§ 1410 — Derivative transactions and derivative instruments

§ 1410. Derivative transactions and derivative instruments. (a) For\npurposes of this section, except subsection (k) of this section, an\ninsurer shall mean a domestic life insurer, a domestic property/casualty\ninsurer, a domestic reciprocal insurer, a domestic mortgage guaranty\ninsurer, a domestic co-operative property/casualty insurance corporation\nor a domestic financial guaranty insurer.\n (b) (1) An insurer may only engage in derivative transactions pursuant\nto and in compliance with the requirements of this section. Any insurer\nsubject to the provisions of subsection (c) of section one thousand four\nhundred three of this article shall also comply with the requirements\nset forth in such subsection relative to derivative transactions\nauthorized by this section.\n (2) An insurer may use derivative instruments under this section to\nengage in hedging transactions, replication transactions, and for\ncertain limited income generation transactions authorized pursuant to\nthis section.\n (3) Prior to entering into any derivative transaction authorized\npursuant to this section:\n (A) the board of directors of the insurer or a committee thereof\ncharged with the responsibility for supervising investments shall: (i)\nauthorize such transactions, (ii) assure that all individuals\nconducting, monitoring, controlling and auditing derivative transactions\nare suitably qualified and have appropriate levels of knowledge and\nexperience, and (iii) approve a derivative use plan for such\ntransactions or an amendment to a previously adopted derivative use\nplan. If such determinations are made by a committee of such a board,\nthe minutes of the committee reflecting such determinations shall be\nrecorded and a report thereon shall be submitted to the board of\ndirectors for its review at such board's next meeting;\n (B) the insurer shall submit a written derivative use plan or\namendment thereto to the superintendent for approval; and\n (C) the superintendent shall approve the insurer's written derivative\nplan for engaging in derivative transactions and investment practices\nrelated to derivative transactions. The plan shall specify guidelines as\nto the quality, maturity and diversification of derivative investments\nand other specifications, including investment strategies,\nasset/liability management practices, its liquidity needs and its\ncapital and surplus as they relate to the derivative use plan. The board\nof directors or a committee thereof charged with the responsibility for\nsupervising investments shall determine at least quarterly whether all\nderivative transactions have been made in accordance with delegations,\nstandards, limitations and investment objectives prescribed in the\ninsurer's derivatives use plan. If such determinations are made by a\ncommittee of such a board, the minutes of the committee reflecting such\ndeterminations shall be recorded and a report thereon shall be submitted\nto the board of directors for its review at such board's next meeting.\n (D) (i) Within ninety days of receipt of a derivative use plan\napplication, the superintendent shall, in writing, approve, submit a\ndetailed list to the insurer requesting all additional information\nnecessary to make a determination on the plan, or deny such plan;\notherwise, such plan shall be deemed approved. Any denial issued by the\nsuperintendent shall state the reasons for such disapproval. If an\ninsurer does not provide the additional information requested by the\nsuperintendent, within forty-five days of receipt of such request, then\nsuch plan shall be deemed denied. Such forty-five day limit for\nproviding such additional information may be extended at the option of\nthe superintendent.\n (ii) In the event that an insurer properly submits the additional\ninformation requested by the superintendent, then such plan shall be\ndeemed approved sixty days after receipt of such information by the\nsuperintendent, unless the insurer is notified in writing prior to such\ndate that the filing has been denied. Such denial shall state the\nreasons for such disapproval. Notwithstanding anything to the contrary\nin this section, the superintendent may, at any time, before a plan is\napproved, affirmatively approved or denied, raise objections to the plan\nthat is based on the requirements of this chapter.\n (iii) The superintendent shall, as soon as practicable, but no later\nthan sixty days after receipt of a plan, notify the insurer if its\nfiling is incomplete or fails to comply with applicable statutory or\nregulatory requirements. Such notice shall indicate that the filing is\nbeing returned with no action by the superintendent and that the period\nfor the superintendent's substantive review has not commenced.\n (4) An insurer which engages in hedging transactions or replication\ntransactions as authorized pursuant to this section shall:\n (A) only maintain its position in any outstanding derivative\ninstrument used as part of a hedging transaction or replication\ntransaction for as long as the hedging transaction or replication\ntransaction, as the case may be, continues to be effective; and\n (B) be able to demonstrate to the superintendent, upon request, that\nany derivative transaction entered into and involving a hedging\ntransaction or replication transaction, at the point of inception is\nand, for as long as the derivative transaction remains outstanding,\ncontinues to be, an effective hedging or replication transaction.