NAIC Posts ACLI Derivatives Proposal

- Intermediate hedging strategies, or hedges that pair a portfolio of assets with a very closely matched basket or index-based derivative containing the same or very similar components as the asset portfolio.

- Advanced hedging strategies, or strategies that cannot be measured using the basic or intermediate methods, such as transactions involving tranches or equity options.

The “ACLI is not making recommendations concerning advanced hedging at this team,” the ACLI team says.

For basic and intermediate hedges, the ACLI would allow credit for the effects of hedging but limit the credit to reflect the risks that remain despite the use of the hedging program.

Some of the residual risks include the risk that a counterparty will default; the risks resulting from the use of shorter-dated credit default swaps to match long-term bonds, because a scarcity of longer-term bonds; and general business risk, the ACLI team says.

The ACLI would express the derivatives RBC credit as a percent of the C-1 asset charge, or the amount an insurer must cut off the statement value of an investment when adjusting the statement value for estimated level of risk.

For credit default swaps, for example, the team would divide the time remaining until the swap matures by the time remaining until the underlying bond matures, multiply that result by 84%, then add 10%.

For a complete hedge on a specific common stock, the ACLI team would set the RBC credit at 94% of the C-1 asset charge.

An intermediate hedge would be treated as a group of basic hedges.

In appendices, the ACLI team addresses topics such as how insurers use derivatives and how indexed credit default swap hedges work.