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STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

David A. Paterson
Governor

Eric R. Dinallo
Superintendent

OGC Op. No. 09-06-02

The Office of General Counsel issued the following opinion on June 3, 2009 representing the position of the New York State Insurance Department.

Re: Qualified Counterparty and Investment Limits Under New York Insurance Law Section 1410(f)

Questions Presented:

1. Under the definition of the term “qualified counterparty” as set forth in Insurance Law §1410(f)(3)(A), does the requirement for a rating of AA-/Aa3 apply only to “other counterparties” and not to “qualified banks” and “qualified broker-dealers”?

2. If the answer to Question No. 1 is in the affirmative, to what ratings category of the “other counterparty” does the AA-/Aa3 requirement apply?

3. Can a bank or trust company that does not meet the AA or better ratings qualification of Insurance Law § 1410(f)(3)(C)(iv) be considered a “qualified counterparty” if it meets the requirements specified in the definition of “other counterparty” in Insurance Law §1410(f)(3)(A)?

4. Are transactions with qualified counterparties subject only to the 10% single entity investment limits of Insurance Law § 1409? Are there any aggregate investment limits that apply to qualified counterparties?

5. Should the 3% aggregate investment limit applicable to non-qualified counterparties set forth in Insurance Law §1410(f)(2)(B) be determined in accordance with the “credit risk” criteria described in Insurance Law §1410(f)(1), or the statement value and potential exposure criteria specified under Insurance Law §1410(f)(3)(D)?

6. Should the 1% investment limit applicable to a single non-qualified counterparty set forth in Insurance Law §1410(f)(2)(A) be determined in accordance with the “credit risk” criteria described in Insurance Law §1410(f)(1), or the statement value and potential exposure criteria established under Insurance Law §1410(f)(3)(D) with respect to aggregate investment limits?

Conclusions:

1. Yes. The AA-/Aa3 rating requirement set forth in Insurance Law §1410(f)(3)(A) applies only to the “other counterparties”, and not to “qualified banks” or “qualified broker-dealers”.

2. The AA-/Aa3 rating requirement applies to the issuer’s overall rating.

3. No. A bank or trust company that does not meet the AA or better ratings qualification of Insurance Law §1410(f)(3)(C)(iv) may not be considered a “qualified counterparty” by meeting the requirements specified in the definition of “other counterparties” in Insurance Law §1410(f)(3)(A).

4. Yes and no. The 10% single entity investment limit set forth in Insurance Law §1409 applies to transactions with qualified counterparties. There are no aggregate investment limits that apply to qualified counterparties.

5. & 6. As explained below, Insurance Law § 1410(f)(1) does not define a distinct “credit risk” criteria for determining investment limits. Insurance Law § 1410(f)(2) alone sets forth the investment limits, and provides that an insurer’s exposure to nonqualified counterparties is limited to 1% of its admitted assets for any single nonqualified counterparty, and a total of 3% of its admitted assets for all nonqualified counterparties. Counterparty exposure is defined by Insurance Law § 1410(f)(3)(D).

Facts:

The inquiry is general in nature, without reference to any particular facts.

Analysis:

Insurance Law § 1410(f) pertains to each of the queries. That statute provides:

(1) The counterparty exposure under a derivative instrument entered into by an insurer authorized to engage in transactions pursuant to this section shall be deemed to be an obligation of the institution to which the insurer is exposed to credit risk and shall be included in determining compliance with any single or aggregate quantitative limitation on investments made by an insurer under this chapter.

(2) Notwithstanding any single or aggregate quantitative limitation on investments made by an insurer under this chapter, the aggregate counterparty exposure under one or more derivative transactions to:

(A) any single counterparty, other than a "qualified counterparty", shall be limited to one percent of an insurer's admitted assets; and

(B) all counterparties, other than qualified counterparties, are limited to three percent of an insurer's admitted assets.

(3) For purposes of this section:
(A) a "qualified counterparty" is a "qualified broker or dealer" or a "qualified bank" or other counterparty rated AA-/Aa3 or higher by a nationally recognized statistical rating organization if it is also approved by the superintendent;
(B) a "qualified broker or dealer" means a broker or dealer that is organized under the laws of a state and is registered under the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78kk, and has net capital in excess of two hundred fifty million dollars;
(C) a "qualified bank" means a bank or trust company that:
(i) is organized and existing, or in the case of a branch or agency of a foreign banking organization is licensed, under the laws of the United States or any state thereof;
(ii) is regulated, supervised and examined by United States federal or state authorities having regulatory authority over banks and trust companies;
(iii) has assets in excess of five billion dollars;
(iv) has senior obligations outstanding, or has a parent corporation that has senior obligations outstanding, rated AA or better (or the equivalent thereto) by two independent nationally recognized statistical rating organizations; and
(v) has a ratio of primary capital to total assets of at least five and one-half percent and a ratio of total capital to total assets of at least six percent; and
(D) "aggregate counterparty exposure" means the sum of:
(i) the aggregate statement value of options, swaptions, caps, floors, and warrants purchased; and
(ii) the aggregate potential exposure of collars, swaps, forwards and futures entered into. (Emphasis added.)

