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

George E. Pataki
Governor

Gregory V. Serio
Superintendent

The Office of General Counsel issued the following opinion on November 12, 2004, representing the position of the New York State Insurance Department.

Re: Clarification of Issues – CAPCO Program Four

Questions:

1. Does the proposed 15 year note satisfy the repayment schedule requirement contained in the "qualified debt instrument" definition of the CAPCO statute?

2. May a CAPCO use more than 35% of its certified capital for the purchase of U.S. Treasury or other investment grade securities where only 35% of its certified capital is being used for investment in such investments for the purpose of ensuring the repayment its debt obligations to the CAPCO’s certified investors?

Conclusions:

1. Yes, the proposed 15 year note satisfies the repayment schedule requirement contained in the "qualified debt instrument" definition of the CAPCO statute.

2. Yes, a CAPCO may use more than 35% of its certified capital for the purchase of U.S. Treasury or other investment grade securities where only 35% of its certified capital is being used for investment in such investments for the purpose of ensuring the repayment its debt obligations to the CAPCO’s certified investors.

Facts:

The inquirer is an applicant for participation in Certified Capital Company ("CAPCO") Program Four and have made the above inquiries to aid in the structuring of his offering and his financing strategy.

Analysis:

CAPCO Program Four was authorized by the enactment of Part D, Ch. 59 L. 2004. Several changes were made to the CAPCO law by that bill. The provision of the law relevant to the first of the inquiries herein (the definition of "qualified debt instrument") was not amended by the bill. That section provides as follows:

"Qualified debt instrument" - a debt instrument issued by a certified capital company, at par value or a premium, with an original maturity date of at least five years from date of issuance, a repayment schedule which is not faster than a level principal amortization, and interest, distribution or payment features which are not related to the profitability of the certified capital company or the performance of the certified capital company's investment portfolio.

N.Y. Tax Law § 11(a)(8)(McKinney 2000, as amended by Ch. 59 L.2004)

The inquirer’s second question is based on a new item of the CAPCO statute which modifies the definition of "qualified distribution" as follows:

(iii) with respect to program four and any subsequent program, all payments by the certified capital company in satisfaction of its indebtedness to its certified investors, provided that no more than thirty-five percent of such certified capital company's certified capital may be used to purchase U.S. treasury securities, other investment-grade securities, a guaranty, indemnity, bond, insurance policy or other payment undertaking, or any combination thereof; and provided further, that nothing in this provision shall be construed to limit a certified capital company from expending non-certified capital in satisfaction of such indebtedness… .

N.Y. Tax Law § 11(a)(9)(A)(iii)(Ch. 59, L. 2004).

Qualified Debt Instrument

With respect to the definition of qualified debt instrument, the inquirer’s question concerns the permissibility of using a 15 year note pursuant to which 20% of the principal is repaid in each of the first four years, no principal is repaid during years 5 through 10, and 4% of the principal is repaid in each of years 11 though 15. This payment structure is proposed for reasons of tax efficiency. In prior CAPCO programs, a 5-year note was used in which 20% of the principal was repaid in each year.

The relevant provisions of the statute require a maturity date of at least five years and a repayment schedule that is not faster than level principal amortization. These requirements ensure that the principal invested in a CAPCO is not returned to the investors too quickly, which could prevent the use of CAPCO funds for the making of qualified investments and meeting the investment milestones of the statute. The inquirer points out that under his proposed note, the return of principal takes considerably longer than under the 5-year notes used by him in earlier CAPCO programs. Accordingly, it is the inquirer’s position that the terms of the proposed 15-year note satisfy the statute.

Arguably, the statute could be interpreted as requiring both a minimum 5 year term and level principal amortization irrespective of the length of the term of the note. Under such an interpretation the 15-year note proposed would fail to comply with the statute because there would not be level principal amortization over the entire 15 year repayment term. However, it is our view that this interpretation is unwarranted and possibly contrary to the intent of the statute’s purpose. Therefore, it is our view that the statute is satisfied where the repayment of principal is no faster than level principal amortization over the first five years of the term of the note.

Qualified Distribution

The second inquiry involved the newly added 35% limitation on the use of certified capital to purchase treasury securities, investment-grade securities, guaranties, indemnities, bonds, or insurance policies or other payment undertakings. This provision was added to prevent a CAPCO from using too great a portion of its certified capital for the purpose of ensuring the repayment of its investors. It was clearly not intended to prevent a CAPCO from investing its capital in a safe and prudent manner pending the identification of suitable qualified investments.

The inquirer has suggested that the statute is best interpreted as permitting a CAPCO to invest more than 35% of its capital in U.S. treasuries provided that only 35% can be used for such investments that are solely held to ensure the repayment of the CAPCO’s certified investors. To hold otherwise would prohibit a CAPCO from utilizing safe and liquid investment vehicles for its investment funds during the period of time in which it is researching possible qualified investments. We agree that this is an impractical result. Therefore, a CAPCO may temporarily invest more than 35% of its certified capital in U.S. treasury securities and other investment grade securities provided that no more that 35% of the certified capital is held in such investments for the purpose of ensuring the repayment of the CAPCO’s certified investors.

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