2023 Indiana Code › Title 27. Insurance › Article 1. Department of Insurance › Chapter 12. Life Insurance Company Powers and Policy Requirements › 27-1-12-2.2. Derivative Transactions

Sec. 2.2. (a) The following definitions apply to this section:
(1) "Acceptable collateral" means, as to over-the-counter derivatives transactions and for the purpose of calculating counterparty exposure amounts:
(A) cash;
(B) cash equivalents;
(C) letters of credit; and
(D) direct obligations of, or securities that are fully guaranteed as to principal and interest by, the government of the United States or any agency of the United States, including the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.
(2) "Admitted assets" means the life insurance company's assets permitted to be reported as admitted assets on the statutory financial statement of the insurer most recently required to be filed with the commissioner.
(3) "Business entity" means:
(A) a sole proprietorship;
(B) a corporation;
(C) a limited liability company;
(D) an association;
(E) a partnership;
(F) a joint stock company;
(G) a joint venture;
(H) a mutual fund;
(I) a trust;
(J) a joint tenancy; or
(K) another, similar form of business organization;
whether organized for-profit or not-for-profit.
(4) "Cap" means an agreement obligating the seller 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 (1) or more underlying interests exceeds a predetermined number, sometimes called the strike rate or strike price.
(5) "Cash" means any of the following:
(A) United States denominated paper currency and coins.
(B) Negotiable money orders and checks.
(C) Funds held in any time or demand deposit in any depository institution, the deposits of which are insured by the Federal Deposit Insurance Corporation.
(6) "Cash equivalent" means any of the following:
(A) A certificate of deposit issued by a depository institution, the deposits of which are insured by the Federal Deposit Insurance Corporation.
(B) A banker's acceptance issued by a depository institution, the deposits of which are insured by the Federal Deposit Insurance Corporation.
(C) A government money market mutual fund.
(D) A class one money market mutual fund.
(7) "Class one money market mutual fund" means a money market mutual fund that at all times qualifies for investment pursuant to the Purposes and Procedures Manual of the NAIC Investment Analysis Office either using the bond class one reserve factor or because it is exempt from asset valuation reserve requirements.
(8) "Collar" means two (2) derivatives transactions on the same underlying interest in which the insurer receives payments as the buyer of an option, cap, or floor in one (1) transaction and makes payments as the seller of a different option, cap, or floor in the second transaction.
(9) A. "Counterparty exposure amount" means the net amount of credit risk attributable to a derivative instrument that a life insurance company enters into with another business entity other than through a qualified exchange or a qualified foreign exchange, or cleared through a qualified clearing house ("over the counter derivative instrument"). The amount of credit risk equals:
(1) the market value of the over-the-counter derivative instrument, if the liquidation of the instrument would result in a final cash payment to the insurer; or
(2) zero (0), if the liquidation of the over-the-counter derivative instrument would not result in a final cash payment to the insurer.
B. If a life insurance company enters into one (1) or more over-the-counter derivative instruments with another business entity under a written master agreement that provides for netting of payments owed by the respective parties, and the domiciliary jurisdiction of the counterparty is either within the United States or a foreign jurisdiction listed in the Purposes and Procedures Manual of the NAIC Investment Analysis Office as eligible for netting, the net amount of credit risk attributable to the counterparty is the greater of zero (0) or the remainder of:
(1) the market value of the over-the-counter derivative instruments entered into under the agreement, the liquidation of which would result in a final cash payment to the insurer by the business entity; minus
(2) the market value of the over-the-counter derivative instruments entered into under the agreement, the liquidation of which would result in a final cash payment by the insurer to the business entity.
C. For open transactions involving over-the-counter derivative instruments, market value:
(1) shall be determined not less frequently than at the end of the most recent quarter of the insurer's fiscal year; and
(2) shall be reduced by the market value of acceptable collateral that is:
(A) held by the insurer; or
(B) placed in escrow by one (1) or both parties.
(10) "Covered" means, in the case of a call option, that:
(A) the life insurance company owns the instrument underlying the call option it has written (a "written call") during the entire period that the written call is outstanding; or
(B) pursuant to the exercise of options, warrants, or conversion rights already owned when the call option is written and held during the period that the written call is outstanding, the life insurance company can immediately acquire the instrument underlying the written call, if:
(1) the price at which the underlying instrument can be acquired is less than or equal to the strike price of the written call; or
(2) the life insurance company has placed in escrow or, pursuant to a custodian agreement, has segregated during the entire period that the written call is outstanding, cash, cash equivalents, or securities with a market value equal to the difference between the price at which the underlying instrument can be acquired and the strike price of the written call.
