40-2b25. Financial futures contracts; definitions; use for hedging purposes; replication transactions; rules and regulations.
40-2b25
40-2b25. Financial futures contracts; definitions;use for hedgingpurposes; replication transactions; rules and regulations.(a) Any life insurance company heretofore or hereafterorganized under any law of this state may use financial instruments under thissection to engage in hedging transactions, replication transactions andcertain income generationtransactions or as these terms may be further defined in regulationspromulgated by the commissioner. For each hedging transaction inwhich a life insurance company engages, such life insurance company shallbe able todemonstrate to the commissioner the intended hedging characteristics and theongoing effectiveness of the financial instrument transaction or combination ofthe transactions through cash flow testing or other appropriate analysis.
(b) As used in this section:
(1) "Cap" means an agreement obligating the seller to make payments to thebuyer, each payment based on the amount by which a reference price or level orthe performance or value of one or more underlying interest exceeds apredetermined number, sometimes called the strike rate or price.
(2) "Collar" means an agreement to receive payments as the buyer of anoption, cap or floor and to make payments as the seller of a different option,cap or floor.
(3) "Commissioner" means the commissioner of insurance as defined inK.S.A.40-102and amendments thereto.
(4) "Counterparty" means the business entity with which a life insurancecompany enters into financial instrument transactions.
(5) "Crediting basis amount" means the amount of interestcredited to aninsured's account value for the percentage of change on an underlyingindex.
(6) (A) "Financial instrument" means an agreement,option, instrument orany series or combination thereof:
(i) To make or take delivery of, or assume or relinquish, a specified amountof one or more underlying interests, or to make a cash settlement in lieuthereof; or
(ii) which has a price, performance, value or cash flow based primarily uponthe actual or expected price, level, performance, value or cash flowof one or more underlying interests.
(B) Financial instruments include options, warrants, caps, floors, collars,swaps, forwards, future and any other agreements, options or instrumentssubstantially similar thereto, or any series or combination thereof.
(7) "Financial instrument transaction" means a transactioninvolving the useof one or more financial instruments.
(8) "Floor" means an agreement obligating the seller tomake payments to thebuyer in which each payment is based on the amount that a predetermined number,sometimes called the floor rate or price, exceeds a reference price, level,performance or value of one or more underlying interests.
(9) "Forward" means an agreement (other than a future) tomake or takedelivery of, or effect a cash settlement based on the actual or expected price,level, performance or value of one or more underlying interests.
(10) "Future" means an agreement traded on a qualifiedexchange, to make ortake delivery of, or effect a cash settlement based on the actual or expectedprice, level, performance or value of one or more underlying interests.
(11) "Hedging transaction" means a financial instrumenttransaction which isentered into and maintained to reduce:
(A) The risk of a change in the value, yield, price, cash flow or quantityof assets or liabilities which the insurer has acquired or incurred oranticipates acquiring or incurring; or
(B) the currency exchange-rate risk or the degree of exposure as to assetsor liabilities which an insurer has acquired or incurred or anticipatesacquiring or incurring.
(12) "Income generation transaction" means a financialinstrument transactioninvolving the writing of covered call options which is intended to generateincome or enhance return.
(13) "Option" means an agreement giving the buyer theright to buy orreceive, sell or deliver, enter into, extend or terminate, or effect a cashsettlement based on the actual or expected price, level, performance or valueof one or more underlying interests.
(14) "Potential exposure" means:
(A) As to a futures position, the amount of the initial margin required forthat position; or
(B) as to swaps, collars and forwards, .5% times the notional amount timesthe square root of the remaining years to maturity.
(15) "Replication transaction" means a financial instrument transaction orcombination of financial instrument transactions effected either separately orinconjunction with cash market investments included in a life insurance company'sinvestment portfolio in order to replicate the investment characteristic ofanother authorized transaction, investment or instrument or operate as asubstitute for cash market transactions. A financial instrument transactionentered intoby a life insurance company as a hedging transaction, as defined in paragraph(11), or income generation transaction, as defined in paragraph (12),authorizedpursuant to this section shall not be considered a replication transaction.
(16) "SVO" means the securities valuation office of thenationalassociationof insurance commissioners or any successor office established by the nationalassociation of insurance commissioners.
(17) "Swap" means an agreement to exchange for netpayments at one or moretimes based on the actual or expected price, level, performance or value of oneor more underlying interests.
(18) "Underlying index" means the index, market orfinancial futurescontract used to determine the crediting basis amount.
(19) "Underlying interest" means the assets, otherinterests, or acombination thereof, underlying a financial instrument, such as any one or moresecurities, currencies, rates, indices, commodities or financial instruments.
