Relates to the regulation of financial guaranty insurers; repealer

Section 2 of the bill would amend Insurance Law § 6901(a)(2)(H), (I) and (J) to conform the language in these subparagraphs to that set forth in Section 1.

Section 3 of the bill would amend Insurance Law § 6901 (b), (c) and (d) to conform the language in these subsections as described under the summary of Section 1.

Section 4 of the bill would amend Insurance Law § 6901(e) by repealing a 2004 amendment to that provision, which defined asset backed securities to include a pool of credit default swaps or a credit default swap referencing a pool of obligations. Section 4 of the bill also would amend Insurance Law § 6901(e)(1)(B) (renumbered as section 6901 (e)(2)) to require that a pool of assets be expected to generate either cash flow or cash proceeds.

Section 5 of the bill would amend Insurance Law § 6901(g) to remove credit default swaps from the definition of collateral.

Section 6 of the bill would repeal Insurance Law . 6901(j-1), which defines "credit default swaps."

Section 7 of the bill would amend Insurance Law § 6901(n), which defines "investment grade," to recognize the use of designations made by the Securities Valuation Office ("SVO") of the National Association of Insurance Commissioners ("NAIC") as an alternative to the ratings given by security rating agencies acceptable to the Superintendent. Section 7 of the bill would further replace "rating" in subsection (n)(3) with "designation" to correspond to the terminology used by the SVO. Section 8 of the bill would amend Insurance Law § 6902(a) to conform the language in this subsection to that set forth in Section 1 and repeals language expressly permitting a financial guaranty insurer to effect and maintain transactions in credit default swaps.

Section 9 of the bill would amend Insurance Law § 6902(b)(1) by relettering the provision as section 6902(b)(1)(A) and increasing the amount of paid-in capital and paid-in surplus that a financial guaranty insurer must have to transact business from at least $2,500,000 to at least $15,000,000, and from at least $72,500,000 to at least $165,000,000, respectively. Section 9 of the bill also would increase the amount of minimum surplus to policyholders that a financial guaranty insurer must maintain from at least $65,000,000 to at least $150,000,000. Section 9 of the bill would further add a new Insurance Law § 6902(b)(1)(B), which would require an insurer to report to the Superintendent within five days if: policyholder surplus declines more than five percent from the level held at the end of the previous quarter if surplus is less than $500,000,000; policyholder surplus declines more than twenty percent from the level held at the end of the previous quarter if surplus is $500,000,000 or more; or the minimum surplus specified in new Insurance Law § 6902(b)(1)(A) falls below $750,000,000.

Section 9 of the bill would further amend Insurance Law § 6902(b)(2) by repealing an obsolete transition rule, and adding new language that requires a financial guaranty insurer to maintain: sufficient liquidity to pay claims in adversity, including extreme stress scenarios; appropriate risk underwriting policies, criteria, and procedures to protect against losses that might erode the insurer's capital strength; and sufficient control and remediation rights to mitigate the potential severity of any loss.

Section 9 of the bill also would add a new Insurance Law § 6902(b)(3), which would require that any report submitted to the Superintendent pursuant to Insurance Law § 6902 and any underwriting guidelines made available to the Superintendent upon the Superintendent's request, be kept confidential, not be subject to subpoena and not made public, unless the Superintendent determines, after notice and a hearing, that publication of the material will best serve the interests of policyholders, stockholders or the public.

Section 10 of the bill would amend Insurance Law § 6902 by adding new subsections (c), (d) and (e). Subsection (c) would move, without substantive changes, requirements governing the deposit of collateral previously set forth in the flush language at the end of Insurance Law § 6901(g). Subsection (d) would specifically authorize the Superintendent, by regulation, to limit the amount of collateral provided by any single issuer or bank. Subsection (e) would authorize the Superintendent to require any financial guaranty insurer to submit any obligations that it insures to the SYO of the NAIC or to another institution specified by regulation, for designation as to investment quality, if the Superintendent determines that the interests of financial guaranty insurers, policyholders, claimants, obligees or indemnitees or the people of New York State so require. A financial guaranty insurer must bear all the expenses of any evaluation.

Section 11 of the bill would amend Insurance Law § 6903(a)to conform the language set forth in this subsection as described under the summary of Section 1.