(11) "Covered" means, in the case of a put option, that the life insurance company has placed in escrow or, pursuant to a custodian agreement, has segregated during the entire period that the put option it has sold (a "written put") is outstanding, cash, cash equivalents, or securities with a market value equal to the amount of the insurer's obligation under the written put.
(12) "Covered" means, in the case of a cap or floor, that the life insurance company holds in its portfolio, during the entire period that the cap or floor is outstanding, investments that generate sufficient cash flow to make all required payments under the cap or floor.
(13) "Derivative instrument" means an agreement (in the nature of a bilateral contract, option, or otherwise), an instrument, or a series or combination of agreements and instruments:
(A) to make or take delivery of, or assume or relinquish, a specified amount of one (1) or more of the interests underlying the derivative instrument, or to make a cash settlement in lieu thereof; or
(B) that has a price, performance, value, or cash flow based primarily upon the actual or expected price, level, performance, value, or cash flow of one (1) or more of the interests underlying the derivative instrument.
Derivative instruments include options, warrants used in a hedging transaction and not attached to another financial instrument, caps, floors, collars, swaps, swaptions, forwards, futures, and any other agreements (in the nature of bilateral contracts, options, or otherwise) or substantially similar instruments, or any series or combination thereof, and any agreements (in the nature of bilateral contracts, options, or otherwise) or instruments permitted under rules adopted by the department.
(14) "Derivative transaction" means a transaction involving the use of one (1) or more derivative instruments. For purposes of this section, a derivative transaction may involve a requirement that the insurer, a counterparty, or both, are required to post collateral with the other party (or a designated third party) pursuant to an agreement between the insurer and the counterparty.
(15) "Domestic jurisdiction" means the United States, any state, territory, or possession of the United States, the District of Columbia, Canada, or any province of Canada.
(16) "Floor" means an agreement obligating the seller to make payments to the buyer, with each payment based on the amount by which a predetermined number, sometimes called the floor rate or price, exceeds a reference price or level or the performance or value of one or more underlying interests.
(17) "Foreign currency" means a currency other than that of a domestic jurisdiction.
(18) "Foreign jurisdiction" means a jurisdiction other than a domestic jurisdiction.
(19) "Forward" means an agreement (other than a future) to make or take delivery of, or effect a cash settlement based on the actual or expected price, level, performance, or value of, one (1) or more underlying interests.
(20) "Future" means an agreement, traded on a qualified exchange or qualified foreign 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.
(21) "Government money market mutual fund" means a money market mutual fund that at all times:
(A) invests only in obligations issued, guaranteed, or insured by the United States or collateralized repurchase agreements composed of these obligations; and
(B) qualifies for investment without a reserve pursuant to the Purposes and Procedures Manual of the NAIC Investment Analysis Office.
(22) "Guaranteed or insured," when used in connection with an obligation acquired under this section, means that the guarantor or insurer has agreed to:
(A) perform or insure the obligation of the obligor or purchase the obligation; or
(B) be unconditionally obligated until the obligation is repaid to maintain in the obligor a minimum net worth, fixed charge coverage, stockholders' equity, or sufficient liquidity to enable the obligor to pay the obligation in full.
(23) "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, liabilities, or assets and liabilities) that the insurer has acquired or incurred or anticipates acquiring or incurring; or
(B) currency exchange rate risk or the degree of exposure to assets or liabilities (or a portfolio of assets, liabilities, or assets and liabilities) that the insurer has acquired or incurred or anticipates acquiring or incurring.
(24) "Income generation transaction" means a derivative transaction involving the writing of covered call options, covered put options, covered caps, or covered floors.
(25) "Investment company" means an investment company as defined in Section 3(a) of the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) and a person described in Section 3(c) of the Investment Company Act of 1940.
(26) "Investment company series" means an investment portfolio of an investment company that is organized as a series company and to which assets of the investment company have been specifically allocated.
(27) "Letter of credit" means a clean, irrevocable, and unconditional letter of credit issued or confirmed by, and payable and presentable at, a financial institution on the list of financial institutions meeting the standards for issuing letters of credit under the Purposes and Procedures Manual of the NAIC Investment Analysis Office.
(28) "Market value" means:
(A) as to cash, cash equivalents, and letters of credit, the amounts thereof;
(B) as to a security (other than a security that is an over-the-counter derivative instrument) as of any date, the price for the security on that date obtained from a generally recognized source or the most recent quotation from such a source or, to the extent no generally recognized source exists, the price for the security as determined in good faith by the parties to a transaction, plus accrued but unpaid income on the security to the extent not included in the price as of that date; and
(C) as to an over-the-counter derivative instrument as of any date, the amount that a life insurance company would have to pay or would receive for entering into an over-the-counter derivative transaction on substantially identical terms with another counterparty.