\n (5) An insurer which enters into derivative transactions as authorized\npursuant to this section shall be required to include, as part of the\nevaluation of accounting procedures and internal controls required to be\nfiled pursuant to subsection (b) of section three hundred seven of this\nchapter, a statement describing the assessment by the independent\ncertified public accountant of the internal controls relative to\nderivative transactions. If the internal controls relative to derivative\ntransactions are determined to be deficient, the insurer shall require\nthe accountant to include in the evaluation a description of such\ndeficiencies and the insurer shall append to the evaluation a\ndescription of any remedial actions taken or proposed to be taken to\ncorrect these deficiencies, if such actions are not already described in\nthe accountant's report.\n (c)(1) An insurer may enter into hedging transactions pursuant to this\nsection if, as a result of and after giving effect to the transaction:\n (A) the aggregate statement value of options, swaptions, caps, floors\nand warrants purchased pursuant to this section does not exceed seven\nand one-half percent of its admitted assets;\n (B) the aggregate statement of value of options, swaptions, caps and\nfloors written pursuant to this section does not exceed three percent of\nits admitted assets; and\n (C) the aggregate potential exposure of collars, swaps, forwards and\nfutures entered into and options, swaptions, caps and floors written\npursuant to this section does not exceed six and one-half percent of its\nadmitted assets.\n (2) Transactions entered into to effectively hedge the currency risk\nof investments denominated in a currency other than United States\ndollars, pursuant to subsection (f) of section one thousand four hundred\nfive of this article, shall not be included in the limits under\nparagraph one of this subsection.\n (d) An insurer may enter into income generation transactions under\nthis section only through the sale of call options on securities,\nprovided that the insurer holds, or can immediately acquire through the\nexercise of options, warrants or conversion rights already owned, the\nunderlying securities during the entire period the option is\noutstanding.\n (e) An insurer may purchase or sell one or more derivative instruments\nto offset any derivative instrument previously purchased or sold, as the\ncase may be, without regard to the quantitative limitations of\nsubsection (c) of this section provided that such derivative instrument\nis an exact offset to the original derivative instrument being offset.\n (f)(1) The counterparty exposure under an over the counter derivative\ninstrument entered into by an insurer authorized to engage in\ntransactions pursuant to this section shall be deemed to be an\nobligation of the institution to which the insurer is exposed to credit\nrisk and shall be included in determining compliance with any single or\naggregate quantitative limitation on investments made by an insurer\nunder this chapter.\n (2) Notwithstanding any single or aggregate quantitative limitation on\ninvestments made by an insurer under this chapter, an insurer may only\ntransact an over the counter derivative instrument with:\n (A) a qualified counterparty; or\n (B) a counterparty other than a "qualified counterparty" if, after\ngiving effect to that transaction, the aggregate counterparty exposure\nof the insurer under one or more over the counter derivative instruments\nto:\n (i) that non-qualified counterparty does not exceed one percent of the\ninsurer's admitted assets; and\n (ii) all counterparties, other than qualified counterparties, does not\nexceed three percent of the insurer's admitted assets.\n (3) For purposes of this section:\n (A) a "qualified counterparty" is a counterparty which has an\ninvestment grade rating from at least one nationally recognized\nstatistical rating organization or a designation of one from the\nSecurities Valuation Office of the National Association of Insurance\nCommissioners, or any successor office established by the National\nAssociation of Insurance Commissioners, and with which the insurer has\nentered into a master agreement, together with a credit support annex or\nother documentation providing for the collateralization of the\ncounterparty's obligations to the insurer under the master agreement, if\nthat collateral documentation provides for (i) daily margin and\ncollateral settlement, in cash or investment grade securities, between\nthe parties, (ii) a minimum transfer amount of no more than one million\ndollars, and (iii) a requirement that collateral be provided by the\ncounterparty from the first dollar of exposure, subject to the minimum\ntransfer amount;\n (B) "aggregate counterparty exposure" means the sum of: (i) the\naggregate statement value of options, swaptions, caps, floors, and\nwarrants purchased; and (ii) the aggregate potential exposure of\ncollars, swaps, forwards and futures entered into;\n (C) "over the counter derivative instrument" means a derivative\ninstrument which is authorized under this chapter other than a\nderivative instrument (i) cleared through a United States or foreign\nderivatives clearinghouse, or (ii) traded on or through a United States\nor foreign exchange providing derivatives clearing services;\n (D) "derivatives clearinghouse" means a derivatives clearing\norganization registered with the Commodity Futures Trading Commission or\nthe Securities and Exchange Commission or, if not so registered, is a\nforeign clearinghouse regulated, supervised and examined by a regulatory\nauthority in a foreign jurisdiction approved by the superintendent;\n (E) "master agreement" means a written master agreement relating to\nderivatives transactions that provides for netting of payments owed by\nthe respective parties, and the domiciliary jurisdiction of the\ncounterparty is either within the United States or if not within the\nUnited States, within a jurisdiction approved by the superintendent as\neligible for netting; and\n (F) "minimum transfer amount" means an amount below which a daily\nmargin and collateral settlement is not required.