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SS/SCS/SB 1009 - The act modifies Missouri law relating to the permissible investments of insurance companies in derivative instruments for hedging, income generation, and replication transactions, and in investment pools by non-insurance affiliates. The purpose of these proposals is to update Missouri investment laws so that Missouri insurance companies can remain competitive.

The proposed changes to Section 375.345, RSMo, are a comprehensive update to Missouri's existing law on derivatives based upon the NAIC Model law and Illinois law. Under the definitions, limitations and conditions contained in the proposed law, derivative transactions can only be used for prudent reduction of risk and not to increase risk or for speculative purposes.

This act defines the various types of derivative transactions including a "hedging transaction" (used to protect against changes in value of assets and liabilities or to generate income or enhance return - Section 375.345.1 (12)), and "replication transaction" (used to replicate the investment characteristics of another investment - Section 375.345.1(18)).

The most common type of derivative transaction is hedging, which is used to protect against changes in the interest rates or values associated with another asset held by the company. Under this act, to engage in derivative transactions, an insurance company must be prepared to:

(1) Demonstrate to the Director the intended hedging characteristics and effectiveness of the derivative transaction;

(2) Maintain its position in any outstanding derivative transaction for as long as the hedging transaction continues to be effective;

(3) Include all counterparty exposure amounts in compliance with the single-entity investment limitations contained in Missouri law;

(4) Comply with any additional conditions imposed by the Director by regulation; and

(5) Have the policies and record-keeping procedures approved by its Board of Directors (Section 375.345.2)

As an additional safeguard, Section 375.345.2(3), (4) and (5) contain the following quantitative limits on the ownership of derivatives:

(1) With respect to hedging transactions: purchased options, caps, floors and warrants can not exceed 7 1/2 percent of admitted assets; written options, caps and floors can not exceed 3 percent of admitted assets; and collars swaps, forwards and futures can not exceed 6 1/2 percent of admitted assets;

(2) With respect to income generation transactions, the limit of 10% of admitted assets; and

(3) With respect to replication transactions the limits are the same as those that apply to the replicated asset or investment.

The proposed change to Section 376.311, RSMo, authorizes a business entity affiliated with an insurer to invest in qualified investment pools under the same conditions that apply to the insurer. Under the current law only affiliated insurers can invest in qualified investment pools. This change is consistent with the current NAIC Model Law.

STEPHEN WITTE