The National Association of Insurance Commissioners (“NAIC”) has released a derivatives risk mitigation proposal (“Proposal”) prepared by the American Council of Life Insurers (“ACLI”) for interim comment.  The Proposal would modify the formula for calculating risk-based capital (“RBC”) to reflect insurers’ use of derivatives to hedge  the risks of default or adverse change in fair market value to fixed income securities and common stocks.  The Proposal categorizes hedges as either basic, intermediate, or advanced, and provides recommendations for the allowance of RBC credit for basic and intermediate hedges.  The Proposal states that the ACLI is not making recommendations concerning advanced hedging (such as tranched transactions, equity options, and first to default baskets) at this time.

According to the ACLI, the Proposal would permit regulators to more accurately evaluate the degree of risk an insurer faces and provide insurers with a regulatory incentive to mitigate such risk.

Comments regarding the Proposal may be submitted to the NAIC until September 17, 2010.  To view the Proposal, click here.