Current through Register Vol. 50, No. 9, March 1, 2024
RELATES TO:
KRS
304.7-361,
304.7-405,
304.7-417,
304.7-419,
304.7-421,
304.7-457,
304.7-469,
304.48-060,
304.49-010,
304.49-020,
304.50-035,
15 U.S.C. §§ 78 et seq.
NECESSITY, FUNCTION, AND CONFORMITY:
KRS
304.2-110(1) authorizes the
Commissioner of Insurance to promulgate administrative regulations necessary
for, or as an aid to, the effectuation of any provision of the Kentucky
Insurance Code, as defined in
KRS
304.1-010.
KRS
304.7-367 authorizes the commissioner to
promulgate administrative regulations to implement the provisions of KRS
Chapter 304, Subtitle 7. This administrative regulation sets standards for the
prudent use of derivative instruments in accordance with
KRS
304.7-419.
Section
1. Definitions.
(1) "Business
entity" is defined by
KRS
304.7-012(8).
(2) "Commissioner" is defined by
KRS
304.1-050(1).
(3) "Counterparty exposure amount" is defined
by
KRS
304.7-012(19).
(4) "Department" is defined by
KRS
304.1-050(2).
(5) "Derivative instrument" is defined by
KRS
304.7-012(22).
(6) "Insurer" is defined in
KRS
304.1-040.
(7) "Over-the-counter derivative" means a
derivative instrument entered into with a business entity other than through a
qualified exchange, qualified foreign exchange, or cleared through a qualified
clearinghouse.
(8) "Qualified
clearinghouse" is defined by
KRS
304.7-012(67).
(9) "Qualified exchange" is defined by
KRS
304.7-012(68).
(10) "Qualified foreign exchange" is defined
by
KRS
304.7-012(69).
Section 2. Applicability. The
provisions of this administrative regulation shall not apply to:
(1) Captive insurers licensed in accordance
with
KRS
304.49-020, except for industrial insured
captive insurers pursuant to
KRS
304.49-010(8);
(2) Workers' compensation self-insured groups
certified in accordance with
KRS
304.50-035; and
(3) Liability self-insurance groups certified
in accordance with
KRS
304.48-060.
Section 3. Amount of Credit Risk.
(1) The amount of credit risk shall equal:
(a) The market value of the derivative
instrument issued through a qualified clearinghouse 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.
(2) If
derivative instruments are entered into through a qualified clearinghouse
pursuant to a written master agreement which provides for netting of payments
owed by the respective parties, and the domiciliary jurisdiction of the
counterparty is either within the United States or if not within the United
States, within a foreign jurisdiction listed by the Securities Valuation Office
as eligible for netting, the net amount of credit risk shall be the greater of
zero or the net sum of:
(a) The market value
of the derivative instruments issued through a qualified clearinghouse entered
into pursuant to the agreement, the liquidation of which would result in a
final cash payment to the insurer; and
(b) The market value of the derivative
instruments issued through a qualified clearinghouse entered into pursuant to
the agreement, the liquidation of which would result in a final cash payment by
the insurer to the business entity.
(3) For open transactions, market value shall
be determined at the end of the most recent quarter of the insurer's fiscal
year and shall be reduced by the market value of acceptable collateral held by
the insurer or placed in escrow by one (1) or both parties.
Section 4. Guidelines and Internal
Control Procedures.
(1) Before engaging in a
derivative transaction, an insurer shall establish written guidelines, approved
by the commissioner pursuant to Section 5 of this administrative regulation,
that shall be used for effecting and maintaining derivative transactions. The
guidelines shall:
(a) Specify insurer
objectives for engaging in derivative transactions and derivative strategies
and all applicable risk constraints, including credit risk limits;
(b) Establish counterparty exposure limits
and credit quality standards;
(c)
Identify permissible derivative transactions and the relationship of those
transactions to insurer operations including a precise identification of the
risks being hedged by a derivative transaction; and
(d) Require compliance with internal control
procedures.
(2) An
insurer shall have a written methodology for determining whether a derivative
instrument used for hedging has been effective.
(3) An insurer shall have written policies
and procedures describing the credit risk management process and a credit risk
management system for over-the-counter derivative instrument transactions that
measures credit risk exposure using the counterparty exposure amount.
(4) An insurer's board of directors shall, in
accordance with
KRS
304.7-361:
(a) Approve:
1. The written guidelines, methodology, and
policies and procedures required by subsections (1), (2), and (3) of this
section; and
2. The systems
required by subsections (1) and (2) of this section;
(b) Determine whether the insurer has
adequate professional personnel, technical expertise, and systems to implement
investment practices involving derivatives;
(c) Review whether derivatives transactions
have been made in accordance with the approved guidelines and consistent with
stated objectives; and
(d) Take
action to correct any deficiencies in internal controls relative to derivative
transactions.
Section
5. Commissioner Approval. Written documentation explaining the
insurer's internal guidelines and controls governing derivative transactions
shall be submitted for approval to the commissioner. The commissioner shall
have the authority to disapprove the guidelines and controls proposed by the
insurer if the insurer cannot demonstrate the proposed internal guidelines and
controls would be adequate to manage the risks associated with the derivative
transactions the insurer intends to engage in.
Section 6. Documentation Requirements. An
insurer shall maintain the following documentation and records relating to each
derivative transaction:
(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
over-the-counter derivative instrument transactions, the name of the
counterparty and the market value; and
(5) For exchange traded derivative
instruments, the name of the exchange and the name of the firm that handled the
trade and the market value.
Section
7. Trading Requirements. 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 with the issuer of the underlying interest on which the derivative
instrument is based; or
(4) Entered
into with a qualified foreign exchange.
Section 8. Effective Date. The requirements
of this administrative regulation shall not be implemented or enforced prior to
the effective date determined pursuant to
KRS
13A.330, or July 15, 2014, whichever is
later.
STATUTORY AUTHORITY:
KRS
304.2-110(1),
304.7-367
