(a) As used in thissection, the following terms have the following meanings:
(1) "Businessentity" includes a sole proprietorship, corporation, limited liabilitycompany, association, partnership, joint stock company, joint venture, mutualfund, trust, joint tenancy or other similar form of business organization,whether for‑profit or not‑for‑profit.
(2) "Counterpartyexposure" amount means:
a. The amount of creditrisk attributable to a derivative instrument entered into with a businessentity other than through a qualified exchange, qualified foreign exchange, orcleared through a qualified clearinghouse ("over‑the‑counterderivative instrument"). The amount of credit risk equals:
1. The market value ofthe over‑the‑counter derivative instrument if the liquidation ofthe derivative instrument would result in a final cash payment to the insurer;or
2. Zero if theliquidation of the derivative instrument would not result in a final cashpayment to the insurer.
b. If over‑the‑counterderivative instruments are entered into under a written master agreement whichprovides for netting of payments owed by the respective parties and thedomicile of the counterparty is either within the United States or, if notwithin the United States, within a foreign jurisdiction listed in the Purposesand Procedures of the Securities Valuation Office of the NAIC as eligible fornetting, the net amount of credit risk shall be the greater of zero or the netsum of:
1. The market value ofthe over‑the‑counter derivative instruments entered into under theagreement, the liquidation of which would result in a final cash payment to theinsurer; and
2. The market value ofthe over‑the‑counter derivative instruments entered into under theagreement, the liquidation of which would result in a final cash payment by theinsurer to the business entity.
c. For opentransactions, market value shall be determined at the end of the most recentquarter of the insurer's fiscal year and shall be reduced by the market valueof acceptable collateral held by the insurer or placed in escrow by one or bothparties.
(3) "Derivativeinstrument" means an agreement, option, instrument, or a series orcombination thereof:
a. To make or takedelivery of, or assume or relinquish, a specified amount of one or moreunderlying interests, or to make a cash settlement in lieu thereof; or
b. That has a price,performance, value, or cash flow based primarily upon the actual or expectedprice level, performance, value, or cash flow of one or more underlyinginterests.
Derivativeinstruments include options, warrants used in a hedging transaction and notattached to another financial instrument, caps, floors, collars, swaps,forwards, futures, and any other agreements, options, or instrumentssubstantially similar thereto or any series or combination thereof. Derivativeinstruments shall additionally include any agreements, options, or instrumentspermitted under rules adopted under subsection (c) of this section. Derivativeinstruments shall not include an investment authorized by G.S. 58‑7‑173,58‑7‑175, 58‑7‑178, 58‑7‑179, 58‑7‑180,and 58‑7‑187.
(4) "Derivativetransaction" means any transaction involving the use of one or morederivative instruments.
(5) "Qualifiedclearinghouse" means a clearinghouse for, and subject to the rules of, aqualified exchange or a qualified foreign exchange. The clearinghouse providesclearing services, including acting as a counterparty to each of the parties toa transaction such that the parties no longer have credit risk as to eachother.
(6) "Qualifiedexchange" means:
a. A securitiesexchange registered as a national securities exchange, or a securities marketregulated under the Securities Exchange Act of 1934 (15 U.S.C. §§ 78, et seq.),as amended;
b. A board of trade orcommodities exchange designated as a contract market by the Commodity FuturesTrading Commission, or any successor thereof;
c. Private Offerings,Resales and Trading through Automated Linkages (PORTAL);
d. A designatedoffshore securities market as defined in Securities Exchange CommissionRegulation S, 17 C.F.R. Part 230, as amended; or
e. A qualified foreignexchange.
(7) "Qualifiedforeign exchange" means a foreign exchange, board of trade, or contractmarket located outside the United States, its territories or possessions:
a. That has receivedregulatory comparability relief under Commodity Futures Trading Commission Rule30.10 (as set forth in Appendix C to Part 30 of the CFTC's Regulations, 17C.F.R. Part 30);
b. That is, or itsmembers are, subject to the jurisdiction of a foreign futures authority thathas received regulatory comparability relief under Commodity Futures TradingCommission Rule 30.10 (as set forth in Appendix C to Part 30 of the CFTC'sRegulations, 17 C.F.R. Part 30) as to futures transactions in the jurisdictionwhere the exchange, board of trade, or contract market is located; or
c. Upon which foreignstock index futures contracts are listed that are the subject of no‑actionrelief issued by the CFTC's Office of General Counsel, but an exchange, boardof trade, or contract market that qualifies as a "qualified foreignexchange" only under this paragraph shall only be a "qualifiedforeign exchange" as to foreign stock index futures contracts that are thesubject of the no‑action relief under this paragraph.
