BILL NUMBER:S2713A

TITLE OF BILL:
An act
to amend the insurance law, in relation to the treatment of
qualified financial
contracts in an insurance insolvency proceeding affecting a domestic,
foreign or alien insurer

PURPOSE:
The purpose of this bill is to increase the certainty of
insurers and their creditors with respect to the enforceability of
certain financial market transactions and related netting agreements
in the event of insurer insolvency. Insurance companies are
significant users of these financial market contracts (called
"qualified financial contracts" in the Bill), including derivatives,
securities lending, repurchase agreements, futures contracts and
other financial instruments. These contracts are typically documented
under master agreements providing for netting of obligations between
the parties. The agreements also establish a right of the
non-defaulting party to close out, liquidate and terminate the
agreements immediately upon the insolvency of the other party and
provide for collateralization of obligations on a net, rather than
gross, basis. The importance of maintaining certainty among the
participants in these markets has been acknowledged and addressed
through changes in the Federal Bankruptcy Code, the Federal Deposit
              

Insurance Act, governing the bankruptcy of banks, and other federal
legislation and regulatory orders, as well as in the New York State
Banking Law and in the laws of major non-U.S. jurisdictions applicable
to the insurers' trading counterparties. All of these legal
structures recognize and enforce the netting and closeout provisions
of financial contract master agreements.

The only major category of financial and business institutions in the
U.S. which lack such certainty are insurance companies. This lack of
certainty threatens the ability of New York insurers to continue to
use these investment tools to manage their risks and remain
financially strong. Recent changes in the international capital rules
for banks under the Basel II accords, events in the financial markets
over the past year and the increasingly sophisticated risk control
methods of financial institutions have placed a spotlight on the lack
of protections for these contracts under the insurance laws of New
York and most other states. While a framework for such protection was
adopted by the NAIC in its Insurer Receivership Model Law (and a
predecessor model), only 6 states have thus far taken action to adopt
legislation validating these netting arrangements for insurers. This
bill, if adopted, will reduce uncertainty and risk to NY insurance
companies, as well as the banks, broker-dealers and other financial
institutions with which they deal and will also reduce systemic risks
to the financial markets. The bill will also redress the competitive
disadvantage of New York insurers vis-a-vis their competitors in
Connecticut and elsewhere
where netting legislation has been adopted.

SUMMARY OF PROVISIONS:


This Bill would add a new §7437 to Article 74
of the Insurance Law in regard to the following:

*Subsection (a) provides, for the purposes of Article 74 of the
insurance law, definitions of specific types of financial contracts
commonly used in the financial markets, including swap contracts,
repurchase agreements, forward contracts, commodity contracts and
security contracts as "qualified financial contracts" and the related
"netting contracts". These definitions are intended to be consistent
with those used under the Federal Deposit Insurance Act, applicable
to bank insolvencies, and are similar to those contained in §619 of
the New York banking law.

*Subsection (b) provides for the enforcement and recognition of the
contractual rights of the insurer's counterparties, other than an
insurer licensed to write financial guaranty insurance, under
qualified financial contracts, netting
agreements and related security arrangements to terminate, accelerate
and close out such contracts, to offset and net off obligations owing
under such contracts, and to enforce any security rights under such
agreements, free of any stay or prohibition which might otherwise
apply under Article 74.

*Subsection (c) provides for the transfer of any net or settlement
amount owing under a qualified financial contract by the
non-defaulting counter party to the insurer, other than an insurer
licensed to write financial guaranty insurance, to the superintendent
as liquidator, conservator or rehabilitator of the insurer. If netting
results in an amount owing to the insurer, this provision confirms
that the superintendent steps into the insurer's shoes with respect
to that net amount.

*Subsections (d) and (e) provide for the transfer of all financial
contracts between an insurer, other than an insurer licensed to write
financial guaranty insurance, and a single counterparty and its
affiliates together if a bulk transfer of insurer liabilities or
contracts is made by the superintendent.

