The Office of General Counsel issued the following opinion on May 3, 2005 representing the position of the New York State Insurance Department.

Re: Collateral Trust Arrangement

Questions Presented:

1) Does the designation of a counterparty as a beneficiary of the Collateral Trust, and the grant of a security interest by the Collateral Trust to such counterparty, constitute the provision or writing of financial guaranty (or any other kind) of insurance under New York law?

2) Will XYZ Co., the Funding Trust or the Collateral Trust be considered to be engaged in the business of insurance by virtue of the designation of a counterparty as beneficiary of the Collateral Trust and the grant of a security interest by the Collateral Trust to such counterparty?

3) Is there any basis in the Insurance Law for the position that a counterparty’s status as a beneficiary of the Collateral Trust and as the holder of a security interest would not be enforceable in accordance with their terms?

4) Will any of XYZ Co., the Funding Trust, or the Collateral Trust (or their stockholders, beneficiaries, owners, partners, directors, officers, employees or agents) be deemed to be (and require licensing as) insurance agents, agencies, brokers, producers, consultants, advisors, administrators, solicitors, service representatives, surplus lines agents, reinsurance intermediaries, managing general agents, supervisory general agents or the like under the New York Insurance Law by virtue of their activities in connection with the designation of a counterparty as a beneficiary of the Collateral Trust and the grant of a security interest by the Collateral Trust to such counterparty?

Conclusions:

1) No, the designation of a counterparty as a beneficiary of the Collateral Trust and the grant of a security interest by the Collateral Trust to such counterparty does not constitute the provision or writing of financial guaranty (or any other kind) of insurance under New York law.

2) No, neither XYZ Co., the Funding Trust nor the Collateral Trust will be considered to be engaged in the business of insurance by virtue of the designation of a counterparty as beneficiary of the Collateral Trust and the grant of a security interest by the Collateral Trust to such counterparty.

3) No, there is no basis in the Insurance Law for the position that a counterparty's status as a beneficiary of the Collateral Trust and as the holder of a security interest would not be enforceable in accordance with their terms.

4) Neither XYZ Co., the Funding Trust, nor the Collateral Trust (nor their stockholders, beneficiaries, owners, partners, directors, officers, employees or agents) will be deemed to be (or require licensing as) insurance agents, agencies, brokers, producers, consultants, advisors, administrators, solicitors, service representatives, surplus lines agents, reinsurance intermediaries, managing general agents, supervisory general agents or the like under the New York Insurance Law by virtue of their activities in connection with the designation of a counterparty as a beneficiary of the Collateral Trust and the grant of a security interest by the Collateral Trust to such counterparty.

Facts:

A letter sent to the Department described the transaction in question as follows:

A Collateral Trust Structure would be utilized by certain corporations seeking to reduce their reliance on credit facilities for the provision of letters of credit or for general liquidity needs. The Collateral Trust Structure would create a new source of funding for corporate clients requiring collateral arrangements and, as a result, would free-up working capital capacity under existing credit facilities. The initial set-up and function of the Collateral Trust Structure is described in more detail below.

A corporation or other entity ("XYZ Co.") would establish a Delaware statutory trust (the "Collateral Trust") by granting a nominal amount to the trust pursuant to the terms of a trust agreement. A second Delaware statutory trust (the "Funding Trust") would also be established and would raise $500,000,000 by issuing trust certificates to U.S. institutional investors (the "Investors") through a Rule 144A Offering. The Funding Trust would pay the Investors a rate set at pricing (estimated to be approximately 5% per annum), which would be derived from income generated by the Portfolio (as defined below) and amounts received by the Funding Trust as payment under the Put Option Agreement (as defined below). In addition, XYZ Co. and the Funding Trust would enter into a put option agreement pursuant to which XYZ Co. would have the right to sell to the Funding Trust specified senior debt securities issued by XYZ Co. (the "XYZ Senior Debt Securities") at a specified amount and at a specified price either at will or upon a draw by a Counterparty (as defined below) from the Collateral Trust (the "Put Option Agreement"). Under the terms of the Put Option Agreement, XYZ Co. would be required to make monthly payments to the Funding Trust, which amount is estimated at 100 basis points (bps) per annum. XYZ Co. would also be required to reimburse the Funding Trust for the expenses of the Funding Trust, which amount is estimated at a maximum of 10 bps per annum.

The Funding Trust would contribute the proceeds of the Rule 144A Offering to the Collateral Trust, which, in turn, would invest the proceeds into a diversified high quality investment portfolio within specified investment guidelines (the "Portfolio"). It is expected that the Portfolio would earn a yield of approximately 4% per annum. The income generated by the Portfolio would be distributed by the Collateral Trust to the Funding Trust. The Funding Trust would beneficially own the assets in the Collateral Trust until the put option is exercised by XYZ Co. under the Put Option Agreement, as more fully described below.

