STATE OF NEW YORK
25 BEAVER STREET
NEW YORK, NEW YORK 10004
|David A. Paterson|
Circular Letter No. 16 (2010)
October 15, 2010
|TO:||All Authorized Insurers|
|RE:||Prudent Practices for Insurers Engaged in Securities Lending|
STATUTORY REFERENCES: New York Insurance Law §§ 201, 301, 1401-1414
The purpose of this Circular Letter is to advise the industry
regarding the Department's expectations for insurers that engage in securities
Securities lending is a practice whereby an insurer loans securities, either directly or through a custodial bank, to a borrower in exchange for collateral, each to be returned at a specified future date or on demand by either party.
Letter No. 16 (2008) ("CL 16"), the Department expressed concern about the practice
of securities lending by insurers. At that time, the Department had become aware
that some insurers had experienced significant losses due to their securities
lending programs. Three of the Department's major areas of concern were whether
insurers were: 1) receiving adequate collateral in exchange for loaned securities;
2) effectively managing the risk associated with investing cash collateral; and
3) clearly reporting their securities lending activities. The economic environment
since CL 16 was issued has exacerbated the risk to insurers when they both loan
securities and invest cash received as collateral for the loaned security.
As a follow up to the issuance of CL 16 and in light
of the subsequent financial crisis, the Department closely examined insurers'
securities lending activities. This Circular Letter sets forth prudent practices
that the Department believes an insurer should follow in conducting a securities
lending program. The Department modeled the recommendations of this Circular Letter
on pre-existing industry practices that it considers prudent in light of recent
economic events. In sum, an insurer should effectively manage credit, market,
and operational risk associated with lending securities. An insurer whose securities
lending practices materially deviate from those outlined herein should communicate
with the Department regarding the nature of the deviations.
Typically, an insurer that receives cash collateral in exchange for a loaned security repays the borrower at a future date upon the return of the security. If an insurer chooses to invest the cash collateral in the meantime, then the insurer should mitigate against market risk by having its SLRMC establish guidelines for the investment of the cash collateral.
guidelines should set forth prudent investment practices designed to reduce the
likelihood of an insurer incurring losses when returning cash collateral. Based
on industry best practices, the Department considers it prudent for an insurer
to limit its investments to the following:
An insurer may also use cash collateral to enter into reverse repurchase agreements, subject to the concentration limitations suggested below.
Insurers can also mitigate market risk by diversifying the investment of cash
collateral. Insurers should be careful not to concentrate their investment of
cash collateral in any one type of security. Thus, the Department suggests that
when investing cash collateral, an insurer should consider the National Association
of Insurance Commissioners ("NAIC") designations associated with securities, and
invest cash collateral in:
(i) Class 1 mutual fund investments;
(ii) Direct or full faith obligations of the United States; and
(iii) Bond mutual funds.
An insurer should
aggregate its investment of cash collateral with all of its other investment activities.
In other words, an insurer should consider investments of cash collateral in determining
the timing and amount of projected cash flows for any financial analyses.
Any insurer making securities loans should maintain records
in accordance with 11 NYCRR § 243 (Regulation 152). Records should include:
The Superintendent will continue to monitor insurers' securities lending practices and may promulgate regulations or seek legislation, as necessary, if the Superintendent concludes that insurers are not engaging in securities lending activities in a prudent manner and in accordance with the Insurance Law.
Any questions regarding this Circular Letter should be directed to Jared Wilner, Assistant Counsel to the Superintendent, at firstname.lastname@example.org.
1 An insurer could prudently choose to make its SLRMC a sub-division of a pre-existing body, such as an audit committee.
2 Maturity date" is the earlier of the date on the face of the instrument on which the principal amount must be paid or for an instrument with an unconditional put or unconditional demand feature, the date on which the principal amount of the instrument can be recovered by demand. For asset-backed securities, the maturity date is the expected maturity date.