HBA-ATS H.B. 3042 76(R) BILL ANALYSIS Office of House Bill AnalysisH.B. 3042 By: Averitt Insurance 4/16/1999 Introduced BACKGROUND AND PURPOSE In 1997, the legislature gave broader authority to life insurance companies to diversify their investment portfolios to increase their returns. No similar provision was made for property and casualty insurers. Currently, property and casualty insurers are authorized to buy put options or sell call options and terminate them, buy or sell interest rate futures contracts and options on interest rate futures contracts, or utilize such other instruments or devices as are consistent with this article and are traded on an established exchange regulated by the Securities and Exchange Commission or the Commodities Futures Trading Commission only for purposes of protecting such assets against the risk of changing asset values or interest rates and for risk reduction. H.B. 3042 includes income generation in addition to risk reduction as a valid purpose in which an insurer is authorized to engage, for purposes of protecting its assets, in certain risk control transactions. This bill also authorizes an insurer to engage in securities lending, repurchase, reverse repurchase and dollar roll transactions. RULEMAKING AUTHORITY It is the opinion of the Office of House Bill Analysis that rulemaking authority is expressly delegated to the commissioner of insurance in SECTION 3 (Article 2.10-4, Insurance Code) of this bill. SECTION BY SECTION ANALYSIS SECTION 1. Amends Article 2.10, Texas Insurance Code, as follows: 5. Adds this section to include any type or form of savings deposits, time deposits, certificates of deposit, NOW accounts, and money market accounts in solvent banks, savings and loan associations, and credit unions, organized under U.S. or state laws among the types of investments in which an insurer (except a life, health, and accident insurer) is required to invest its funds over and above its minimum capital and its minimum surplus. Provides an exception to the investment in these types of investments by providing that the amount of the deposits in any one bank, savings and loan association, or credit union will not exceed the greater of 20 percent of the insurer's capital and surplus, the amount of federal or state deposit insurance coverage pertaining to such deposit, or 10 percent of the amount of capital, surplus, and undivided profits of the entity receiving such deposits. 6. Adds evidence of indebtedness in the list of investments of any partnership or solvent dividend paying corporation from which an insurer (except a life, health, and accident insurer) is required to invest its funds over and above its minimum capital and its minimum surplus. Redesignates this section from existing Section 5. 7. Deletes the prohibition that the aggregate of all investments made under Subsection (c) of this section are not to exceed 25 percent of the insurer's assets. Redesignates this section from existing Section 6. 14. Adds this section to require the percentage authorizations and limitations set forth in any or all of the provisions of this article to apply only at the time of the original acquisition of an investment or at the time a transaction is entered into. Prohibits these percentage authorizations and limitations from being applicable to the insurer or such investment or transaction thereafter except as provided in this section. Requires that any investment, once qualified under any subsection of this section, to remain qualified notwithstanding any refinancing, restructuring or modification of such investment. Prohibits the insurer from engaging in any such refinancing, restructuring or modification of any investment for the purpose of circumventing the requirements or limitations of this article. Redesignates existing Sections 7, 8, 9, 10, 11, and 12, to existing Sections 8, 9, 10, 11, 12 and 13, respectively, and makes conforming changes. SECTION 2. Amends Article 2.10-3, Texas Insurance Code, as follows: ART. 2.10-3. New title: Securities Lending, Repurchase, Reverse Repurchase and Dollar Roll Transactions (a) Adds this subsection to define "repurchase transaction," "reverse repurchase transaction," "securities lending transaction," and "dollar roll transaction" for purposes of this article. (b) Adds this subsection to authorize an insurer to engage in securities lending, repurchase, reverse repurchase and dollar roll transactions. Requires the insurer to enter into a written agreement for all transactions, except dollar roll transactions, that require each transaction to terminate no more than one year from its inception. (c) Adds this subsection to require cash received in a transaction under this article to be invested in accordance with this article and in a manner that recognizes the liquidity needs of the transaction or used by the insurer for its general corporate purposes. Requires, the insurer, its agent, or custodian, for as long as the transaction remains outstanding, to maintain, as to acceptable collateral received in a transaction under this subsection, either physically or through the book entry systems of the Federal Reserve, Depository Trust Company, Participants Trust Company, or other securities depositories approved by the commissioner on insurance (commissioner): _possession of the acceptable collateral; _a perfected security interest in the acceptable collateral; or _in the case of a jurisdiction outside of the United States, title to, or rights of a secured creditor to, the acceptable collateral; (d) Prohibits an insurer from entering into a transaction if, as a result of and after giving effect to the transaction the aggregate amount of securities then loaned, sold to, or purchased from, any one business entity counterparty under this article would exceed five percent of its assets. (Provides that in calculating the amount sold to or purchased from a business entity counterparty under repurchase or reverse repurchase transactions, effect may be given to netting provisions under a master written agreement); or the aggregate amount of all securities then loaned, sold to, or purchased from all business entities under this article would exceed 40 percent of its assets. (e) Provides that the amount of collateral required for securities lending, repurchase and reverse repurchase transactions is the amount required pursuant to the provisions of the Purposes and Procedures of the Securities Valuation Office or such successor publication. Deletes existing Subsections (a) and (b). SECTION 3. Amends Article 2.10-4, Texas Insurance Code, as follows: Sec. 1. Includes income generation in addition to risk reduction as a valid purpose in which an insurer is authorized to engage, for purposes of protecting its assets, in certain risk control transactions. Makes nonsubstantive changes. 