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CA Department of Insurance
CA Department of Insurance
CA Department of Insurance

Bulletin 95-10

November 1, 1995

To: All Admitted Life Insurers and Other Interested Parties

Subject: Procedures and Requirements for Implementation of California Insurance Code Section 10507.5 (SB 188, 1995) Governing Life Insurance Company Obligations Regarding Contract holder Owned Asset.

This Bulletin is issued pursuant to Section 10507.5 of. the California Insurance Code (CIC), effective August 11, 1995, which authorizes the Insurance Commissioner("Commissioner") to issue a bulletin setting forth reasonable requirements for insurers issuing products authorized by this statute and further specifies that the bulletin has the same force and effect as regulations issued by the Commissioner.

Included in this bulletin are requirements relating to application procedures for CIC Section 10507.5 financial qualification and to reserves and reporting requirements by companies so qualified. Please note that this bulletin does not purport to reiterate or summarize Section 10507.5, so reference to the statute, as well as to this bulletin, is essential to obtain information on all pertinent requirements relating to the newly authorized insurance products. Note that the products authorized by CIC Section 10507.5 are called "synthetic GICs" in the industry vernacular.
  1. Purpose

    The purpose of this Bulletin is to interpret and clarify the types of non-traditional insurance company obligations permitted under CIC Section 10507.5 by prescribing the terms and conditions under which admitted life insurance companies may issue policies, contracts or agreements that establish the insurer's obligations under the policies, contracts or agreements by reference to a portfolio of assets not owned or possessed by the insurance company.

    This Bulletin constitutes the exclusive legal authorization for the issuance of synthetic GICs or other contracts pursuant to or described in CIC Section 10507.5 and no such contracts may be issued, delivered or marketed in this state, or anywhere by domestic insurers, except according to the provisions of this Bulletin.

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  2. Definitions

    As used in this Bulletin, the following terms shall have the following meanings:
    1. "Contract Value Record" means an accounting record established by the Contract in relation to the Segregated Portfolio, which is credited with a fixed rate of return over regular periods. The Contract Value Record is experience rated relative to the Market Value Record and is used to measure the extent of the insurance company's obligations to the contract holder with regard to the Segregated Portfolio.
    2. "Department" or "CDI" means the California Department of Insurance and any employee of the Department authorized to act on behalf of the Department.
    3. "Experience Crediting Formula" means a mathematical formula used to calculate the fixed rate of return credited to the Contract Value Record during any Rate Period which is based upon the differences between the Contract Value Record and the Market Value Record, on a period of time not to exceed the average duration of the assets held in the Segregated Portfolio and any other appropriate actuarial factors or methods.
    4. "Investment Guidelines" means the set of written guidelines established by the contract holder setting forth the quality, sector and duration corridors within which the Investment Manager may invest and reinvest the assets within the Segregated Portfolio.
    5. "Investment Manager" means the insurance company, if it is registered as an investment advisor under the Investment Advisors Act of 1940 and is managing the assets in the Segregated Portfolio, or any third party so registered as an investment advisor and approved by the insurance company to manage the Segregated Portfolio in accordance with the Investment Guidelines.
    6. "Market Value Record" means an accounting record established by the Contract in relation to the market value of the Segregated Portfolio and expressed as the sum of:

      The aggregate of the prices at which the publicly traded assets held in the Segregated Portfolio are traded as of any valuation date, or in the case of any asset for which no such price is available, a price that appropriately reflects its fair market value, plus

      Any related cash or currency held in the Segregated Portfolio 

    7. "Permitted Custodial Institution" means a bank, savings and loan association or trust company.
    8. "Rate Period" means the period of time during which the fixed rate of return credited to the Contract Value Record is applicable between Experience Crediting Formula adjustments.
    9. "Segregated Portfolio" means:

      Shares of a regulated investment company, or

      A portfolio or sub-portfolio of assets to which the contract pertains that is held in a custody or trust account by the Permitted Custodial Institution and identified on the records of the Permitted Custodial Institution as special custody assets held for the exclusive benefit of the retirement plans or other entities on whose behalf the contract holder holds the Contract, plus

      Any related cash or currency received by the Permitted Custodial Institution for the account of the contract holder and held in a deposit account for the exclusive benefit of the retirement plans or other entities on whose behalf the contract holder holds the Contract.

