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You are here: Home . rules . 2002 . custodian
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SUBCHAPTER A. Examination and Corporate Custodian and Tax 28 TAC §7.86

The Texas Department of Insurance proposes to amend §7.86 concerning the demonstration of ownership by an insurer or a health maintenance organization (HMO) of its certificated and uncertificated securities. Under Insurance Code Article 21.39-B an insurer is required to have its securities registered in its name except securities held under a custodial agreement and it directs the commissioner to adopt rules authorizing a domestic insurance company to demonstrate ownership of an uncertificated security consistent with common practices of securities exchanges and markets. The section requires custodians to meet certain requirements and requires custodial agreements to contain provisions enumerated in the section. By complying with the section, insurers and HMOs can satisfactorily demonstrate to the department the ownership of the securities they own. The proposed amendment requires HMOs to comply with the requirements of the section. In addition, the department proposes to amend subsection (a) to improve clarity. The proposed amendments to subsection (b), include amending the definition of clearing corporation to reflect a change in the citation to Insurance Code Article 21.39-B and amending the definition of "qualified broker/dealer" by increasing the tangible net worth from $100 million to $250 million. The definitions of securities issuer and transfer agent are proposed for deletion as a result of the proposed deletion of a sentence in subsection (c). Proposed subsection (c) is amended to require an insurer or HMO to be able to demonstrate to the department that a custodian is qualified under this section. The last sentence in the existing subsection (c) is proposed for deletion since it is not relevant to the subject of the section. Proposed subsection (d)(1) changes the standard of care for a custodian from a fiduciary standard to the reasonable commercial standards of the custodial business. The latter standard is appropriate for the activity. The proposed amendment to subsection (d)(6) deletes a n unnecessary reference to statutory deposit requirements since it is not a required provision of a custodial agreement. Subsection (d)(7) is proposed be amended to correct a typographical error. The proposed amendment to subsection (d)(8) clarifies that clearing corporations and the Federal Reserve Book Entry System are not subject to examination. The amendment to subsection (d)(11) proposes to delete an obsolete requirement. The proposed amendments to subsection (d)(12) clarify the insurance coverage required to be maintained by a custodian that holds securities for an insurer or an HMO. Several insurers reported that "securities all risks coverage" could not be found. A proposed new subsection (d)(13) will require a custodian to notify the commissioner when an insurer withdraws all securities held by the custodian. Finally, subsection (e) is proposed to be amended to require insurers and HMOs to comply with the amended section within 90 days of its effective date. HMOs are currently subject to similar requirements under §11.803(5) of this title (relating to Investments, Loans, and Other Assets). An amendment to that section is proposed elsewhere in this issue of the Texas Register which will harmonize the two sections.

Betty Patterson, CPA, AFE, Senior Associate Commissioner, Financial Program, has determined that, for the first five-year period the amended section will be in effect, there will be no fiscal implications for state or local government as a result of enforcing or administering the section. There will be no effect on local employment or local economy.

Ms. Patterson also has determined that, for each year of the first five years the proposed section will be in effect, the public benefit anticipated as a result of compliance with the section will be improved financial safeguards and more efficient and accurate safekeeping of insurers' and HMOs' certificated and uncertificated securities held by custodians. The anticipated economic cost to insurers and HMOs required to comply with the amended section will vary for the first year of the first five year period the amended section is in effect. Each insurer and HMO will need to review the custodial agreements currently in place and determine whether changes are necessary to comply with the section as amended. Assuming changes to the custodial agreement are necessary, a new agreement must be prepared and executed by the insurer or HMO and the custodian. If the custodied securities must be transferred to another custodian as a result of the increased net worth requirement for broker/dealers acting as custodians, an insurer or HMO may incur additional costs for the transfer. Since custodial fees are negotiable and are impacted by other services an insurer or HMO may have with the custodian, the total cost of compliance will vary. Based on the department's experience, the cost of compliance with the amended section due to the foregoing activities should not exceed $5,000. After the cost of compliance in the first year of the first five-year period, there are no other anticipated economic costs to insurers or HMOs as a result of the amended section. The department finds it is neither legal nor feasible to waive or reduce the effect of the amended section on insurers or HMOs that are micro or small businesses since the section implements a statutory requirement by establishing minimum standards for the prudent safekeeping of an insurer's or HMO's securities. The department believes those standards must be applied to all insurers and HMOs to assure their investments are prudently protected to minimize the risk of los s of the investments.

