Relates to derivative transactions and over the counter derivative instruments.
TITLE OF BILL: An act to amend the insurance law, in relation to derivative transactions and derivative instruments
PURPOSE: This bill would amend §§1401 and 1410 of the insurance law to refine the definition of "qualified counterparty" and make other definitional amendments to the provisions of the law relating to permissible counterparties with which insurers may enter into derivative transactions pursuant to the current restrictions in the insurance law.
These amendments are intended to strengthen the rules applied to insurer derivative transactions with "qualified counterparties" in order to ensure that they are fully collateralized pursuant to a master netting agreement. These amendments will allow insurers to continue entering into responsible derivatives arrangements to hedge their investment strategies. These arrangements assist insurers in supporting their ability to continue to offer certain variable insurance products to consumers, to keep product pricing affordable and ensure that they can continue to meet their policyholder obligations.
SUMMARY OF PROVISIONS: This bill would amend subsection (a) of section 1401 of the insurance law to add new paragraphs (19) - (21) which establish new definitions of "over the counter derivative instrument", "clearinghouse" and "master agreement" to Article 14 of the insurance law which addresses investment by insurers. This bill would also amend subsection (f) of section 1410 of the insurance law to redefine the terms "qualified counterparty" and "aggregate counterparty exposure" and to refine the rules which insurers must follow in order to enter into derivative transactions with "qualified counterparties" and other than qualified counterparties. The new standard provided for in this bill will require that, in order for a counterparty to be a "qualified counterparty" it would need to have entered into a netting and collateral agreement with the insurer and would also need to he rated (or have a parent or guarantor or other credit enhancer rated) investment grade or better.
EXISTING LAW: Section 1401 of the insurance law currently does not define the terms over the counter derivative instrument", "clearinghouse" and "master agreement." Section 1410 of the insurance law currently contains an alternative definition for "qualified counterparty" and "aggregate counterparty exposure." The current definitions of these terms are meant to establish that, in order to be qualified to enter into a derivative transaction with an insurer, an entity must have a credit rating of AA or better by a nationally-recognized statistical rating organization. The current restrictions contained in section 1410 of the insurance law and placed on insurers entering into derivative transactions remain intact.
JUSTIFICATION: Section 1410 of the insurance law was adopted in 1998 to establish the rules which domestic insurers must follow in order to enter into derivative transactions in New York. The law strictly limits the amount of derivative transactions that insurers may enter into and provides that they should be used primarily for hedging purposes. It also requires that insurer derivative use must be overseen by the company Board of Directors and requires that insurers must have a derivative use plan approved by the Superintendent and audited by an independent, outside auditing firm. This law has proven to be successful in ensuring that insurers in New York are limited to entering only into appropriate derivative transactions which are suitable for their level of assets, By requiring that these transactions are used primarily for the purposes of hedging, this law has allowed insurers to have the ability to adjust to the changing markets during the recent economic downturn.
Most importantly, the ability to enter into responsible and well-regulated derivative transactions, primarily for the purposes of hedging insurer investment strategies, has enabled insurers to continue to offer certain variable life insurance products that are currently very popular with consumers and also allowed them 10 offer their products at more affordable rates, since the 2008 economic downturn.
Chapter 650 of the Laws of 1998 allowed for certain, expanded insurer derivative use authority with restrictions and significant oversight by insurer Boards, the Superintendent of the Department of Financial Services and outside auditors. Under the current law, insurer derivative transactions with counterparties which are not "qualified counterparties" are subject to strict quantitative limits. The term "qualified counterparty" is defined as a counterparty rated AA or higher by at least one nationally recognized statistical rating organization and meeting certain other qualifications. These standards were carried over from earlier law governing insurance derivative transactions and, even in 1998, did not reflect the actual counterparty universe. Current derivatives markets and participants are considerably different from that which were in place in 1998 and, following the restructuring of this market due to certain provisions of the Federal Dodd-Frank Wall Street Reform and Consumer Protection Act, additional changes are occurring.
The primary counterparties with which insurers enter into derivatives transactions are banks. Bank ratings have deteriorated markedly since 1998 and are expected to continue to decline. On February 15, 2012, Moody's announced a review for downgrade of the long-term debt ratings of 17 banks and securities firms with global capital markets operations. This action will likely result in additional downgrades in this sector. The downgrading of insurer banking counterparties will reduce the number of qualified counterparties available, perhaps even to the point where there will no longer be any "qualified counterparties" under New York law.
The current law is also outdated in its enumeration of types of qualified counterparties. It includes registered broker dealers, which no longer engage in this business, and does not include either foreign banks or non-rated derivatives dealers guaranteed by a parent
or affiliate, both of which are major participant categories in this market. Also, the Federal Dodd-Frank Act will begin to require that banks must spin off certain of their derivatives activities into affiliate entities and many of these newly-created entities will not meet the current AA standard necessary in order to be determined a "qualified counterparty".
