(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:

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Terms Used In South Carolina Code 38-12-510

  • Admitted assets: means assets of an insurer considered admitted on the most recent statutory financial statement of the insurer filed with the department pursuant to § 38-13-80. See South Carolina Code 38-1-20
  • Affiliate: means , in respect to a person, another person that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with the person. See South Carolina Code 38-12-30
  • Assets: (1) The property comprising the estate of a deceased person, or (2) the property in a trust account.
  • Business entity: means a sole proprietorship, corporation, limited liability company, association, general or limited partnership, joint stock company, joint venture, mutual fund, bank, trust, real estate investment trust, joint tenancy, or other similar form of business organization, whether organized for-profit or not-for-profit. See South Carolina Code 38-12-30
  • Cash equivalents: means highly rated, highly liquid, and readily marketable obligations that are convertible readily into known amounts of cash without penalty and have a remaining term to maturity of one year or less. See South Carolina Code 38-12-30
  • Commission: means the part of the premium paid to the producer as compensation for his services. See South Carolina Code 38-1-20
  • Control: means the possession, directly or indirectly, by a person of the power to direct or cause the direction of the management and policies of another person, whether through the ownership of voting securities, by contract other than a commercial contract for goods or nonmanagement services, or otherwise, unless the power is the result of an official position with or corporate office held by the person. See South Carolina Code 38-12-30
  • Counterparty: means the business entity that is the other party to an investment practices transaction with the insurer or, as to a securities lending transaction, the custodian bank or agent, if any, acting on behalf of the insurer. See South Carolina Code 38-12-30
  • counterparty exposure amount: means for an over-the-counter derivative instrument:

    (i) not entered into pursuant to a written master agreement that provides for netting of payments owed by the respective parties:

    (A) 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

    (B) zero if the liquidation of the derivative instrument would not result in a final cash payment to the insurer; and

    (ii) entered into pursuant to a written master agreement that provides for netting of payments owed by the respective parties, if the domiciliary jurisdiction of the counterparty is either within the United States or within a foreign jurisdiction listed as eligible for netting in the SVO procedures manual, the greater of:

    (A) zero; and

    (B) the net sum payable to the insurer in connection with all derivative instruments subject to the written master agreement upon their liquidation if the counterparty defaults pursuant to the master agreement, assuming there are no conditions precedent to the obligations of the counterparty to make the payment and no setoff of amounts payable pursuant to any other instrument or agreement. See South Carolina Code 38-12-30
  • derivative instrument: includes options, warrants not attached to another financial instrument purchased by the insurer, caps, floors, collars, swaps, forwards, futures, and other substantially similar agreements, options, or instruments, or a series or combination of any of them. See South Carolina Code 38-12-30
  • Derivative transaction: means a transaction involving the use of one or more derivative instruments. See South Carolina Code 38-12-30
  • directly: when used in connection with an obligation, means that the designated obligor is primarily liable on the instrument representing the obligation. See South Carolina Code 38-12-30
  • Director: means the person who is appointed by the Governor upon the advice and consent of the Senate and who is responsible for the operation and management of the department. See South Carolina Code 38-1-20
  • Escrow: Money given to a third party to be held for payment until certain conditions are met.
  • Hedging transaction: means a derivative transaction that is entered into and maintained to reduce the:

    (a) risk of a change in the value, yield, price, cash flow, or quantity of assets or liabilities, or a portfolio of assets or liabilities or both, that an insurer has acquired or incurred or anticipates acquiring or incurring; or

    (b) currency exchange rate risk related to assets or liabilities, or a portfolio of assets or liabilities, or both of them, that an insurer has acquired or incurred or anticipates acquiring or incurring. See South Carolina Code 38-12-30
  • Income generation transaction: means a derivative transaction that is intended to generate income or enhance return. See South Carolina Code 38-12-30
  • Insurer: includes a corporation, fraternal organization, burial association, other association, partnership, society, order, individual, or aggregation of individuals engaging or proposing or attempting to engage as principals in any kind of insurance or surety business, including the exchanging of reciprocal or interinsurance contracts between individuals, partnerships, and corporations. See South Carolina Code 38-1-20
  • Investment practices: means transactions of the types described in Sections 38-12-280, 38-12-300, 38-12-490, and 38-12-510. See South Carolina Code 38-12-30
  • Liabilities: The aggregate of all debts and other legal obligations of a particular person or legal entity.
  • Market value: means :

    (a) the amount of cash or a letter of credit; or

    (b) the price of a security or derivative instrument on any date obtained from a generally recognized source or the most recent quotation from the source or, to the extent no generally recognized source exists, the price for the security or derivative instrument as determined pursuant to the terms of the instrument or in good faith by the parties to a transaction, plus accrued but unpaid income on the security or derivative instrument to the extent that income is not included in the price as of the date that market value is determined. See South Carolina Code 38-12-30
  • Option: includes an insurance futures option. See South Carolina Code 38-12-30
  • Over-the-counter derivative instrument: means a derivative instrument entered into with a counterparty other than through a qualified exchange or futures exchange or cleared through a qualified clearinghouse. See South Carolina Code 38-12-30
  • Potential exposure: means :

    (a) the amount of initial margin required for a futures position; or

    (b) as to swaps, collars, and forwards, one-half of one percent times the notional amount times the square root of the remaining years to maturity. See South Carolina Code 38-12-30
  • Qualified bank: means :

    (a) a national bank, state-chartered bank, or trust company that is at all times capitalized adequately as determined by standards adopted by United States banking regulators and that is either regulated by state banking laws or is a member of the Federal Reserve System; or

    (b) a bank or trust company incorporated or organized pursuant to the laws of a country other than the United States that is regulated as a bank or trust company by that country's government or an agency of it and that is at all times capitalized adequately as determined by the standards adopted by international banking authorities. See South Carolina Code 38-12-30
  • Qualified exchange: means :

    (a) a securities exchange registered as a national securities exchange, or a securities market regulated pursuant to the Securities Exchange Act of 1934 (15 U. See South Carolina Code 38-12-30
  • Replication transaction: means a derivative transaction or combination of derivative transactions that is entered into separately or in conjunction with other permissible investments held or acquired by the insurer in order to replicate the investment characteristics of otherwise permissible investments or operate as a substitute for cash market transactions, or for both reasons. See South Carolina Code 38-12-30
  • Sell: means to exchange a contract of insurance by any means, for money or its equivalent, on behalf of an insurance company. See South Carolina Code 38-1-20
  • SVO: means the Securities Valuation Office of the NAIC or any successor office established by the NAIC. See South Carolina Code 38-12-30
  • Underlying interest: means the assets, liabilities, or other interests, or a combination of them, underlying a derivative instrument such as any one or more securities, currencies, rates, indices, commodities, or derivative instruments that are or relate to investments or investment practices that an insurer is permitted to acquire or engage in pursuant to this chapter. See South Carolina Code 38-12-30

(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 § 38-12-430.

(B) Pursuant to regulations promulgated pursuant to § 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.

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