Kentucky Statutes 304.7-419 – Derivative transactions — Hedging — Income generation — Counterparty exposure amounts
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An insurer may, directly or indirectly through an investment subsidiary, engage in derivative transactions under this section under the following conditions:
(1) (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 in regulations promulgated by the commissioner; and
(b) 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.
(2) An insurer may enter into hedging transactions under this section if, as a result of and after giving effect to the transaction:
(a) 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 (7.5%) of its admitted assets;
(b) The aggregate statement value of options, caps, and floors written in hedging transactions does not exceed three percent (3%) of its admitted assets; and
(c) The aggregate potential exposure of collars, swaps, forwards, and futures used in hedging transactions does not exceed six and one-half percent (6.5%) of its admitted assets.
(3) 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 (10%) of its admitted assets:
(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 options sold;
(c) Sales of covered puts on investments that the insurer is permitted to acquire under this subtitle, 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
(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.
(4) An insurer shall include all counterparty exposure amounts in determining compliance with the limitations of KRS § 304.7-403.
(5) In accordance with administrative regulations promulgated under KRS § 304.7-367, the commissioner may approve additional transactions involving the use of derivative instruments in excess of the limits of subsection (2) of this section or for other risk management purposes under administrative regulations promulgated by the commissioner, but replication transactions shall not be permitted for other than risk management purposes.
Effective: July 15, 2010
History: Amended 2010 Ky. Acts ch. 24, sec. 1019, effective July 15, 2010. — Created
2000 Ky. Acts ch. 388, sec. 16, effective July 14, 2000.
(1) (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 in regulations promulgated by the commissioner; and
Terms Used In Kentucky Statutes 304.7-419
- Admitted assets: means assets permitted to be reported as admitted assets in accordance with Subtitle 6 of KRS Chapter 304 on the statutory financial statement of the insurer most recently required to be filed with the commissioner, but excluding assets of separate accounts. See Kentucky Statutes 304.7-012
- Assets: (1) The property comprising the estate of a deceased person, or (2) the property in a trust account.
- 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, level, or the performance or value of one (1) or more underlying interests exceeds a predetermined number, sometimes called the strike rate or strike price. See Kentucky Statutes 304.7-012
- Cash equivalents: means short-term, highly rated, and highly liquid investments or securities readily convertible to known amounts of cash without penalty and so near maturity that they present insignificant risk of change in value. See Kentucky Statutes 304.7-012
- 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. See Kentucky Statutes 304.7-012
- Derivative instrument: means an agreement, option, instrument, a series, or combination thereof:
1. See Kentucky Statutes 304.7-012 - Derivative transaction: means a transaction involving the use of one (1) or more derivative instruments. See Kentucky Statutes 304.7-012
- directly: when used in connection with an obligation, means that the designated obligor is primarily liable on the instrument representing the obligation. See Kentucky Statutes 304.7-012
- 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 (1) or more underlying interests. See Kentucky Statutes 304.7-012 - Income: means , as to a security, interest, accrual of discount, dividends, or other
distributions, such as rights, tax or assessment, or assessment credits, warrants, and
distributions in kind. See Kentucky Statutes 304.7-012 - Market value: means :
(a) As to cash and letters of credit, the amounts thereof. See Kentucky Statutes 304.7-012 - 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, terminate, or effect a cash settlement based on the actual or expected price level, performance or value of one (1) or more underlying interests. See Kentucky Statutes 304.7-012
- Potential exposure: means the amount determined in accordance with the NAIC Annual Statement Instructions. See Kentucky Statutes 304.7-012
(b) 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.
(2) An insurer may enter into hedging transactions under this section if, as a result of and after giving effect to the transaction:
(a) 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 (7.5%) of its admitted assets;
(b) The aggregate statement value of options, caps, and floors written in hedging transactions does not exceed three percent (3%) of its admitted assets; and
(c) The aggregate potential exposure of collars, swaps, forwards, and futures used in hedging transactions does not exceed six and one-half percent (6.5%) of its admitted assets.
(3) 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 (10%) of its admitted assets:
(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 options sold;
(c) Sales of covered puts on investments that the insurer is permitted to acquire under this subtitle, 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
(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.
(4) An insurer shall include all counterparty exposure amounts in determining compliance with the limitations of KRS § 304.7-403.
(5) In accordance with administrative regulations promulgated under KRS § 304.7-367, the commissioner may approve additional transactions involving the use of derivative instruments in excess of the limits of subsection (2) of this section or for other risk management purposes under administrative regulations promulgated by the commissioner, but replication transactions shall not be permitted for other than risk management purposes.
Effective: July 15, 2010
History: Amended 2010 Ky. Acts ch. 24, sec. 1019, effective July 15, 2010. — Created
2000 Ky. Acts ch. 388, sec. 16, effective July 14, 2000.