Section 12 of the bill would amend Insurance Law § 6903(b)(1) to clarify that the discount rate to be applied to loss reserves by financial guaranty insurers shall be the zero-coupon yield of United States Treasury obligations over the prior calendar year or such other period as the Superintendent determines to be appropriate as of the date of computation. Section 13 of the bill would amend Insurance Law §6904(b)(1) to define the asset-backed securities that may be either insured or guaranteed by a financial guaranty insurer. An example of asset backed securities is a group of credit card receivables that have been placed in a single pool so that the debt can be securitized. Less frequently, a pool of asset-backed securities may itself contain parts or all of another pool. For example, a pool might contain tranches (specified portions of other pools that bear a particular investment quality rating) from several pools in an effort to produce a higher degree of diversification. In practice, however, the grouping of part or all of several pools has intensified rather than reducing risk. Accordingly, the new subparagraph specifies that, with respect to any asset-backed securities backed by another pool of asset-backed securities (a pool of pools), the conditions set forth in Insurance Law § 6904(b)(5)(B) must be met.

Section 13 of the bill would also permit a financial guaranty insurer to insure investment grade obligations issued by the government of a country, municipality, or a political subdivision of either of the foregoing, or any public agency or instrumentality thereof, if the entity does not qualify as a governmental unit. This failure to qualify will generally occur because the government is not a member country of the Organization for Economic Co-operation and Development having a sovereign rating in one of the two generic lettered rating classifications by a security rating agency acceptable to the Superintendent.

Section 14 of the bill would amend Insurance Law § 6904(b)(2), to require the obligations insured by financial guaranty insurers to be at least ninety-five percent investment grade. The law currently applies that limitation only to the categories of permissible guaranties specified in Insurance Law § 6904(b)(1)(A), (B) and (C). The amendment would apply the ninety-five percent investment grade floor to all categories of permissible guaranties.

New subparagraph (B) of Insurance Law § 6904(b)(2) would allow the Superintendent, upon application by a financial guaranty insurer, to establish a lower minimum investment grade requirement if the Superintendent determines that there is no undue risk to the insurer, its policyholders, or the people of New York State. In making the determination, the Superintendent must take into consideration, among other factors, the financial guaranty insurer's outstanding liabilities on non-investment grade obligations in relation to the amount of its surplus to policyholders, and contingency reserves. Further, new subparagraph (C) would require any financial guaranty insurer whose non-investment obligation liabilities continuously exceed the permitted amount by more than twenty percent for thirty calendar days, to notify and provide the Superintendent with a plan for corrective action within five calendar days after the conclusion of that thirty-day period. Insurers that obtain the Superintendent's approval to maintain net liabilities more than five percent of which are not investment grade will be able to offer a valuable service to certain municipalities and other governmental entities that may not be able to pay for the quality of guaranty available from an insurer with a ninety-five percent floor.

Section 14 of the bill also would add a new Insurance Law § 6904(b)(5), which would substantially restrict a financial guaranty insurer's ability to insure or guarantee pools of assets comprised of portions of other pools. The insurance or guaranty may be provided only if: (1) the pool of asset-backed securities is comprised of asset-backed securities having a right to payment and rights in insolvency that are not subordinated to any other security of the issuer, in the event of a payment default by, or rehabilitation or insolvency of, the issuer; (2) the insurer possesses control and remediation rights substantially similar to those held by the most senior class of securities of the issuer of the insured obligations backed by the same pool of assets; (3) all of the assets are issued or guaranteed by a governmental unit, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the Federal Home Loan Bank, the Federal Agricultural Mortgage Corporation, or the Federal Farm Credit System Banks as a consolidated debt obligation or a system-wide debt obligation to the extent that the obligations are covered by the Farm Credit Insurance Fund; (4) the combination does not increase or affect the quantity or investment quality of obligations insured by that insurer; (5) the pool consists entirely of asset-backed securities insured by the financial guaranty insurer; or (6) the Superintendent determines, upon application of the insurer, that the combination would not result in undue risk to the insurer, its policyholders or the people of New York State.

Section 15 of the bill would amend Insurance Law § 6904( c) to conform the language set forth in this subsection to that set forth in Section 1.

