records or
minutes of the domestic insurer and, if made upon the authority of a
committee of directors, shall be submitted to the full board of
directors for ratification at their next meeting. The entry of
approval shall show the fact of entering into the hedging
transaction, the specific policies hedged, the size of the hedge as
measured pursuant to subdivision (e), and the name of each director
voting to approve the hedging transaction.
(g) The commissioner may, in his or her discretion, by written
order require the disposal of any insurance futures contracts or
options on insurance futures contracts made in violation of this
section. Pending a disposal pursuant to an order by the commissioner,
the insurance futures contracts or options on insurance futures
contracts shall not be given any effect on any statement required by
this code purporting to show the financial condition of the domestic
insurer or in measuring the financial condition of the domestic
insurer for the purpose of determining whether the domestic insurer
is solvent or insolvent. The commissioner may also, for good cause
shown, order the disposal of any insurance futures contract or option
on insurance futures contracts.
(h) Insurance futures contracts and put and call options on
insurance futures contracts shall not be deemed to be investments for
purposes of any investment limitations or authorizations contained
in this code.
(i) The commissioner may adopt rules and guidelines establishing
standards and requirements relative to practices authorized in this
section. The commissioner shall issue a bulletin by June 30, 1994,
setting forth the accounting, reporting, and valuation practices and
procedures for insurance futures contracts. However, a bulletin shall
not be required if, prior to June 30, 1994, accounting practices and
procedures are officially promulgated by the National Association of
Insurance Commissioners. The bulletin issued pursuant to this
subdivision shall not be superseded by any action of the National
Association of Insurance Commissioners that conflicts with or that
fails to address matters addressed by the bulletin. No insurer shall
engage in hedging transactions with respect to insurance futures
contracts or put and call options on insurance futures contracts
until the earlier of the date a bulletin is issued or the date
accounting practices and procedures are officially promulgated by the
National Association of Insurance Commissioners and except pursuant
to this section.
1211. (a) For the purposes of this section the following
definitions shall apply:
(1) "Aggregate counterparty exposure" means the sum of the
aggregate statement value options, swaptions, caps, floors, and
warrants purchased, and the aggregate potential exposure of collars,
swaps, forwards, and futures entered into.
(2) "Cap" means an agreement obligating the seller to make
payments to the buyer with each payment based on the amount by which
a reference price or level or the performance or value of one or more
underlying interests exceeds a predetermined number, sometimes
referred to as the strike rate or strike price.
(3) "Collar" means an agreement to receive payments as the buyer
of an option, cap, or floor and to make payments as the seller of a
different option, cap, or floor.
(4) "Credit default swap" means an agreement obligating the buyer
to pay a periodic payment to the seller in return for the seller's
obligation to make a payment to the buyer if a credit event or events
occur with respect to underlying interests or an entity, as
specified in the documentation of the credit default swap.
(5) "Derivative instrument" means an agreement, option,
instrument, or a series or combination of those (A) to make or take
delivery of, or assume or relinquish, a specified amount of one or
more underlying interests, or to make a cash settlement in lieu
thereof, or (B) that has a price, performance, value, or cashflow
based primarily upon the actual or expected price, level,
performance, value, or cashflow of one or more underlying interests.
A derivative instrument includes all investment instruments or
contracts that derive all or almost all of their value from the
performance of an underlying market, index, or financial instruments.
The term includes options, warrants, caps, floors, collars, swaps,
credit default swaps, swaptions, forwards, and futures.
(6) "Derivative transaction" means a transaction involving the use
of one or more derivative instruments.
(7) "Floor" means an agreement obligating the seller to make
payments to the buyer in which each payment is based on the amount by
which a predetermined number, sometimes called the floor rate or
price, exceeds a reference price, level, performance, or value of one
or more underlying interests.
