Administrative Rules of the State of Montana

BEFORE THE STATE AUDITOR AND COMMISSIONER OF INSURANCE

OF THE STATE OF MONTANA

In the matter of the adoption of NEW RULES I through VI, regarding Insurer Investments in Derivative Instruments

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NOTICE OF PUBLIC HEARING ON PROPOSED ADOPTION

TO: All Concerned Persons

1. On June 16, 2011, at 10:00 a.m., the Commissioner of Insurance, Office of the State Auditor, Monica Lindeen, will hold a public hearing in the 2nd floor conference room, at the State Auditor's Office, 840 Helena Ave., Helena, Montana, to consider the proposed adoption of the above-stated rules.

2. The Commissioner of Insurance, Office of the State Auditor, Monica Lindeen, will make reasonable accommodations for persons with disabilities who wish to participate in this public hearing, or need an alternative accessible format of this notice. If you require an accommodation, contact the department no later than 5:00 p.m., June 9, 2011, to advise us of the nature of the accommodation that you need. Please contact Darla Sautter, State Auditor's Office, 840 Helena Avenue, Helena, Montana, 59601; telephone (406) 444-2726; TDD (406) 444-3246; fax (406) 444-3499; or e-mail [email protected].

3. The new rules proposed to be adopted provide as follows:

NEW RULE I PURPOSE (1) The purpose of these rules is to establish standards for the prudent use of derivative instruments by insurers in accordance with Title 33, chapter 12, MCA regarding insurer investments.

AUTH: 33-1-313, 33-12-111, MCA

IMP: 33-12-210, 33-12-310, MCA

New Rule II Definitions The words and phrases used in these rules have the same meaning as in 33-12-102, MCA, unless a different meaning is required by the context of the particular rule.

AUTH: 33-1-313, 33-12-111, MCA

IMP: 33-12-210, 33-12-310, MCA

New Rule III Guidelines and Internal Control Procedures

(1) Before engaging in a derivative transaction, an insurer shall establish written guidelines, approved by the commissioner, that shall be used for effecting and maintaining derivative transactions. The guidelines shall:

(a) specify the insurer's objectives for engaging in derivative transactions, derivative strategies, and all applicable risk constraints, including credit risk limits;

(b) establish counterparty exposure limits and credit equity standards;

(c) identify permissible derivative transactions and the relationship of those transactions to insurer operations; for example, a precise identification of the risks being hedged by a derivative transaction; and

(d) require compliance with internal control procedures.

(2) An insurer shall have a written methodology for determining whether a derivative instrument used for hedging has been effective.

(3) An insurer shall have written policies and procedures describing the credit risk management process and a credit risk management system for over-the-counter derivative transactions that measures credit risk exposure using the counterparty exposure amount.

(4) An insurer's board of directors shall, in accordance with 33-12-104, MCA:

(a) approve the written guidelines, methodology, polices and procedures, and systems required by this rule;

(b) determine whether the insurer has adequate professional personnel, technical expertise, and systems to implement investment practices involving derivatives;

(c) review whether derivatives transactions have been made in accordance with the approved guidelines, and consistent with the stated objectives; and

(d) take action to correct any deficiencies in internal controls relative to derivative transactions.

AUTH: 33-1-313, 33-12-111, MCA

IMP: 33-12-210, 33-12-310, MCA

New Rule IV Commissioner Approval (1) Written documentation explaining the insurer's internal guidelines and controls governing derivative transactions shall be submitted for approval to the commissioner. The commissioner shall have the authority to disapprove the guidelines and controls proposed by the insurer if the insurer cannot demonstrate the proposed internal guidelines and controls would be adequate to manage the risks associated with the derivative transactions the insurer intends to engage in.

AUTH: 33-1-313, 33-12-111, MCA

IMP: 33-12-210, 33-12-310, MCA

New Rule V Insurer Documentation Requirements (1) An insurer shall maintain documents and records relating to each derivative transaction, including:

(a) the purpose of the transaction;

(b) the assets or liabilities to which the transaction relates;

(d) for over-the-counter derivative instrument transactions, the name of the counterparty and the market value; and

(e) for exchange traded derivative instruments, the name of the exchange and the name of the firm that handled the trade and the market value.

AUTH: 33-1-313, 33-12-111, MCA

IMP: 33-12-210, 33-12-310, MCA

New Rule VI Trading Requirements (1) Each derivative instrument shall be:

(a) traded on a qualified exchange;

(b) entered into with, or guaranteed by, a business entity;

(d) entered into with a qualified foreign exchange.

AUTH: 33-1-313, 33-12-111, MCA

IMP: 33-12-210, 33-12-310, MCA

4. REASONABLE NECESSITY STATEMENT: The Commissioner of Securities and Insurance - Office of the State Auditor, Monica J. Lindeen, (Commissioner) is the statewide elected official responsible for administering the Montana Insurance Department and regulating insurers. The Commissioner is a member of the National Association of Insurance Commissioners (NAIC). The NAIC is an organization of insurance regulators from the 50 states, the District of Columbia, and the U.S. territories. The NAIC provides a forum for the development of uniform policy and regulation when uniformity is appropriate.