Section 16 of the bill would amend Insurance Law § 6904(d)(2) by relettering certain portions of paragraph (2) as subparagraphs (A) (C) and (D), and adding new subparagraphs (B), (C), (F) and (G). Subparagraph (A) would limit the risk that may be assumed by the insurer to ten percent of aggregate surplus to policyholders and contingency reserves with respect to each type of asset described in subparagraph (E) issued by a single entity. New subparagraph (B) would state that if an asset-backed security is subordinate with respect to the right of payment to any other securities of the entity backed by the same pool of assets, then the insured average annual debt service and insured unpaid principal shall be deemed the lesser of: three hundred percent of the insured average annual debt service or insured unpaid principal respectively, or the insured average annual debt service or insured unpaid principal for both the insured security and all securities senior to the insured security that are backed by the same pool of assets, but not insured by the same financial guaranty insurer.

New subparagraph (C) would state that for all issues of asset-backed securities (1) originated by the same originator, serviced on the effective date of the related insurance policy by the same servicer, or both, and (2) backed by the same type of asset and issued in the same calendar year, the lesser of five times the insured average annual debt service or insured unpaid principal (reduced by certain factors) divided by nine, cannot exceed fifty percent of the aggregate of the financial guaranty insurer's surplus to policyholders and contingency reserves. New subparagraph (D) would state that an asset in the pool supporting the asset-backed securities cannot exceed the single risk limits prescribed in new subparagraph (A) if directly guaranteed.

New subparagraph (F) would allow for the continued consolidation of financial institutions by disregarding mergers, acquisitions or loss of corporate identity for purposes of the single risk limits of Insurance Law § 6904(d), whereas new subparagraph(G) would define the types of assets to be taken into account in the computation of single risk limits. Section 16 of the bill would also amend Insurance Law § 6409(d)(2), (4) and (5) to conform the language in these paragraphs to that set forth in Section 1.

Section 17 of the bill would amend Insurance Law § 6904(f) by making technical amendments and removing language stating that if an insurer was not in compliance with the single risk limit in effect in New York at the time that the insurer issued the financial guaranty insurance policy, then the financial guaranty insurance must comply with the limitations prescribed by Insurance Law § 6904(d) within three years after Article 69's effective date. Section 17 of the bill would also amend Insurance Law § 6904 by adding new subsections (h), (i), 0), (k), (1) and (m). New subsection (h) would state that all policies issued by a financial guaranty insurer shall be aggregated for the purposes of determining whether any limitation prescribed by Insurance Law § 6904(d) has been exceeded. This new subsection would clarify that the revised limits and other rules of Insurance Law § 6904 apply not only to policies or guaranties issued after the effective date of this bill, but to all insurance or guaranties of an insurer.

New subsection (i) would impose a quarterly notification requirement upon a financial guaranty insurer if the notional value of its aggregate liabilities on certain government issues, gross of liabilities assumed and net of liabilities reinsured, is equal to or greater than one hundred times policyholder surplus plus contingency reserves. For all other aggregate liabilities, gross of liabilities assumed and net of liabilities reinsured, notice is required for all other insurance or guaranties if the liability is equal to or greater than two hundred times policyholder surplus plus contingency reserves.

New subsection (j) would require a financial guaranty insurer to submit to the Superintendent on a quarterly basis, a listing of its aggregate liabilities, including the fair value of each, and identification of all guaranteed obligations in a form and manner acceptable to the Superintendent, identifying the obligation for its proper evaluation by the Superintendent for degree of risk. Further, new subsection (k) would specify the type of information that an insurer must provide to the Superintendent in a report required by Insurance Law § 6904, and new subsection (1) would allow the Superintendent, pursuant to regulation, to prohibit the writing of financial guaranty insurance or impose limitations with respect to the writing of financial guaranty insurance, with respect to any instrument or other monetary obligation that is not investment grade, if the Superintendent determines that the prohibition or imposition of limitations is necessary to protect the interests of financial guaranty insurers, policyholders, claimants, obligees or indemnitees, or the people of New York State. New subsection (m} would require that any report submitted pursuant to Insurance Law § 6904 be kept confidential, and not be made public unless the Superintendent determines,'after notice and a hearing, that the interests of policyholders, stockholders or the public will be served by publication of the report.