*Subsection (f) provides for validation of payments and transfers of
money and property under netting agreements and qualified financial
contracts made prior to the commencement of a rehabilitation,
insolvency or conservation proceeding, unless such transfers were
made with actual intent to hinder, delay or defraud the insurer,
other than an insurer licensed to write financial guaranty insurance,
the superintendent or other creditors. Parties to "qualified
financial contracts" make payments and transfer collateral
continually through the life of the agreements. Subsection (f)
protects the creditor from the risk of "claw-back" of normal payment
and collateral transfers under these agreements during the statutory
preference period.

*Subsection (g) provides that, likewise, if the superintendent
disaffirms or repudiates any qualified financial contracts or netting
agreements with a counterparty, it must disaffirm or repudiate all
such contracts. The Bill also establishes the amount of the
counterparty's claim in the event of disaffirmance or repudiation.
These provisions secure the integrity of the netting provisions under


qualified financial contracts by protecting the insurer's
counterparties, other than an insurer licensed to write financial
guaranty insurance, from "selective enforcement," the practice of
keeping favorable contracts and rejecting unfavorable contracts.

This new section of the law would apply to contracts of both general
and separate accounts of insurers, and would be effective
immediately, except that it would not apply to any liquidation,
receivership or conservatorship proceedings that have previously been
commenced under Article 74.

JUSTIFICATION:
Recent turmoil in the financial markets have heightened
scrutiny, in the markets and among financial institutions about
identifying, managing and limiting risk, the need for adequate
capitalization and for understanding the interdependency of the
different financial sectors. One source of risk to financial market
participants has arisen due to the lack of certainty in the treatment of
financial intermediaries in the event of the insolvency of state
regulated insurers. Under the patchwork of state laws, only a handful
attempt to address the issue of certainty. This bill attempts to
correct this lack of clarity in New York insurance law by specifying
the status of "qualified financial contracts" in an insurance
insolvency proceeding. This amendment brings New York's insurance law
into conformance with similar provisions of the state banking code,
the Federal bankruptcy law and the NAIC Insurance Receivership Model
Act (IRMA).

As defined in this Bill, "Qualified Financial Contracts" encompass a
range of commonly traded financial market contracts, including
over-the-counter and exchange traded derivatives, such as swaps,
forwards and futures contracts, securities contracts, including
securities lending arrangements and options, repurchase (repo) and
reverse repurchase agreements. What these transactions have in
common is that they are time sensitive, normally valued based on
current market prices and traded repetitively and continuously
between financial market participants.
Trading in these contracts frequently involves chains of transactions,
with intermediary institutions aggregating and transferring risk and
providing liquidity to financial institutions and markets.

Because of the key role played by these transactions in facilitating
financial market functioning, the Federal Bankruptcy Code and other
laws regulating market participants have been revised to provide
special treatment for these transactions. For example, the
legislative history of the Bankruptcy Code states that these
obligations warranted a degree of finality at the outset of
bankruptcy in order to prevent uncertainty in a marketplace where
trading is continuous and often transactional. Other regulators have
noted the important liquidity function in the
financial markets played by these contracts and their providers and
the financial systemic risks that a lack of certainty in these
contracts could cause, including the potential for chain insolvencies.

The use of netting agreements for financial market contracts has
evolved from common law setoff and recoupment law. Netting reduces
the credit risk between two parties by offsetting of mutual


obligations and liabilities. Qualified transactions are typically
entered into under master agreements, which allow the execution of
multiple individual transactions and the close-out or termination of
all of these transactions upon the occurrence of an event of default,
including insolvency. Following the termination of the
transactions, the close-out amount, representing the total lost value
to one of the parties for terminating the transactions prior to their
stated maturity is calculated for each individual transaction. Since
a party may be "in the money" on some transactions and "out of the
money" on others, such amounts are then netted against one another,
creating a single net amount owing from one party to another.

The power of netting agreements to reduce credit exposure and risk
from these financial market contracts can be illustrated with a
simple example:

Under a single netting agreement, Party A and Party B have entered
into 10 contracts. There are 5 contracts under which Party A owes
money to Party B - worth $1000. There are 5 contracts under which
Party B owes Party A money - worth $800. If this contract is
terminated, a net amount owing is calculated: Party A owes Party B a
net amount of $200.

