[Federal Register Volume 60, Number 82 (Friday, April 28, 1995)]
[Notices]
[Pages 21014-21016]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-10485]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-35640; File No. SR-GSCC 94-7]


Self-Regulatory Organizations; Government Securities Clearing 
Corporation; Order Approving a Proposed Rule Change Relating to Changes 
in Membership Standards

April 24, 1995.
    On October 11, 1994, pursuant to Section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act''),\1\ the Government Securities Clearing 
Corporation (``GSCC'') filed with the Securities and Exchange 
Commission (``Commission'') a proposed rule change to establish minimum 
financial standards for two current netting system membership 
categories: insurance companies and registered investment companies. On 
December 5, 1994, GSCC filed an amendment to the proposed rule 
change.\2\ On December 15, 1994, the Commission published notice of the 
proposed rule change in the Federal Register to solicit comment from 
interested persons.\3\ On February 14, 1995, GSCC filed a second 
amendment to the proposed rule change.\4\ The amendment was a technical 
amendment that did not require republication of notice. On April 20, 
1995, GSCC filed a third amendment to the proposed rule change.\5\ That 
amendment withdrew that portion of the proposed rule change relating to 
financial standards for investment companies. No comments were 
received. This order approves the proposal as amended.

    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\Letter from Jeffrey F. Ingber, General Counsel and Secretary, 
GSCC, to Jerry Carpenter, Assistant Director, Division of Market 
Regulation (``Division''), Commission (December 1, 1994).
    \3\Securities Exchange Act Release No. 35061 (December 7, 1994), 
59 FR 64720.
    \4\Letter from Jeffrey F. Ingber, General Counsel and Secretary, 
GSCC, to Christine Sibille, Staff Attorney [sic], Division, 
Commission (February 10, 1995).
    \5\Letter from Jeffrey F. Ingber, General Counsel and Secretary, 
GSCC, to Jerry Carpenter, Assistant Director, Division, Commission 
(April 20, 1995).
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I. Description

    The proposed rule change establishes minimum financial standards 
for insurance company applicants for membership in GSCC's Netting 
System.\6\

    \6\Currently, no insurance companies are members of GSCC's 
Netting System.
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(A) Background

    GSCC Rule 2, Section 1 currently provides that insurance companies 
as defined by Section 2(a)(17) of the Investment Company Act of 1940 
(``Investment Company Act'') are eligible to become members of GSCC's 
Netting System if they are in good standing with their primary 
regulator.\7\ Insurance companies are regulated primarily by the states 
in which they organize and operate. States generally have imposed 
statutory and administrative requirements for the maintenance of 
reserves that are intended to bear a reasonable relationship to the 
risks presented by the insurers' outstanding contractual obligations. 
These requirements appear generally to have served to ensure that 
insurance companies are financially responsible.