Question 1 – Application of the AA-/Aa3 Requirement

With respect to the issue of qualified counterparties, the AA-/Aa3 rating requirement set forth in Insurance Law § 1410(f)(3)(A) applies only to the “other counterparties”, and not to “qualified banks” and “qualified broker-dealers”. Indeed, under a plain reading of the provision, the modifying phrase “rated AA-/Aa3  or higher” applies only to the term “other counterparty”.

Question 2 – Applicable Ratings Category

The second inquiry asks about the ratings category of an “other counterparty” to which the AA-/Aa3 applies. The Insurance Law expressly refers to specific ratings categories where applicable. See, e.g., Insurance Law § 1404(a)(2)(A)(ii) (referring to obligations that are rated “A” or higher); Insurance Law § 1405(a)(7)(C)(ii)(II) (referring to United States banking institutions with a parent corporation having obligations that are rated in one of the two highest categories); Insurance Law § 1410(f)(3)(C)(iv) (referring to senior obligations outstanding rated AA or better). An entity may have different ratings for its long-term, corporate obligations, its general issuer rating, a counterparty rating for derivative products, or a bank financial strength rating. But as used in Insurance Law §1410(f)(3)(A), the reference to AA-/Aa3 pertains to the overall rating of the counterparty, in that the statute makes no mention of any specific ratings category.

Question 3 – Qualification of a Bank or Trust Company as “other counterparties”

The third question asks whether a bank or trust company that does not meet the AA or better ratings qualification of Insurance Law § 1410(f)(3)(C)(iv) can be considered a “qualified counterparty if it meets the definition of “other counterparty” set forth in Insurance Law §1410(f)(3)(A). Even if a bank or trust company were to satisfy the requirements specified for “other counterparties”, it cannot be a “qualified counterparty” unless it meets the AA or better rating requirement of Insurance Law § 1410(f)(3)(C)(iv). To conclude otherwise would effectively read out of the statute the stricter requirement for “qualified banks”. Under normal rules of statutory construction, an interpretation that renders part or all of a statute without effect, or results in surplusage, should be rejected. See McKinney’s Statutes § 98(a); Majewski v. Broadalbin-Perth C.S.D., 91 N.Y.2d 577 (1998).

Question 4 – Application of the 10% Investment Limit of N.Y. Ins. Law § 1409

The fourth question asks whether transactions with qualified counterparties are subject only to the 10% single entity investment limitation set forth in Insurance Law §1409 and if there are any aggregate investment limits that apply to qualified counterparties. Insurance Law §1409(a) states that no domestic insurer shall have more than 10% of its admitted assets invested in (or loaned upon) the securities of any one institution. This 10% limit applies to transactions with qualified counterparties. The Insurance Law does not set forth a distinct investment limit for “qualified counterparties”. Accordingly, only the 10% limit of Insurance Law § 1409(a) applies to investments in “qualified counterparties”.

Questions 5 & 6 – Determination of the 3% Aggregate and 1% Single Counterparty Exposure Limits

The fifth and sixth questions ask how the 3% aggregate and 1% single counterparty exposure limits are determined. Insurance Law § 1410(f)(2) expressly limits an insurer’s exposure to nonqualified counterparties to 1% of its admitted assets for any single nonqualified counterparty, and a total of 3% of its admitted assets for all nonqualified counterparties. Counterparty exposure is defined by Insurance Law § 1410(f)(3)(D). Although that definition uses the term “aggregate counterparty exposure”, the definition applies to both the single (1%) and total (3%) limits. The “aggregate” in that definition refers to the aggregation of the various trades entered into, and not to multiple counterparties.

The inquiry suggests that Insurance Law § 1410(f)(1) establishes an alternative “credit risk criteria” for determining counterparty exposure limits. It does not. Rather, that section provides that in determining an insurer’s compliance with quantitative investment limits under the Insurance Law, counterparty derivative exposure must be included. That reading of Insurance Law §1410(f)(1) is supported by the statute’s legislative history. Indeed, a letter from First Deputy Superintendent Gregory V. Serio to Hon. James M. McGuire, Counsel to the Governor, dated July 3, 1998, reads in relevant part as follows:

Section 1410(f)(1) provides that, in determining compliance with any single and aggregate quantitative limitation on investments set forth in the Insurance Law, the counterparty exposure amounts with respect to derivative instruments must be included. For purposes of Article 14, these counterparty exposure amounts are deemed to be an obligation of the institutions to which the insurer is expose to credit risks.

Thus, Insurance Law § 1410(f)(1) ensures that derivative exposure to an entity is included as part of an insurer’s overall investment exposure to that entity. The statute does not establish alternative criteria for determining counterparty exposure limits.

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