AN
ACT Relating to investment practices of insurance companies; and adding a new
section to chapter 48.13 RCW.
BE IT ENACTED BY THE
LEGISLATURE OF THE STATE OF WASHINGTON:
NEW
SECTION. Sec. 1. A
new section is added to chapter 48.13 RCW to read as follows:
(1)
An insurer may, directly or indirectly through an investment subsidiary, engage
in derivative transactions under this section under the following conditions:
(a)
An insurer may use derivative instruments under this section to engage in
hedging transactions and certain income generation transactions, as these terms
may be further defined by rule by the insurance commissioner;
(b)
Derivative instruments shall not be used for speculative purposes, but only as
stated in (a) of this subsection;
(c)
An insurer shall be able to demonstrate to the insurance commissioner the
intended hedging characteristics and the ongoing effectiveness of the
derivative transaction or combination of transactions through cash flow
testing or other appropriate analysis;
(d)
An insurer may enter into hedging transactions under this section if, as a
result of and after giving effect to the transaction:
(i)
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 of its admitted assets;
(ii)
The aggregate statement value of options, caps, and floors written in hedging
transactions does not exceed three percent of its admitted assets; and
(iii)
The aggregate potential exposure of collars, swaps, forwards, and futures used
in hedging transactions does not exceed six and one-half percent of its
admitted assets;
(e)
An insurer may only enter into the following types of income generation transactions
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 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 of its admitted assets:
(i)
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;
(ii)
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;
(iii)
Sales of covered puts on investments that the insurer is permitted to acquire
under this chapter, 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 its purchase obligations under the put during the complete term
of the put option sold; or
(iv)
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;
(f)
An insurer shall include all counterparty exposure amounts in determining
compliance with general diversification requirements and medium and low grade
investment limitations under this chapter; and
(g)
Pursuant to rules adopted by the insurance commissioner under subsection (3) of
this section, the commissioner may approve additional transactions involving
the use of derivative instruments in excess of the limitations in (d) of this
subsection or for other risk management purposes under rules adopted by the
commissioner, but replication transactions shall not be permitted for other
than risk management purposes.
(2)
For purposes of this section:
(a)
"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 or more underlying interests exceeds a
predetermined number, sometimes called the strike rate or strike price;
(b)
"Collar" means an agreement to receive payments as the buyer of an
option, cap, or floor and to make payments as the seller of a different option,
cap, or floor;
(c)
"Counterparty exposure amount" means the net amount of credit risk
attributable to a derivative instrument entered into with a business entity
other than through a qualified exchange, qualified foreign exchange, or cleared
through a qualified clearinghouse. The amount of the credit risk equals the
market value of the over-the-counter derivative instrument if the liquidation
of the derivative instrument would result in a final cash payment to the
insurer, or zero if the liquidation of the derivative instrument would not
result in a final cash payment to the insurer.
If
over-the-counter derivative instruments are entered into under a written master
agreement which provides for netting of payments owed by the respective
parties, and the domiciliary jurisdiction of the counterparty is either within
the United States or, if not within the United States, within a foreign jurisdiction
listed in the purposes and procedures of the securities valuation office as
eligible for netting, the net amount of credit risk shall be the greater of
zero or the sum of:
(i)
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; and
(ii)
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.
For
open transactions, market value shall be determined at the end of the most
recent quarter of the insurer's fiscal year and shall be reduced by the market
value of acceptable collateral held by the insurer or placed in escrow by one
or both parties;
(d)
"Covered" means that an insurer owns or can immediately acquire,
through the exercise of options, warrants or conversion rights already owned,
the underlying interest in order to fulfill or secure its obligations under a
call option, cap or floor it has written, or has set aside under a custodial or
escrow agreement cash or cash equivalents with a market value equal to the
amount required to fulfill its obligations under a put option it has written,
in an income generation transaction;
(e)
"Derivative instrument" means an agreement, option, instrument, or a
series or combination thereof:
(i)
To make or take delivery of, or assume or relinquish, a specified amount of one
or more underlying interests, or to make a cash settlement in lieu thereof; or
(ii)
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 or
more underlying interests.
Derivative
instruments include options, warrants used in a hedging transaction and not
attached to another financial instrument, caps, floors, collars, swaps,
forwards, futures, and any other agreements, options, or instruments
substantially similar thereto or any series or combination thereof and any
agreements, options, or instruments permitted under rules adopted by the commissioner
under subsection (3) of this section;
(f)
"Derivative transaction" means a transaction involving the use of one
or more derivative instruments;
(g)
"Floor" means an agreement obligating the seller to make payments to
the buyer in which each payment is based on the amount by which a predetermined
number, sometimes called the floor rate or price, exceeds a reference price,
level, performance, or value of one or more underlying interests;
(h)
"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;
(i)
"Hedging transaction" means a derivative transaction which is entered
into and maintained to reduce:
(i)
The risk of a change in the value, yield, price, cash flow, or quantity of
assets or liabilities which the insurer has acquired or incurred or anticipates
acquiring or incurring; or
(ii)
The currency exchange rate risk or the degree of exposure as to assets or
liabilities which an insurer has acquired or incurred or anticipates acquiring
or incurring;
(j)
"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;
(k)
"Swap" means an agreement to exchange or to net payments at one or
more times based on the actual or expected price, level, performance, or value
of one or more underlying interests;
(l)
"Underlying interest" means the assets, liabilities, other interests,
or a combination thereof underlying a derivative instrument, such as any one or
more securities, currencies, rates, indices, commodities, or derivative
instruments; and
(m)
"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.
(3) The insurance commissioner may adopt rules implementing the
provisions of this section.