(8) "Forward" means an agreement, other than a future, to make or
take delivery in the future of one or more underlying interests, or
effect a cash settlement, based on the actual or expected price,
level, performance, or value of those underlying interests, but does
not mean or include spot transactions effected within customary
settlement periods, when issued purchases, or other similar cash
market transactions.
(9) "Future" means an agreement traded on an organized and
qualified futures exchange, to make or take delivery of, or effect a
cash settlement based on the actual or expected price, level,
performance, or value of, one or more underlying interests.
(10) "Hedging transaction" means a derivative transaction that is
entered into and at all times maintained to reduce (A) risk due to a
change in the value, yield, price, cashflow, or quantity of assets or
liabilities that the insurer has acquired or incurred or anticipates
acquiring or incurring or (B) risk due to changes in the currency
exchange rate or the degree of exposure as to assets or liabilities
denominated in a foreign currency that an insurer has acquired or
incurred or anticipates acquiring or incurring.
(11) "Option" means an agreement giving the buyer the right to buy
or receive, sell, or deliver, enter into, extend, or terminate or
effect a cash settlement based on the actual or expected price,
spread, level, performance, or value of one or more underlying
interests.
(A) For purposes of this paragraph, an agreement giving the buyer
the right to buy or receive may also be called a "call option."
(B) For purposes of this paragraph, an agreement giving the buyer
the right to sell or deliver may be called a "put option."
(12) "Potential exposure" means the amount determined in
accordance with the National Association of Insurance Commissioners
Annual Statement Instructions.
(13) "Qualified bank" means a bank or trust company that meets all
of the following:
(A) The bank or trust company is organized and existing, or in the
case of a branch or agency of a foreign banking organization is
licensed, under federal law or the law of any state.
(B) The bank or trust company is regulated, supervised, and
examined by the United States federal or state authorities having
regulatory authority over banks and trust companies.
(C) The bank or trust company has assets in excess of five billion
dollars ($5,000,000,000).
(D) The bank or trust company has senior obligations outstanding,
or has a parent corporation that has senior obligations outstanding,
rated AA or better, or the equivalent, by two independent nationally
recognized statistical rating organizations.
(E) The bank or trust company has a ratio of primary capital to
total assets of at least 5 1/2 percent and a ratio of total capital
to total assets of at least 6 percent.
(14) "Qualified counterparty" is a qualified broker or dealer or a
qualified bank or other counterparty rated AA- or Aa3 or higher by a
nationally recognized statistical rating organization.
(15) "Qualified broker or dealer" means a broker or dealer that is
organized under the laws of a state and is registered under the
Securities Exchange Act of 1934 (15 U.S.C. Sec. 78a et seq.), and has
net capital in excess of two hundred fifty million dollars
($250,000,000).
(16) "Replication transaction" means a derivative transaction or
combination of derivative transactions effected either separately or
in conjunction with cash market investments included in the insurer's
investment portfolio in order to replicate the investment
characteristic of another authorized transaction, investment, or
instrument or that may operate as a substitute for cash market
investments. A derivative transaction entered into by the insurer as
a hedging transaction authorized pursuant to this section shall not
be considered a replication transaction.
(17) "Swap" means an agreement to exchange or to net payments or
income streams at one or more times based on the actual or expected
price, yield, level, performance, or value of one or more underlying
interests.
(18) "Swaption" means an option to purchase or sell a swap at a
given price and time or at a series of prices and times. A swaption
does not mean a swap with an embedded option.
(19) "Underlying interest" means the assets, liabilities, other
interests, or a combination thereof, underlying a derivative
instrument, such as any one or more securities, currencies, rates,
indices, commodities, or derivative instruments.
(20) "Warrant" means an instrument that gives the holder the right
to purchase or sell the underlying interest at a given price and
time or at a series of prices and times outlined in the warrant
agreement.
(b) Any domestic incorporated insurer having admitted assets, as
of the preceding December 31, of at least one billion dollars
($1,000,000,000) and capital and surplus of at least two hundred
million dollars ($200,000,000), after investing an amount equal to
its required minimum paid-in capital in securities specified in
Article 3 (commencing with Section 1170), may engage in derivative
transactions pursuant to, and in compliance with, this section.
