§ 27-1-12-2.2 — Derivative transactions

Indiana § 27-1-12-2.2

• Jurisdiction: Indiana
• Title 27: INSURANCE
• Art. 1: DEPARTMENT OF INSURANCE
• Ch. 12: Life Insurance Company Powers and Policy

Text

2. (a) The following definitions apply to this
section:
(1) "Acceptable collateral" means, as to over-the-counter
derivatives transactions and for the purpose of calculating
counterparty exposure amounts:
(A) cash;
(B) cash equivalents;
(C) letters of credit; and
(D) direct obligations of, or securities that are fully guaranteed
as to principal and interest by, the government of the United
States or any agency of the United States, including the Federal
National Mortgage Association and the Federal Home Loan
Mortgage Corporation.
(2) "Admitted assets" means the life insurance company's assets
permitted to be reported as admitted assets on the statutory
financial statement of the insurer most recently required to be
filed with the commissioner.
(3) "Business entity" means:
(A) a sole proprietorship;
(B) a corporation;
(C) a limited liability company;
(D) an association;
(E) a partnership;
(F) a joint stock company;
(G) a joint venture;
(H) a mutual fund;
(I) a trust;
(J) a joint tenancy; or
(K) another, similar form of business organization;
whether organized for-profit or not-for-profit.
(4) "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 (1) or more underlying interests exceeds a predetermined
number, sometimes called the strike rate or strike price.
(5) "Cash" means any of the following:
(A) United States denominated paper currency and coins.
(B) Negotiable money orders and checks.
(C) Funds held in any time or demand deposit in any depository
institution, the deposits of which are insured by the Federal
Deposit Insurance Corporation.
(6) "Cash equivalent" means any of the following:
(A) A certificate of deposit issued by a depository institution,
the deposits of which are insured by the Federal Deposit
Insurance Corporation.
(B) A banker's acceptance issued by a depository institution, the
deposits of which are insured by the Federal Deposit Insurance
Corporation.
(C) A government money market mutual fund.
(D) A class one money market mutual fund.
(7) "Class one money market mutual fund" means a money
market mutual fund that at all times qualifies for investment
pursuant to the Purposes and Procedures Manual of the NAIC
Investment Analysis Office either using the bond class one
reserve factor or because it is exempt from asset valuation reserve
requirements.
(8) "Collar" means two (2) derivatives transactions on the same
underlying interest in which the insurer receives payments as the
buyer of an option, cap, or floor in one (1) transaction and makes
payments as the seller of a different option, cap, or floor in the
second transaction.
(9) A. "Counterparty exposure amount" means the net amount of
credit risk attributable to a derivative instrument that a life
insurance company enters into with another business entity other
than through a qualified exchange or a qualified foreign
exchange, or cleared through a qualified clearing house ("over the
counter derivative instrument"). The amount of credit risk equals:
(1) the market value of the over-the-counter derivative
instrument, if the liquidation of the instrument would result in
a final cash payment to the insurer; or
(2) zero (0), if the liquidation of the over-the-counter derivative
instrument would not result in a final cash payment to the
insurer.
B. If a life insurance company enters into one (1) or more
over-the-counter derivative instruments with another business
entity under a written master agreement that provides for netting
of payments owed by the respective parties, and the domiciliary
jurisdiction of the counterparty is either within the United States
or a foreign jurisdiction listed in the Purposes and Procedures
Manual of the NAIC Investment Analysis Office as eligible for
netting, the net amount of credit risk attributable to the
counterparty is the greater of zero (0) or the remainder of:
(1) the market value of the over-the-counter derivative
instruments entered into under the agreement, the liquidation of
which would result in a final cash payment to the insurer by the
business entity; minus
(2) the market value of the over-the-counter derivative
instruments entered into under the agreement, the liquidation of
which would result in a final cash payment by the insurer to the
business entity.
