Texas Insurance Code - Not Codified - Article 2.10-4. Risk-Limiting Provisions
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Art. 2.10-4. RISK-LIMITING PROVISIONS.
Article repealed effective April 1, 2007
Definitions
Sec. 1. In this article:
(1) "Acceptable collateral" means:
(A) cash;
(B) cash equivalents;
(C) letters of credit and direct obligations; and
(D) securities that are fully guaranteed as to principal and
interest by the United States.
(2) "Business entity" includes a sole proprietorship,
corporation, limited liability company, association, partnership,
joint stock company, joint venture, mutual fund, bank, trust, joint
tenancy, or other similar form of business organization, whether
organized for profit or not for profit.
(3) "Cap" means an agreement under which a seller is
obligated to make payments to the buyer with each payment based on
the amount by which a reference price or level or the performance or
value of one or more underlying interests exceeds a predetermined
number, sometimes called the strike rate or strike price.
(4) "Cash equivalent" means an investment or security that
is short-term, highly rated, highly liquid, and readily marketable.
The term includes money market funds as described by Article 2.10 of
this code. For purposes of this subdivision:
(A) a short-term investment is an investment with a
remaining term to maturity of one year or less; and
(B) a highly rated investment is an investment rated:
(i) "P-1" by Moody's Investors Service, Inc.;
(ii) "A-1" by the Standard and Poor's Division of the McGraw
Hill Companies, Inc.; or
(iii) an equivalent rating by a nationally recognized
statistical rating organization recognized by the Securities
Valuation Office.
(5) "Collar" means an agreement to receive payments as the
buyer of an option, cap, or floor and to make payments as the seller
of a different option, cap, or floor.
(6)(A) "Counterparty exposure amount" means:
(i) for an over-the-counter derivative instrument that is
not entered into under 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; or
(ii) for an over-the-counter derivative instrument that is
entered into under a written master agreement that provides for
netting of payments owed by the respective parties and in which the
domiciliary jurisdiction of the counterparty is either in the
United States or in a foreign jurisdiction listed in the Purposes
and Procedures Manual of the Securities Valuation Office as
eligible for netting, the greater of:
(a) zero; or
(b) the net sum payable to the insurer in connection with
all derivative instruments subject to the written master agreement
on their liquidation in the event of default by the counterparty
under the master agreement, if there are no conditions precedent to
the obligations of the counterparty to make such a payment and no
setoff of amounts payable under any other instrument or agreement.
(B) For purposes of this subdivision, the market value or
the net sum payable, as applicable, is determined at the end of the
most recent quarter of the insurer's fiscal year and is reduced by
the market value of acceptable collateral held by the insurer or a
custodian on the insurer's behalf.
(7) "Derivative instrument" means an agreement, option, or
instrument, or any series or combination of agreements, options, or
instruments, to make or take delivery of, or assume or relinquish, a
specified amount of one or more underlying interests, or instead to
make a cash settlement, or that has a price, performance, value, or
cash flow based primarily on the actual or expected price, yield,
level, performance, value, or cash flow of one or more underlying
interests. The term includes an option, a warrant not otherwise
permitted to be held by the insurer under this article, a cap, a
floor, a collar, a swap, a swaption, a forward, a future, and any
other substantially similar agreement, option, or instrument or
series or combinations of those agreements, options, or
instruments. The term does not include a collateralized mortgage
obligation, another asset-backed security, a principal-protected
structured security, a floating rate security, an instrument that
an insurer is otherwise permitted to invest in or receive under this
article other than under this definition, or any debt obligation of
the insurer.
(8) "Derivative transaction" means a transaction that
involves the use of one or more derivative instruments. The term
does not include a dollar roll transaction, repurchase transaction,
reverse repurchase transaction, or securities lending transaction.
(9) "Floor" means an agreement under which the seller is
obligated to make payments to the buyer and 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 or more underlying interests.
(10) "Forward" means an agreement to make or take delivery
in the future of one or more underlying interests, or effect a cash
settlement, based on the actual or expected price, level,
performance, or value of those underlying interests. The term does
not include a future or a spot transaction effected within
customary settlement periods, when-issued purchases, or other
similar cash market transactions.
