375.345. Derivative transactions permitted, conditions--definitions--rules.

Derivative transactions permitted, conditions--definitions--rules.

375.345. 1. As used in this section, the following words and termsmean:

(1) "Admitted assets", assets permitted to be reported as admittedassets on the statutory financial statement of the insurance company mostrecently required to be filed with the director, but excluding assets ofseparate accounts, the investments of which are not subject to the provisionsof law governing the general investment account of the insurance company;

(2) "Cap", an agreement obligating the seller to make payments to thebuyer, with each payment based on the amount by which a reference price,level, performance, or value of one or more underlying interests exceeds apredetermined number, sometimes called the strike rate or strike price;

(3) "Collar", an agreement to receive payments as the buyer of anoption, cap, or floor and to make payments as the seller of a differentoption, cap, or floor;

(4) "Counterparty exposure amount":

(a) The amount of credit risk attributable to an over-the-counterderivative instrument. The amount of credit risk equals:

a. The market value of the over-the-counter derivative instrument if theliquidation of the derivative instrument would result in a final cash paymentto the insurance company; or

b. Zero if the liquidation of the derivative instrument would not resultin a final cash payment to the insurance company;

(b) If over-the-counter derivative instruments are entered into under awritten master agreement which provides for netting of payments owed by therespective parties, and the domicile of the counterparty is either within theUnited States or within a foreign jurisdiction listed in the Purposes andProcedures of the Securities Valuation Office as eligible for netting, the netamount of credit risk shall be the greater of zero or the net sum of:

a. The market value of the over-the-counter derivative instrumentsentered into under the agreement, the liquidation of which would result in afinal cash payment to the insurance company; and

b. The market value of the over-the-counter derivative instrumentsentered into under the agreement, the liquidation of which would result in afinal cash payment by the insurance company to the business entity;

(c) For open transactions, market value shall be determined at the endof the most recent quarter of the insurance company's fiscal year and shall bereduced by the market value of acceptable collateral held by the insurancecompany or placed in escrow by one or both parties;

(5) "Derivative instrument", an agreement, option, instrument, or aseries or combination thereof that makes, takes delivery of, assumes,relinquishes, or makes a cash settlement in lieu of a specified amount of oneor more underlying interests, or that has a price, performance, value, or cashflow based primarily upon the actual or expected price, level, performance,value or cash flow of one or more underlying interests. Derivativeinstruments also include options, warrants used in a hedging transaction andnot attached to another financial instrument, caps, floors, collars, swaps,forwards, futures and any other agreements, options or instrumentssubstantially similar thereto, and any other agreements, options, orinstruments permitted under rules or orders promulgated by the director;

(6) "Derivative transaction", a transaction involving the use of one ormore derivative instruments;

(7) "Director", the director of the department of insurance, financialinstitutions and professional registration of this state;

(8) "Floor", an agreement obligating the seller to make payments to thebuyer in which each payment is based on the amount by which a predeterminednumber, sometimes called the floor rate or price, exceeds a reference price,level, performance, or value of one or more underlying interests;

(9) "Forward", an agreement other than a future to make or take deliveryof, or effect a cash settlement based on the actual or expected price, level,performance or value of, one or more underlying interests, but not includingspot transactions effected within customary settlement periods, when issuedpurchases or other similar cash market transactions;

(10) "Future", an agreement traded on an exchange to make or takedelivery of, or effect a cash settlement based on the actual or expectedprice, level, performance or value of one or more underlying interests andwhich includes an insurance future;

(11) "Hedging transaction", a derivative transaction that is enteredinto and maintained to reduce:

(a) The risk of economic loss due to a change in the value, yield,price, cash flow or quantity of assets or liabilities that the insurancecompany has acquired or incurred or anticipates acquiring or incurring;

(b) The currency exchange rate risk or the degree of exposure as toassets or liabilities that the insurance company has acquired or incurred oranticipates acquiring or incurring; or

(c) Risk through such other derivative transactions as may be specifiedto constitute hedging transactions by rules or orders adopted by the director;

(12) "Income generation transaction":

(a) A derivative transaction involving the writing of covered calloptions, covered put options, covered caps or covered floors that is intendedto generate income or enhance return; or

(b) Such other derivative transactions as may be specified to constituteincome generation transactions in rules or orders adopted by the director;

(13) "Initial margin", the amount of cash, securities or otherconsideration initially required to be deposited to establish a futuresposition;

(14) "NAIC", the National Association of Insurance Commissioners;

(15) "Option", an agreement giving the buyer the right to buy orreceive, sell or deliver, enter into, extend, terminate or effect a cashsettlement based on the actual or expected price, level, performance or valueof one or more underlying interests;

(16) "Over-the-counter derivative instrument", a derivative instrumententered into with a business entity other than through an exchange orclearinghouse;

(17) "Potential exposure", the amount determined in accordance with theNAIC Annual Statement Instructions;

