CHAPTER 93 HOUSE BILL No. 2473 An Act concerning life insurance companies; relating to replication transactions; amending K.S.A. 40-2b25 and repealing the existing section. Be it enacted by the Legislature of the State of Kansas:

      Section  1. K.S.A. 40-2b25 is hereby amended to read as follows: 40-
2b25. (a) Any life insurance company heretofore or hereafter organized
under any law of this state may use financial instruments under this sec-
tion to engage in hedging transactions, replication transactions and cer-
tain income generation transactions or as these terms may be further
defined in regulations promulgated by the commissioner. The For each
hedging transaction in which a life insurance company engages, such life
insurance company shall be able to demonstrate to the commissioner the
intended hedging characteristics and the ongoing effectiveness of the fi-
nancial instrument transaction or combination of the transactions through
cash flow testing or other appropriate analysis.

      (b) As used in this section:

      (1) ``Cap'' means an agreement obligating the seller to make pay-
ments to the buyer, each payment based on the amount by which a ref-
erence price or level or the performance or value of one or more under-
lying interest exceeds a predetermined number, sometimes called the
strike rate or price.

      (2) ``Collar'' means an agreement to receive payments as the buyer
of an option, cap or floor and to make payments as the seller of a different
option, cap or floor.

      (3) ``Commissioner'' means the commissioner of insurance as defined
in K.S.A. 40-102 and amendments thereto.

      (4) ``Counterparty'' means the business entity with which a life in-
surance company enters into financial instrument transactions.

      (4) (5) ``Crediting basis amount'' means the amount of interest cred-
ited to an insured's account value for the percentage of change on an
underlying index.

      (5) (6)  (A) ``Financial instrument'' means an agreement, option, in-
strument or any series or combination thereof:

      (i) 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

      (ii) which 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.

      (B) Financial instruments include options, warrants, caps, floors, col-
lars, swaps, forwards, future and any other agreements, options or instru-
ments substantially similar thereto, or any series or combination thereof.

      (6) (7) ``Financial instrument transaction'' means a transaction in-
volving the use of one or more financial instruments.

      (7) (8) ``Floor'' means an agreement obligating the seller to make
payments to the buyer in which each payment is based on the amount
that a predetermined number, sometimes called the floor rate or price,
exceeds a reference price, level, performance or value of one or more
underlying interests.

      (8) (9) ``Forward'' means an agreement (other than a future) to make
or take delivery of, or effect a cash settlement based on the actual or
expected price, level, performance or value of one or more underlying
interests.

      (9) (10) ``Future'' means an agreement traded on a qualified
exchange, to make or take delivery of, or effect a cash settlement based
on the actual or expected price, level, performance or value of one or
more underlying interests.

      (10) (11) ``Hedging transaction'' means a financial instrument trans-
action which is entered into and maintained to reduce:

      (A) The risk of a change in the value, yield, price, cash flow or quan-
tity of assets or liabilities which the insurer has acquired or incurred or
anticipates acquiring or incurring; or

      (B) the currency exchange-rate risk or the degree of exposure as to
assets or liabilities which an insurer has acquired or incurred or anticipates
acquiring or incurring.

      (11) (12) ``Income generation transaction'' means a financial instru-
ment transaction involving the writing of covered call options which is
intended to generate income or enhance return.

      (12) (13) ``Option'' means an agreement giving the buyer the right to
buy or receive, sell or deliver, enter into, extend or terminate, or effect
a cash settlement based on the actual or expected price, level, perform-
ance or value of one or more underlying interests.

      (13) (14) ``Potential exposure'' means:

      (A) As to a futures position, the amount of the initial margin required
for that position; or

      (B) as to swaps, collars and forwards, .5% times the notional amount
times the square root of the remaining years to maturity.

      (15) ``Replication transaction'' means a financial instrument trans-
action or combination of financial instrument transactions effected either
separately or in conjunction with cash market investments included in a
life insurance company's investment portfolio in order to replicate the
investment characteristic of another authorized transaction, investment
or instrument or operate as a substitute for cash market transactions. A
financial instrument transaction entered into by a life insurance company
as a hedging transaction, as defined in paragraph (11), or income gen-
eration transaction, as defined in paragraph (12), authorized pursuant to
this section shall not be considered a replication transaction.

      (14) (16) ``SVO'' means the securities valuation office of the national
association of insurance commissioners or any successor office established
by the national association of insurance commissioners.

      (15) (17) ``Swap'' means an agreement to exchange for net payments
at one or more times based on the actual or expected price, level, per-
formance or value of one or more underlying interests.

      (16) (18) ``Underlying index'' means the index, market or financial
futures contract used to determine the crediting basis amount.

      (17) (19) ``Underlying interest'' means the assets, other interests, or
a combination thereof, underlying a financial instrument, such as any one
or more securities, currencies, rates, indices, commodities or financial
instruments.