    \7\Section 2(a)(17) of the Investment Company Act provides that 
```Insurance company' means a company which is organized as an 
insurance company, whose primary and predominant business activity 
is the writing of insurance or the reinsuring of risks underwritten 
by insurance companies, and which is subject to supervision by the 
insurance commissioner or a similar official or agency of a State; 
or any receiver or similar official or any liquidating agent for 
such a company, in his capacity as such.''
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    In December 1992, the National Association of Insurance 
Commissioners (``NAIC'') adopted a model law that establishes standards 
for the adequacy of life and health insurance company surplus levels 
based upon the risk profile of their operations and investments.\8\ The 
model law is to replace the fixed dollar minimum capital requirements 
under state law with an authorized control level risk-based capital 
(``RBC'') at or below which an insurance commissioner must act and 
place an insurer under varying degrees of increased state control.

    \8\While only twenty states have adopted the model law as of 
November 1994, the risk-based capital report has been included in 
the NAIC financial statement used by all states. As a result, all 
insurance companies must disclose the risk profile in their annual 
financial reports.
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    The RBC is an adjusted capital requirement based on four main risk 
categories (asset risk, insurance risk, interest rate risk, and 
business risk). The asset risk category provides for risk of default on 
investments held by insurance companies by imposing reductions in 
valuation ranging from .3% of the value of obligations guaranteed by 
the U.S. government to 30% of the value of common stock to 100% of the 
carrying value of foreign domiciled subsidiaries. The insurance risk 
category imposes capital levels with respect to an insurer's 
liabilities and obligations. In general, liabilities under 
[[Page 21015]] health insurance policies require higher capital levels 
than liabilities under life insurance policies. The interest rate risk 
category is designed to cover the risk of losses from annuity and other 
deposit type liabilities with interest guarantees as a result of 
interest rate swings. Capital requirements range from .75% to 3% of 
reserve amounts. The business risk category is designed to account for 
the risk of state guaranty fund assessments and is a percentage of life 
and annuity premiums.
    An insurance company's RBC level is calculated using the company's 
``total adjusted capital'' (which is the sum of its statutory surplus, 
asset valuation reserve, voluntary investment reserves, and half of the 
annual dividend liability as adjusted for the capital contribution by 
subsidiaries) as the numerator and its RBC number as the denominator. 
If an insurance company's RBC level is equal to or greater than the 
``company action level,'' then no regulatory intervention is required 
under the Model Act. A ratio of 200 percent or more is necessary for a 
life or health insurance company to avoid any regulatory action.\9\

    \9\If a life or health insurance company's RBC level is between 
150-200%, under the Model Act regulators would require a company to 
file a plan to increase the capital ratio to greater than 200%. At a 
RBC level of 100-150%, regulators would do an examination of the 
company and issue corrective orders. At 70-100%, the regulators 
would be authorized to take control of the company. Below 70%, the 
regulators would be reaquired to take control of a company.
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    In December 1993, the NAIC adopted similar risk-based standards for 
property and casualty insurance companies. These standards will take 
effect for the 1994 annual financial reports. The RBC property and 
casualty insurance companies is based on asset risk, credit risk, loss 
reserve risk, and written premium risk. The asset risk capital 
represents the capital required to support the risk of potential 
default of invested assets. Credit risk capital represents the capital 
required to support the risk of default by reinsurers and other 
creditors. Loss reserve risk capital represents the capital required to 
support the risk of adverse development in excess of expected 
investment income from loss reserves. Written premium risk represents 
the capital required to support the risk of inadequate rates on 
business written over the coming year. As with life and health 
insurers, the RBC level for property and casualty insurers is 
calculated by dividing the insurer's surplus by its calculated RBC. The 
``company action level'' for property and casualty insurers is 80%.\10\

    \10\Under the Model Act, at an RBC level at 28% or less 
regulators would be required to take control of a company.
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    There are several private organizations that rate insurance 
companies. A.M. Best (``Best'') was the first rating agency to report 
on the condition of insurance companies. Standards & Poor's (``S&P''), 
Moody's, and Duff & Phelps (``D&P'') also rate insurance companies.

(B) Membership Standards

    As a result of the regulation of insurance companies by the states, 
no uniform regulatory financial standard exists for insurance 
companies. Instead, the proposed rule change relies on the analysis and 
rating of each insurance company provided by the rating agencies as a 
proxy for such a uniform standard. The proposal also establishes a 
``size'' test that at least initially only insurance companies of 
substantial size can meet and requires that insurance company netting 
members have a satisfactory RBC level.
    Specifically, the proposal establishes the following minimum 
financial standards for insurance company netting members to be 