The utility of using rating categories to define a "qualified counterparty" has been called into question since the 2008 economic downturn when several very highly rated banking organizations were downgraded to junk status overnight. Recognizing this, many, if not most, insurers have moved to the use of standard netting and collateral agreements, under which the counterparty's obligations to the insurer are collateralized, subject to normal credit thresholds and minimum transfer amounts. This has greatly reduced the risk to insurers of these trading relationships.
This bill would codify the responsible practice of collateralizing these types of transactions by requiring that a "qualified counterparty" will need to have entered into a netting and collateral agreement with the insurer and would also need to be rated (or have a parent or guarantor or other credit enhancer rated) investment grade or better.
Enactment of this bill will result in simplification of the current "qualified counterparty" standard to more flexibly reflect current and future market conditions, will permit lower rated counterparties to be qualified, so long as collateral arrangements are entered into to protect insurers and their policyholders, and will update the law for the new Dodd-Frank era derivatives marketplace.
By making these refinements to the current law, insurers will be enabled to continue entering into responsible derivative transactions in the limited manner provided for in the current law, with the continuing oversight by their Board of Directors and the NYS Department of Financial Services. It will also enable insurers to continue offering certain variable life insurance products that are currently very popular with consumers and to offer these and other products at more affordable rates.
LEGISLATIVE HISTORY: New bill.
FISCAL IMPLICATIONS: None.
EFFECTIVE DATE: Immediately.
STATE OF NEW YORK ________________________________________________________________________ 7306--A IN SENATE May 2, 2012 ___________Introduced by Sen. SEWARD -- read twice and ordered printed, and when printed to be committed to the Committee on Insurance -- committee discharged, bill amended, ordered reprinted as amended and recommitted to said committee AN ACT to amend the insurance law, in relation to derivative trans- actions and derivative instruments THE PEOPLE OF THE STATE OF NEW YORK, REPRESENTED IN SENATE AND ASSEM- BLY, DO ENACT AS FOLLOWS: Section 1. Subsection (a) of section 1401 of the insurance law is amended by adding three new paragraphs 19, 20 and 21 to read as follows: (19) "OVER THE COUNTER DERIVATIVE INSTRUMENT" MEANS A DERIVATIVE INSTRUMENT WHICH IS AUTHORIZED UNDER THIS CHAPTER OTHER THAN A DERIVA- TIVE INSTRUMENT (A) CLEARED THROUGH A UNITED STATES OR FOREIGN CLEARING- HOUSE OR (B) TRADED ON OR THROUGH A UNITED STATES OR FOREIGN EXCHANGE PROVIDING CLEARING SERVICES. (20) "CLEARINGHOUSE" MEANS A DERIVATIVES CLEARING ORGANIZATION WHICH ACTS AS A MEDIUM FOR CLEARING, OR EFFECTING SETTLEMENTS OF, DERIVATIVE INSTRUMENTS SUCH THAT THE CLEARINGHOUSE IS SUBSTITUTED AS THE OTHER PARTY TO THE DERIVATIVE TRANSACTION. (21) "MASTER AGREEMENT" MEANS A WRITTEN MASTER AGREEMENT RELATING TO DERIVATIVES TRANSACTIONS THAT PROVIDES FOR NETTING OF PAYMENTS OWED BY THE RESPECTIVE PARTIES, AND THE DOMICILIARY JURISDICTION OF THE COUNTER- PARTY IS EITHER WITHIN THE UNITED STATES OR IF NOT WITHIN THE UNITED STATES, WITHIN A FOREIGN (NOT UNITED STATES) JURISDICTION DEEMED BY THE SECURITIES VALUATION OFFICE OF THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS, OR ANY SUCCESSOR OFFICE ESTABLISHED BY THE NATIONAL ASSO- CIATION OF INSURANCE COMMISSIONERS, AS ELIGIBLE FOR NETTING. S 2. Subsection (f) of section 1410 of the insurance law, as added by chapter 650 of the laws of 1998, is amended to read as follows: (f)(1) The counterparty exposure under
[a]AN OVER THE COUNTER deriva- tive instrument entered into by an insurer authorized to engage in tran- sactions pursuant to this section shall be deemed to be an obligation of the institution to which the insurer is exposed to credit risk and shall be included in determining compliance with any single or aggregate quan-EXPLANATION--Matter in ITALICS (underscored) is new; matter in brackets [ ] is old law to be omitted. LBD15578-02-2 S. 7306--A 2