(c) An insurer may only use derivative instruments under this
section to engage in hedging transactions and replication
transactions authorized pursuant to this section.
(d) An insurer that engages in hedging transactions or replication
transactions as authorized pursuant to this section shall do both of
the following:
(1) Maintain its position in any outstanding derivative instrument
used as part of a hedging transaction or replication transaction for
only as long as the hedging transaction or replication transaction,
as the case may be, continues to be effective in meeting the
objective and the rationale the insurer identifies at the point of
inception of the hedging or replication transaction.
(2) Be able to demonstrate to the commissioner, upon request, that
any hedging transaction or replication transaction continues to be
effective in meeting that objective and rationale.
(e) (1) The aggregate statement value, and potential exposure, of
all transactions held under the authority of this section at any one
time shall not be in excess of 7 1/2 percent of the insurer's
admitted assets, as of the preceding December 31.
(2) Hedging transactions under this section may only be made if,
as a result of, and after giving effect to the transaction, all of
the following is established:
(A) Excluding options acquired under Section 1212, the aggregate
statement value of options, swaptions, caps, floors, and warrants
purchased pursuant to this section does not exceed 7 1/2 percent of
its admitted assets as of the preceding December 31.
(B) Excluding options acquired under Section 1212, the aggregate
statement value of options, swaptions, caps, and floors written
pursuant to this section does not exceed 3 percent of its admitted
assets as of the preceding December 31.
(C) Excluding futures entered into under Section 1212, the
aggregate potential exposure of collars, swaps, forwards, and
futures, entered into and, except for options acquired under Section
1212, options, swaptions, caps, and floors written pursuant to this
section does not exceed 6 1/2 percent of its admitted assets as of
the preceding December 31.
(f) An insurer may purchase or sell one or more derivative
instruments to offset any derivative instrument previously purchased
or sold, as the case may be, without regard to the quantitative
limitations of this section, provided that the derivative instrument
is an exact offset to the original derivative instrument being
offset.
(g) (1) The board of directors of any domestic insurer that makes
investments pursuant to this section shall first adopt written
guidelines for the making of the investments. The guidelines shall
cover factors including concentration and diversification of
counterparty risk, quality, maturity, and diversification of
derivative investments, and other specifications, including
investment strategies, asset liability management practices, the
insurer's liquidity needs and its capital and surplus, and other
factors that the board of directors deems appropriate. The guidelines
shall also include processes and practices that will facilitate the
monitoring of derivative transactions through cashflow testing or
other methods to substantiate the effectiveness of the hedging
strategies and derivative transactions and provide the board of
directors of the committee thereof charged with the responsibility
for supervising investments the opportunity to assure itself of the
training, sufficient understanding, and competency of pertinent
personnel implementing the derivative transactions.
(2) In order to address the need for appropriate oversight by
senior management and by the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
and to provide for a comprehensive risk management process, an
insurer shall establish the following with respect to derivative
transactions:
(A) Appropriate limits for various identified risks relevant to
the derivative transactions used by the insurer.
(B) Procedures and practices that control the nature and amount of
those risks.
(C) Adequate systems or processes for identifying and measuring
those risks.
(D) Systems or processes for documenting, monitoring, and
reporting risk exposures on a timely basis.
(E) Systems or processes of internal review and audit to ensure
the integrity of the overall risk management process.
(3) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, shall receive and
review quarterly reports which shall include all of the following:
(A) Information to ascertain that all derivative transactions have
been made in accordance with delegations, standards, limitations,
and investment objectives contained in the derivative guidelines.
(B) The outstanding derivative positions.
(C) The unrealized gains or losses thereon.
(D) The derivative transactions closed during the report period.
(E) A performance review of the derivative transactions.
