3 AAC 21.271. Derivative transactions for a life and health insurer

(a) A life and health insurer may, directly or indirectly through an investment subsidiary, engage in a derivative transaction under the following conditions:

(1) a life and health insurer may use a derivative instrument to engage in a hedging transaction or in an income generation transaction;

(2) a life and health insurer shall demonstrate to the director 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.

(b) A life and health insurer may not enter into a hedging transaction if, as a result of and after giving effect to the transaction, the aggregate

(1) admitted asset value of options, caps, floors, and warrants not attached to another financial instrument purchased and used in hedging transactions exceeds seven and one-half percent of the life and health insurer's admitted assets;

(2) admitted asset value of options, caps, and floors written in hedging transactions exceeds three percent of the life and health insurer's admitted assets; or

(3) potential exposure of collars, swaps, forwards, and futures used in hedging transactions exceeds six and one-half percent of the life and health insurer's admitted assets.

(c) Except as otherwise provided in (d) of this section, a life and health insurer may not enter into an income generation transaction if, as a result of and after giving effect to the transaction, the aggregate admitted asset value of the fixed income assets that are subject to call or that generate the cash flows for payments under caps or floors, the face value of fixed income securities underlying a derivative instrument subject to call, and the amount of the purchase obligations under the puts exceeds 10 percent of the life and health insurer's admitted assets.

(d) A life and health insurer may only enter into income generation transactions of one or more of the following types:

(1) a sale of a covered call option on a

(A) noncallable fixed income security;

(B) callable fixed income security if the option expires by the option's terms before the end of the noncallable period; or

(2) a sale of a covered call option on an equity security if the life and health insurer

(A) holds the equity security in the life and health insurer's portfolio; or

(B) through the exercise of an option, warrant, or conversion right already owned, has the right to acquire immediately the equity security subject to call during the complete term of the call option sold;

(3) a sale of a covered put on an investment that the life and health insurer is permitted to acquire under 3 AAC 21.201 - 3 AAC 21.399 if the life and health insurer has escrowed, or has entered into a custodian agreement segregating cash or cash equivalents with a market value equal to the amount of the life and health insurer's purchase obligations under the put during the complete term of the put option sold;

(4) a sale of a covered cap or floor if the life and health insurer holds in the life and health insurer's portfolio the investments generating the cash flow to make the required payments under the cap or floor during the complete term that the cap or floor is outstanding.

(e) A life and health insurer shall include all counterparty exposure amounts in determining compliance with the limitations of 3 AAC 21.231. For purposes of calculating counterparty exposure amount for a derivative instrument, if

(1) the instrument is an over-the-counter derivative instrument, and the liquidation of that instrument would result in a final cash payment to the insurer, the life and health insurer shall calculate the net amount of credit risk as the market value of that instrument;

(2) the liquidation of the derivative instrument would not result in a final cash payment to the insurer, the life and health insurer shall calculate the net amount of credit risk as zero;

(3) the instrument is an over-the-counter derivative instrument, if that instrument is entered into under a written master agreement that provides for netting of payments owed by the respective parties, and if the domiciliary jurisdiction of the counterparty is within the United States or, if not within the United States, within a foreign jurisdiction listed in the purposes and procedures manual of the securities valuation office as eligible for netting, the life and health insurer shall calculate the net amount of credit risk as the greater of zero or the net sum of

(A) the market value of the over-the-counter derivative instrument entered into under the agreement, the liquidation of which would result in a final cash payment to the insurer; and

(B) the market value of the over-the-counter derivative instrument entered into under the agreement, the liquidation of which would result in a final cash payment by the insurer to the business entity; or

(4) the transaction is an open transaction, the life and health insurer shall calculate the net amount of credit risk as the market value that is determined at the end of the most recent quarter of the insurer's fiscal year, and shall reduce that amount by the market value of acceptable collateral held by the insurer or placed in escrow by one or both parties.

(f) A replication transaction is not permitted for other than a risk management purpose.

History: Eff. 12/28/2001, Register 160

Authority: AS 21.06.090

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