(8) "Replicationtransaction" means a derivative transaction that is intended to replicatethe investment in one or more assets that an insurer is authorized to acquireor sell under this section or G.S. 58‑7‑165. A derivativetransaction that is entered into as a hedging transaction shall not beconsidered a replication transaction.
(b) An insurer may,directly or indirectly through an investment subsidiary, engage in derivativetransactions under this section under the following conditions:
(1) An insurer may usederivative instruments under this section to engage in hedging transactions andcertain income generation transactions as may be further defined by rulesadopted by the Commissioner.
(2) An insurer shall beable to demonstrate to the Commissioner the intended hedging characteristicsand the ongoing effectiveness of the derivative transaction or combination ofthe transactions through cash flow testing or other appropriate analyses.
(c) The Commissionermay adopt reasonable rules for investments and transactions under this sectionincluding, but not limited to, rules which impose financial solvency standards,valuation standards, and reporting requirements.
(d) An insurer mayenter into hedging transactions under this section if, as a result of and aftergiving effect to the transaction:
(1) The aggregatestatement value of options, caps, floors, and warrants not attached to anotherfinancial instrument purchased and used in hedging transactions then engaged inby the insurer does not exceed seven and one‑half percent (7.5%) of itsadmitted assets;
(2) The aggregatestatement value of options, caps, and floors written in hedging transactionsthen engaged in by the insurer does not exceed three percent (3%) of itsadmitted assets; and
(3) The aggregatepotential exposure of collars, swaps, forwards, and futures used in hedgingtransactions then engaged in by the insurer does not exceed six and one‑halfpercent (6.5%) of its admitted assets.
(e) An insurer mayenter into the following types of income generation transactions if, as aresult of and after giving effect to the transactions, the aggregate statementvalue of the fixed income assets that are subject to call or that generate thecash flows for payments under the caps or floors, plus the face value of fixedincome securities underlying a derivative instrument subject to call, plus theamount of the purchase obligations under the puts, does not exceed ten percent(10%) of its admitted assets:
(1) Sales of coveredcall options on noncallable fixed‑income securities, callable fixed‑incomesecurities if the option expires by its terms before the end of the noncallableperiod, or derivative instruments based on fixed income securities;
(2) Sales of covered calloptions on equity securities, if the insurer holds in its portfolio, or canimmediately acquire through the exercise of options, warrants, or conversionrights already owned, the equity securities subject to call during the completeterm of the call option sold;
(3) Sales of coveredputs on investments that the insurer is permitted to acquire under thisChapter, if the insurer has escrowed or entered into a custodian agreementsegregating cash or cash equivalents with a market value equal to the amount ofits purchase obligations under the put during the complete term of the putoption sold; or
(4) Sales of coveredcaps or floors, if the insurer holds in its portfolio the investmentsgenerating the cash flow to make the required payments under the caps or floorsduring the complete term that the cap or floor is outstanding.
(f) An insurer shallinclude all counterparty exposure amounts in determining compliance with thelimitations of G.S. 58‑7‑170.
(g) Under rules thatmay be adopted by the Commissioner, additional transactions involving the useof derivative instruments in excess of the limits of subsection (d) of thissection or for other risk management purposes may be approved by theCommissioner.
(h) An insurer shallestablish guidelines and internal procedures as follows:
(1) Before engaging in aderivative transaction, an insurer shall establish written guidelines thatshall be used for effecting and maintaining the transactions. The guidelinesshall:
a. Address investmentor, if applicable, underwriting objectives, and risk constraints such as creditrisk limits;
b. Address permissibletransactions and the relationship of those transactions to its operations, suchas a precise identification of the risks being hedged by a derivativetransaction; and
c. Require compliancewith internal control procedures.
