Insurers May Come Up Short On SarboxDemands

Washington

There is bad news on the horizon for insurance executivesalready feeling overburdened by the costly efforts involved incomplying with the Sarbanes-Oxley Act, experts contend.

The so-called “Sarbox” act officially known as The PublicCompany Accounting and Investor Protection Act of 2002, which setsrules of corporate governance and financial disclosure for publiccompanies, as well as penalties for executives involved incorporate fraud isn't the last word from Congress, according toSusan Geiger, a partner with Preston, Gates, Ellis, Rouvelas, MeedsLLP in Washington.

Even under regulations that already exist, many insurers facequalified audit opinions on Dec. 31 if they don't work harder tocomplete the third phase of implementation of Sarbox rules, warnedPatricia Teufel, consulting actuary and principal for KPMG inHartford. Both experts presented their views at the spring meetingof the American Academy of Actuaries here earlier this month.

Ms. Teufel was referring to 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 hardpart, she said, “what you risk is that you, the company, or yourexternal auditors find a problem [that you don't have time to fixbefore] the rubber hits the road on Dec. 31,” she said, referringto the deadline for most insurers.

That means “you risk a qualified internal controls attestation”from outside auditors, she said, adding that a dreaded consequencewill be adverse investor reaction to a qualified opinion. To avoidthis, she suggested that companies must start looking at thecontrols on loss reserve reporting processes before June 30. Thatway they can remediate by Sept. 30, and auditors can have a quarterto test and sign off on controls by Dec. 31.

Explaining why she expects insurers to find problems that willneed fixing, she said internal controls to the reserving processdon't simply mean checking the completeness of data underlyingactuarial processes against data that's reported in the accountinggeneral ledger. In addition, judgments need to be tested.

“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 such as loss reserve estimation. Someaudience participants suggested that with loss reserves being thebiggest liability on an insurer's balance sheet, insurers don'tjust 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.

More generally, Ms. Geiger, who counsels clients on regulatoryand legislative issues, delivered bad news on the possibility ofmore 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-Oxle it is to push itforward,” she said. Among other things, the bill wouldsubstantially increase penalties for corporate wrongdoing byeliminating the ability “to hide behind state Homestead laws inbankruptcy.” In other words, white-collar criminals wouldn't beable to keep their homes if they file for bankruptcy, sheexplained.

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.

Reproduced from National Underwriter Edition, May 14, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.