C. For open transactions involving over-the-counter derivative
instruments, market value:
(1) shall be determined not less frequently than at the end of the
most recent quarter of the insurer's fiscal year; and
(2) shall be reduced by the market value of acceptable collateral
that is:
(A) held by the insurer; or
(B) placed in escrow by one (1) or both parties.
(10) "Covered" means, in the case of a call option, that:
(A) the life insurance company owns the instrument underlying
the call option it has written (a "written call") during the entire
period that the written call is outstanding; or
(B) pursuant to the exercise of options, warrants, or conversion
rights already owned when the call option is written and held
during the period that the written call is outstanding, the life
insurance company can immediately acquire the instrument
underlying the written call, if:
(1) the price at which the underlying instrument can be
acquired is less than or equal to the strike price of the written
call; or
(2) the life insurance company has placed in escrow or,
pursuant to a custodian agreement, has segregated during the
entire period that the written call is outstanding, cash, cash
equivalents, or securities with a market value equal to the
difference between the price at which the underlying
instrument can be acquired and the strike price of the written
call.
(11) "Covered" means, in the case of a put option, that the life
insurance company has placed in escrow or, pursuant to a
custodian agreement, has segregated during the entire period that
the put option it has sold (a "written put") is outstanding, cash,
cash equivalents, or securities with a market value equal to the
amount of the insurer's obligation under the written put.
(12) "Covered" means, in the case of a cap or floor, that the life
insurance company holds in its portfolio, during the entire period
that the cap or floor is outstanding, investments that generate
sufficient cash flow to make all required payments under the cap
or floor.
(13) "Derivative instrument" means an agreement (in the nature
of a bilateral contract, option, or otherwise), an instrument, or a
series or combination of agreements and instruments:
(A) to make or take delivery of, or assume or relinquish, a
specified amount of one (1) or more of the interests underlying
the derivative instrument, 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 expected price, level, performance,
value, or cash flow of one (1) or more of the interests
underlying the derivative instrument.
Derivative instruments include options, warrants used in a
hedging transaction and not attached to another financial
instrument, caps, floors, collars, swaps, swaptions, forwards,
futures, and any other agreements (in the nature of bilateral
contracts, options, or otherwise) or substantially similar
instruments, or any series or combination thereof, and any
agreements (in the nature of bilateral contracts, options, or
otherwise) or instruments permitted under rules adopted by the
department.
(14) "Derivative transaction" means a transaction involving the
use of one (1) or more derivative instruments. For purposes of this
section, a derivative transaction may involve a requirement that
the insurer, a counterparty, or both, are required to post collateral
with the other party (or a designated third party) pursuant to an
agreement between the insurer and the counterparty.
(15) "Domestic jurisdiction" means the United States, any state,
territory, or possession of the United States, the District of
Columbia, Canada, or any province of Canada.
(16) "Floor" means an agreement obligating the seller to make
payments to the buyer, with each payment based on the amount
by which a predetermined number, sometimes called the floor rate
or price, exceeds a reference price or level or the performance or
value of one or more underlying interests.
(17) "Foreign currency" means a currency other than that of a
domestic jurisdiction.
(18) "Foreign jurisdiction" means a jurisdiction other than a
domestic jurisdiction.
(19) "Forward" means an agreement (other than a future) to make
or take delivery of, or effect a cash settlement based on the actual
or expected price, level, performance, or value of, one (1) or more
underlying interests.
(20) "Future" means an agreement, traded on a qualified exchange
or qualified foreign 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.
(21) "Government money market mutual fund" means a money
market mutual fund that at all times:
(A) invests only in obligations issued, guaranteed, or insured by
the United States or collateralized repurchase agreements
composed of these obligations; and
(B) qualifies for investment without a reserve pursuant to the
Purposes and Procedures Manual of the NAIC Investment
Analysis Office.