(2) An insurer shallhave a system for determining whether a derivative instrument used for hedginghas been effective.
(3) An insurer shallhave a credit risk management system for over‑the‑counter derivativetransactions that measures credit risk exposure using the counterparty exposureamount.
(4) An insurer's boardof directors shall, in accordance with G.S. 58‑7‑168:
a. Approve theguidelines required by subdivision (1) of this subsection and the systemsrequired by subdivisions (2) and (3) of this subsection; and
b. Determine whetherthe insurer has adequate professional personnel, technical expertise andsystems to implement investment practices involving derivatives.
(i) An insurer shallmaintain documentation and records relating to each derivative transaction,such as:
(1) The purpose orpurposes of the transaction;
(2) The assets orliabilities to which the transaction relates;
(3) The specificderivative instrument used in the transaction;
(4) For over‑the‑counterderivative instrument transactions, the name of the counterparty andcounterparty exposure amount; and
(5) For exchange‑tradedderivative instruments, the name of the exchange and the name of the firm thathandled the trade.
(j) Each derivativeinstrument shall be:
(1) Traded on aqualified exchange;
(2) Entered into with,or guaranteed by, a business entity;
(3) Issued or written byor entered into with the issuer of the underlying interest on which thederivative instrument is based; or
(4) Entered into with aqualified foreign exchange. (2001‑223, s. 8.17.)
(a) As used in thissection, the following terms have the following meanings:
(1) "Businessentity" includes a sole proprietorship, corporation, limited liabilitycompany, association, partnership, joint stock company, joint venture, mutualfund, trust, joint tenancy or other similar form of business organization,whether for‑profit or not‑for‑profit.
(2) "Counterpartyexposure" amount means:
a. The amount of creditrisk attributable to a derivative instrument entered into with a businessentity other than through a qualified exchange, qualified foreign exchange, orcleared through a qualified clearinghouse ("over‑the‑counterderivative instrument"). The amount of credit risk equals:
1. The market value ofthe over‑the‑counter derivative instrument if the liquidation ofthe derivative instrument would result in a final cash payment to the insurer;or
2. Zero if theliquidation of the derivative instrument would not result in a final cashpayment to the insurer.
b. If over‑the‑counterderivative instruments are entered into under a written master agreement whichprovides for netting of payments owed by the respective parties and thedomicile of the counterparty is either within the United States or, if notwithin the United States, within a foreign jurisdiction listed in the Purposesand Procedures of the Securities Valuation Office of the NAIC as eligible fornetting, the net amount of credit risk shall be the greater of zero or the netsum of:
1. The market value ofthe over‑the‑counter derivative instruments entered into under theagreement, the liquidation of which would result in a final cash payment to theinsurer; and
2. The market value ofthe over‑the‑counter derivative instruments entered into under theagreement, the liquidation of which would result in a final cash payment by theinsurer to the business entity.
c. For opentransactions, market value shall be determined at the end of the most recentquarter of the insurer's fiscal year and shall be reduced by the market valueof acceptable collateral held by the insurer or placed in escrow by one or bothparties.
(3) "Derivativeinstrument" means an agreement, option, instrument, or a series orcombination thereof:
a. To make or takedelivery of, or assume or relinquish, a specified amount of one or moreunderlying interests, or to make a cash settlement in lieu thereof; or
b. That has a price,performance, value, or cash flow based primarily upon the actual or expectedprice level, performance, value, or cash flow of one or more underlyinginterests.
Derivativeinstruments include options, warrants used in a hedging transaction and notattached to another financial instrument, caps, floors, collars, swaps,forwards, futures, and any other agreements, options, or instrumentssubstantially similar thereto or any series or combination thereof. Derivativeinstruments shall additionally include any agreements, options, or instrumentspermitted under rules adopted under subsection (c) of this section. Derivativeinstruments shall not include an investment authorized by G.S. 58‑7‑173,58‑7‑175, 58‑7‑178, 58‑7‑179, 58‑7‑180,and 58‑7‑187.
(4) "Derivativetransaction" means any transaction involving the use of one or morederivative instruments.