Section 18 of the bill would amend Insurance Law § 6905 by relettering subsections (b) and (c) as subsections (f) and (g), and add new subsections (b), (c), (d) and (e). New subsection (b) would grant a financial guaranty insurer the sole right of acceleration of payment obligations, whereas new subsection (c) would prohibit a financial guaranty insurance policy from providing for acceleration upon the commencement of rehabilitation, liquidation or conservatorship proceedings with respect to a financial guaranty insurer or the insured, absent a payment default by the obligor or insurer; However, new subsection (d) would permit either the financial guaranty insurer or the insured to terminate the policy as a consequence of the commencement of rehabilitation, liquidation or conservatorship proceedings if the , termination does not accelerate or otherwise increase the obligation of the insurer to make scheduled payments when due under the policy and does not require the insurer to make any additional payment to the insured by reason of the termination.

Further, new subsection (e) would allow the Superintendent to require, by regulation, other policy provisions as may be necessary or appropriate to protect financial guaranty insurers, policyholders, claimants, obligees or indemnities, or the people of New York State.

Section 19 of the bill would amend Insurance Law § 6907 by repealing obsolete language in subsection (a), renumbering subsections (b) and (c) as (a)(1)and (a)(2), respectively, and adding new subsections (b) and (c). New subsection(b) would allow for amendments to, or replacements of, insurance policies issued before August 1,2009, without consequence, if the insurer executes the amendment or replacement solely to mitigate accumulated losses and reduce exposure to future losses under the unmodified policy. New subsection (c) would provide a transition rule for insurers whose business mix will produce an immediate excess over the risk limits effective on August 1, 2009.

Section 20 of the bill would amend Insurance Law § 1108 to add a new subsection G) to exclude a writer of a credit default swap or any agent, broker or other person acting in connection with the making of the credit default swap, from licensing and other provisions of the Insurance Law (except Article 74) if the Superintendent determines by regulation that the issuance of the credit default swap is effectively and comprehensively regulated in a manner that protects the people of New York State, including the maintenance of adequate capital, the posting of sufficient trading margins to minimize counter party risk, and the collection and availability of comprehensive market data. Absent such a determination, makers or issuers of credit default swaps may be subject to the requirements, restrictions and rules of the New York Insurance Law.

Section 21 of the bill sets forth an effective date of August 1, 2009.

Existing law

Article 69 of the Insurance Law governs the operations of financial guaranty insurers and the issuance of financial guaranty insurance, as defined in section 6901(a) thereof. Financial guaranty insurance is broadly defined, irrespective of whether written as a surety bond, insurance policy, indemnity contract, or any similar guaranty covering financial obligations, but only certain types of financial guaranty insurance are permissible. Article 69 specifies the types of guaranties that an insurer may write and also sets forth limitations on permissible guaranties, specifying the aggregate risk limits, single risk limits, and other constraints.

Article 69 also sets forth organizational and financial requirements for financial guaranty insurers, as well as required contingency, loss, and unearned premium reserves necessary to pay claims and support the issuance of additional financial guaranty insurance policies. Provisions governing policy forms and rates and the terms for reinsurance are also set forth in the article. Furthermore, the laws pertaining to property/casualty insurers apply to the extent that they are consistent with Article 69. Finally, Article 69 expressly excludes financial guaranty insurance policies from coverage under the property/casualty insurance security fund.

Prior legislative history

This is a new bill.

Statement in support

Financial guaranty insurers, through their guaranties, have long been an integral part of the financial system for the purchase and transfer of governmental and non-governmental obligations. In the late 1980s, however, it was recognized that financial guaranties imposed too much of a risk on other insureds in multi-line insurers. Hence, in 1989, Article 69 was enacted, carving financial guaranty insurance out of surety and credit insurance and broadening the kinds of risks that were deemed to be financial guaranty insurance. The law required financial guaranty insurers to be essentially monoline and therefore they were prohibited from engaging in both financial guaranty insurance as well as general property/casualty insurance.

Generally speaking, the minimum capital requirements of Article 69, while fixed and somewhat arbitrary, were seen as sufficient to support the issuance of guaranties on obligations with a low risk of default. A purchaser of a small municipality's bond issue could buy the debt based on the creditworthiness of the insurer without researching the details of the city or town's finances. These guaranties have supported a liquid and high-quality market for obligations used to fund essential governmental operations at minimal cost to the issuers.

However, financial guaranty insurers have also participated in the securitization of asset-backed securities, particularly residential real estate mortgages. Beginning in 2005, the underwriting applied by originators to the subprime, alt-A (low documentation), home-equity lines of credit deteriorated. This lower-quality debt as packaged into collateralized debt obligations ("CDOs"), which were then divided into marketable pieces ("tranches") and often combined, split, and otherwise "sliced and diced" into securities such as "CDOs squared" which these insurers sometimes guaranteed. Under these circumstances, experience has shown that neither the market nor the insurers were able to adequately determine the quality of the underlying debt.