(20) "Warrants" means an option to purchase or sell theunderlyingsecurities or investments at a given price and time or at a series of pricesand times outlined in the warrant agreement. Warrants may be issued alone orin connection with the sale of other securities, as part of a merger orrecapitalization agreement, or to facilitate divestiture of the securities ofanother corporation.
(c) A life insurance company may enter into financial instrumenttransactions for the purpose of hedging except that the transaction shall notcause any of the following limits to be exceeded:
(1) The aggregate statement value of options, caps, floors and warrants notattached to any other security or investment purchase in hedging transactionsmay not exceed110% of the excess of such insurer's capital and surplus as shown on thecompany's last annual or quarterly report filed with the commissioner over theminimum requirements of a new stock or mutual company toqualify for a certificate of authority to write the kind of insurance which theinsurer is authorized to write;
(2) the aggregate statement value of options, caps and floors written inhedging transactions may not exceed 3% of the life insurance company's admittedassets; and
(3) the aggregate potential exposure of collars, swaps, forwards and futuresused in hedging transactions may not exceed 5% of the life insurance company'sadmitted assets.
(d) A life insurance company may enter into the following types of incomegeneration transactions if:
(1) Selling covered call options on noncallable fixed income securities orfinancial instruments based on fixed income securities, but the aggregatestatement value of assets subject to call during the complete term of the calloptions sold, plus the face value of fixed income securities underlying anyfinancial instrument subject to call, may not exceed 10% of the life insurancecompany's admitted assets; and
(2) selling covered call options on equity securities, if the life insurancecompany holds in its portfolio the equity securities subject to call during thecomplete term of the call option sold.
(e) A life insurance company may enter into replication transactions if:
(1) Such life insurance company would otherwise be authorized to invest itsfunds under this article in the asset being replicated;
(2) the asset being replicated is subject to all provisions and limitation(including quantitative limits) on the making thereof specified in this articlewith respect to investments by such life insurance company, as if thetransaction constituted a direct investment by such life insurance company inthe asset being replicated;
(3) as a result of giving effect to the replication transaction, theaggregate statement value of all assets being replicated does not exceed 10%of such life insurance company's admitted assets; and
(4) the replication transaction is entered into in accordance with therequirements concerning replication transactions contained in the SVO purposesand procedures manual of the SVO entitled "Purposes and procedures manual ofthe securities valuation office of the national association of insurancecommissioners" as published on December 31, 1999, or any later version asestablished in rules and regulations adopted by the commissioner.
(f) The limitations set forth in subsection (c) regarding financialinstrument transactions for the purpose of hedging and in subsection (d)regarding income generation transactions shall not apply to any investmentsmadeby a life insurance company where such investments are used only to hedge thecrediting basis amount an insured receives on a particular insurance policywhich is determined by an underlying index, provided, however, that suchinvestments shall not in the aggregate amountexceed 10% of the life insurance company's admitted assets as shown on thecompany's last annual or quarterly report, without the prior written approvalof the commissioner. All investments made pursuant to thissubsection shall only be made with counterparties that have a rating designatedas "1" by the national association of insurance commissioners (NAIC) in itsmost recently published valuations of securities manual or supplement thereto,or its equivalent rating by a nationally recognized statistical ratingorganization recognized by the SVO.
(g) Upon request of the life insurance company, thecommissioner may approveadditional transactions involving the use of financial instruments in excess ofthe limits of subsection (c) or for other risk management purposes pursuant toregulations promulgated by thecommissioner.
(h) For the purposes of this section, the value or amountof an investmentacquired or held under this section, unless otherwise specified in this code,shall be the value at which assets of an insurer are required to be reportedfor statutory accounting purposes as determined in accordance with proceduresprescribed in published accounting and valuation standards of the nationalassociation of insurance commissioners (NAIC), including the purposes andprocedures of the securities valuation office, the valuation of securitiesmanual, the accounting practices and procedures manual, the annual statementinstructions or any successor valuation procedures officially adopted by theNAIC.
(i) Prior to engaging in transactions in financialinstruments, an insurershall develop and adequately document policies and procedures regardinginvestment strategies and objectives, recordkeeping needs and reportingmatters. Such policies and procedures shall address authorized investments,investment limitations, authorization and approval procedures, accounting andreporting procedures and controls and shall provide for review of activity infinancial instruments by the insurer's board of directors or such board'sdesignee.
Recordkeeping systems must be sufficiently detailed to permit internalauditors and insurance department examiners to determine whether operatingpersonnel have acted in accordance with established policies and procedures, asprovided in this section. Insurer records must identify for each transactionthe related financial instruments contracts.
(j) The commissioner shall have the authority to adopt rules andregulationsnecessary to implement this section.
History: L. 1985, ch. 156, § 1;L. 1995, ch. 102, § 1;L. 2000, ch. 7, § 1;L. 2001, ch. 93, § 1; July 1.