Insurer solvency is a principal area in which uniformity is efficient and effective for insurers and regulators. The NAIC has promulgated model regulations regarding insurer investments to promote insurer solvency and protect the interests of insureds. One such model is the NAIC's Derivative Instruments Model Regulation which has been adopted in several states. Derivative instruments are investment vehicles that derive their value from other assets or financial instruments. Examples of derivative instruments include options, caps, floors, collars, swaps, forwards, and futures. Derivative instruments might be used by insurers to hedge against interest rate risks to preserve principal and maintain solvency.

The Commissioner is proposing to adopt new rules regarding insurer investments in derivative instruments based on and consistent with the NAIC Derivative Instruments Model Regulation, as revised in 2009. Adoption of the new rules is reasonably necessary to promote more consistency for insurers and regulators across jurisdictions in regard to the standards and practices considered prudent investing in derivative instruments.

New Rule I is reasonably necessary to provide that the purpose of the subchapter is to set standards for prudent use of derivative instruments by insurers. This rule is consistent with the NAIC model regulation.

New Rule II is reasonably necessary to provide that the words and phrases used throughout the subchapter will have the same meaning as in 33-12-102, MCA, regarding insurer investments unless a different meaning is required by the rule context. This rule is consistent with the NAIC model regulation.

New Rule III is reasonably necessary to provide that insurers establish written guidelines and internal controls for derivative transactions before engaging in any derivative transactions. The written guidelines and internal controls must be approved by the insurer's board of directors and the Commissioner. The guidelines must include the insurer's objectives for engaging in derivative transactions, identification of permissible derivative transactions and the relationship of those transactions to insurer operations, establishment of counterparty exposure limits and credit equity standards, and compliance with internal control procedures. Additionally, insurers are required to have a written methodology for determining whether a derivative instrument used for hedging has been effective. This rule is consistent with the NAIC model regulation.

New Rule IV is reasonably necessary to provide that insurers proposing to engage in derivative transactions submit their guidelines and internal controls to the Commissioner for approval prior to engaging in derivative transactions. The Commissioner may disapprove the proposed guidelines and controls if the insurer cannot demonstrate that the proposed guidelines and controls would be adequate to manage the risks associated with the derivative transactions. This rule is consistent with the NAIC model regulation.

New Rule V is reasonably necessary to provide that insurers maintain documents and records relating to each derivative transaction. Examples of records that must be maintained include the specific derivative instruments used in the transaction, the purpose of the transaction, and the assets or liabilities to which the transaction relates. This rule is consistent with the NAIC model regulation.

New Rule VI is reasonably necessary to establish trading requirements for derivative transactions entered by insurers, such as the derivative instrument used must be traded on a qualified exchange. This rule is consistent with the NAIC model regulation.

5. Concerned persons may submit their data, views, or arguments concerning the proposed actions either orally or in writing at the hearing. Written data, views, or arguments may also be submitted to Jennifer L. Massman, Staff Attorney, Office of the Commissioner of Securities and Insurance, State Auditor, Monica Lindeen, 840 Helena Ave., Helena, Montana, 59601; telephone (406) 444-2040; fax (406) 444-3499; or e-mail [email protected], and must be received no later than 5:00 p.m., June 24, 2011.

6. Jennifer L. Massman, Staff Attorney, has been designated to preside over and conduct this hearing.

7. The department maintains a list of concerned persons who wish to receive notices of rulemaking actions proposed by this agency. Persons who wish to have their name added to the list shall make a written request that includes the name and mailing address of the person to receive notices and specifies for which program the person wishes to receive notices. Such written request may be mailed or delivered to Darla Sautter, Office of the Commissioner of Securities and Insurance, 840 Helena Ave., Helena, Montana, 59601; telephone (406) 444-2726; fax (406) 444-3499; or e-mail [email protected] or may be made by completing a request form at any rules hearing held by the department.

8. An electronic copy of this proposal notice is available through the Secretary of State's web site at http://sos.mt.gov/ARM/Register. The Secretary of State strives to make the electronic copy of the notice conform to the official version of the notice, as printed in the Montana Administrative Register, but advises all concerned persons that in the event of a discrepancy between the official printed text of the notice and the electronic version of the notice, only the official printed text will be considered. In addition, although the Secretary of State works to keep its web site accessible at all times, concerned persons should be aware that the web site may be unavailable during some periods, due to system maintenance or technical problems.

9. The bill sponsor contact requirements of 2-4-302, MCA, apply and have been fulfilled. The primary bill sponsor for SB107 (1999), Senator Mahlum, was notified by regular mail on April 28, 2011, at his home address.

/s/ Christina L. Goe /s/ Jesse L. Laslovich

Christina L. Goe Jesse L. Laslovich

Rule Reviewer Chief Legal Counsel

Certified to the Secretary of State May 16, 2011.