(5) "Qualifiedclearinghouse" means a clearinghouse for, and subject to the rules of, aqualified exchange or a qualified foreign exchange. The clearinghouse providesclearing services, including acting as a counterparty to each of the parties toa transaction such that the parties no longer have credit risk as to eachother.
(6) "Qualifiedexchange" means:
a. A securitiesexchange registered as a national securities exchange, or a securities marketregulated under the Securities Exchange Act of 1934 (15 U.S.C. §§ 78, et seq.),as amended;
b. A board of trade orcommodities exchange designated as a contract market by the Commodity FuturesTrading Commission, or any successor thereof;
c. Private Offerings,Resales and Trading through Automated Linkages (PORTAL);
d. A designatedoffshore securities market as defined in Securities Exchange CommissionRegulation S, 17 C.F.R. Part 230, as amended; or
e. A qualified foreignexchange.
(7) "Qualifiedforeign exchange" means a foreign exchange, board of trade, or contractmarket located outside the United States, its territories or possessions:
a. That has receivedregulatory comparability relief under Commodity Futures Trading Commission Rule30.10 (as set forth in Appendix C to Part 30 of the CFTC's Regulations, 17C.F.R. Part 30);
b. That is, or itsmembers are, subject to the jurisdiction of a foreign futures authority thathas received regulatory comparability relief under Commodity Futures TradingCommission Rule 30.10 (as set forth in Appendix C to Part 30 of the CFTC'sRegulations, 17 C.F.R. Part 30) as to futures transactions in the jurisdictionwhere the exchange, board of trade, or contract market is located; or
c. Upon which foreignstock index futures contracts are listed that are the subject of no‑actionrelief issued by the CFTC's Office of General Counsel, but an exchange, boardof trade, or contract market that qualifies as a "qualified foreignexchange" only under this paragraph shall only be a "qualifiedforeign exchange" as to foreign stock index futures contracts that are thesubject of the no‑action relief under this paragraph.
(8) "Replicationtransaction" means a derivative transaction that is intended to replicatethe investment in one or more assets that an insurer is authorized to acquireor sell under this section or G.S. 58‑7‑165. A derivativetransaction that is entered into as a hedging transaction shall not beconsidered a replication transaction.
(b) An insurer may,directly or indirectly through an investment subsidiary, engage in derivativetransactions under this section under the following conditions:
(1) An insurer may usederivative instruments under this section to engage in hedging transactions andcertain income generation transactions as may be further defined by rulesadopted by the Commissioner.
(2) An insurer shall beable to demonstrate to the Commissioner the intended hedging characteristicsand the ongoing effectiveness of the derivative transaction or combination ofthe transactions through cash flow testing or other appropriate analyses.
(c) The Commissionermay adopt reasonable rules for investments and transactions under this sectionincluding, but not limited to, rules which impose financial solvency standards,valuation standards, and reporting requirements.
(d) An insurer mayenter into hedging transactions under this section if, as a result of and aftergiving effect to the transaction:
(1) The aggregatestatement value of options, caps, floors, and warrants not attached to anotherfinancial instrument purchased and used in hedging transactions then engaged inby the insurer does not exceed seven and one‑half percent (7.5%) of itsadmitted assets;
(2) The aggregatestatement value of options, caps, and floors written in hedging transactionsthen engaged in by the insurer does not exceed three percent (3%) of itsadmitted assets; and
(3) The aggregatepotential exposure of collars, swaps, forwards, and futures used in hedgingtransactions then engaged in by the insurer does not exceed six and one‑halfpercent (6.5%) of its admitted assets.
(e) An insurer mayenter into the following types of income generation transactions if, as aresult of and after giving effect to the transactions, the aggregate statementvalue of the fixed income assets that are subject to call or that generate thecash flows for payments under the caps or floors, plus the face value of fixedincome securities underlying a derivative instrument subject to call, plus theamount of the purchase obligations under the puts, does not exceed ten percent(10%) of its admitted assets:
(1) Sales of coveredcall options on noncallable fixed‑income securities, callable fixed‑incomesecurities if the option expires by its terms before the end of the noncallableperiod, or derivative instruments based on fixed income securities;
(2) Sales of covered calloptions on equity securities, if the insurer holds in its portfolio, or canimmediately acquire through the exercise of options, warrants, or conversionrights already owned, the equity securities subject to call during the completeterm of the call option sold;
(3) Sales of coveredputs on investments that the insurer is permitted to acquire under thisChapter, if the insurer has escrowed or entered into a custodian agreementsegregating cash or cash equivalents with a market value equal to the amount ofits purchase obligations under the put during the complete term of the putoption sold; or
(4) Sales of coveredcaps or floors, if the insurer holds in its portfolio the investmentsgenerating the cash flow to make the required payments under the caps or floorsduring the complete term that the cap or floor is outstanding.