To be considered, written comments on the proposal must be submitted no later than 5:00 p.m. on October 7, 2002 to Gene C. Jarmon, Acting General Counsel and Chief Clerk, Mail Code 113-2A, Texas Department of Insurance, P.O. Box 149104, Austin, Texas 78714-9104. An additional copy of the comments must be simultaneously submitted to Betty Patterson, Senior Associate Commissioner, Financial Program, Mail Code 305-2A, Texas Department of Insurance, P.O. Box 149104, Austin, Texas 78714-9104. A request for a public hearing should be submitted separately to the Office of the Chief Clerk.

The amendments are proposed under Insurance Code Articles 21.39-B, 20A.22 and §36.001. Article 21.39-B §6 directs the commissioner to adopt rules authorizing a domestic insurance company to demonstrate ownership of an uncertificated security consistent with common practices of securities exchange markets. Article 21.39-B §3 authorizes the commissioner to promulgate such regulations as may be deemed necessary to carry out the provisions of Article 21.39-B. Insurance Code Article 20A.22(a) authorizes the commissioner to propose reasonable rules as are necessary and proper to carry out the provisions of Insurance Code Chapter 20A. Section 36.001 authorizes the commissioner to determine rules for general and uniform application for the conduct and execution of the duties and functions of the department.

The proposal affects Insurance Code Articles 21.39-B, 20A.22 and 3.33 §7.

§7.86. Custodied Securities.

(a) Purpose. The purpose of this section is to enable insurers and HMOs to demonstrate ownership of securities held by a custodian in a manner consistent with the common practices of securities exchanges and markets while protecting the public interest [ interests of policyholders and shareholders].

(b) Definitions. The following words and terms, when used in this section, shall have the following meanings, unless the context clearly indicates otherwise.

(1) Clearing corporation--A corporation or system that provides for the book entry settlement and custody of securities and is further defined in Insurance Code, Article 21.39-B, §5(b) [ §4(b)] and Texas Business Commerce and Code, §8.102(a)(5).

(2) Custodian--A qualified bank, qualified broker/dealer or a clearing corporation that accepts deposits of securities from an insurer or HMO and safeguards, holds and reports on such securities pursuant to a written custodial or trust agreement with an insurer or HMO.

(3) Custodied Securities--An insurer's or HMO's securities deposited with a custodian or redeposited with a subcustodian.

(4)-(5) (No change.)

(6) Qualified Broker/Dealer--A securities firm which has, as shown by its most recent audited financial statement, a tangible net worth of at least $250 [ $100] million, is registered with and subject to the jurisdiction of the Securities and Exchange Commission, and is a member of the Securities Investor Protection Corporation.

(7) (No change.)

(8) [ Securities issuer--The enterprise, organization or other entity which issues securities.]

[ (9)] Subcustodian--A qualified bank, qualified broker dealer or a clearing corporation that accepts deposits of securities from a custodian for safeguarding and holding.

(9) HMO--A health maintenance organization as defined in the Insurance Code Article 20A.02(n).

[ (10) Transfer agent--A person or firm which engages on behalf of a securities issuer in transferring record ownership of securities.]

(c) Evidence of Securities Ownership.

(1) An insurer or HMO may demonstrate ownership of its securities by having them held by a custodian pursuant to subsection (d) of this section.

(2) An insurer or HMO shall maintain evidence that the custodian meets the requirements to be a qualified bank or a qualified broker/dealer as defined in subsection (b) of this section. [ In addition, an insurer may demonstrate ownership of its securities by having them registered in the insurer's name on the books of the securities issuer and/or the securities issuer's transfer agent.]

(d) Required Provisions For Custodial Agreements. An [ Any arrangement involving an] insurer's or HMO's deposit of its securities with a custodian must be evidenced by an agreement signed by the insurer or HMO and the custodian. The agreement signed by the insurer or HMO and the custodian must provide for the conditions described in paragraphs (1)- (13) [ (12)] of this subsection:

(1) The custodian shall exercise the same due care that is in accordance with reasonable commercial standards expected of a custodian [ fiduciary] with the responsibility for the safeguarding of the insurer's or HMO's custodied securities and for compliance with all provisions of the custodial agreement, whether the insurer's or HMO's custodied securities are in the custodian's possession or have been redeposited by the custodian with a subcustodian.