Following adverse developments in the real estate market, rating agencies questioned the merits of the debt underlying the CDOs. These agencies concluded that high default rates expected in the future warranted current exceptional additions of capital to the surplus of insurers in order to maintain the insurers' AAA ratings. A destructive cycle has ensued with deteriorating credit markets requiring additional capital. Liquidity has been reduced and the issuance of CDOs of asset-backed securities has largely ceased.

The Department has endeavored to bring new capital and insurance capacity into New York and has worked extensively with insurers to minimize stress on the market. This bill would establish necessary restrictions and limitations on financial guaranty insurance, and strengthen the tools available to the Superintendent to ensure the continued viability of the financial guaranty market.

This bill would take a multi-pronged approach to enhancing the regulation of financial guaranty insurance by:

* Restricting guarantees of CDOs of asset-backed securities; * Deleting the capacity of financial guaranty insurers to guarantee credit default swaps; * Allowing the Superintendent to respond promptly to market changes; * Limiting concentration of risk; * Limiting non-investment grade credit risk; * Improving oversight of underwriting and risk management by applying principles-based standards; * Permitting the insurance of lower quality (yet still investment-grade) government issues with commensurate reserves; * Increasing minimum surplus and capital requirements; * Requiring increased capital for insurance that includes operating leverage; and * Requiring insurers to address credit deterioration of book of business.

The bill would provide a comprehensive reform of Article 69 of the Insurance Law to restrict the ability of financial guaranty insurers to engage in guaranties of business that could potentially unduly stress their ability to support governmental functions while preserving the critical role that financial guaranty insurers play in the financial markets, particularly in the public finance area. Although the bill focuses on remedying certain problematic structures (such as CDOs of asset-backed securities and credit default swaps), the bill also would grant the Superintendent the authority to address future problems as they arise.

The bill would not specify by label or form the type of debt or obligation that may be insured, or the structures to be used. Rather, the bill would require insurers to more adequately diversify their risks among issuers, pools, originators, and vintages to minimize correlation across the portfolio. Additional criteria for operations would be set forth as well. Insurers also would be allowed to participate in certain underserved portions of the governmental market.

Although financial guaranty insurers have traditionally been thought to bear little risk of insolvency, the nature of their business - increasing the credit quality of the obligations insured - requires maintenance of a high level of capital in order to write new business. Accordingly, the bill would not only increase capital and surplus requirements, but also would provide alternative methods of evaluating the obligations to be insured, and grant the Department additional regulatory oversight.

The bill also would address credit default swaps ("CDS"). CDS is a generic term for a transaction under which credit risk is transferred from a counter party ("protection buyer") to another party ("protection seller"). The common standard in the capital markets is to reference the International Swaps and Derivatives Association, Inc. ("ISDA") Master Agreement (2003), which defines terms and thereby establishes uniformity for the capital markets. CDS have been virtually unregulated, but have been a significant factor contributing to the financial crisis affecting the markets today. On September 22, 2008, the Superintendent issued Circular Letter 19 (2008), which concluded that the making of CDS under certain circumstances may constitute "the doing of an insurance business" within the meaning of Insurance Law § 1101.

On November 20, 2008, the Superintendent issued the First Supplement to Circular Letter 19, noting that:

On November 14, 2008, the President's Working Group on Financial Markets announced a series of initiatives to strengthen oversight and transparency and to create a centralized market infrastructure for the over-the-counter derivatives market, including credit default swaps ("CDS"). The initiatives include the development of CDS central counterparties, some of which are expected to begin operations before the end of 2008.

Recognizing the rapidly changing landscape and uncertainty with respect to CDS, this bill would remove all references to CDS in Article 69, and authorize the Superintendent to exempt them from the Insurance law requirements, provided certain conditions are met, including that the Superintendent is satisfied that CDS are subject to comprehensive and effective regulation sufficient to protect New York. In this manner, the bill would permit the Superintendent to quickly address changes in the CDS marketplace, while maintaining necessary safeguards.

Budget implications

This bill will not have an impact on State finances, as the requirements of this bill can be performed within existing resources.

Effective date

This bill would take effect on August 1, 2009.