(22) "Guaranteed or insured," when used in connection with an
obligation acquired under this section, means that the guarantor
or insurer has agreed to:
(A) perform or insure the obligation of the obligor or purchase
the obligation; or
(B) be unconditionally obligated until the obligation is repaid
to maintain in the obligor a minimum net worth, fixed charge
coverage, stockholders' equity, or sufficient liquidity to enable
the obligor to pay the obligation in full.
(23) "Hedging transaction" means a derivative transaction that is
entered into and maintained to manage:
(A) the risk of a change in the value, yield, price, cash flow, or
quantity of assets or liabilities (or a portfolio of assets,
liabilities, or assets and liabilities) that the insurer has acquired
or incurred or anticipates acquiring or incurring; or
(B) currency exchange rate risk or the degree of exposure to
assets or liabilities (or a portfolio of assets, liabilities, or assets
and liabilities) that the insurer has acquired or incurred or
anticipates acquiring or incurring.
(24) "Income generation transaction" means a derivative
transaction involving the writing of covered call options, covered
put options, covered caps, or covered floors.
(25) "Investment company" means an investment company as
defined in Section 3(a) of the Investment Company Act of 1940
(15 U.S.C. 80a-1 et seq.) and a person described in Section 3(c)
of the Investment Company Act of 1940.
(26) "Investment company series" means an investment portfolio
of an investment company that is organized as a series company
and to which assets of the investment company have been
specifically allocated.
(27) "Letter of credit" means a clean, irrevocable, and
unconditional letter of credit issued or confirmed by, and payable
and presentable at, a financial institution on the list of financial
institutions meeting the standards for issuing letters of credit
under the Purposes and Procedures Manual of the NAIC
Investment Analysis Office.
(28) "Market value" means:
(A) as to cash, cash equivalents, and letters of credit, the
amounts thereof;
(B) as to a security (other than a security that is an
over-the-counter derivative instrument) as of any date, the price
for the security on that date obtained from a generally
recognized source or the most recent quotation from such a
source or, to the extent no generally recognized source exists,
the price for the security as determined in good faith by the
parties to a transaction, plus accrued but unpaid income on the
security to the extent not included in the price as of that date;
and
(C) as to an over-the-counter derivative instrument as of any
date, the amount that a life insurance company would have to
pay or would receive for entering into an over-the-counter
derivative transaction on substantially identical terms with
another counterparty.
(29) "Money market mutual fund" means a mutual fund that
meets the conditions of 17 CFR 270.2a-7, under the Investment
Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
(30) "Mutual fund" means:
(A) an investment company; or
(B) in the case of an investment company that is organized as
a series company, an investment company series;
that is registered with the United States Securities and Exchange
Commission under the Investment Company Act of 1940 (15
U.S.C. 80a-1 et seq.).
(31) "Obligation" means any of the following:
(A) A bond.
(B) A note.
(C) A debenture.
(D) Any other form of evidence of debt.
(32) "Option" means an agreement giving the buyer the right to
buy or receive (a "call option"), sell or deliver (a "put option"),
enter into, extend or terminate, or effect a cash settlement based
on the actual or expected price, level, performance, or value of
one or more underlying interests.
(33) "Qualified business entity" means a business entity that is:
(A) an issuer of obligations, preferred stock, or derivative
instruments that are rated 1 or 2 or are rated the equivalent of
1 or 2 by the Securities Valuation Office or by a nationally
recognized statistical rating organization recognized by the
Securities Valuation Office; or
(B) a primary dealer in United States government securities,
recognized by the Federal Reserve Bank of New York.
(34) "Qualified clearinghouse" means a clearinghouse:
(A) that is for, and subject to the rules of, a qualified exchange
or qualified foreign exchange; and
(B) that provides clearing services, including acting as a
counterparty to each of the parties to a transaction so that the
parties no longer have credit risk as to each other.