(f) An insurer shallinclude all counterparty exposure amounts in determining compliance with thelimitations of G.S. 58‑7‑170.
(g) Under rules thatmay be adopted by the Commissioner, additional transactions involving the useof derivative instruments in excess of the limits of subsection (d) of thissection or for other risk management purposes may be approved by theCommissioner.
(h) An insurer shallestablish guidelines and internal procedures as follows:
(1) Before engaging in aderivative transaction, an insurer shall establish written guidelines thatshall be used for effecting and maintaining the transactions. The guidelinesshall:
a. Address investmentor, if applicable, underwriting objectives, and risk constraints such as creditrisk limits;
b. Address permissibletransactions and the relationship of those transactions to its operations, suchas a precise identification of the risks being hedged by a derivativetransaction; and
c. Require compliancewith internal control procedures.
(2) An insurer shallhave a system for determining whether a derivative instrument used for hedginghas been effective.
(3) An insurer shallhave a credit risk management system for over‑the‑counter derivativetransactions that measures credit risk exposure using the counterparty exposureamount.
(4) An insurer's boardof directors shall, in accordance with G.S. 58‑7‑168:
a. Approve theguidelines required by subdivision (1) of this subsection and the systemsrequired by subdivisions (2) and (3) of this subsection; and
b. Determine whetherthe insurer has adequate professional personnel, technical expertise andsystems to implement investment practices involving derivatives.
(i) An insurer shallmaintain documentation and records relating to each derivative transaction,such as:
(1) The purpose orpurposes of the transaction;
(2) The assets orliabilities to which the transaction relates;
(3) The specificderivative instrument used in the transaction;
(4) For over‑the‑counterderivative instrument transactions, the name of the counterparty andcounterparty exposure amount; and
(5) For exchange‑tradedderivative instruments, the name of the exchange and the name of the firm thathandled the trade.
(j) Each derivativeinstrument shall be:
(1) Traded on aqualified exchange;
(2) Entered into with,or guaranteed by, a business entity;
(3) Issued or written byor entered into with the issuer of the underlying interest on which thederivative instrument is based; or
(4) Entered into with aqualified foreign exchange. (2001‑223, s. 8.17.)
(a) As used in thissection, the following terms have the following meanings:
(1) "Businessentity" includes a sole proprietorship, corporation, limited liabilitycompany, association, partnership, joint stock company, joint venture, mutualfund, trust, joint tenancy or other similar form of business organization,whether for‑profit or not‑for‑profit.
(2) "Counterpartyexposure" amount means:
a. The amount of creditrisk attributable to a derivative instrument entered into with a businessentity other than through a qualified exchange, qualified foreign exchange, orcleared through a qualified clearinghouse ("over‑the‑counterderivative instrument"). The amount of credit risk equals:
1. The market value ofthe over‑the‑counter derivative instrument if the liquidation ofthe derivative instrument would result in a final cash payment to the insurer;or
2. Zero if theliquidation of the derivative instrument would not result in a final cashpayment to the insurer.
b. If over‑the‑counterderivative instruments are entered into under a written master agreement whichprovides for netting of payments owed by the respective parties and thedomicile of the counterparty is either within the United States or, if notwithin the United States, within a foreign jurisdiction listed in the Purposesand Procedures of the Securities Valuation Office of the NAIC as eligible fornetting, the net amount of credit risk shall be the greater of zero or the netsum of:
1. The market value ofthe over‑the‑counter derivative instruments entered into under theagreement, the liquidation of which would result in a final cash payment to theinsurer; and
2. The market value ofthe over‑the‑counter derivative instruments entered into under theagreement, the liquidation of which would result in a final cash payment by theinsurer to the business entity.
c. For opentransactions, market value shall be determined at the end of the most recentquarter of the insurer's fiscal year and shall be reduced by the market valueof acceptable collateral held by the insurer or placed in escrow by one or bothparties.