(F) An evaluation of the risks and benefits of the derivative
transactions.
(G) Other information necessary to ensure that the internal
control procedures are being followed.
(4) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, shall establish the
following management oversight standards for derivative transactions:
(A) The board of directors, or a committee thereof charged with
the responsibility for supervising investments, has an affirmative
obligation to inform management of its desired risk tolerance levels.
Management shall appropriately translate these risk tolerance levels
into effective policies and procedures that address both individual
transactions and entire portfolios.
(B) Management and the board of directors, or a committee thereof
charged with the responsibility for supervising investments, shall
receive sufficient information to assess the strengths and
limitations of the insurer's risk measurement systems in order to
determine appropriate risk limits. The board of directors, or a
committee thereof charged with the responsibility for supervising
investments, shall also review management's response to strengths and
limitations identified through oversight processes such as stress
testing, independent validation, and back-testing of risk measurement
models. Management and the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
shall consider the information identified by the oversight processes,
including the potential for indirect effects of downside performance
beyond the insurer's finances, when they determine and communicate
their risk profile.
(C) When management or the board of directors, or a committee
thereof charged with the responsibility for supervising investments,
identifies weaknesses in the risk management process, they shall
consider alternatives and take steps to strengthen that process and
maintain detailed documentation of steps and actions taken.
(D) Actions shall be taken to correct any deficiencies in internal
controls relative to derivative transactions, including any
deficiencies determined by the independent certified public
accountant in the evaluation of accounting procedures and internal
controls and maintain detailed documentation of steps and actions
taken.
(E) Personnel responsible for risk oversight functions shall
possess independence, authority, and expertise.
(F) Issuer and counterparty credit decisions for each transaction
shall be consistent with the overall credit standards of the insurer.
(G) In connection with each derivative transaction under this
section, insurers shall maintain a statement in their records listing
any member of the board of directors who is employed by, or a
partner in, a party involved in the derivative transaction.
(5) The board of directors or committee charged with the
responsibility of supervising investments shall determine at least
quarterly whether all derivative transactions have been made in
accordance with delegations, standards, limitations, and investment
objectives prescribed in the guidelines. If the determinations are
made by a committee of the board of directors, the minutes of the
committee reflecting the determinations shall be recorded and a
report thereon shall be submitted to the board for its review at the
board's next meeting.
(6) The commissioner shall require the guidelines to be submitted
and shall disapprove the guidelines if the insurer is unable to show
that the guidelines are found sufficient to prevent financially
unsound or hazardous transactions or practices.
(h) An insurer shall comply with applicable financial requirements
as promulgated by the commissioner and the National Association of
Insurance Commissioners included in the Purposes and Procedures
Manual of the National Association of Insurance Commissioners
Securities Valuation Office, the National Association of Insurance
Commissioners Accounting Practices and Procedures Manual, and the
National Association of Insurance Commissioners Annual Statement
Instructions, including, but not limited to, the reporting of
transfers, if any, of interests in the assets of the insurer pledged
as collateral or interests in the assets of counterparties received
as collateral in connection with derivative transactions.
(i) (1) The counterparty exposure under a derivative instrument
entered into by an insurer authorized to engage in derivative
transactions pursuant to this section shall be deemed to be an
obligation of the institution to which the insurer is exposed to
credit risk and shall be included in determining compliance with any
single or aggregate quantitative limitation on investments made by an
insurer under this section.
(2) An insurer shall only enter into derivative transactions with
counterparties that are rated one by the Securities Valuation Office.
(3) Notwithstanding any single or aggregate quantitative
limitation on investments made by an insurer under this section, the
aggregate counterparty exposure under one or more derivative
transactions to any single counterparty rated one by the Securities
Valuation Office, other than a "qualified counterparty," shall be
limited to one-half of 1 percent of an insurer's admitted assets, and
all counterparties rated one by the Securities Valuation Office,
other than qualified counterparties, shall be limited to 3 percent of
an insurer's admitted assets.