1. Defines "acceptable collateral," "business entity," "cap," "cash equivalents," "collar," "counterparty exposure amount," "derivative instrument," "derivative transaction," "floor," "forward," "future," "futures exchange," "hedging transaction," "income generation transaction," "market value," "option," "over-the-counter derivative instrument," "potential exposure," "qualified clearinghouse," "replication transaction," "securities exchange," "swap," "swaption," "underlying interest," and "warrant." 2. Requires the board of directors of the insurer, before entering into any derivative transaction, to approve a derivative use plan, as part of the insurer's investment plan otherwise required by law, that describes investment objectives and risk constraints, such as counterparty exposure amounts; defines permissible transactions identifying the risks to be hedged, the assets or liabilities being replicated; and requires compliance with internal control procedures. 3. Requires the insurer to establish written internal control procedures for a quarterly report to the board of directors relating to derivative transactions; a system for determining whether hedging or replication strategies utilized have been effective; a system of regular reports (not less frequently than monthly) to management relating to derivative transactions; written authorizations that identify the responsibilities and limitations of authority of persons authorized to effect and maintain derivative transactions; and documentation appropriate for each transaction. 4. Requires an insurer to be able to demonstrate to the commissioner, upon request, the intended hedging characteristics and ongoing effectiveness of the derivative transaction or combination of transactions through cash flow testing, duration analysis, or other appropriate analysis. 5. Requires an insurer to include all counterparty exposure amounts in determining compliance with the limitations of Subsection (c). 6. Requires the insurer, 10 days prior to entering into the initial hedging transaction, to notify the commissioner, in writing that the insurer's board of directors has adopted an investment plan which authorizes hedging transactions, and that all hedging transactions will comply with this article. Requires insurers already engaged in hedging transactions to notify the commissioner as set forth in the preceding sentence within 30 days of the effective date of this article. Authorizes an insurer to enter into hedging transactions under this article, if as a result of and after giving effect to each such transaction certain outcomes are realized: _the aggregate statement value of all outstanding options (other than collars), caps, floors, swaptions and warrants (not attached to another financial instrument purchased by the insurer) pursuant to this article does not exceed 7.5 percent of its assets; _the aggregate statement value of all outstanding options (other than collars), swaptions, warrants, caps and floors written by the insurer pursuant to this article does not exceed three percent of its assets; and _the aggregate potential exposure of all outstanding collars, swaps, forwards and futures entered into or acquired by the insurer pursuant to this article does not exceed 6.5 percent of its assets. Authorizes the commissioner, whenever the derivative transactions entered into under this Subsection 6, are not in compliance with this Subsection 6 or, if continued, may now or subsequently, create a hazardous financial condition to the insurer which affects its policyholders, creditors, or the general public, after notice and an opportunity for a hearing, to order the insurer to take such action as may be reasonably necessary to rectify a hazardous financial condition or to prevent an impending hazardous financial condition from occurring. 7. Authorizes an insurer only to enter into an income generation transaction if two enumerated conditions are met: 8. Authorizes an insurer to enter into replication transactions only with prior written approval from the commissioner. Authorizes the commissioner to adopt such rules and regulations regarding replication transactions as may be fair and reasonable to implement this subsection. 9. Authorizes an insurer to purchase or sell one or more derivative instruments to offset, in whole or in part, any derivative instrument previously purchased or sold, as the case may be, without regard to the quantitative limitations of this article, provided that such offsetting transaction utilizes the same type of derivative instrument as the derivative instrument being offset. 10. Trading Requirements. Requires each derivative instrument to be traded on a securities exchange; entered into with, or guaranteed by, a business entity; issued or written by or entered into with the issuer of the underlying interest on which the derivative instrument is based; or in the case of futures, traded through a broker which is registered as a futures commission merchant under the Commodity Exchange Act or which has received exemptive relief from such registration under Rule 30.10 promulgated under the Commodity Exchange Act. Deletes existing Subsection (a)-(d). Sec. 2. Makes a conforming change. SECTION 4. Effective date: September 1, 1999. SECTION 5. Emergency clause.