KRS 304.7-419: Derivative transactions -- Hedging -- Income generation -- Counterparty

exposure amounts.

An insurer may, directly or indirectly through an investment subsidiary, engage in

derivative transactions under this section under the following conditions:

(1) (a) An insurer may use derivative instruments under this section to engage in

hedging transactions and certain income generation transactions, as these

terms may be further defined in regulations promulgated by the commissioner;

and

(b) An insurer shall be able to demonstrate to the commissioner the intended

hedging characteristics and the ongoing effectiveness of the derivative

transaction or combination of the transactions through cash flow testing or

other appropriate analyses.

(2) An insurer may ente r into hedging transactions under this section if, as a result of

and after giving effect to the transaction:

(a) The aggregate statement value of options, caps, floors, and warrants not

attached to another financial instrument purchased and used in hedgin g

transactions does not exceed seven and one-half percent (7.5%) of its admitted

assets;

(b) The aggregate statement value of options, caps, and floors written in hedging

transactions does not exceed three percent (3%) of its admitted assets; and

(c) The aggregate potential exposure of collars, swaps, forwards, and futures used

in hedging transactions does not exceed six and one -half percent (6.5%) of its

admitted assets.

(3) An insurer may only enter into the following types of income generation

transactions if, as a result of and after giving effect to the transactions, the aggregate

statement value of the fixed income assets that are subject to call or that generate

the cash flows for payments under the caps or floors, plus the face value of fixed

income securities underlying a derivative instrument subject to call, plus the amount

of the purchase obligations under the puts, does not exceed ten percent (10%) of its

admitted assets:

(a) Sales of covered call options on noncallable fixed income securities, c allable

fixed income securities if the option expires by its terms prior to the end of the

noncallable period, or derivative instruments based on fixed income

securities;

(b) Sales of covered call options on equity securities, if the insurer holds in its

portfolio, or can immediately acquire through the exercise of options,

warrants, or conversion rights already owned, the equity securities subject to

call during the complete term of the call options sold;

(c) Sales of covered puts on investments that the i nsurer is permitted to acquire

under this subtitle, if the insurer has escrowed or entered into a custodian

agreement segregating cash or cash equivalents with a market value equal to

the amount of its purchase obligations under the put during the complete term

of the put option sold; or

(d) Sales of covered caps or floors, if the insurer holds in its portfolio the

investments generating the cash flow to make the required payments under the

caps or floors during the complete term that the cap or floor is outstanding.

(4) An insurer shall include all counterparty exposure amounts in determining

compliance with the limitations of KRS 304.7-403.

(5) In accordance with administrative regulations promulgated under KRS 304.7 -367,

the commissioner may approve additional transactions involving the use of

derivative instruments in excess of the limits of subsection (2) of this section or for

other risk mana gement purposes under administrative regulations promulgated by

the commissioner, but replication transactions shall not be permitted for other than

risk management purposes.