(11) "Future" means an agreement that is traded on a futures
exchange to make or take delivery of, or effect a cash settlement,
based on the actual or expected price, level, performance, or value
of, one or more underlying interests.
(12) "Futures exchange" means a foreign or domestic
exchange, contract market, or board of trade on which trading in
futures is conducted and that, in the United States, is authorized
to conduct that trading by the Commodities Futures Trading
Commission or any successor organization.
(13) "Hedging transaction" means a derivative transaction
that is entered into and maintained to manage:
(A) the risk of a change in the value, yield, price, cash
flow, or quantity of assets or liabilities, or a portfolio of assets
or liabilities, that the insurer has acquired or incurred or
anticipates acquiring or incurring; or
(B) the currency exchange rate risk related to assets or
liabilities, or a portfolio of assets or liabilities, that an
insurer has acquired or incurred or anticipates acquiring or
incurring.
(14) "Income generation transaction" means a derivative
transaction that is entered into to generate income. The term does
not include a derivative transaction entered into as a hedging
transaction or a replication transaction.
(15) "Market value" means the price for a security or
derivative instrument obtained from a generally recognized source
or the most recent quotation from such a source or, if a generally
recognized source does not exist, the price for the security or
derivative instrument as determined under the terms of the
instrument or in good faith by the insurer, as can be reasonably
demonstrated to the commissioner on request, plus accrued but
unpaid income on the security or derivative instrument to the
extent not included in the price as of the applicable date.
(16) "Option" means an agreement under which the buyer has
the right to buy or receive, referred to as a "call option," sell or
deliver, referred to as a "put option," enter into, extend or
terminate, or effect a cash settlement based on the actual or
expected price, spread, level, performance, or value of one or more
underlying interests.
(17) "Over-the-counter derivative instrument" means a
derivative instrument entered into with a business entity other
than through a securities exchange or futures exchange or cleared
through a qualified clearinghouse.
(18) "Potential exposure" means:
(A) as to a futures position, the amount of initial margin
required for that position; or
(B) as to swaps, collars, and forwards, one-half percent
times the notional amount times the square root of the remaining
years to maturity.
(19) "Qualified clearinghouse" means a clearinghouse that
is subject to the rules of a securities exchange or a futures
exchange and provides clearing services, including acting as a
counterparty to each of the parties to a transaction in such a
manner that the parties no longer have credit risk to each other.
(20) "Replication transaction" means a derivative
transaction or combination of derivative transactions effected
either separately or in conjunction with cash market investments
included in the insurer's investment portfolio to replicate the
risks and returns of another authorized transaction, investment, or
instrument or to operate as a substitute for a cash market
transaction. The term does not include a derivative transaction
entered into by the insurer as a hedging transaction.
(21) "Securities exchange" means:
(A) an exchange registered as a national securities
exchange or a securities market registered under the Securities
Exchange Act of 1934 (15 U.S.C. Section 78a et seq.), as amended;
(B) the Private Offerings Resales and Trading through
Automated Linkages (PORTAL); or
(C) a designated offshore securities market as defined by
Securities Exchange Commission Regulation S, 17 C.F.R. Part 230, as
amended.
(22) "Swap" means an agreement to exchange or to net
payments at one or more times based on the actual or expected price,
yield, level, performance, or value of one or more underlying
interests.
(23) "Swaption" means an option to purchase or sell a swap
at a given price and time or at a series of prices and times. The
term does not include a swap with an embedded option.
(24) "Underlying interest" means the assets, liabilities,
or other interests, or a combination of those assets, liabilities,
or other interests, that underlie a derivative instrument. The
term includes securities, currencies, rates, indices, commodities,
or derivative instruments.
(25) "Warrant" means an instrument under which the holder
has the right to purchase or sell the underlying interest at a given
price and time or at a series of prices and times stated in the
warrant.
Authorized Risk Control Transactions; General Requirements
Relating to Derivative Transactions
Sec. 2. (a) Except as provided by Section 8 of this article,
an insurer may, for purposes of protecting the assets owned by the
insurer against the risk of changing asset values or interest rates
and for risk reduction and income generation, engage in risk
control transactions authorized under this article.
(b) Before entering into a derivative transaction, the
board of directors of the insurer must approve a derivative use plan
as part of the insurer's investment plan otherwise required by law.
