RS 22:586 Derivative transactions
§586. Derivative transactions
A. In this Section, unless the context otherwise requires, the following definitions shall be applicable:
(1)(a) "Counterparty exposure amount" on over-the-counter derivatives means:
(i) The market value of the derivative instrument if the liquidation of the derivative instrument would result in a final cash payment to or by the insurer; or
(ii) Zero, if the liquidation of the derivative instrument would not result in a final cash payment to or by the insurer; or
(iii) The net sum payable to or by the insurer in connection with all derivative instruments subject to the written master agreement on their liquidation in the event of default by the counterparty under the master agreement, if there are no conditions precedent to the obligations of the counterparty to make such a payment and no set off of amounts payable under any other instrument or agreement.
(b) Insurers can only enter into a written master agreement that provides for netting of payments owed by or to the respective parties if the domiciliary jurisdiction of the counterparty is either in the United States or in a foreign jurisdiction listed in the Purposes and Procedures Manual of the Securities Valuation Office as eligible for netting.
(c) For purposes of this Section, the market value or the net sum payable, as applicable, is determined at the end of the most recent quarter of the insurer's fiscal year and is reduced by the market value of acceptable collateral held by the insurer or a custodian on the insurer's behalf.
(2) "Derivative instrument" means an agreement, option or instrument, or any series or combination thereof, to make or take delivery of, or assume or relinquish, a specified amount of one or more underlying interests, or instead to make a cash settlement, or that has a price, yield, level, performance, value, or cash flow which is based primarily on that of one or more underlying interests. The term includes options (calls and puts), a warrant not otherwise permitted to be held by the insurer under this Section, a cap, a floor, a collar, a swap, a swaption, a forward, a future, and any other substantially similar instruments. The term does not include a collateralized mortgage obligation, another asset-backed security, a principal-protected structured security, a floating rate security, an instrument that an insurer is otherwise permitted to invest in or receive under this Section other than under this definition, or any debt obligation of the insurer.
(3) "Market value" means the price for a security or derivative obtained from a generally recognized source or the most recent quotation from such a source or, if a generally recognized source does not exist, the price for the security or derivative instrument as determined under the terms of the instrument or in good faith by the insurer, as can be reasonably demonstrated to the commissioner on request, plus accrued but unpaid income on the security or derivative instrument to the extent not included in the price as of the applicable date.
(4) "Potential exposure" means:
(a) As to a futures position, the amount of the initial margin required for that position.
(b) As to swaps, swaptions, collars, and forwards, one-half percent times the notional amount times the square root of the remaining years to maturity.
(5) "Replication transaction" means a derivative transaction or combination of derivative transactions affected either separately or in conjunction with cash market investments included in the insurer's investment portfolio to replicate the risks and returns of another authorized transaction, investment, or instrument or to operate as a substitute for a cash market transaction. The term does not include a derivative transaction entered into by the insurer as a hedging transaction.
B. A domestic insurer may engage in derivative transactions under this Section under the following general conditions:
(1) An insurer may use derivative instruments under this Section to engage in hedging transactions and income generation transactions.
(2) An insurer may use derivative instruments only if prior thereto the board of directors of such insurer has adopted a written policy and has filed the policy with the commissioner of insurance specifying the following:
(a) The types of risk-limiting practices and income-generating transactions approved for such insurer.
(b) The aggregate maximum limits in such instruments, which maximum limits must be reasonably related to the insurer's business needs and its capacity to fulfill its obligations thereunder.
(c) The specific assets or class of assets or cash flows for which risk-limiting practices may be employed.
(d) The insurer's accounting or investment records shall specifically identify the assets or cash flows for which each risk-limiting practice is used.
(3) All transactions in derivative instruments shall be authorized or approved by the insurer's board of directors or by a committee authorized by such board and charged with the supervision or making of such transactions. The minutes of any such committee shall be recorded and regular reports of the committee shall be submitted to the board of directors.