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  3. Request for Authority to Issue Contracts under this Bulletin

    No admitted life insurer may issue, deliver or market in this state, nor may any domestic life insurer issue, deliver or market anywhere, Contracts as defined in Section 2(a) of this Bulletin unless it has received authority to issue Contracts under this Bulletin pursuant to this Section 3.

    The following items are required to be submitted in duplicate to the Commissioner accompanying a request for authority to issue products authorized by CIC Section 10507.5.

    1. A statement that the company meets the financial qualifications of Section 10507.5(a)(2), with a copy of the assets and liabilities pages (pages 2 and 3) of the most recent financial statements. (If a company ceases to meet the statutory financial qualifications it shall immediately notify the Commissioner of this fact in writing.

    2. The filing for approval of the contract forms (including application) that will be used to provide these products with document submission form and otherwise following the procedures of Title 10, California Code of Regulations 2200-2218.10 and California Department of Insurance Bulletin 94-6, as applicable. (Future contract form filings shall also follow these procedures.)

      A contract form may not be used unless it has been approved by the Commissioner. The Commissioner shall disapprove a form if, in his or her discretion, the form or provisions contained therein: (1) contravene requirements of this Bulletin or (2) afford other good cause for disapproval. The Commissioner, may rescind an approval on any basis which would have justified initial disapproval. In the case of rescission of approval, the insurer may, within 15 days of rescission, request a hearing before the Commissioner or his or her designee, and the hearing shall be held within 30 days of the request.

    3. A Statement of the Essential Operating Features as outlined in Section 4 below.

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  4. Statement of Essential Operating Features

    Each company applying for authority to issue Contracts under this Bulletin shall file for approval with the CDI a Statement of the Essential Operating Features for each such type of Contract, and a statement describing the reserving methodology that will be used, which would include but not be limited to the following:

    1. A description of how the Contract Value Record will be determined, including the method by which the fixed rate of return credited to the Contract Value Record will be determined.
    2. A description of how the Market Value Record will be calculated, including a summary description of the procedures to be followed by the insurance company in verifying, through periodic spot audits or otherwise, any market value reporting to it performed by the contract holder or the Permitted Custodial Institution which the insurance company may use as the basis for calculating the Market Value Record.
    3. A description of all contingencies and circumstances under which the Contract might require the insurance company to make payments or perform any other obligation to the contract holder in support of the Contract Value Record.
    4. The means by which the Experience Crediting Formula will take into account any differences between the Market Value Record and the Contract Value Record.
    5. A description of the manner by which the insurance company shall monitor the Segregated Portfolio and verify that the Segregated Portfolio is being managed in accordance with the Investment Guidelines.
    6. A description of any special termination features of the Contract whereby interest rate movements or participant withdrawal activity, or any combination thereof, might cause a termination of the insurance company's contractual obligations.
    7. A discussion of the underwriting criteria applied by the insurance company in evaluating the appropriateness of Investment Guidelines submitted by a potential contract holder.
    8. A demonstration of how the interest rate credited to the Contract Value Record will be affected by changes in interest rates and withdrawal experience. The demonstration shall include at least three hypothetical interest rate scenarios (level, increasing and decreasing) and for each of those interest rate scenarios, at least three withdrawal scenarios (zero, moderate arid high) shall be modeled. The Department may require additional scenarios if deemed necessary to fully understand the risks of the contract or agreement. The demonstration period shall be at least 1.5 years.
    9. The criteria the insurance company uses in approving the Investment Manager to be used in managing the Segregated Portfolio, if the Investment Manager is an entity other than the insurance company or its wholly owned subsidiaries.
    10. A demonstration that the consideration charged by the insurance company for the Contract is appropriate in view of the risks to the insurance company with respect to the Contract.
    11. Such additional statements of essential operating features as the CDI may require.
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  5. Minimum Contractual Provisions

    The insurance company's obligations shall be legally documented in the form of a Contract which includes items defined in Section 2 (a), (b), (d), (e), (f), (g), (h), (i) and G) and contains at least the following minimum provisions.

    1. The Contract must clearly specify the insurance company's obligations under the contract and identify the contingencies and circumstances under which insurance company payments to the contract holder are to be made. No contract shall obligate the insurance company to purchase any assets at greater than market value or assets that would not be permitted investments under the CIC.

    2. If a market value adjustment formula is to be used in calculating the effect on the Contract Value Record of certain withdrawals from the Segregated Portfolio, the types of withdrawal subject to market value adjustment must be clearly identified in the Contract.