(18) "Replication transaction", a derivative transaction effected eitherseparately or in conjunction with cash market investments included in theinsurer's investment portfolio and intended to replicate the investmentcharacteristic of another authorized transaction, investment or instrument orto operate as a substitute for cash market transactions. A derivativetransaction that is entered into as a hedging transaction or an incomegeneration transaction shall not be considered a replication transaction;

(19) "SVO", the Securities Valuation Office of the NAIC or any successoroffice established by the NAIC;

(20) "Swap", an agreement to exchange or to net payments at one or moretimes based on the actual or expected price, level, performance or value ofone or more underlying interests;

(21) "Underlying interest", the assets, liabilities, other interests, ora combination thereof underlying a derivative instrument, such as any one ormore securities, currencies, rates, indices, commodities or derivativeinstruments;

(22) "Warrant", an instrument that gives the holder the right topurchase an underlying financial instrument at a given price and time or at aseries of prices and times outlined in the warrant agreement.

2. An insurance company, including those organized under chapter 376,RSMo, may, directly or indirectly through an investment subsidiary, engage inderivative transactions pursuant to this section under the followingconditions:

(1) In general:

(a) An insurance company may use derivative instruments pursuant to thischapter to engage in hedging transactions and certain income generationtransactions;

(b) Upon request, an insurance company shall demonstrate to the directorthe intended hedging characteristics and the ongoing effectiveness of thederivative transaction or combination of the transactions through cash flowtesting or other appropriate analyses;

(2) An insurance company shall only maintain its position in anyoutstanding derivative instrument used as part of a hedging transaction for aslong as the hedging transaction continues to be effective;

(3) An insurance company may enter into hedging transactions if as aresult of and after giving effect to the transaction:

(a) The aggregate statement value of options, caps, floors and warrantsnot attached to another financial instrument purchased and used in hedgingtransactions then engaged in by the insurer does not exceed seven and one-halfpercent of its admitted assets;

(b) The aggregate statement value of options, caps and floors written inhedging transactions then engaged in by the insurer does not exceed threepercent of its admitted assets; and

(c) The aggregate potential exposure of collars, swaps, forwards andfutures used in hedging transactions then engaged in by the insurer does notexceed six and one-half percent of its admitted assets;

(4) An insurance company may only enter into the following types ofincome generation transactions if as a result of and after giving effect to anincome generation transaction, the aggregate statement value of the fixedincome assets that are subject to call or that generate the cash flows forpayments under the caps or floors, plus the face value of fixed incomesecurities underlying a derivative instrument subject to call, plus the amountof the purchase obligations under the puts, shall not exceed ten percent ofits admitted assets:

(a) Sales of covered call options on noncallable fixed incomesecurities, callable fixed income securities if the option expires by itsterms prior to the end of the noncallable period, or derivative instrumentsbased on fixed income securities;

(b) Sales of covered call options on equity securities if the insurancecompany holds in its portfolio or can immediately acquire through the exerciseof options, warrants or conversion rights already owned, the equity securitiessubject to call during the complete term of the call option sold;

(c) Sales of covered puts on investments that the insurance company ispermitted to acquire under the applicable insurance laws of the state, if theinsurance company has escrowed or entered into a custodian agreementsegregating cash or cash equivalents with a market value equal to the amountof its purchase obligations under the put during the complete term of the putoption sold; or

(d) Sales of covered caps or floors if the insurance company holds inits portfolio the investments generating the cash flow to make the requiredpayments under the caps or floors during the complete term that the cap orfloor is outstanding;

(5) An insurance company may use derivative instruments for replicationtransactions only after the director promulgates reasonable rules that setforth methods of disclosure, reserving for risk-based capital, and determiningthe asset valuation reserve for these instruments. Any asset being replicatedis subject to all the provisions and limitations on the making thereofspecified in this chapter and chapters 376 and 379, RSMo, with respect toinvestments by the insurer as if the transaction constituted a directinvestment by the insurer in the replicated asset;

(6) An insurance company shall include all counterparty exposure amountsin determining compliance with this state's single-entity investmentlimitations;

(7) The director may approve, by rule or order, additional transactionconditions involving the use of derivative instruments for other riskmanagement purposes.

3. Written investment policies and record-keeping procedures shall beapproved by the board of directors of the insurance company or by a committeeauthorized by such board before the insurance company may engage in thepractices and activities authorized by this section. These policies andprocedures must be specific enough to define and control permissible andsuitable investment strategies with regard to derivative transactions with aview toward the protection of the policyholders. The minutes of any suchcommittee shall be recorded and regular reports of such committee shall besubmitted to the board of directors.

4. The director may promulgate reasonable rules and regulations pursuantto the provisions of chapter 536, RSMo, not inconsistent with this section andany other insurance laws of this state, establishing standards andrequirements relating to practices and activities authorized in this section,including, but not limited to, rules which impose financial solvencystandards, valuation standards, and reporting requirements.

(L. 1985 H.B. 823, A.L. 2002 S.B. 1009, A.L. 2007 S.B. 66)