New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

The Office of General Counsel issued the following informal opinion on November 4, 2001, representing the position of the New York State Insurance Department.

Re. GIC-backed LYONS

Questions:

Do the insurer’s sale of Guaranteed Investment Contracts ("GICs") to the Trust; the (Insurer’s) Parent’s sale of options to the Trust; and the Trust’s sale of Certificates to investors (together, the "initial transactions") constitute transactions subject to regulation by the Department as holding company transactions under N.Y. Ins. Law §1505 (McKinney 2000)?

Is the delivery of an interest in the GIC by the Trust to the (Insurer’s) Parent pursuant to an exercise of an option by an investor a holding company transaction?

Is the receipt of yield and principal payments by the Parent with respect to an interest in a GIC acquired by the Parent through an exercise of the options a holding company transaction?

Conclusions:

1. — 3. Subject to the caveats described below in greater detail, none of the above described transactions constitute holding company transactions under N.Y. Ins. Law §1505 (McKinney 2000).

Facts:

The inquirer’s client has developed a product it calls GIC-backed Liquid Yield Option Notes ("GIC-backed LYONS"). Unlike traditional GIC-backed bonds or notes, which allow investors to receive interest and principal payments similar or identical to those paid under the GIC itself, a GIC-backed LYON is a form of convertible bond investment. An investor in a convertible bond essentially accepts a lower interest yield in exchange for the opportunity to participate in the appreciation of the equity of the issuer.

In the insurance industry context, it is often the case that the insurance companies that issue GICs are not publicly traded entities. Therefore, it would be impossible for such an insurer to issue LYONs that would provide an option for obtaining an equity interest therein. Therefore in order to provide opportunity for obtaining capital appreciation, the inquirer suggests that options for the stock of the insurer’s publicly traded parent be used. In many cases, convertible bonds are issued featuring an option for the stock of the parent of the issuer.

The features of the proposed plan are as follows:

A trust (the "Trust") is formed to purchase and hold a GIC issued by an insurer ("the Insurer") and to acquire and hold options (the "Options") to purchase stock in the insurer’s parent (the "Parent").

Convertible bond investors purchase certificates (the "Certificates") in the Trust representing beneficial interests in the GIC and the Options.

The Trust uses the proceeds from the sale of the Certificates to purchase a GIC from the Insurer. For purposes of discussion, we will assume the GIC has a four-year term and provides for interest at 7%.

The Trust also purchases the Options from Parent. The Trust will use a portion of the yield payments on the GICs, for example, 2% out of the 7% paid, to pay the Parent an arm’s-length consideration for the Options. The Options provide that the option holder may pay the option exercise price by delivering debt securities of the Insurer to the Parent.

If an investor wishes to exercise its proportionate part of the Options, the investor/certificate holder directs the Trust to exercise part of the Options and deliver its proportionate part of the GIC to the Parent for the Parent stock. After the Options are exercised, the investor will own the Parent stock and the Parent will directly own a proportionate part of GIC. If all the investors exercise the Options, the Trust will terminate and the Parent will hold the entire GIC directly.

The insurer pays interest directly to the Parent (at the full 7% rate) on the Parent’s proportionate part of the GIC, and the Insurer repays the Parent for a proportionate part of the GIC at maturity of the GIC.

Analysis:

I note as a preliminary matter that this letter addresses the inquirer’s specific holding company inquiries and is not intended to provide an analysis of every aspect of the proposed transaction. Nevertheless, an important issue not raised in the inquiry must be addressed at the outset. In the submission, the inquirer refers to the exchange as involving the acquisition of a "proportionate interest in the GIC" by the investors in the Trust and the possible transfer of this interest to the Parent. Such a situation would not be permitted. In all previous Department Opinions addressing GIC or funding agreement securitizations, it is expressly required that the investors must not have any direct interest in the underlying insurance contract. Nor may they have any privity of contract with, or recourse to, the insurance company issuer. See, e.g. Office of General Counsel Opinion letters dated August 6, 2001; June 4, 2001, and June 18, 2000. Thus, under the inquirer’s proposed plan, the Option exercise should be structured as an exchange of the securities of the Trust for the shares of the Parent. This approach further removes the transaction from the possibility of resembling a holding company transaction in that the Parent, upon an exercise of the Options, will not own an interest in the Insurer’s (its subsidiary’s) GIC. Rather, it will own an interest in the securities of the Trust. One further assumption in the preparation of this letter is that the exercise of the options will not cause any party to obtain control of the Parent.