    3. Except under the circumstances set forth in Section 9 below, if the Contract does not have a set maturity, the Contract must provide settlement options at termination permitting the contract holder to receive the Contract Value Record over time.

    4. The Contract must state the maximum Rate Period between Experience Rating Formula recalculations that will be permitted.

    5. The Contract must grant the insurance company the right to perform audits and inspections of assets held in the Segregated Portfolio from time to time upon reasonable notice to the Permitted Custodial Institution.

    6. The Contract must provide the insurance company with the rights to receive prior notice of, and to approve, any change of Investment Managers and any change to the Investment Guidelines.

    7. The Contract shall provide that forbearance by the insurer in a particular case, (for example, non-termination under the causes listed in Section 9 below) shall not be a waiver as to actions that may be taken with regard to future non-compliance.

    Nothing in this list of minimum provisions shall be construed as precluding the CDI from requiring, pursuant to its contract review authority, additional provisions in response to specific circumstances presented by particular Contracts, nor shall it be construed as limiting in any respect the Commissioner's authority to disapprove a Contract for good cause.

    See also Section 9 - Unilateral Contract Terminations, below.

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  6. Establishment of Segregated Portfolio

    1. No Contract subject to this Bulletin may be written unless the assets which it supports and for which a Contract Value is established are maintained in a Segregated Portfolio of a Permitted Custodial Institution or are shares of a regulated investment company.
    2. The Segregated Portfolio must be regularly accounted for by the insurance company. Accounting must be prepared no less frequently than quarterly, and must include the following items.
      1. a complete statement of Segregated Portfolio holdings and values (market or book/amortized value, as appropriate); and
      2. the cash balance within the Segregated Portfolio.
    3. The insurance company must maintain a Market Value Record at all times for each Contract subject to this Bulletin. No less frequently than monthly, the insurance company must update the Market Value Record to reflect the market value of the Segregated Portfolio. In performing the market value calculation, the method of valuation selected must be designed to reflect the fair market value of the Segregated Portfolio and may include the use of a vendor market value valuation service.

    4. The contract holder and the insurance company must agree in the Contract on the permissible levels and timing of any new deposits to the Segregated Portfolio.
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  7. Investment Management of Segregated Portfolio

    1. The Investment Manager must have responsibility for, and control over, the purchase and sale of all Segregated Portfolio assets within the sector, quality and duration constraints of Investment Guidelines submitted by the contract holder to the Investment Manager and as accepted by the insurance company from time to time.
    2. The Investment Guidelines must be submitted to the insurance company for underwriting review prior to the effectiveness of the Contract. Any changes made to the Investment Guidelines which are not submitted to and accepted by the insurance company prior to the effective date of the change shall be a reason for immediate termination of the Contract by the insurance company, unless the Investment Manager is under the insurer's" control" as defined in CIC Section 1215. The Investment Guidelines shall set forth explicit procedures for establishing market valuations where such values are not readily ascertainable.
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  8. Purchase of Annuities

    1. For Contracts which make available to the contract holder the purchase of immediate or deferred annuities for the benefit of individual members of the group, no annuity may be purchased without the prior delivery of the contractually-agreed annuity consideration in cash to the insurance company from the Segregated Portfolio for allocation to the insurance company's general account or separate account where the annuity's reserve assets will be held.

    2. To the extent that annuities are "issued to and owned by an individual" or are "annuity benefits guaranteed to an individual by an insurer" (CIC Section 1067.04 (0)) they are considered allocated and eligible for Guarantee Fund coverage. Therefore, insurers are required to deliver to certificate holders the Summary Document and Disclaimer described in CIC Section 1067.l7(b).

    3. To the extent that annuities are unallocated, insurers are required to give contract holders conspicuous written notice that they are not eligible for Guarantee Fund coverage. (CIC Sections 1067. 17(d) and 1067.02(e).
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  9. Unilateral Contract Terminations

    Any Contract subject to this Bulletin must allow the insurance company to unilaterally and immediately terminate with refund of any unearned risk premium or investment management fees, without future liability of the insurance company or obligation to provide further benefits, upon the occurrence of anyone of the following events.

