Insurers Unready For Sarbanes-Oxley Phase Three

By Susanne Sclafane

NU Online News Service, May 12, 4:25 p.m.EDT?Insurance executives struggling to comply withcorporate disclosure provisions of the Sarbanes-Oxley Act canexpect audit problems ahead as well as additional legislation,knowledgeable experts warned at an industry conference.[@@]

The Act, officially known as The Public Company Accounting andInvestor Protection Act of 2002, sets rules of corporate governanceand financial disclosure for public companies, as well as penaltiesfor executives involved in corporate fraud.

Congress is at work on more regulation in the same vein,cautioned Susan Geiger, a partner for the law firm of Preston,Gates, Ellis, Rouvelas, Meeds LLP in Washington.

Meanwhile, if they don't work harder to complete the third phaseof implementation of existing Sarbanes-Oxley rules, many insurers,rather than a clean bill of financial health, will be hit withqualified audit opinions on Dec. 31, said Patricia Teufel,consulting actuary and principal for KPMG in Hartford, Conn.

Their views were aired at the spring meeting of the AmericanAcademy of Actuaries last week in Washington, D.C.

Ms. Teufel discussed Section 404, which requires companymanagements to report annually on the effectiveness of internalcontrols over financial reporting and auditors to separately testand opine on the controls. To meet these requirements, companiesmust design, document and test controls?and then remediate any thatare found deficient, she said.

While many of her insurer clients have started the work involvedwith 404 compliance, "the difficulty I see is that most companiesare saving the hardest processes for the end," she said, referringspecifically to the loss reserving process.

By postponing the hard part, she said, "what you risk is thatyou, the company, or your external auditors find a problem" thatyou don't have time to fix before "the rubber hits the road on Dec.31," she said, referring to the deadline for most insurancecompanies.

That means "you risk a qualified internal controls attestation"from the outside auditors, she said, adding that a dreadedconsequence will be adverse investor reaction to a qualifiedopinion.

To avoid this, she suggested that companies must start lookingat the controls on loss reserve reporting processes before June 30.That way they can remediate by Sept. 30 and auditors can have aquarter to test and sign off on controls by Dec. 31.

Explaining why she expects insurers to find problems that willneed fixing, she said that internal controls to the reservingprocess don't simply mean checking the completeness of dataunderlying actuarial processes against data that's reported in theaccounting general ledger. In addition, judgments need to betested.

"The process that is supposed to be documented in 404 is theprocess by which management arrives at its recorded reserves," shesaid. What if management overrides a loss reserve estimate producedby a qualified actuary? "How do you effectively test professionaljudgment?" she asked.

Ms. Teufel and other audit firm representatives went on todebate the likelihood of companies actually receiving qualifiedopinions on processes like loss reserve estimation.

Some audience participants suggested that with loss reservesbeing the biggest liability on an insurer's balance sheet, insurersdon't just risk qualified opinions on the reserve process, but riskadverse opinions on internal controls generally.

Others said pressures on both sides would make both qualifiedand adverse opinions unlikely?with firms accelerating theirtimetables because they fear unfavorable investor reactions toqualified opinions, and auditors moving to issue clean opinionsgiven the fact that they've never uncovered material weaknesses inthe past.

Ms. Geiger, who counsels clients on regulatory and legislativeissues, delivered bad news on the possibility of more regulation."This is only Act I," she said.

Rep. Richard Baker, R-La., and Rep. Michael Oxley, R-Ohio, havepassed a bill out of the House Financial Services Committee "andit's not to retract provisions of Sarbanes-Oxley; it is to push itforward," she said.

The latest measure would substantially increase penalties forcorporate wrongdoing by eliminating the ability "to hide behindstate Homestead laws in bankruptcy." In other words, white-collarcriminals wouldn't be able to keep their homes if they file forbankruptcy, she explained.

While Ms. Geiger noted that the amendments actually face a "veryuphill battle" to get passed, "there's more coming," she predicted."If it doesn't come from Congress, it will come from prosecutorsand the Judiciary," she said, reasoning that these parties "want tosee enforcement of Sarbanes-Oxley happen and happen now."

Last year, Congress allocated enough money to the Securities andExchange Commission to hire 800 new people, and 188 of them aredevoted to finding financial fraud. With that kind of backing,"they're going to find it," she said.

Also speaking during the session, Dave McRoberts, a CPA andbusiness risk management consultant for Smart and Associates inChicago, saw some good coming out of the 404 requirements tounderstand internal controls.

"My clients are going through this huge, massive, costly effortinternally to document and test financial reporting controls. Itvirtually is a part-time job for everyone. [But] at the end of theday, these companies will have a much better understanding ofwhat's going on in their companies, enhanced controls and betterprocesses," he said.

In the insurance industry, in particular, he said that asinsurance companies look at internal controls on information theyget from third-party administrators, managing general agents andmanaging general underwriters, they are discovering the need formore controls. "There are a lot of loose situations out there," hesaid.