      (18) (20) ``Warrants'' means an option to purchase or sell the under-
lying securities or investments at a given price and time or at a series of
prices and times outlined in the warrant agreement. Warrants may be
issued alone or in connection with the sale of other securities, as part of
a merger or recapitalization agreement, or to facilitate divestiture of the
securities of another corporation.

      (c) A life insurance company may enter into financial instrument
transactions for the purpose of hedging except that the transaction shall
not cause any of the following limits to be exceeded:

      (1) The aggregate statement value of options, caps, floors and war-
rants not attached to any other security or investment purchase in hedging
transactions may not exceed 110% of the excess of such insurer's capital
and surplus as shown on the company's last annual or quarterly report
filed with the commissioner of insurance over the minimum requirements
of a new stock or mutual company to qualify for a certificate of authority
to write the kind of insurance which the insurer is authorized to write;

      (2) the aggregate statement value of options, caps and floors written
in hedging transactions may not exceed 3% of the life insurance com-
pany's admitted assets; and

      (3) the aggregate potential exposure of collars, swaps, forwards and
futures used in hedging transactions may not exceed 5% of the life in-
surance company's admitted assets.

      (d) A life insurance company may enter into the following types of
income generation transactions if:

      (1) Selling covered call options on noncallable fixed income securities
or financial instruments based on fixed income securities, but the aggre-
gate statement value of assets subject to call during the complete term of
the call options sold, plus the face value of fixed income securities un-
derlying any financial instrument subject to call, may not exceed 10% of
the life insurance company's admitted assets; and

      (2) selling covered call options on equity securities, if the life insur-
ance company holds in its portfolio the equity securities subject to call
during the complete term of the call option sold.

      (e) A life insurance company may enter into replication transactions
if:

      (1) Such life insurance company would otherwise be authorized to
invest its funds under this article in the asset being replicated;

      (2) the asset being replicated is subject to all provisions and limitation
(including quantitative limits) on the making thereof specified in this ar-
ticle with respect to investments by such life insurance company, as if the
transaction constituted a direct investment by such life insurance com-
pany in the asset being replicated;

      (3) as a result of giving effect to the replication transaction, the ag-
gregate statement value of all assets being replicated does not exceed 10%
of such life insurance company's admitted assets; and

      (4) the replication transaction is entered into in accordance with the
requirements concerning replication transactions contained in the SVO
purposes and procedures manual of the SVO entitled ``Purposes and pro-
cedures manual of the securities valuation office of the national association
of insurance commissioners'' as published on December 31, 1999, or any
later version as established in rules and regulations adopted by the com-
missioner.

      (f) The limitations set forth in subsection (c) regarding financial in-
strument transactions for the purpose of hedging and in subsection (d)
regarding income generation transactions shall not apply to any invest-
ments made by a life insurance company where such investments are
used only to hedge the crediting basis amount an insured receives on a
particular insurance policy which is determined by an underlying index,
provided, however, that such investments shall not in the aggregate
amount exceed 10% of the life insurance company's admitted assets as
shown on the company's last annual or quarterly report, without the prior
written approval of the commissioner of insurance. All investments made
pursuant to this subsection shall only be made with counterparties that
have a rating designated as ``1'' by the national association of insurance
commissioners (NAIC) in its most recently published valuations of se-
curities manual or supplement thereto, or its equivalent rating by a na-
tionally recognized statistical rating organization recognized by the SVO.

      (f) (g) Upon request of the life insurance company, the commissioner
may approve additional transactions involving the use of financial instru-
ments in excess of the limits of subsection (c) or for other risk manage-
ment purposes, excluding replication transactions, pursuant to regulations
promulgated by the commissioner.

      (g) (h) For the purposes of this section, the value or amount of an
investment acquired or held under this section, unless otherwise specified
in this code, shall be the value at which assets of an insurer are required
to be reported for statutory accounting purposes as determined in ac-
cordance with procedures prescribed in published accounting and valu-
ation standards of the national association of insurance commissioners
(NAIC), including the purposes and procedures of the securities valuation
office, the valuation of securities manual, the accounting practices and
procedures manual, the annual statement instructions or any successor
valuation procedures officially adopted by the NAIC.

      (h) (i) Prior to engaging in transactions in financial instruments, an
insurer shall develop and adequately document policies and procedures
regarding investment strategies and objectives, recordkeeping needs and
reporting matters. Such policies and procedures shall address authorized
investments, investment limitations, authorization and approval proce-
dures, accounting and reporting procedures and controls and shall pro-
vide for review of activity in financial instruments by the insurer's board
of directors or such board's designee.

      Recordkeeping systems must be sufficiently detailed to permit internal
auditors and insurance department examiners to determine whether op-
erating personnel have acted in accordance with established policies and
procedures, as provided in this section. Insurer records must identify for
each transaction the related financial instruments contracts.

      (j) The commissioner shall have the authority to adopt rules and reg-
ulations necessary to implement this section.

 Sec.  2. K.S.A. 40-2b25 is hereby repealed.
 Sec.  3. This act shall take effect and be in force from and after its
publication in the statute book.

Approved April 6, 2001.
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