(j) Investments made pursuant to this section, and related
transactions, are deemed excess funds investments and shall be
subject to the provisions of Sections 1153.5, 1154, and 1210, and
Article 4 (commencing with Section 1190), provided that if an insurer
classifies an investment under Section 1210 that investment shall
continue to be subject to the limitations of paragraph (1) of
subdivision (e). Notwithstanding anything to the contrary, a
requirement providing that any derivative transaction be disposed of
by the insurer pursuant to Section 1202 shall be deemed conclusive
unless the insurer establishes that the derivative transaction or
transactions are financially sound and not hazardous. This section
shall only be deemed to permit replication of investments or
instruments, that are otherwise permitted in this code, and that are
reported in compliance with the requirements of the risk-based
capital and risk-based capital instructions required by Section
739.2.
(k) Except as permitted in this section, nothing in this section
shall be deemed to permit an investment, transaction, or practice
that is not authorized by another section of this code. Exposure to
risk by use of derivatives shall be consistent with the overall
investment guidelines. Insurers shall not enter into derivative
transactions in whole or in part with funds borrowed for that
purpose, including, but not limited to, on margin.
(l) The commissioner may adopt rules and issue guidelines
establishing standards and requirements relative to practices
authorized in this section. In connection with any of the actions
contemplated by this section to be taken by the commissioner,
including review of an insurer's written guidelines with respect to
derivative transactions and review of documentation maintained by an
insurer with respect to derivative transactions, the commissioner may
deem the actions to be an examination of an insurer subject to the
provisions of Sections 730 to 738, inclusive. The commissioner shall
issue regulations establishing requirements regarding the disclosure
of affiliations and conflicts of interest between an insurer and
persons contracted by the commissioner to perform services on behalf
of the commissioner in connection with the matters authorized by this
section.
(m) An insurer that is not engaged in the issuance of new policies
of insurance and that is formed for the purpose of facilitating the
rehabilitation of an insolvent insurer under Article 14 (commencing
with Section 1010) of Chapter 1, shall, prior to engaging in any
derivative transaction, obtain approval for each transaction from the
commissioner, and shall otherwise comply with the requirements of
this section. However, the insurer may, upon request to the
commissioner, and upon showing satisfactory to the commissioner that
prior approval of each transaction would not be in the best interests
of the policyholders, request that the commissioner waive the
requirement of prior approval and the insurer shall, in addition to
complying with the requirements of this section, submit monthly
written reports of all derivative transactions to the commissioner in
the form required by the commissioner within 30 days of the prior
month's end.
1212. (a) Any domestic incorporated insurer having aggregate
capital and surplus as of the preceding December 31 of at least
twenty-five million dollars ($25,000,000), after investing an amount
equal to its required minimum paid-in capital in securities specified
in Article 3 (commencing with Section 1170), may purchase insurance
futures contracts, purchase call options on insurance futures
contracts, and sell put options on insurance futures contracts in
bona fide hedging transactions, subject to the limitations set forth
in this section.
Domestic insurers may sell insurance futures contracts, sell call
options on insurance futures contracts, and purchase put options on
insurance futures contracts only for the purpose of a closing
transaction. No other sales of insurance futures contracts, sales of
call options on insurance futures contracts, or purchases of put
options on insurance futures contracts are authorized under this
section.
(b) For purposes of this section, "insurance futures contracts"
mean contracts based on indices of loss performance of insurance
contracts and traded in accordance with the rules and procedures of a
board of trade regulated by the Commodity Futures Trading
Commission, or any successor agency, and subject to the terms and
conditions of the Commodity Exchange Act (7 U.S.C. Sec. 1 et seq.),
as amended. For purposes of this section, "put and call options on
insurance futures contracts" mean put or call options, regulated in
accordance with the rules of the board of trade on which the options
are traded, on insurance futures contracts.