(29) "Money market mutual fund" means a mutual fund that meets the conditions of 17 CFR 270.2a-7, under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
(30) "Mutual fund" means:
(A) an investment company; or
(B) in the case of an investment company that is organized as a series company, an investment company series;
that is registered with the United States Securities and Exchange Commission under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
(31) "Obligation" means any of the following:
(A) A bond.
(B) A note.
(C) A debenture.
(D) Any other form of evidence of debt.
(32) "Option" means an agreement giving the buyer the right to buy or receive (a "call option"), sell or deliver (a "put option"), enter into, extend or terminate, or effect a cash settlement based on the actual or expected price, level, performance, or value of one or more underlying interests.
(33) "Qualified business entity" means a business entity that is:
(A) an issuer of obligations, preferred stock, or derivative instruments that are rated 1 or 2 or are rated the equivalent of 1 or 2 by the Securities Valuation Office or by a nationally recognized statistical rating organization recognized by the Securities Valuation Office; or
(B) a primary dealer in United States government securities, recognized by the Federal Reserve Bank of New York.
(34) "Qualified clearinghouse" means a clearinghouse:
(A) that is for, and subject to the rules of, a qualified exchange or qualified foreign exchange; and
(B) that provides clearing services, including acting as a counterparty to each of the parties to a transaction so that the parties no longer have credit risk as to each other.
(35) "Qualified exchange" means:
(A) a securities exchange registered as a national securities exchange, or a securities market regulated under the Securities Exchange Act of 1934 (15 U.S.C. 78 et seq.);
(B) a board of trade or commodities exchange designated as a contract market by the Commodity Futures Trading Commission (CFTC);
(C) Private Offerings, Resales, and Trading through Automated Linkages (PORTAL);
(D) a designated offshore securities market as defined in Securities Exchange Commission Regulation S (17 CFR Part 230); or
(E) a qualified foreign exchange.
(36) "Qualified foreign exchange" means a foreign exchange, board of trade, or contract market located outside the United States or its territories or possessions:
(A) that has received regulatory comparability relief under CFTC Rule 30.10 (as set forth in Appendix C to Part 30 of the CFTC's Regulations (17 CFR Part 30));
(B) that is, or whose members are, subject to the jurisdiction of a foreign futures authority that has received regulatory comparability relief under CFTC Rule 30.10 (as set forth in Appendix C to Part 30 of the CFTC's Regulations (17 CFR Part 30)) as to futures transactions in the jurisdiction where the exchange, board of trade, or contract market is located; or
(C) upon which are listed foreign stock index futures contracts that are the subject of no-action relief issued by the CFTC's Office of the General Counsel, provided that an exchange, board of trade, or contract market that qualifies as a qualified foreign exchange only under this clause is a qualified foreign exchange only as to foreign stock index futures contracts that are the subject of no-action relief.
(37) "Replication transaction" means a derivative transaction that is intended to replicate the investment in one (1) or more assets that an insurer is authorized to acquire or sell under this section or section 2 of this chapter. A derivative transaction that is entered into as a hedging transaction shall not be considered a replication transaction.
(38) "Securities Valuation Office" refers to the Securities Valuation Office of the NAIC.
(39) "Swap" means an agreement to exchange or to net payments at one (1) or more times based on the actual or expected price, level, performance, or value of one (1) or more underlying interests.
(40) "Swaption" means an agreement giving the buyer the right (but not the obligation) to enter into a swap at a specified time in the future.
(41) "Underlying interest" means the assets, liabilities, other interests or a combination thereof underlying a derivative instrument, such as any one (1) or more securities, currencies, rates, indices, commodities, or derivative instruments.
(42) "Warrant" means an instrument that gives the holder the right to purchase an underlying financial instrument at a given price and time or at a series of prices and times outlined in the warrant agreement. Warrants may be issued alone or in connection with the sale of other securities, for example, as part of a merger or recapitalization agreement or to facilitate divestiture of the securities of another business entity.
(b) A life insurance company's board of directors shall do all the following:
(1) Before engaging in derivatives transactions, approve a written plan that specifies guidelines, systems, and objectives to be followed, such as:
(A) investment or, if applicable, underwriting objectives and risk constraints, such as credit risk limits;
(B) permissible transactions and the relationship of those transactions to the insurer's operations;
(C) internal control procedures;
(D) a system for determining whether a derivative instrument used for hedging has been effective;
(E) a credit risk management system for over-the-counter derivatives transactions that measures credit risk exposure using the counterparty exposure amount; and
(F) a mechanism for reviewing and auditing compliance with the guidelines, systems, and objectives specified in the written plan.