(4) With respect to all hedging transactions, an insurer shall be able to demonstrate to the commissioner the intended hedging characteristics and the ongoing effectiveness of the derivative transaction or combination of the transactions through cash-flow testing or other appropriate analyses.
(5) The counterparty must have a quality rating of NAIC 1.
(6) The commissioner may adopt reasonable rules for investments and transactions under this Section, including but not limited to rules which impose financial solvency standards, valuation standards, and reporting requirements.
C. An insurer may enter into hedging transactions under this Section if, as a result of 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 then engaged in by the insurer does not exceed the lesser of thirty percent of its surplus and three percent of its admitted assets.
(2) The aggregate statement value of options, caps, and floors written or sold in hedging transactions then engaged in by the insurer does not exceed the lesser of ten percent of its surplus and one percent of its admitted assets.
(3) The aggregate potential exposure of collars, swaps, swaptions, forwards, and futures used in hedging transactions then engaged in by the insurer does not exceed the lesser of twenty percent of its surplus and two percent of its admitted assets.
(4) The limitations specified in this Subsection can be exceeded if the insurer obtains prior approval from the commissioner.
D.(1) An insurer may enter into the following types of income-generating transactions subject to the quantitative limits of Paragraph (2) of this Subsection:
(a) Sales of covered call options on noncallable fixed income securities, callable fixed income securities if the option expires by its terms prior to the end of the noncallable period, or derivative instruments based on fixed income securities.
(b) Sales of covered call options on equity securities, if the insurer holds in its portfolio or can immediately acquire through the exercise of options, warrants, or conversion rights already owned, the equity securities subject to call during the complete term of the call option sold.
(c) Sales of covered puts on investments that the insurer is permitted to acquire under this Section, if the insurer has escrowed, or entered into a custodian agreement segregating, cash or cash equivalents with a market value equal to the amount of the purchase obligations under the put during the complete term of the put option sold.
(d) Sales of covered caps or floors, if the insurer holds in its portfolio the investments generating the cash flow to make the required payments under the caps or floors during the complete term that the cap or floor is outstanding.
(2) If as a result of and after giving effect to the transactions, the aggregate statement value of the fixed income assets that are subject to call or that generate the cash flow 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, shall not exceed the lesser of fifty percent of its surplus and five percent of its admitted assets.
E.(1) An insurer may enter into a replication transaction only with the prior written approval of the commissioner. To be eligible for approval by the commissioner:
(a) The insurer must be otherwise authorized to invest its funds under this Subpart in the asset being replicated; and
(b) Any asset being replicated is subject to all the provisions and limitations on the making thereof specified in this Section with respect to investments by the insurer as if the transaction constituted a direct investment by the insurer in the replicated asset.
(2) The commissioner may adopt rules regarding replication transactions as necessary to implement this Subsection.
F.(1) Before engaging in a transaction authorized under this Section, an insurer that has a statutory net capital and surplus of less than ten million dollars shall file a written notice with the commissioner describing the need to engage in the transaction, the lack of acceptable alternatives, and the insurer's plan to engage in the transaction. If the commissioner does not issue an order prohibiting the insurer from engaging in the transaction within ninety days after the date of receipt of the insurer's notice, the insurer may engage in the transaction described in the notice.
(2) An insurer that has a statutory net capital and surplus of ten million dollars or greater shall file a written notice with the commissioner describing the need to engage in the transaction and the lack of acceptable alternatives within ninety days of initiating the transaction.
(3) The commissioner may at any time issue an order prohibiting an insurer or insurers from engaging in transactions otherwise authorized under this Section, if the transactions are deemed likely to subject the insurance company to a hazardous financial condition.
(4) An insurer with a statutory net capital and surplus less than the minimum amount of capital and surplus required for a new charter and certificate of authority for the same type of insurer may not engage in the transactions authorized under this Section.
G. The commissioner of insurance may adopt regulations to implement the provisions of this Section.
Acts 2001, No. 61, §1; Redesignated from R.S. 22:844.2 by Acts 2008, No. 415, §1, eff. Jan. 1, 2009; Acts 2009, No. 503, §1.