(A)
Purpose
The purpose of this rule is to allow
insurance companies to utilize certain alternative derivative and reserve
accounting practices for eligible derivative instruments and indexed products,
respectively, in order to better match derivative and reserve accounting as it
relates to interest crediting for indexed products and to provide for a more
true and fair representation of the capital position and net gain from
operations of insurance companies that offer or have in force indexed products.
Specifically, this rule addresses the mismatches related to the changes in
value of an eligible derivative instrument as compared to the interest accrual
in the reserve calculation for the underlying indexed product in two ways. This
rule provides insurance companies with the ability, once certain criteria are
met, to:
(1)
account for eligible derivative instruments using the
amortized cost method, and
(2)
make an election
at a policy level to use a reserve calculation methodology for indexed annuity
products under which interest credits based upon one or more external indices
are included in the reserve only after those interest credits have been
credited to the contract holder under the terms of the annuity contract. In
addition, regardless of the use of the ability provided for in the previous
sentence, this rule provides insurance companies with the ability to record
changes in, and settlement of, eligible derivative instruments through net
investment income in the summary of operations.
(B)
Authority
This rule is promulgated pursuant to
the authority vested in the superintendent under sections
3901.77
and
3903.72
to
3903.7211
of the Revised Code.
(C)
Definitions
For the purposes of this rule, the
following definitions shall apply:
(1)
"Eligible
derivative instrument" means:
(a)
A call or put option derivative instrument that is
purchased to hedge the growth in interest credited to an indexed product as a
direct result of changes in the related external index or external
indices;
(b)
A call or put option derivative instrument that is
written to offset all or a portion of a call or put option derivative
instrument that meets the criteria set forth in paragraph (C)(1)(a) of this
rule; or
(c)
Other derivative instruments, such as index futures,
swaps and "swaptions," that may be used to hedge the growth in interest
credited to indexed products as a direct result of changes in the related
external index or external indices.
(2)
"External index"
means an index, a combination of indices, a combination of indices and other
financial instruments, or an exchange traded fund that is published or
disseminated by a source external to the insurance company and its
affiliates.
(3)
"Indexed annuity products" means fixed indexed or
index-linked variable annuity contracts that include interest crediting
provisions under which interest (which may be subject to caps, participation
rates, spreads, floors, terms or similar limitations) is credited based upon
the performance of one or more external indices.
(4)
"Indexed life
products" means fixed indexed or index-linked variable life insurance policies
that include interest crediting provisions under which interest (which may be
subject to caps, participation rates, spreads, floors, buffers, terms or
similar limitations) is credited based upon the performance of one or more
external indices.
(5)
"Indexed products" means indexed annuity products and
indexed life products.
(6)
"Interest crediting period" means the period of time
over which the performance of an external index or external indices is measured
for purposes of determining the amount of interest credited under an indexed
product.
(D)
Derivative accounting
Insurance companies may elect to
account for eligible derivative instruments at amortized cost with the ability
to record settlement gains or losses through net investment income, if the
insurance company can demonstrate that such eligible derivative instruments
meet all of the following criteria for an economic hedge:
(1)
At inception of
the hedge, or as of the date that an insurance company elects to use the
accounting practices prescribed by this rule if later, there must be formal
documentation of the economic hedging relationship and the insurance company's
risk management objective and strategy for undertaking the economic hedge,
including identification of the specific eligible derivative instruments
purchased to hedge indexed products, the nature of the particular risk being
hedged, and how the eligible derivative instruments' effectiveness will be
assessed, retrospectively and prospectively, on a qualitative
basis.
(2)
At inception of the hedge, or as of the date that an
insurance company elects to use the accounting practices prescribed by this
rule if later, and at the end of each quarterly reporting period thereafter,
the insurance company must maintain documentation that the economic hedge is
expected to be and continues to be highly effective as defined by the criteria
in paragraph (D)(1) of this rule in achieving offsetting changes in fair value
attributable to the hedged risk during the period that the economic hedge is
designated.