\n (g) For the purposes of this section, "admitted assets" means the\nassets, as shown on the insurer's last annual statement filed with the\nsuperintendent, which conform to the requirements of section one\nthousand three hundred one of this chapter, except that a domestic life\ninsurer shall include assets held in separate accounts established under\nsection four thousand two hundred forty of this chapter to the extent of\namounts allocated to such separate accounts pursuant to paragraph three\nof subsection (a) of section four thousand two hundred forty of this\nchapter, and shall exclude investments in subsidiaries referred to in\nsubsection (c) of section one thousand seven hundred four of this\nchapter.\n (h) The superintendent shall promulgate regulations to:\n (1) define terms used in this section that are not otherwise defined;\n (2) establish the content of the derivative use plan to be submitted\nby an insurer to the superintendent pursuant to this section;\n (3) establish effective management oversight standards, including\nquarterly reporting to the board of directors or a committee thereof\ncharged with the responsibility for supervising investments, for\ntransactions authorized pursuant to this section;\n (4) require that the insurer establish adequate systems of internal\ncontrol and reporting to ensure that derivative transactions are\nproperly supervised and that transactions are in accordance with the\ninsurer's authorized policies and procedures;\n (5) establish documentation and reporting requirements for\ntransactions authorized pursuant to this section;\n (6) establish appropriate accounting standards for derivative\ntransactions authorized pursuant to this section; and\n (7) the provisions of this section shall not be deemed to authorize\nthe superintendent to promulgate any rule or regulation, circular letter\nor directive, that in any way expands the superintendent's authority to\n(i) approve or regulate an insurer's entire investment portfolio or\ninvestment strategy, or (ii) impose standards on corporate governance\nthat are either stricter or contrary to the provisions contained in this\narticle or the business corporation law.\n (i) For purposes of other provisions of this chapter, derivative\ninstruments and derivative transactions entered into under this section\nshall be deemed to be investments, provided that if this section\nconflicts with any other provisions of this chapter, the provisions of\nthis section shall prevail.\n (j) The superintendent may order an insurer to cease effecting and\nmaintaining transactions authorized by this section upon a finding that\ncontinued operations hereunder could be detrimental to the best\ninterests of the policyholders or the public.\n (k) Any foreign insurer engaging in derivative transactions and\nderivative instruments shall be subject to and comply with all the\nprovisions of this section. However, a foreign insurer may engage in\nderivative transactions not authorized by this section provided that:\n(1) such insurer is authorized to engage in such transactions pursuant\nto its domestic state law; (2) such insurer includes the intent to\nengage in such derivative transactions in the derivative use plan\nsubmitted to and approved by the superintendent pursuant to paragraph\nthree of subsection (b) of this section; (3) the transactions are not\ndeemed, by the superintendent, to be potentially detrimental to the\npolicy holders or the public in this state; and (4) the insurer complies\nwith subsection (a) of section one thousand four hundred thirteen of\nthis article after the surplus to policyholders is reduced by the amount\nof all derivative transactions not authorized by this section in\naccordance with the measurement standards of paragraph one of subsection\n(c) of this section. For purposes of this subsection, a foreign insurer\nshall include foreign insurers as defined in paragraph twenty-one of\nsubsection (a) of section one hundred seven of this chapter, foreign\nfraternal benefit societies, and accredited reinsurers.\n (l) An insurer may enter into replication transactions provided that:\n (1) the insurer would otherwise be authorized to invest its funds\nunder this chapter in the asset being replicated;\n (2) the asset being replicated is subject to all provisions and\nlimitations (including quantitative limits) on the making thereof\nspecified in this chapter with respect to investments by the insurer, as\nif the transaction constituted a direct investment by the insurer in the\nasset being replicated; and\n (3) as a result of giving effect to the replication transaction, the\naggregate statement value of all assets being replicated does not exceed\nten percent of the insurer's admitted assets.\n