The inquiry is focused on the possible holding company implications of the above-described investment transactions. For the reasons described below, and subject to the conditions noted in the preceding paragraph, the Department concurs with the view that the proposed transactions do not constitute holding company transactions subject to regulation under the New York Insurance Law.

Article 15 of the New York Insurance Law, N.Y. Ins. Law §§1501 – 1510 (McKinney 2000), sets forth the rules governing holding company transactions. These rules came about in response to the corporate trend in the 1960’s to form diverse corporate conglomerates of widely disparate businesses. In this environment, cash-rich insurance companies were often viewed as favorable takeover targets. It was of concern to regulators that insurance company subsidiaries would be abused as sources of funding for the weaker components of a corporate conglomerate. This concern led to in the formation and adoption of the holding company rules.

In general, Article 15 regulates holding company ownership of insurers and governs the relationship between holding company affiliates. Article 15 also establishes standards for transactions between an insurer and other members of the holding company system. Finally, Article 15 requires domestic insurers to obtain the approval of the Superintendent prior to entering into certain significant transactions and to notify the Superintendent of certain other transactions prior to entering into them.

N.Y. Ins. Law §1505 (c) and (d) provide as follows:

The superintendent’s prior approval shall be required for the following transactions between a domestic controlled insurer and any person in its holding company system; sales, purchases, exchanges, loans or extensions of credit, or investments, involving five percent or more of the insurer’s admitted assets at last year-end.

The following transactions between a domestic controlled insurer and any person in its holding company system may not be entered into unless the insurer has notified the superintendent in writing of its intention to enter into any such transaction at least thirty days prior thereto, or such shorter period as he may permit, and he has not disapproved it within such period:

sales, purchases, exchanges, loans or extensions of credit, or investments, involving more than on-half of one percent but less than five percent of the insurer’s admitted assets at last year-end;

reinsurance treaties or agreements;

rendering of services on a regular or systematic basis; or

any material transaction, specified by regulation, which the superintendent determines may adversely affect the interests of the insurer’s policyholders or shareholders.

Nothing herein contained shall be deemed to authorize or permit any transaction which, in the case of a non-controlled insurer, would be otherwise contrary to law.

The internal transactions among a holding company group are also addressed in Regulation 52, N.Y. Comp. Codes R. & Regs. tit. 11, §80 (1995). Section 80-1.4 provides that:

The issuance of contracts of insurance issued in the normal course of business, other than contracts of reinsurance shall not be deemed transactions hereunder.

As indicated by the above-cited authority, the holding company provisions of the New York Insurance Law apply only to transactions between a domestic controlled insurer and any person in its holding company system. Furthermore, in the normal course of business issuance of an insurance contract is not considered to constitute such a transaction. The relevance and applicability of these provisions to your specific inquiries is addressed below.

The Initial Exchanges

The Initial Exchanges are not subject to the holding company rules. First, the Parent’s sale of Options to the Trust is not a transaction between the "controlled insurer" and another party in its holding company system. Thus, the holding company rules are inapplicable to it. Similarly, the Trust’s sale of Certificates to investors does not involve the controlled insurer in any way as the insurer is not a party thereto. Secondly, the sale of the GIC is viewed by the Department as the issuance of an insurance contract in the ordinary course of business. Therefore the issuance of the GIC to the Trust is not a covered transaction.

Delivery of Trust Securities to Parent Pursuant to Exercise of Option

The exercise of the Option by an investor will result in the Parent owning an interest in the Trust securities. This situation does not present a holding company issue under the New York Insurance Law. First, the exercise of the Option does not constitute a transaction involving the controlled insurer herein. Rather, it is an exchange occurring outside the holding company system. Secondly, the ownership by the Parent, after the Option exercise, of the Trust’s securities similarly does not constitute a holding company transaction.

3. Receipt of Interest and Principal Payments

The receipt of interest and principal by the Parent from its interest in the Trust following the exercise of the Option by the investors will not be viewed as a holding company transaction. The receipt of these funds by the Parent does not constitute a "transaction" between the Parent and the Insurer under the terms of N.Y. Ins. Law §1505 (McKinney 2000).

In conclusion, the proposed transaction does not involve the application of the holding company rules. However, as is pointed out above, the investors cannot be characterized as "owning a proportional interest in the GIC" in that such an ownership interest on their part (which would constitute a complete look-through of the Trust) is not permitted by the Department in securitizations of the type proposed herein.

For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.