Collateral arrangements normally included in the netting agreements
further reduce exposure of market participants.
Under these contracts, collateral is computed and collected, based on
the "net" exposure. If enforceable these agreements potentially
dramatically reduce the credit exposure of financial institutions to
each other that are inherent to these financial market transactions
and the risk that the default or insolvency of an institution could
have on the financial system. Therefore, the importance of clarifying
enforceability of these agreements is great.

Netting can also involve the setoff of securities, whether as a true
setoff (as in the case of repurchase or securities lending
agreements) or as foreclosure on collateral (as in the case of cash
or securities held to secure derivative transactions.) The ability of
an institution to set off or to sell securities to immediately
satisfy a claim against an insolvent counterparty is critical not
only to reduce the parties' credit risk but to maintain liquidity in
the securities markets, since many of these transactions are part of
a whole chain of interlocking trades. The imposition of a stay on the
liquidation of these securities, as is normally the case in a New
York insurer insolvency proceeding, could result in uncertainty,
gridlock or a chain of insolvencies.

Finally, financial market transactions are usually valued,
collateralized and traded based on current market prices, and credit
exposures are calculated or managed on this basis. Any legal
uncertainty which affects the ability to make exposure calculations,
any delay or uncertainty around the time of payment or any subsequent
legal determinations in an insolvency proceeding which might overturn
the previously calculated credit exposures undermine the
effectiveness of these contractual provisions and procedures and the
certainty they provide in the market.


This bill would substitute the needed certainty and reliability to
enforcement of these important contractual protections for the
current state of doubt and unpredictability which currently prevails
under the New York insolvency laws.

Qualified financial contracts are widely used by insurers, largely for
hedging purposes. They have proven to be of great assistance to
insurers during the recent market downturn. Derivative instruments
are used for hedging risks, for asset/liability management and for
creation of synthetic asset exposures in the insurer's investment
operations. The Legislature recognized the importance of this
activity in granting New York insurers' derivative authority in 1998
under § 1410 of the insurance law and making that law permanent.
Pursuant to that law, insurers' use of these types
of instruments are largely limited to hedging purposes and are
strictly governed by derivative use plans that are filed with and
approved by the New York State Insurance Department. These Plans must
be re-filed with the Insurance Department when updated and are
required to be audited annually by an independent auditing firm.

The New York insurance industry's continued access to these
instruments, on favorable terms, is threatened by recent developments
in the financial markets. In particular, implementation of the Basel
II accords intensifies the pressure on insurers and their major
counterparties. Basel II has currently been implemented in Europe and
is in the process of implementation for major US banks through their
regulation by the Federal Reserve and Office of Comptroller of the
Currency, and for major investment banking organizations through
consolidated regulation by the Securities Exchange Commission. Under
Basel II, regulated institutions will be required to maintain
significant additional capital for its derivatives transactions and
other financial contracts with parties with which it does not have a
legally enforceable netting agreement, including the ability to close
out upon insolvency without being affected by any stay.

Without the certainty sought through the amendment of New York law
proposed in the Bill it will become difficult for the counterparties
of NY insurers to obtain the necessary legal comfort to transact
business with New York insurers. The consequence for the domestic
companies will be increasingly poor pricing for their transactions,
and potentially, lack of equal access to these financial markets. An
inability to continue to trade or a deterioration of the prices at
which insurers can transact, potentially threatens the competitiveness
and financial strength of New York companies.

By providing for the enforcement of netting and closeout rights for
"qualified financial contracts" in an insurer insolvency, New York
will be bringing its insurer insolvency law into harmony with federal
law as well as the New York banking law and will give both insurers
and their creditors the certainty and safety they need to continue to
transact business.

LEGISLATIVE HISTORY:
S.4772 of 2009-10.

FISCAL IMPLICATIONS:
None to the state.


EFFECTIVE DATE:
This act will take effect immediately, except that
section one will only apply to a liquidation, rehabilitation or
conservation proceeding that commences under article 74 of the
insurance law on or after the effective date.