titative limitation on investments made by an insurer under this chap- ter. (2) Notwithstanding any single or aggregate quantitative limitation on investments made by an insurer under this chapter, AN INSURER MAY ONLY TRANSACT AN OVER THE COUNTER DERIVATIVE INSTRUMENT WITH: (A) A QUALIFIED COUNTERPARTY; OR (B) A COUNTERPARTY OTHER THAN A "QUALIFIED COUNTERPARTY" IF, AFTER GIVING EFFECT TO THAT TRANSACTION, the aggregate counterparty exposure OF THE INSURER under one or more OVER THE COUNTER derivative
[trans- actions]INSTRUMENTS to: [(A) any single counterparty, other than a "qualified counterparty", shall be limited to one](I) THAT NON-QUALIFIED COUNTERPARTY DOES NOT EXCEED ONE percent of [an]THE insurer's admitted assets; and [(B)](II) all counterparties, other than qualified counterparties, [are limited to]DOES NOT EXCEED three percent of [an]THE insurer's admitted assets. (3) For purposes of this section: (A) a "qualified counterparty" is a ["qualified broker or dealer" or a "qualified bank" or other counterparty rated AA-/Aa3 or higher by a nationally recognized statistical rating organization if it is also approved by the superintendent; (B) a "qualified broker or dealer" means a broker or dealer that is organized under the laws of a state and is registered under the Securi- ties Exchange Act of 1934, 15 U.S.C. SS 78a-78kk, and has net capital in excess of two hundred fifty million dollars; (C) a "qualified bank" means a bank or trust company that: (i) is organized and existing, or in the case of a branch or agency of a foreign banking organization is licensed, under the laws of the United States or any state thereof; (ii) is regulated, supervised and examined by United States federal or state authorities having regulatory authority over banks and trust companies; (iii) has assets in excess of five billion dollars; (iv) has senior obligations outstanding, or has a parent corporation that has senior obligations outstanding, rated AA or better (or the equivalent thereto) by two independent nationally recognized statistical rating organizations; and (v) has a ratio of primary capital to total assets of at least five and one-half percent and a ratio of total capital to total assets of at least six percent; and (D)]COUNTERPARTY WITH WHICH THE INSURER HAS ENTERED INTO A MASTER AGREEMENT, TOGETHER WITH A CREDIT SUPPORT ANNEX OR OTHER DOCUMENTATION PROVIDING FOR THE COLLATERALIZATION OF THE COUNTERPARTY'S OBLIGATIONS TO THE INSURER UNDER THE MASTER AGREEMENT AND WHICH MEETS ONE OF THE FOLLOWING RATING STANDARDS: (I) AN INVESTMENT GRADE CREDIT RATING FROM AT LEAST ONE NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION; (II) WHOSE PARENT HAS AN INVESTMENT GRADE CREDIT RATING FROM AT LEAST ONE NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION; OR (III) THAT HAS CREDIT ENHANCEMENT FOR ALL OF ITS FINANCIAL OR SETTLE- MENT OBLIGATIONS UNDER THE OVER THE COUNTER DERIVATIVE INSTRUMENT FOR THE DURATION OF THE DERIVATIVE INSTRUMENT FROM AN ENTITY THAT HAS AN INVESTMENT GRADE CREDIT RATING FROM AT LEAST ONE NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION FOR THE BENEFIT OF THE INSURER; AND (B) "aggregate counterparty exposure" means the [sum of: (i) the aggregate statement value of options, swaptions, caps, floors, andAGGREGATE, NET AMOUNT OF CREDIT RISK ATTRIBUTABLE TO ALL OVER THE COUNTER DERIVATIVE INSTRU- MENTS ENTERED INTO WITH A COUNTERPARTY, CALCULATED AS FOLLOWS: (I) IF THERE IS NO MASTER AGREEMENT IN PLACE WITH THE COUNTERPARTY, THE SUM OF THE MARKET VALUES OF ALL OVER THE COUNTER DERIVATIVE INSTRU- MENTS WITH THE COUNTERPARTY THAT HAVE A POSITIVE MARKET VALUE, LESS ANY COLLATERAL; OR (II) IF A MASTER AGREEMENT IS IN PLACE WITH THE COUNTERPARTY, THE GREATER OF ZERO OR THE NET SUM PAYABLE TO THE INSURER IN CONNECTION WITH ALL OVER THE COUNTER DERIVATIVE INSTRUMENTS SUBJECT TO THE MASTER NETTING AGREEMENT, LESS ANY COLLATERAL. S 3. This act shall take effect immediately.S. 7306--A 3
warrants purchased; and (ii) the aggregate potential exposure of collars, swaps, forwards and futures entered into]