The derivative use plan must:
(1) describe investment objectives and risk constraints,
such as counterparty exposure amounts;
(2) define permissible transactions, identifying the risks
to be hedged and the assets or liabilities being replicated; and
(3) require compliance with the insurer's internal control
procedures established under Subsection (c) of this section.
(c) The insurer shall establish written internal control
procedures that require:
(1) a quarterly report to be made to the board of directors
that reviews:
(A) all derivative transactions entered into, outstanding,
or closed out;
(B) the results and effectiveness of the derivatives
program; and
(C) the credit risk exposure to each counterparty for
over-the-counter derivative transactions based on the counterparty
exposure amount;
(2) a system for determining whether hedging or replication
strategies used by the insurer have been effective;
(3) a system of reports, at least as frequent as monthly, to
the insurer's management, that include:
(A) a description of each derivative transaction entered
into, outstanding, or closed out during the period since the last
report;
(B) the purpose of each outstanding derivative transaction;
(C) a performance review of the derivative instrument
program; and
(D) the counterparty exposure amount for over-the-counter
derivative transactions;
(4) written authorizations that identify the
responsibilities and limitations of authority of persons
authorized to effect and maintain derivative transactions; and
(5) appropriate documentation for each transaction,
including:
(A) the purpose of the transaction;
(B) the assets or liabilities to which the transaction
relates;
(C) the specific derivative instrument used in the
transaction;
(D) for over-the-counter derivative instrument
transactions, the name of the counterparty and the counterparty
exposure amount; and
(E) for exchange-traded derivative instruments, the name of
the exchange and the name of the firm that handled the transaction.
(d) The insurer must be able to demonstrate to the
commissioner, on request, the intended hedging characteristics and
ongoing effectiveness of the derivative transaction or combination
of transactions through cash flow testing, duration analysis, or
any other appropriate analysis.
(e) The insurer shall include all counterparty exposure
amounts in determining compliance with the limitations of this
article.
(f) 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 article if the offsetting transaction uses the
same type of derivative instrument as the derivative instrument
being offset.
Requirements Relating to Hedging Transactions
Sec. 3. (a) Not later than the 10th day before the date on
which an insurer is scheduled to enter into an initial hedging
transaction, the insurer shall notify the commissioner in writing
that:
(1) the insurer's board of directors has adopted an
investment plan that authorizes hedging transactions; and
(2) all hedging transactions will comply with this article.
(b) An insurer engaged in hedging transactions on September
1, 1999, shall send to the commissioner a notice containing the
statements required by Subsection (a) of this section not later
than October 1, 1999.
(c) After the notice under Subsection (a) or (b), the
insurer may enter into hedging transactions under this article, if
as a result of and after giving effect to each hedging transaction:
(1) the aggregate statement value of all outstanding
options, caps, floors, swaptions, and warrants that are not
attached to another financial instrument purchased by the insurer,
but not including collars, under this article does not exceed seven
and one-half percent of the insurer's assets;
(2) the aggregate statement value of all outstanding
options, swaptions, warrants, caps, and floors, but not including
collars, written by the insurer under this article does not exceed
three percent of the insurer's assets; and
(3) the aggregate potential exposure of all outstanding
collars, swaps, forwards, and futures entered into or acquired by
the insurer under this article does not exceed six and one-half
percent of the insurer's assets.
(d) If a hedging transaction entered into under this section
is not in compliance with this article or, if continued, may create
a hazardous financial condition to the insurer that affects the
insurer's policyholders or creditors or the public, the
commissioner may, after notice and an opportunity for a hearing,
order the insurer to take action that the commissioner determines
is reasonably necessary to:
(1) rectify a hazardous financial condition; or
(2) prevent an impending hazardous financial condition from
occurring.
Requirements Relating to Income Generation Transactions
Sec. 4. (a) An insurer may enter into an income generation
transaction only as provided by this section.
(b) An insurer may enter into an income generation
transaction only if, as a result of and after giving effect to the
transaction, the aggregate 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 under this article, plus
the statement value of admitted assets underlying derivative
instruments then subject to calls sold by the insurer and
outstanding under this article, plus the purchase price of assets
subject to puts then outstanding under this article, does not
exceed 10 percent of the insurer's assets.