(3) "Derivativeinstrument" means an agreement, option, instrument, or a series orcombination thereof:
a. To make or takedelivery of, or assume or relinquish, a specified amount of one or moreunderlying interests, or to make a cash settlement in lieu thereof; or
b. That has a price,performance, value, or cash flow based primarily upon the actual or expectedprice level, performance, value, or cash flow of one or more underlyinginterests.
Derivativeinstruments include options, warrants used in a hedging transaction and notattached to another financial instrument, caps, floors, collars, swaps,forwards, futures, and any other agreements, options, or instrumentssubstantially similar thereto or any series or combination thereof. Derivativeinstruments shall additionally include any agreements, options, or instrumentspermitted under rules adopted under subsection (c) of this section. Derivativeinstruments shall not include an investment authorized by G.S. 58‑7‑173,58‑7‑175, 58‑7‑178, 58‑7‑179, 58‑7‑180,and 58‑7‑187.
(4) "Derivativetransaction" means any transaction involving the use of one or morederivative instruments.
(5) "Qualifiedclearinghouse" means a clearinghouse for, and subject to the rules of, aqualified exchange or a qualified foreign exchange. The clearinghouse providesclearing services, including acting as a counterparty to each of the parties toa transaction such that the parties no longer have credit risk as to eachother.
(6) "Qualifiedexchange" means:
a. A securitiesexchange registered as a national securities exchange, or a securities marketregulated under the Securities Exchange Act of 1934 (15 U.S.C. §§ 78, et seq.),as amended;
b. A board of trade orcommodities exchange designated as a contract market by the Commodity FuturesTrading Commission, or any successor thereof;
c. Private Offerings,Resales and Trading through Automated Linkages (PORTAL);
d. A designatedoffshore securities market as defined in Securities Exchange CommissionRegulation S, 17 C.F.R. Part 230, as amended; or
e. A qualified foreignexchange.
(7) "Qualifiedforeign exchange" means a foreign exchange, board of trade, or contractmarket located outside the United States, its territories or possessions:
a. That has receivedregulatory comparability relief under Commodity Futures Trading Commission Rule30.10 (as set forth in Appendix C to Part 30 of the CFTC's Regulations, 17C.F.R. Part 30);
b. That is, or itsmembers are, subject to the jurisdiction of a foreign futures authority thathas received regulatory comparability relief under Commodity Futures TradingCommission Rule 30.10 (as set forth in Appendix C to Part 30 of the CFTC'sRegulations, 17 C.F.R. Part 30) as to futures transactions in the jurisdictionwhere the exchange, board of trade, or contract market is located; or
c. Upon which foreignstock index futures contracts are listed that are the subject of no‑actionrelief issued by the CFTC's Office of General Counsel, but an exchange, boardof trade, or contract market that qualifies as a "qualified foreignexchange" only under this paragraph shall only be a "qualifiedforeign exchange" as to foreign stock index futures contracts that are thesubject of the no‑action relief under this paragraph.
(8) "Replicationtransaction" means a derivative transaction that is intended to replicatethe investment in one or more assets that an insurer is authorized to acquireor sell under this section or G.S. 58‑7‑165. A derivativetransaction that is entered into as a hedging transaction shall not beconsidered a replication transaction.
(b) An insurer may,directly or indirectly through an investment subsidiary, engage in derivativetransactions under this section under the following conditions:
(1) An insurer may usederivative instruments under this section to engage in hedging transactions andcertain income generation transactions as may be further defined by rulesadopted by the Commissioner.
(2) An insurer shall beable to demonstrate to the Commissioner the intended hedging characteristicsand the ongoing effectiveness of the derivative transaction or combination ofthe transactions through cash flow testing or other appropriate analyses.
(c) The Commissionermay adopt reasonable rules for investments and transactions under this sectionincluding, but not limited to, rules which impose financial solvency standards,valuation standards, and reporting requirements.