    1. The Investment Guidelines are changed without the advance consent of the insurance company.
    2. The Segregated Portfolio is invested in a manner that does not comply with the Investment Guidelines.
    3. Investment discretion over the Segregated Portfolio is exercised by or granted to anyone other than the Investment Manager, or
    4. Occurrence of any act of fraud, misrepresentation of material facts, deceit or any other action of the contract holder which materially affects or would have affected ~e intent, structure or risk profile of the Contract.

    Notwithstanding the foregoing, subsections (a) and (b) of this Section shall not apply in situations where the Investment Manager is controlled by the insurer.

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  10. Actuarial Reserving and Reporting

  11. Fees shall be separated into risk premiums and investment management fees, if any, and reported separately.

    Risk reserves shall be established as follows.
  1. Gross unearned risk premium. (Analogous to the gross unearned premium reserve.
  2. At least 30% of any annual excess of risk premium over claims shall be accumulated without interest. The maximum required reserve shall be 150% of the current annualized risk premium. The reserve may be reduced (but not below zero) by any excess of annual claims over annual risk premiums.
    Risk premiums and investment management fees are to be reported on page 6, line 6, Aggregate write-ins for miscellaneous income, Column 8, and separated in the Details of Write-ins, lines 0601 and following; reserves are to be included on page 16, Exhibit 10, line 2, column 8. For 1995 and later a new Question 7 will be in the footnotes to Exhibit 8, page 14 asking for the amount of assets covered and the reserves held under synthetic GICs. References in this paragraph are to the NAIC blank for life insurers.

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  • 11. Miscellaneous

    Policies, contracts or agreements issued under CIC Section 10507.5.

    1. Shall not be considered to be "financial guarantee insurance" as authorized in CIC Sections 12100 through 12122. (This is a product offered by property/casualty companies, not life insurers. The risks contemplated by CIC Section 10507.5 are much narrower than the range of risks of financial loss covered by CIC Section 12100).

    2. Shall not be covered under the California Life and Health Guarantee Association, CIC Section 1067 and following. (Section 1067.02(b)(2)(D) excludes guaranteed interest contracts and similar products; the policies, contracts or agreements issued under CIC Section 10507.5 are thus excluded.) Pursuant to CIC Section 1067.17(d) the insurer shall provide the contract holder with a clear and conspicuous written notice that the Contact defined in Section 2 (a) of this Bulletin, is not eligible for Guarantee Fund coverage.

    3. Shall not be exempt from premium taxes. Therefore, risk premiums are subject to premium tax based at the rate (either for qualified plans or for other policies) for life insurers. (The authorizing legislation did not contain an express exemption from premium taxation, unlike CIC Section 10541 for funding agreements, and the Commissioner does not have authority to exempt premiums for such contracts or agreements from premium taxation).

    4. Which entail contractual guarantees or other obligations to be paid from the insurance company's general account, shall come under the priority of CIC Section 1033(a)(5) in event of insolvency of the general account (such a claim for benefits is similar to any other policy claim).

    5. Are not "investment return assurance" as authorized in CIC Sections 10507 through 10507.4 and Section 10203.10. (In these contracts, investment experience is significantly less important as a risk factor than in investment return assurance. Additionally, these contracts lack the life contingencies contemplated by investment return assurance); and

    6. Shall come under the requirements of CIC Section 10506.4(h).

  • All filings with the Commissioner pursuant to this Bulletin shall be submitted by the insurer to the California Insurance Commissioner, Financial Analysis Division, Life Bureau, 300 South Spring Street, and 13th floor, Los Angeles.

    The Commissioner reserves the right to request from any insurance company at any time additional information and documentation deemed necessary under the circumstances for a more complete understanding and to facilitate consideration of a company's proposed or presently-used products and their essential operating features; and such information and documentation shall be provided by the insurer promptly upon -request. Time expended on review of contracts and related materials pursuant to this Bulletin may be charged to the insurer pursuant to rates for examination.

    Inasmuch as the subject matter of CIC Section 10507.5 and this Bulletin is relatively recent and still evolving and developing, this Bulletin may, for good cause, be amended, supplemented or superseded from time to time, in the exercise of the Commissioner's sound discretion and in pursuance of his responsibility for protection of the contract holder and preservation of insurer solvency.

    Questions regarding this bulletin may be referred to.

    Senior Life Actuary
    Department of Insurance
    300 South Spring St., South Tower
    Los Angeles, CA 90013
    Telephone: (213) 346-614.

    Insurance Commissione.

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