(c) The transaction must be a sale of:
(1) a call option on assets that meets the requirements of
Subsection (d);
(2) a put option on assets that meets the requirements of
Subsection (e);
(3) a call option on a derivative instrument, including a
swaption that meets the requirements of Subsection (f); or
(4) a cap or floor that meets the requirements of Subsection
(g).
(d) If the transaction is a sale of a call option on assets,
the insurer must hold or have a currently exercisable right to
acquire the underlying assets during the entire period that the
option is outstanding.
(e) If the transaction is a sale of a put option on assets,
the insurer must hold sufficient cash, cash equivalents, or
interests in a short-term investment pool to be able to purchase the
underlying assets on exercise of the option during the entire
period that the option is outstanding, and must be able to hold the
underlying assets in the insurer's portfolio. If the total market
value of all put options sold by the insurer exceeds two percent of
the insurer's assets, the insurer shall set aside, under a
custodial or escrow agreement, cash or cash equivalents that have a
market value equal to the amount of the insurer's put option
obligations in excess of two percent of the insurer's assets during
the entire period the option is outstanding.
(f) If the transaction is a sale of a call option on a
derivative instrument, including a swaption, the insurer must hold
or have a currently exercisable right to acquire assets generating
the cash flow necessary to make any payments for which the insurer
is liable under the underlying derivative instrument during the
entire period that the call option is outstanding, and must be able
to enter into the underlying derivative transaction for the
insurer's portfolio.
(g) If the transaction is a sale of a cap or a floor, the
insurer must hold or have a currently exercisable right to acquire
assets generating the cash flow necessary to make any payments for
which the insurer is liable under the cap or floor during the entire
period that the cap or floor is outstanding.
Requirements Relating to Replication Transactions
Sec. 5. (a) An insurer may enter into a replication
transaction only with the prior written approval of the
commissioner. To be eligible for approval by the commissioner:
(1) the insurer must be otherwise authorized to invest its
funds under this chapter in the asset being replicated; and
(2) the asset being replicated must be subject to all the
provisions and limitations on the making of the transaction
specified by this article relating to investments by the insurer as
if the transaction constituted a direct investment by the insurer
in the replicated asset.
(b) The commissioner may adopt rules regarding replication
transactions as necessary to implement this section.
Trading Requirements
Sec. 6. Each derivative instrument must be:
(1) traded on a securities exchange;
(2) entered into with, or guaranteed by, a business entity;
(3) issued or written by, or entered into with, the issuer
of the underlying interest on which the derivative instrument is
based; or
(4) in the case of futures, traded through a broker who is
registered as a futures commission merchant under the Commodity
Exchange Act (7 U.S.C. Section 1 et seq.), as amended, or who is
exempt from that registration under 17 C.F.R. Rule 30.10, adopted
under the Commodity Exchange Act (7 U.S.C. Section 1 et seq.), as
amended.
Rules
Sec. 7. The commissioner may adopt rules consistent with this
article that prescribe reasonable limits, standards, and
guidelines with respect to the risk-limiting transactions
authorized under this article and plans related to those
transactions.
Notice to Commissioner
Sec. 8. (a) Before engaging in a transaction authorized under
this article, an insurer that has a statutory net capital and
surplus of less than $10 million shall file a written notice with
the commissioner describing the need to engage in the transaction,
the lack of acceptable alternatives, and the insurer's plan to
engage in the transaction. If the commissioner does not issue an
order prohibiting the insurer from engaging in the transaction
within 90 days after the date of receipt of the insurer's notice,
the insurer may engage in the transaction described in the notice.
(b) An insurer with a statutory net capital and surplus less
than the minimum amount of capital and surplus required for a new
charter and certificate of authority for the same type of insurer
may not engage in the transactions authorized under this article.
(c) For purposes of this section, net capital and surplus
are determined by the most recent financial statement of the
insurer required to be filed with the department.
Added by Acts 1983, 68th Leg., p. 4025, ch. 627, Sec. 3, eff. June
19, 1983. Amended by Acts 1999, 76th Leg., ch. 1040, Sec. 3, eff.
Sept. 1, 1999.
Article: 1.33 1.39 1.61 2.10 2.10-1 2.10-2 2.10-3A 2.10-4 2.10-5 3.10 3.11 3.16 3.17 3.18 3.28
Last modified: August 11, 2007
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