(2) Before engaging in derivatives transactions, make a determination that the insurer's investment managers have adequate professional personnel, technical expertise, and systems to implement the insurer's intended investment practices involving derivative instruments.
(3) Review whether derivatives transactions have been made in accordance with the approved guidelines and are consistent with stated objectives.
(4) Take action to correct any deficiencies in internal controls relating to derivatives transactions.
(c) A life insurance company may use derivative instruments under this section to engage in hedging transactions, certain income generation transactions, and certain replication transactions, as these terms may be further defined in rules adopted by the department. For each hedging and replication transaction in which it engages, a life insurance company must be able to demonstrate to the commissioner:
(1) the intended characteristics; and
(2) the ongoing effectiveness;
of the derivative transaction or combination of the derivatives transactions through appropriate analyses.
(d) A life insurance company insurer may enter into a hedging transaction under this section if, as a result of the transaction, and after giving effect to the transaction:
(1) the aggregate statement value of options, caps, floors, and warrants not attached to another financial instrument purchased and used in hedging transactions does not exceed seven and one half percent (7.5%) of the insurer's admitted assets;
(2) the aggregate statement value of options, caps, and floors written in hedging transactions does not exceed three percent (3%) of the insurer's admitted assets; and
(3) the aggregate potential exposure of collars, swaps, forwards, and futures used in hedging transactions does not exceed six and one-half percent (6.5%) of the insurer's admitted assets.
(e) A life insurance company may enter into the following types of income generation transactions:
(1) sales of covered call options on:
(A) non-callable fixed income securities;
(B) callable fixed income securities if the option expires by its terms before the end of the noncallable period; or
(C) derivative instruments based on fixed income securities or yields;
(2) sales of covered call options on equity securities;
(3) sales of covered puts on investments that the insurer is permitted to acquire under section 2 of this chapter; and
(4) sales of covered caps or floors;
only if, as a result of the transactions and after giving effect to the transactions, the aggregate statement value of the fixed income securities that are subject to call or that generate the cash flows for payments under the caps or floors, plus the face value of fixed income securities underlying a derivative instrument subject to call, plus the amount of the purchase obligations under the puts, does not exceed ten percent (10%) of the insurer's admitted assets.
(f) A life insurance company may enter into replication transactions. For the purposes of this subsection, a replication transaction is subject to the limitations and restrictions set forth in section 2 of this chapter to which the replicated investments are subject.
(g) An investment of a life insurance company that is:
(1) permitted under section 2(b)(17A) or 2(b)(17B) of this chapter; and
(2) denominated in a foreign currency;
shall not be considered denominated in a foreign currency if the acquiring insurer enters into one (1) or more contracts permitted under this section in which the business entity counterparty agrees to exchange, or grants to the insurer the option to exchange, all payments made on the foreign currency denominated investment (or amounts equivalent to the payments that are or will be due to the insurer in accordance with the terms of such investment) for United States or Canadian dollars during the period that the contract or contracts are in effect, or other contracts with like effect, to insulate the insurer against loss caused by diminution of the value of payments owed to the insurer due to future changes in currency exchange rates.
(h) A life insurance company shall include all counterparty exposure amounts in determining compliance with the limitations set forth in section 2(b)(21) of this chapter.
(i) Upon the request of a life insurance company, the commissioner may approve additional transactions involving the use of derivative instruments that:
(1) exceed the limits set forth in subsections (d), (e), and (f); or
(2) are for other risk management purposes.
(j) A life insurance company shall maintain documentation and records relating to each derivative transaction. The documentation and records must record and include matters such as the following:
(1) The purpose or purposes of the transaction.
(2) The assets or liabilities to which the transaction relates.
(3) The specific derivative instrument used in the transaction.
(4) For collateralized derivatives transactions, a description of any collateral posted by the insurer or the counterparty, as well as records documenting any subsequent variations in the amount of the collateral.
(5) For over-the-counter derivative transactions, the name of the counterparty and the counterparty exposure amount.
(6) For exchange traded derivative instruments, the name of the exchange and the name of the firm that handled the trade.
(k) Each derivative instrument shall be:
(1) traded on a qualified 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) entered into on a qualified foreign exchange.
As added by P.L.186-1997, SEC.2. Amended by P.L.81-2012, SEC.1; P.L.124-2018, SEC.13.