The Office of General Counsel issued the following informal opinion on April 9, 2002, representing the position of the New York State Insurance Department.
Re: Derivative Investments by an Accredited Reinsurer
1. If ABC Life Insurance Corp. ("ABC Life") wants to write covered call options on certain equity investments, must it file a Derivative Use Plan ("DUP") with the New York State Insurance Department?
2. If the options in question are sold in a separate account, would ABC Life still be required to file a DUP?
1. Yes, as an accredited reinsurer, ABC Life is subject to the New York Insurance Laws and Regulations governing investments in derivatives.
2. No, separate account transactions are not subject to the rules governing insurance company investments in derivatives.
ABC Life is a life insurer domiciled in Nebraska. It is not licensed to sell insurance in New York, but it is an accredited reinsurer in New York. At present, ABC Life does not engage in derivative transactions, but is considering the possibility of writing covered calls on certain equity investments.
Investments in derivative instruments by insurers is governed by N.Y. Ins. Law § 1410 (McKinney Interim Supp. 2001-2002) and Insurance Department Regulation 163, N.Y. Comp. Codes R. & Regs., tit. 11, § 178 (2001). As an accredited reinsurer, ABC Life is subject to these provisions. See, N.Y. Ins. Law § 1410(k), which provides as follows:
(k) Any foreign insurer engaging in derivative transactions and derivative instruments shall be subject to and comply with all the provisions of this section. However, a foreign insurer may engage in derivative transactions not authorized by this section provided that:
(1) such insurer is authorized to engage in such transactions pursuant to its domestic state law;
(2) such insurer includes the intent to engage in such derivative transactions in the derivative use plan submitted to and approved by the superintendent pursuant to paragraph three of subsection (b) of this section;
(3) the transactions are not deemed, by the superintendent, to be potentially detrimental to the policy holders or the public in this state; and
(4) the insurer complies with subsection (a) of section one thousand four hundred thirteen of this article after the surplus to policyholders is reduced by the amount of all derivative transactions not authorized by this section in accordance with the measurement standards of paragraph one of subsection (c) of this section.
For purposes of this subsection, a foreign insurer shall include foreign insurers as defined in paragraph twenty-one of subsection (a) of section one hundred seven of this chapter, foreign fraternal benefit societies, and accredited reinsurers. (emphasis supplied)
A call option gives the owner of the option the right to buy a given stock or security. In a covered call option, the writer or seller of the option owns the underlying stock on which the call is written. The writing of covered calls on equity investments is regarded as a derivative transaction for purposes of the New York Insurance Law. N.Y. Ins. Law §§ 1401(a)(7) and (13) provide as follows:
(7) "Derivative instrument" means an agreement, option, instrument or a series or combination thereof:
(A) to make or take delivery of, or assume or relinquish, a specified amount of one or more underlying interests, or to make a cash settlement in lieu thereof; or
(B) that has a price, performance, value or cash flow based primarily upon the actual or expected price, level, performance, value or cash flow of one or more underlying interests.
(C) The term "derivative instrument" includes options, warrants, caps, floors, collars, swaps, swaptions, forwards, and futures.
(13) "Option" means an agreement giving the buyer the right to buy or receive (a "call option"), sell or deliver (a "put option"), enter into, extend or terminate or effect a cash settlement based on the actual or expected price, spread, level, performance or value of one or more underlying interests.
Under the above-quoted provisions, if ABC Life were to engage in the writing of covered calls, it would be required to file a derivative use plan ("DUP") with the New York Insurance Department.
The second inquiry envisioned the writing of covered calls on securities held by a separate account. In such a case, a DUP would not have to be filed by ABC Life. This is because investments allocated to a separate account are generally not subject to the provisions of the New York Insurance Law governing investments by insurance companies. N. Y. Ins. Law § 4240(a) (McKinney 2000) provides, in pertinent part, as follows:
(2) With respect to investments allocated to a separate account: (A) except as provided in paragraphs three and five of this subsection, the insurer may invest in any investments contractually permitted for such separate account, the restrictions, limitations and other provisions relating to investments specified in this chapter shall not apply to such investments, and such investments shall be disregarded, and shall be excluded from admitted assets, in applying the quantitative investment limitations contained in this chapter to other investments .
None of the exceptions referenced in the above-quoted provision impact upon the issue in question herein.
In summary, the proposed writing of covered call options by ABC Life directly would necessitate the filing of a DUP by the company. The writing of such options on equities held in a separate account would not.
For further information you may contact Supervising Attorney Michael Campanelli at the New York City Office.