(d) An insurer mayenter into hedging transactions under this section if, as a result of and aftergiving effect to the transaction:
(1) The aggregatestatement value of options, caps, floors, and warrants not attached to anotherfinancial instrument purchased and used in hedging transactions then engaged inby the insurer does not exceed seven and one‑half percent (7.5%) of itsadmitted assets;
(2) The aggregatestatement value of options, caps, and floors written in hedging transactionsthen engaged in by the insurer does not exceed three percent (3%) of itsadmitted assets; and
(3) The aggregatepotential exposure of collars, swaps, forwards, and futures used in hedgingtransactions then engaged in by the insurer does not exceed six and one‑halfpercent (6.5%) of its admitted assets.
(e) An insurer mayenter into the following types of income generation transactions if, as aresult of and after giving effect to the transactions, the aggregate statementvalue of the fixed income assets that are subject to call or that generate thecash flows for payments under the caps or floors, plus the face value of fixedincome securities underlying a derivative instrument subject to call, plus theamount of the purchase obligations under the puts, does not exceed ten percent(10%) of its admitted assets:
(1) Sales of coveredcall options on noncallable fixed‑income securities, callable fixed‑incomesecurities if the option expires by its terms before the end of the noncallableperiod, or derivative instruments based on fixed income securities;
(2) Sales of covered calloptions on equity securities, if the insurer holds in its portfolio, or canimmediately acquire through the exercise of options, warrants, or conversionrights already owned, the equity securities subject to call during the completeterm of the call option sold;
(3) Sales of coveredputs on investments that the insurer is permitted to acquire under thisChapter, if the insurer has escrowed or entered into a custodian agreementsegregating cash or cash equivalents with a market value equal to the amount ofits purchase obligations under the put during the complete term of the putoption sold; or
(4) Sales of coveredcaps or floors, if the insurer holds in its portfolio the investmentsgenerating the cash flow to make the required payments under the caps or floorsduring the complete term that the cap or floor is outstanding.
(f) An insurer shallinclude all counterparty exposure amounts in determining compliance with thelimitations of G.S. 58‑7‑170.
(g) Under rules thatmay be adopted by the Commissioner, additional transactions involving the useof derivative instruments in excess of the limits of subsection (d) of thissection or for other risk management purposes may be approved by theCommissioner.
(h) An insurer shallestablish guidelines and internal procedures as follows:
(1) Before engaging in aderivative transaction, an insurer shall establish written guidelines thatshall be used for effecting and maintaining the transactions. The guidelinesshall:
a. Address investmentor, if applicable, underwriting objectives, and risk constraints such as creditrisk limits;
b. Address permissibletransactions and the relationship of those transactions to its operations, suchas a precise identification of the risks being hedged by a derivativetransaction; and
c. Require compliancewith internal control procedures.
(2) An insurer shallhave a system for determining whether a derivative instrument used for hedginghas been effective.
(3) An insurer shallhave a credit risk management system for over‑the‑counter derivativetransactions that measures credit risk exposure using the counterparty exposureamount.
(4) An insurer's boardof directors shall, in accordance with G.S. 58‑7‑168:
a. Approve theguidelines required by subdivision (1) of this subsection and the systemsrequired by subdivisions (2) and (3) of this subsection; and
b. Determine whetherthe insurer has adequate professional personnel, technical expertise andsystems to implement investment practices involving derivatives.
(i) An insurer shallmaintain documentation and records relating to each derivative transaction,such as:
(1) The purpose orpurposes of the transaction;
(2) The assets orliabilities to which the transaction relates;
(3) The specificderivative instrument used in the transaction;
(4) For over‑the‑counterderivative instrument transactions, the name of the counterparty andcounterparty exposure amount; and
(5) For exchange‑tradedderivative instruments, the name of the exchange and the name of the firm thathandled the trade.
(j) Each derivativeinstrument shall be:
(1) Traded on aqualified exchange;
(2) Entered into with,or guaranteed by, a business entity;
(3) Issued or written byor entered into with the issuer of the underlying interest on which thederivative instrument is based; or
(4) Entered into with aqualified foreign exchange. (2001‑223, s. 8.17.)
