Illinois § 126.18

§ 126.18.

Derivative transactions. An insurer may, directly or indirectly through an investment subsidiary, engage in derivative transactions under this Section under the following conditions: A. General conditions. (1) An insurer may use derivative instruments under this Section to engage in hedging transactions and income generation transactions. (2) An insurer may use derivative instruments for replication transactions only after the Director promulgates reasonable rules that set forth methods of disclosure, reserving for risk-based capital, and determining the asset valuation reserve for these investments. Any asset being replicated is subject to all the provisions and limitations on the making thereof specified in this Article with respect to investments by the insurer as if the transaction constituted a direct investment by the insurer in the replicated asset. (3) With respect to all hedging transactions, an insurer shall be able to demonstrate to the Director the intended hedging characteristics and the ongoing effectiveness of the derivative transaction or combination of the transactions through cash flow testing or other appropriate analyses. (4) The Director may promulgate reasonable rules for investments and transactions under this Section including, but not limited to, rules which impose financial solvency standards, valuation standards, and reporting requirements. B. Limitations on hedging transactions. An insurer may enter into hedging transactions under this Section if, as a result of 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 then engaged in by the insurer does not exceed 7.5% of its admitted assets; (2) The aggregate statement value of options, caps and floors written in hedging transactions then engaged in by the insurer does not exceed 3% of its admitted assets; and (3) The aggregate potential exposure of collars, swaps, forwards and futures used in hedging transactions then engaged in by the insurer does not exceed 6.5% of its admitted assets. C. Limitations on income generation transactions. An insurer may enter into the following types of income generation transactions subject to the quantitative limits of subsection C(5): (1) 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; (2) Sales of covered call options on equity securities, if the insurer holds in its portfolio, or can 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; (3) Sales of covered puts on investments that the insurer is permitted to acquire under this Article, if the insurer has escrowed, or entered into a custodian 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 (4) 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. (5) If as a result of and after giving effect to the transactions, the aggregate statement value of the fixed income 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 a derivative instrument subject to call, plus the amount of the purchase obligations under the puts, does not exceed 10% of its admitted assets. D. Counterparty exposure. An insurer shall include all counterparty exposure amounts in determining compliance with the limitations of Section 126.10. E. Additional transactions. Pursuant to rules promulgated under Section 126.8, the Director may approve additional transactions involving the use of derivative instruments in excess of the limits of subsection B of this Section or for other risk management purposes. (Source: P.A. 90-418, eff. 8-15-97.)