(1) For the purposes of this section, unless the context otherwise requires: (a) "Counter-party exposure amount" means: (I) The net amount of credit risk attributable to a derivative instrument entered into with a business entity other than through a qualified exchange or qualified foreign exchange, or cleared through a qualified clearinghouse as an over-the-counter derivative instrument. The net amount of credit risk shall equal: (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. (II) If over-the-counter derivative instruments are entered into under a written master agreement that provides for netting of payments owed by the respective parties, and the domiciliary jurisdiction of the counter-party is either within the United States or within a foreign jurisdiction listed in the purposes and procedures manual of the national association of insurance commissioners' 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 over-the-counter derivative instruments entered into under the agreement, the liquidation of which would result in a final cash payment to the insurer; and (B) 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. (III) 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 or both parties. (b) (I) "Derivative instrument" means an agreement, option, instrument, or a series or combination thereof: (A) To make or take delivery of, or assume or relinquish, a specified amount of one or more underlying interests 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 or more underlying interests. (II) (A) "Derivative instrument" includes options, warrants used in a hedging transaction and not attached to another financial instrument, caps, floors, collars, swaps, forwards, futures, and any other agreements, options, or investments that are substantially similar and any agreements, options, and instruments permitted under rules adopted by the commissioner. (B) "Derivative instrument" does not include investments that are otherwise permitted pursuant to this article, nor does "derivative instrument" include repurchase, reverse repurchase, dollar roll, securities lending, or similar transactions. (c) "Hedging transaction" means a derivative transaction that is entered into and maintained to reduce or manage: (I) The risk of a change in value, yield, price, cash flow, or quantity of assets or liabilities that an insurer has acquired or incurred or anticipates acquiring or incurring; or (II) The currency exchange rate risk or the degree of exposure as to assets or liabilities that an insurer has acquired or incurred or anticipates acquiring or incurring. (d) "Income generation" means a derivative transaction involving the writing of covered call options, covered put options, covered caps, or covered floors that is intended to generate income or enhance return. (e) "Replication transaction" means a derivative transaction or combination of derivative transactions that is intended to replicate the investment in one or more assets that an insurer is authorized to acquire or sell under this title. A derivative transaction that is entered into as a hedging transaction shall not be considered a replication transaction. (2) A domestic insurer may, directly or indirectly through an investment subsidiary, engage in derivative transactions under this section by: (a) Using derivative instruments to engage in hedging transactions if, as a result of and after giving effect to the transactions: (I) 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 of its admitted assets; (II) The aggregate statement value of options, caps, and floors written in hedging transactions does not exceed three percent of its admitted assets; and (III) The aggregate potential exposure of collars, swaps, forwards, and futures used in hedging transactions does not exceed six and one-half percent of its admitted assets; (b) Entering into the following types of income generation transactions if, as a result of and after giving effect to the transactions, the aggregate statement value of the fixed income or equity assets 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 derivative instruments subject to call, plus the amount of the purchase obligations under the puts, does not exceed ten percent of its admitted assets: (I) Sales of covered call options on noncallable fixed income securities, callable fixed income securities if the option expires by its terms prior to the end of the noncallable period, or derivative instruments based on fixed income securities; (II) Sales of covered call options on equity securities, if the insurer holds in its portfolio, or is able to immediately acquire through the exercise of options, warrants, or conversion rights already owned, the equity securities subject to call during the complete term of the call option sold; (III) Sales of covered puts on investments that the insurer is permitted to acquire under this section, if the insurer has placed into escrow, or entered into a custodial agreement segregating, cash or cash equivalents with a market value equal to the amount of its purchase obligations under the put during the complete term of the put option sold; or (IV) Sales of covered caps or floors, if the insurer holds in its portfolio the investments generating the cash flow to make the required payments under the caps or floors during the complete term that the cap or floor is outstanding. (c) An insurer may use derivative instruments for replication transactions if any asset being replicated is subject to all the provisions and limitations on the making thereof specified in this title with respect to investments by the insurer as if the transaction constituted a direct investment by the insurer in the replicated asset. (d) An insurer shall include all counter-party exposure amounts in determining compliance with general diversification requirements and medium- and low-grade investment limitations under this section. (e) Any investments in derivative investments shall be made in accordance with a written derivative use plan approved by the company's board of directors. The derivative use plan must be available for review by the commissioner upon request. An insurer must be able to demonstrate to the commissioner the intended hedging characteristics and ongoing effectiveness of the derivative transactions through cash flow testing or other appropriate analysis. (f) The commissioner may approve additional transactions involving the use of derivative instruments in excess of the limits in this section. (3) Notwithstanding any provision of this section to the contrary, domestic insurers are prohibited from establishing margin accounts without the prior approval of the commissioner; except that the commissioner shall approve reasonable plans for domestic insurance companies to use financial futures or short selling techniques for hedging purposes. (4) The commissioner may promulgate rules as necessary to implement this section.
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