(35) "Qualified exchange" means:
(A) a securities exchange registered as a national securities
exchange, or a securities market regulated under the Securities
Exchange Act of 1934 (15 U.S.C. 78 et seq.);
(B) a board of trade or commodities exchange designated as a
contract market by the Commodity Futures Trading
Commission (CFTC);
(C) Private Offerings, Resales, and Trading through Automated
Linkages (PORTAL);
(D) a designated offshore securities market as defined in
Securities Exchange Commission Regulation S (17 CFR Part
230); or
(E) a qualified foreign exchange.
(36) "Qualified foreign exchange" means a foreign exchange,
board of trade, or contract market located outside the United
States or its territories or possessions:
(A) that has received regulatory comparability relief under
CFTC Rule 30.10 (as set forth in Appendix C to Part 30 of the
CFTC's Regulations (17 CFR Part 30));
(B) that is, or whose members are, subject to the jurisdiction of
a foreign futures authority that has received regulatory
comparability relief under CFTC Rule 30.10 (as set forth in
Appendix C to Part 30 of the CFTC's Regulations (17 CFR Part
30)) as to futures transactions in the jurisdiction where the
exchange, board of trade, or contract market is located; or
(C) upon which are listed foreign stock index futures contracts
that are the subject of no-action relief issued by the CFTC's
Office of the General Counsel, provided that an exchange,
board of trade, or contract market that qualifies as a qualified
foreign exchange only under this clause is a qualified foreign
exchange only as to foreign stock index futures contracts that
are the subject of no-action relief.
(37) "Replication transaction" means a derivative transaction that
is intended to replicate the investment in one (1) or more assets
that an insurer is authorized to acquire or sell under this section
or section 2 of this chapter. A derivative transaction that is
entered into as a hedging transaction shall not be considered a
replication transaction.
(38) "Securities Valuation Office" refers to the Securities
Valuation Office of the NAIC.
(39) "Swap" means an agreement to exchange or to net payments
at one (1) or more times based on the actual or expected price,
level, performance, or value of one (1) or more underlying
interests.
(40) "Swaption" means an agreement giving the buyer the right
(but not the obligation) to enter into a swap at a specified time in
the future.
(41) "Underlying interest" means the assets, liabilities, other
interests or a combination thereof underlying a derivative
instrument, such as any one (1) or more securities, currencies,
rates, indices, commodities, or derivative instruments.
(42) "Warrant" means an instrument that gives the holder the right
to purchase an underlying financial instrument at a given price
and time or at a series of prices and times outlined in the warrant
agreement. Warrants may be issued alone or in connection with
the sale of other securities, for example, as part of a merger or
recapitalization agreement or to facilitate divestiture of the
securities of another business entity.
(b) A life insurance company's board of directors shall do all the
following:
(1) Before engaging in derivatives transactions, approve a written
plan that specifies guidelines, systems, and objectives to be
followed, such as:
(A) investment or, if applicable, underwriting objectives and
risk constraints, such as credit risk limits;
(B) permissible transactions and the relationship of those
transactions to the insurer's operations;
(C) internal control procedures;
(D) a system for determining whether a derivative instrument
used for hedging has been effective;
(E) a credit risk management system for over-the-counter
derivatives transactions that measures credit risk exposure
using the counterparty exposure amount; and
(F) a mechanism for reviewing and auditing compliance with
the guidelines, systems, and objectives specified in the written
plan.
(2) Before engaging in derivatives transactions, make a
determination that the insurer's investment managers have
adequate professional personnel, technical expertise, and systems
to implement the insurer's intended investment practices
involving derivative instruments.
(3) Review whether derivatives transactions have been made in
accordance with the approved guidelines and are consistent with
stated objectives.
(4) Take action to correct any deficiencies in internal controls
relating to derivatives transactions.
(c) A life insurance company may use derivative instruments under
this section to engage in hedging transactions, certain income
generation transactions, and certain replication transactions, as these
terms may be further defined in rules adopted by the department. For
each hedging and replication transaction in which it engages, a life
insurance company must be able to demonstrate to the commissioner:
(1) the intended characteristics; and
(2) the ongoing effectiveness;
of the derivative transaction or combination of the derivatives
transactions through appropriate analyses.