An entity with which XYZ Co. does business, and for which XYZ Co. has some form of collateralization obligation, would become a beneficiary of the Collateral Trust (the "Counterparty"). In addition, XYZ Co., as a grantor of the Collateral Trust, would have the right, unconditionally and at all times, to direct the Collateral Trust to grant a first priority perfected security interest in the Collateral Trust to such Counterparty (the "Security Interest"). In the event that XYZ Co. intends to collateralize its obligations to multiple Counterparties utilizing a single Collateral Trust, this could be accomplished in various ways, including, but not limited to, granting security interests in different assets in the Collateral Trust, segregating the assets in the Collateral Trust for the benefit of each Counterparty and/or utilizing a series trust.

In the event that a Counterparty forecloses on its Security Interest, the following transactions would take place. First, the Portfolio would be redeemed or sold for cash equal to the amount to be drawn by such Counterparty on the Collateral Trust, up to a maximum of $500,000,000.1   Second, the Collateral Trust would transfer the proceeds from the sale or redemption of the Portfolio to the Counterparty. Simultaneously with the foregoing and pursuant to the terms of the Put Option Agreement, the Funding Trust would subscribe for a specified amount of XYZ Senior Debt Securities, which would have an aggregate par value equal to the amount of proceeds paid to the Counterparty by the Collateral Trust. The floating rate coupon on the XYZ Senior Debt securities would be equal to the floating rate amounts previously paid by the Funding Trust to the Investors. Further, the Collateral Trust could be replenished if XYZ Co. redeems the XYZ Senior Debt securities from the Funding Trust and the Funding Trust contributes the cash back into the Collateral Trust.

Analysis:

N. Y. Ins. Law § 1101(a)(1) (McKinney 2000) defines "insurance contract" as follows:

"Insurance contract" means any agreement or other transaction whereby one party, the "insurer", is obligated to confer benefit of pecuniary value upon another party, the "insured" or "beneficiary", dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event.

Financial guaranty insurance is covered by Article 69 of the New York Insurance Law, which defines financial guaranty insurance, in pertinent part, as follows:

"Financial guaranty insurance" means a surety bond, an insurance policy or, when issued by an insurer or any person doing an insurance business as defined in paragraph one of subsection (b) of section one thousand one hundred one of this chapter, an indemnity contract, and any guaranty similar to the foregoing types, under which loss is payable, upon proof of occurrence of financial loss, to an insured claimant, obligee or indemnitee as a result of any of the following events:

(A) failure of any obligor on or issuer of any debt instrument or other monetary obligation (including equity securities guarantied under a surety bond, insurance policy or indemnity contract) to pay when due to be paid by the obligor or scheduled at the time insured to be received by the holder of the obligation, principal, interest, premium, dividend or purchase price of or on, or other amounts due or payable with respect to, such instrument or obligation, when such failure is the result of a financial default or insolvency or, provided that such payment source is investment grade, any other failure to make payment, regardless of whether such obligation is incurred directly or as guarantor by or on behalf of another obligor that has also defaulted;

(B) changes in the levels of interest rates, whether short or long term or the differential in interest rates between various markets or products;

(C) changes in the rate of exchange of currency;

(D) changes in the value of specific assets or commodities, financial or commodity indices, or price levels in general; or

(E) other events which the superintendent determines are substantially similar to any of the foregoing.

N.Y. Ins. Law § 6901(a) (McKinney Supp. 2005).

The central purpose of the inquiry is to ascertain whether or not the arrangement described above or any of its constituent parts constitutes the doing of an insurance business, particularly, the business of financial guaranty insurance. Based on a review of the details provided and the analysis of the same, we conclude that the arrangement is not an insurance transaction. There is no transfer of risk and no promise to pay in the event of the occurrence of a fortuitous event under the arrangement. Rather, the arrangement is a method for raising capital to be held in trust as collateral; similar in some respects, as noted, to the holding of assets for the repayment of reinsurance recoverables in a Regulation 114 Trust. This similarity does not, however, render the arrangement an insurance transaction.

Accordingly, neither XYZ Co., the Funding Trust, nor the Collateral Trust are viewed as doing an insurance business of any kind and no personnel associated with any of the above are viewed as requiring licensure by the Department with respect to any of their activities in connection with the operation of the arrangement as described.

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

1  It was stated that the amounts and percentages used in the description of the Collateral Trust Structure are for illustrative purposes only.