§ 38-12-300 — Derivative transactions.

(A) An insurer may engage, directly or indirectly through an investment affiliate, in derivative transactions including, without limitation, hedging transactions, income generation transactions, and replication transactions pursuant to this section, subject to the following conditions: (1) before entering into any derivative transaction, the board of directors of the insurer must determine that the insurer directly or through an investment management subsidiary or affiliate has adequate professional personnel, technical expertise, and systems to implement investment practices involving derivative transactions and approve a derivative instruments use plan that: (a) describes investment objectives and risk constraints, such as counterparty exposure amounts; (b) defines permissible transactions including identification of the risks that may be hedged, the assets or liabilities that may be replicated, and permissible types of income generation transactions; and (c) requires compliance with internal control procedures; (2) the insurer must establish written internal control procedures that provide for: (a) a quarterly report to the board of directors, reviewing: (i) all derivative transactions entered into, outstanding, or closed out; (ii) the results and effectiveness of the insurer's implementation of its derivative instruments use plan; and (iii) the credit risk exposure to each counterparty for over-the-counter derivative transactions based upon the counterparty exposure amount; (b) a system for determining whether hedging, income generation, or replication strategies used by the insurer have been effective; (c) a system of regular, but at least monthly, reports to management that include: (i) a description of all derivative transactions entered into, outstanding, or closed out during the period since the last report; (ii) the purpose of each outstanding derivative transaction; (iii) a performance review of the derivative instruments program; and (iv) the counterparty exposure amounts for over-the-counter derivative transactions; (d) written authorizations identifying the responsibilities and limitations of authority of persons authorized to effect and maintain derivative transactions; and (e) documentation for each transaction including: (i) the purpose of the transaction; (ii) the assets or liabilities to which the transaction relates; (iii) the specific derivative instrument used in the transaction; (iv) for over-the-counter derivative instrument transactions, the name of the counterparty and the counterparty exposure amount; and (v) for exchange-traded derivative instruments, the name of the exchange and the name of the firm that handled the transaction; (3) whenever the derivative transactions entered into pursuant to this section are not in compliance with this section or, if continued, may create a hazardous financial condition of the insurer that affects its policyholders, creditors, or the general public, the director, after notice and an opportunity for a hearing, may order the insurer to take action that is reasonably necessary to rectify the noncompliance or hazardous financial condition or to prevent the impending hazardous financial condition from occurring; (4) with respect to hedging transactions, an insurer shall demonstrate to the director upon request the intended hedging characteristics and effectiveness of the hedging transaction or combination of hedging transactions through cash-flow testing, duration analysis, or other appropriate analysis. An insurer may enter into hedging transactions pursuant to this item if as a result of and after giving effect to each hedging transaction, the aggregate: (a) statutory financial statement value of all outstanding caps, floors, warrants not attached to another financial instrument, and options other than collars purchased by the insurer pursuant to this item does not exceed seven and one-half percent of its admitted assets; (b) statutory financial statement value of all outstanding warrants, caps, floors, and options other than collars written by the insurer pursuant to this item does not exceed three percent of its admitted assets; and (c) potential exposure of all outstanding collars, swaps, forwards, and futures entered into or acquired by the insurer pursuant to this item does not exceed six and one-half percent of its admitted assets; (5) an insurer may enter into an income generation transaction if: (a) as a result of and after giving effect to the transaction, the aggregate statutory financial statement value of admitted assets that are then subject to call or that generate the cash flows for payments required to be made by the insurer under caps and floors sold by the insurer and then outstanding pursuant to this item, plus the statutory financial statement value of admitted assets underlying derivative instruments then subject to call sold by the insurer and outstanding pursuant to this item, plus the purchase price of assets subject to puts then outstanding pursuant to this item, does not exceed ten percent of its admitted assets; and (b) the transaction is one of the following types and meets the other requirements specified in this subitem that are applicable to that type of transaction: (i) sales of call options on assets, if the insurer holds or has a currently exercisable right to acquire the underlying assets during the entire period that the option is outstanding; (ii) sales of put options on assets, if the insurer holds sufficient cash, cash equivalents, or interests in a short-term investment pool to purchase the underlying assets upon exercise during the entire period that the option is outstanding, and has the ability to hold the underlying assets in its portfolio. If the total market value of all put options sold by the insurer exceeds two percent of the insurer's admitted assets, the insurer shall set aside, pursuant to a custodial or escrow agreement, cash or cash equivalents having a market value equal to the amount of its put option obligations in excess of two percent of the insurer's admitted assets during the entire period the option is outstanding; (iii) sales of call options on derivative instruments if the insurer holds, or has a currently exercisable right to acquire, assets generating the cash flow to make any payments for which the insurer is liable pursuant to the underlying derivative instruments during the entire period that the call options are outstanding and has the ability to enter into the underlying derivative transactions for its portfolio; or (iv) sales of caps and floors, if the insurer holds, or has a currently exercisable right to acquire, assets generating the cash flow to make any payments for which the insurer is liable pursuant to the caps and floors during the entire period that the caps and floors are outstanding; (6) an insurer may enter into a replication transaction that complies with the requirements of the SVO procedures manual concerning replication transactions, provided that: (a) the insurer would be authorized to invest its funds pursuant to this chapter in the asset being replicated; (b) the asset being replicated is subject to all provisions and limitations, including quantitative limitations, on the making of the investment as specified in this chapter, as if the replication transaction constituted a direct investment by the insurer in the asset being replicated; and (c) as a result of and after giving effect to the replication transaction, the aggregate statement value of all assets being replicated does not exceed ten percent of its admitted assets; (7) an insurer may purchase or sell one or more derivative instruments to offset in whole or in part a derivative instrument previously purchased or sold, without regard to the quantitative limitations of this section, provided that the transaction may be recognized as an offsetting transaction in accordance with generally accepted accounting principles; (8) each derivative instrument must be: (a) traded on a qualified exchange; (b) entered into with or guaranteed by a qualified bank or a qualified business entity; (c) issued or written by or entered into with the issuer of the underlying interest on which the derivative instrument is based; or (d) in the case of futures, traded through a broker that is registered as a futures commission merchant under the federal Commodity Exchange Act or that has received exemptive relief from registration pursuant to rule 30.10 promulgated under that act; and (9) an insurer must include all counterparty exposure amounts in determining compliance with the limitations of Section 38-12-220; (B) Pursuant to regulations promulgated pursuant to Section 38-12-90, the director may approve additional transactions involving the use of derivative instruments in excess of the limits of items (4), (5), and (6) or for other risk management purposes.

Legislative History

HISTORY: 2002 Act No. 319, SECTION 2, eff June 3, 2002.