(c) No domestic insurer may purchase insurance futures contracts,
purchase call options on insurance futures contracts, or sell put
options on insurance futures contracts unless the insurance futures
contracts are required to be settled in cash within nine months after
the end of the loss period underlying the insurance futures
contracts, and the relevant type of insurance futures contracts have
attained an average daily trading volume of at least 250 contracts
and an open interest of 1,000 contracts as reported by the relevant
board of trade for the one-month period prior to the insurer
initiating the transaction.
(d) A transaction will be considered a bona fide hedging
transaction only if, upon execution, (1) the insurance futures
contract or option is specifically identified with a group of
insurance policies issued or reasonably expected to be issued by the
insurer in the ordinary course of business and (2) the insurer's
relevant underwriting or insurance-related risk exposures bear a
correlation to the risk exposures of the index underlying the
insurance futures contracts or options thereon entered into as part
of the hedging transaction. For purposes of this section,
"correlation" means that the loss experience of the policies hedged
is, at the date of purchase of the insurance futures contracts,
expected to develop similarly to the loss experience of the policies
underlying the insurance futures contract when exposed to similar
occurrences and conditions. The insurer shall identify this hedging
transaction and the policies and written premiums hedged on its books
and records and any insurance futures contract or option position
shall be terminated as soon as possible after this correlation does
not exist.
(e) Notwithstanding other limitations of this section, an insurer
may hold open insurance futures contracts and put and call options on
insurance futures contracts which do not exceed the equivalent of 75
percent of the insurer's written premium for each line of business,
as designated in the annual statement required by Section 923, being
hedged pursuant to this section. For purposes of this subdivision,
equivalence shall be based on the par dollar value of the insurance
futures contracts and an insurer's written premium shall be measured
based on the loss period reflected in the underlying futures
contracts.
(f) A domestic insurer shall not enter into hedging transactions
in insurance futures contracts or options on insurance futures
contracts unless the transaction is authorized or approved by the
insurer's board of directors or a committee designated by the board.
This authorization or approval shall be entered on the records or
minutes of the domestic insurer and, if made upon the authority of a
committee of directors, shall be submitted to the full board of
directors for ratification at their next meeting. The entry of
approval shall show the fact of entering into the hedging
transaction, the specific policies hedged, the size of the hedge as
measured pursuant to subdivision (e), and the name of each director
voting to approve the hedging transaction.
(g) The commissioner may, in his or her discretion, by written
order require the disposal of any insurance futures contracts or
options on insurance futures contracts made in violation of this
section. Pending a disposal pursuant to an order by the commissioner,
the insurance futures contracts or options on insurance futures
contracts shall not be given any effect on any statement required by
this code purporting to show the financial condition of the domestic
insurer or in measuring the financial condition of the domestic
insurer for the purpose of determining whether the domestic insurer
is solvent or insolvent. The commissioner may also, for good cause
shown, order the disposal of any insurance futures contract or option
on insurance futures contracts.
(h) Insurance futures contracts and put and call options on
insurance futures contracts shall not be deemed to be investments for
purposes of any investment limitations or authorizations contained
in this code.
(i) The commissioner may adopt rules and guidelines establishing
standards and requirements relative to practices authorized in this
section. The commissioner shall issue a bulletin by June 30, 1994,
setting forth the accounting, reporting, and valuation practices and
procedures for insurance futures contracts. However, a bulletin shall
not be required if, prior to June 30, 1994, accounting practices and
procedures are officially promulgated by the National Association of
Insurance Commissioners. The bulletin issued pursuant to this
subdivision shall not be superseded by any action of the National
Association of Insurance Commissioners that conflicts with or that
fails to address matters addressed by the bulletin. No insurer shall
engage in hedging transactions with respect to insurance futures
contracts or put and call options on insurance futures contracts
until the earlier of the date a bulletin is issued or the date
accounting practices and procedures are officially promulgated by the
National Association of Insurance Commissioners and except pursuant
to this section.