accepted into GSCC Netting System membership:
    (1) A Best's rating of ``A-'' or better (if the member is rated by 
Best),\11\

    \11\Best's ratings are as follows:
    A++ and A+=superior
    A and A-=excellent
    B++ and B+=very good
    B and B-=good
    C++ and C+=fair
    C and C-=marginal
    D=below minimum standards
    E=under state supervision
    F=in liquidation
    Currently, approximately one-third of all life insurance 
companies rated by Best and over one-half of all property and 
casualty insurance companies rated by Best have a rating of A- or 
better.
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    (2) A rating by at least one of the other three major rating 
agencies (D&P, Moody's, or S&P) of at least ``A-'' or ``A3'', as 
applicable (or an equivalent rating by either a nationally-recognized 
statistical rating organization or another rating agency acceptable to 
GSCC),
    (3) No rating by any one of the other three major rating agencies 
of less than ``A-'' or ``A3'', as applicable,\12\

    \12\A rating of below ``A-'' or ``A3'' by one of the other three 
major rating agencies generally indicates some weakness.
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    (4) A RBC level equal to or greater than the applicable ``company 
action level'' as set forth in the Risk-Based Capital for Insurers 
Model Act, and
    (5) Statutory capital (consisting of adjusted policyholders' 
surplus plus the company's asset valuation reserve) of no less than 
$500 million.\13\

    \13\Currently, this standard encompasses roughly the twenty-five 
largest life insurers and the twenty-five largest property and 
casualty insurers.
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(C) Reporting Requirements

    Each applicant for membership in GSCC's Netting System that is an 
insurance company will be required to provide its two most recent 
annual statements and three most recent quarterly financial statements 
filed with the NAIC, the Commission, and/or the applicant's regulatory 
authority in its state of domicile. In order to monitor the financial 
status of insurance company netting members on an ongoing basis, each 
such member will be required to provide GSCC with copies of its 
quarterly and annual financial statements and any intervening 
amendments and addendums thereto at the time that such statements are 
filed with the NAIC, the Commission, and/or the member's regulatory 
authority in its state of domicile.

II. Discussion

    Section 17A(b)(3)(B) of the Act\14\ provides that the rules of a 
clearing agency must provide that certain types of entities, including 
insurance companies, may become participants in such clearing agency. 
Section 17A(b)(4)(B) of the Act\15\ provides that a registered clearing 
agency may deny participation to or condition the participation of any 
person if such person does not meet such standards of financial 
responsibility, operational capacity, experience, and competence as are 
prescribed by the rules of the clearing agency.

    \14\15 U.S.C. 78q-1(b)(3)(B) (1988).
    \15\15 U.S.C. 78q-1(b)(4)(B) (1988).
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    In the Commission's release adopting standards for clearing agency 
registration (``Standards Release''), the Commission stated that 
although the categories enumerated by Section 17A(b)(3)(B) are already 
subject to regulation by various federal and state authorities, such 
regulation does not necessarily qualify an applicant for participation 
in a clearing agency.\16\ Instead, a clearing agency may impose such 
additional or higher standards as it deems necessary to protect the 
clearing agency and it participants from unreasonable risks.

    \16\Securities Exchange Act Release No. 16900 (June 17, 1980), 
45 FR 41920.
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    In its registration application, GSCC requested an exemption from 
Sections 17A(b)(3)(B) and 17A(b)(4)(B) of the Act. At that time GSCC's 
rules did not enumerate all of the statutory categories of membership. 
In addition, GSCC's [[Page 21016]] rules did not include applicant and 
membership financial standards as contemplated by Section 17A(b)(4)(B) 
of the Act. In its initial temporary registration order,\17\ the 
Commission stated that in developing member financial and operation 
standards, GSCC should ensure that the standards would allow GSCC to 
allocate losses resulting from member defaults in order to support 
GSCC's netting system. The Commission believes that GSCC's experience 
in operating a clearing and settlement facility for government 
securities transactions has provided GSCC with the necessary guidance 
to develop applicant and continuing membership standards for insurance 
companies that are both fair and adequate to protect GSCC and its 
participants from unreasonable risk.

    \17\Securities Exchange Act Release No. 25740 (May 24, 1988), 53 
FR 19639.

    The proposals also limits Netting System membership to the largest 
insurance companies in existence. The Standards Release notes that a 
clearing agency may discriminate among persons in the admission to the 
clearing agency if such discrimination is based on standards of 
financial responsibility, operational capability, experience, and 
competence. The Division believes that, at least initially, the 
limitations on the basis of capital appear to be reasonable as 
demonstrations of greater financial responsibility, operational 
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capacity, experience and competence.

III. Conclusion

    For the reasons stated above, the Commission finds that the 
proposed rule change is consistent with Section 17A of the Act.

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-GSCC-94-07) be and hereby is 
approved.


    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 95-10485 Filed 4-27-95; 8:45 am]

BILLING CODE 8010-01-M