(d) A life insurance company insurer may enter into a hedging
transaction under this section if, as a result of the transaction, and after
giving effect to the transaction:
(1) the aggregate statement value of options, caps, floors, and
warrants not attached to another financial instrument purchased
and used in hedging transactions does not exceed seven and one
half percent (7.5%) of the insurer's admitted assets;
(2) the aggregate statement value of options, caps, and floors
written in hedging transactions does not exceed three percent
(3%) of the insurer's admitted assets; and
(3) the aggregate potential exposure of collars, swaps, forwards,
and futures used in hedging transactions does not exceed six and
one-half percent (6.5%) of the insurer's admitted assets.
(e) A life insurance company may enter into the following types of
income generation transactions:
(1) sales of covered call options on:
(A) non-callable fixed income securities;
(B) callable fixed income securities if the option expires by its
terms before the end of the noncallable period; or
(C) derivative instruments based on fixed income securities or
yields;
(2) sales of covered call options on equity securities;
(3) sales of covered puts on investments that the insurer is
permitted to acquire under section 2 of this chapter; and
(4) sales of covered caps or floors;
only if, as a result of the transactions and after giving effect to the
transactions, the aggregate statement value of the fixed income
securities that are subject to call or that generate the cash flows for
payments under the caps or floors, plus the face value of fixed income
securities underlying a derivative instrument subject to call, plus the
amount of the purchase obligations under the puts, does not exceed ten
percent (10%) of the insurer's admitted assets.
(f) A life insurance company may enter into replication transactions.
For the purposes of this subsection, a replication transaction is subject
to the limitations and restrictions set forth in section 2 of this chapter
to which the replicated investments are subject.
(g) An investment of a life insurance company that is:
(1) permitted under section 2(b)(17A) or 2(b)(17B) of this
chapter; and
(2) denominated in a foreign currency;
shall not be considered denominated in a foreign currency if the
acquiring insurer enters into one (1) or more contracts permitted under
this section in which the business entity counterparty agrees to
exchange, or grants to the insurer the option to exchange, all payments
made on the foreign currency denominated investment (or amounts
equivalent to the payments that are or will be due to the insurer in
accordance with the terms of such investment) for United States or
Canadian dollars during the period that the contract or contracts are in
effect, or other contracts with like effect, to insulate the insurer against
loss caused by diminution of the value of payments owed to the insurer
due to future changes in currency exchange rates.
(h) A life insurance company shall include all counterparty exposure
amounts in determining compliance with the limitations set forth in
section 2(b)(21) of this chapter.
(i) Upon the request of a life insurance company, the commissioner
may approve additional transactions involving the use of derivative
instruments that:
(1) exceed the limits set forth in subsections (d), (e), and (f); or
(2) are for other risk management purposes.
(j) A life insurance company shall maintain documentation and
records relating to each derivative transaction. The documentation and
records must record and include matters such as the following:
(1) The purpose or purposes of the transaction.
(2) The assets or liabilities to which the transaction relates.
(3) The specific derivative instrument used in the transaction.
(4) For collateralized derivatives transactions, a description of any
collateral posted by the insurer or the counterparty, as well as
records documenting any subsequent variations in the amount of
the collateral.
(5) For over-the-counter derivative transactions, the name of the
counterparty and the counterparty exposure amount.
(6) For exchange traded derivative instruments, the name of the
exchange and the name of the firm that handled the trade.
(k) Each derivative instrument shall be:
(1) traded on a qualified exchange;
(2) entered into with, or guaranteed by, a business entity;
(3) issued or written by or entered into with the issuer of the
underlying interest on which the derivative instrument is based;
or
(4) entered into on a qualified foreign exchange.

Legislative History

As added by P.L.186-1997, SEC.2. Amended by P.L.81-2012, SEC.1; P.L.124-2018, SEC.13.