(2) The custodian shall indemnify the insurer or HMO for any loss of custodied securities occasioned by the negligence or dishonesty of custodian's officers and employees, or burglary, robbery, hold-up, theft or mysterious disappearance, including loss by damage or destruction. In the event of such loss, the custodian must promptly replace the custodied securities or the value thereof, and the value of any loss of rights or privileges resulting from said loss of custodied securities.

(3) (No change.)

(4) The custodian's official records shall separately identify custodied securities owned by the insurer or the HMO, whether held by the custodian or subcustodian. If held by a subcustodian, the custodian's records shall also identify the subcustodian.

(5) Custodied securities that are in registered form shall be registered only in the name of the insurer or HMO, the custodian or its nominee, or the subcustodian or its nominee.

(6) All activities involving the insurer's or HMO's custodied securities shall be subject to the insurer's or HMO's instructions and the custodied securities shall be withdrawable upon demand of the insurer or HMO. [ Securities deposited with insurance regulators to satisfy statutory requirements shall not be withdrawn without approval of the appropriate insurance regulatory authority.]

(7) The custodian shall furnish, upon request by the insurer or HMO, a confirmation of all transfers of custodied securities to or from the account of the insurer or HMO, and reports of custodied securities sufficient to verify information reported in the insurer's or HMO's annual statement filed with the Texas Department of Insurance and supporting schedules and information required in any audit of the insurer's or HMO's financial statements [ statement] whether the custodied securities are held by the custodian or by a subcustodian.

(8) The insurer , HMO or its designee shall [ at all times] be entitled to examine all records maintained by the custodian or subcustodian relating to the insurer's or HMO's custodied securities during the course of the custodian's regular business hours. This paragraph does not apply to a clearing corporation or the Federal Reserve Book Entry System.

(9) Upon request of the insurer or HMO, the custodian shall be required to send to the insurer or HMO all reports it receives from a clearing corporation or the Federal Reserve book-entry system on their respective systems of internal accounting control, and all reports prepared on the custodian's and subcustodian's systems of internal accounting control of custodied securities.

(10) The custodian shall not use any of the insurer's or HMO's custodied securities for the custodian's benefit and none of the insurer's or HMO's custodied securities shall be loaned, pledged, or hypothecated by the custodian or subcustodian without a written contract executed by the insurer or HMO separate and apart from the custodial agreement.

(11) The custodian is authorized and instructed by the insurer or HMO to honor any requests made by the Texas Department of Insurance for information concerning the insurer's or HMO's custodied securities. The department, from time to time, may request, and the custodian shall furnish, a detailed listing of the insurer's or HMO's custodied securities (whether in the possession of the custodian or with a subcustodian) [ and an affidavit by the custodian certifying the custodian's safekeeping responsibilities relative to the custodied securities]. The custodian's response to such requests shall be made directly to the department and shall encompass all of the insurer's or HMO's custodied securities (whether in the possession of the custodian or with a subcustodian).

(12) The custodian and subcustodian shall maintain the usual and customary insurance coverage for custodial banking risks [ "securities all risks coverage"] at levels considered reasonable and customary for the custodian banking industry covering the custodian's duties and activities as custodian for the insurer's or HMO's assets and shall describe the nature and extent of such insurance protection. Any change in such insurance protection during the term of the custodial agreement shall be promptly disclosed to the insurer or HMO.

(13) The custodian shall provide written notification to the Texas Department of Insurance if the custodial agreement with the insurer or HMO has been terminated or if 100% of the account assets in any one custody account have been withdrawn. This notification shall be submitted to the Senior Associate Commissioner, Financial Program, Mail Code 305-2A, Texas Department of Insurance, P.O. Box 149104, Austin, Texas 78714-9104 within three business days of the receipt by the custodian of the insurer's written notice of termination or within three business days of the withdrawal of 100% of the account assets.

(e) Effective Date. All insurers and HMOs subject to this section shall comply with subsection (d) of this section no later than 90 [ 180] days after the effective date of this section.



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