(3)
Amortized cost will be based on the value at purchase
for eligible derivative instruments defined in paragraphs (C)(1)(a) and
(C)(1)(b) of this rule. For eligible derivative instruments defined in
paragraph (C)(1)(c) of this rule, amortized cost will be established at the
beginning of a policy's crediting term based upon the company's best estimate
of the expected cost of the strategy using well-established financial market
mathematical models, formulae, or equations that use assumptions that maximize
the use of verifiable inputs. Deviations from this estimate or other breakage
on dynamic trading strategies will be recognized immediately.
(4)
All income
associated with eligible derivative instruments shall be recorded in the
summary of operations, and shall be consistent with how the changes in indexed
products are recorded.
(E)
Indexed annuity
products reserve calculation methodology
Insurance companies account for indexed
annuity product reserves in accordance with sections
3903.72
to
3903.7211
of the Revised Code, and with the applicable actuarial guidelines and statutory
accounting principles. Based on the current guidelines, this rule provides
insurance companies with the ability to make the following adjustment, on a
policy level, to their indexed annuity product reserves for any index crediting
period that the policy is hedged by eligible derivative instruments that are
accounted for in accordance with paragraph (D) of this rule:
(1)
If an insurance
company determines indexed annuity product reserves based on "Actuarial
Guideline XXXV," the insurance company may assume the market value of the
eligible derivative instruments associated with the current interest crediting
period is zero, regardless of the observable market for such eligible
derivative instruments. Cash surrender values used to determine the reserves
shall be calculated consistently.
(2)
At the conclusion
of each interest crediting period, interest credited to an indexed annuity
product shall be reflected in the reserves and cash surrender value as
realized, based on the actual performance of the relevant external
index.
(F)
Indexed life product reserve calculation
methodology
Insurance companies account for indexed
life product reserves in accordance with the applicable actuarial guidelines
and statutory accounting principles. This rule does not provide for any
adjustment to the reserve calculation methodology for indexed life
products.
(G)
Other requirements
(1)
Indexed annuity
products. The alternative accounting practices prescribed by this rule must be
applied during an index crediting period to both the eligible derivative
instruments used to hedge indexed annuity products and the related indexed
annuity product reserves.
(2)
Indexed life products. The alternative accounting
practices prescribed by this rule must be applied only to the eligible
derivative instruments used to hedge indexed life products. This rule shall not
impact the calculation of indexed life product reserves.
(3)
If an insurance
company elects to use the alternative accounting practices prescribed by this
rule, it shall report quarterly to the superintendent, for analysis
purposes:
(a)
The market value of its eligible derivative instruments and
what the related actuarial reserves would be using market value of such
eligible derivative instruments, and the documentation the economic hedge is
and remains highly effective required by paragraph (D)(2) of this
rule.
(b)
For hedging activity that uses the dynamic hedging
strategy, the company shall report:
(i)
The estimate of amortized cost, including the
assumptions used in financial market models; and
(ii)
The amount of
deviation from the estimate of amortized cost recognized during the period
reported.
(4)
Application of
this rule is not mandatory. An insurance company that elects to use the
alternative accounting practices prescribed by this rule may not elect to
change its accounting practices back to those that would apply in the absence
of this rule without the prior approval of the superintendent.
(H)
Severability
If any paragraph, term or provision of
this rule is adjudged invalid for any reason, the judgment shall not affect,
impair or invalidate any other paragraph, term or provision of this rule, but
the remaining paragraphs, terms and provisions shall be and continue in full
force and effect.
Notes
Ohio Admin. Code
3901-1-67
Effective:
4/15/2021
Five Year Review (FYR) Dates:
08/30/2025
Promulgated
Under:
119.03
Statutory Authority:
3901.77,
3903.722,
3903.723,
3903.724,
3903.725,
3903.726,
3903.727,
3903.728,
3903.7211
Rule Amplifies:
3901.77,
3903.72
to
3903.7211
