Insurers May Come Up Short On Sarbox Demands

Washington

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

The so-called “Sarbox” act officially known as The Public Company Accounting and Investor Protection Act of 2002, which sets rules of corporate governance and financial disclosure for public companies, as well as penalties for executives involved in corporate fraud isn't the last word from Congress, according to Susan Geiger, a partner with Preston, Gates, Ellis, Rouvelas, Meeds LLP in Washington.

Even under regulations that already exist, many insurers face qualified audit opinions on Dec. 31 if they don't work harder to complete the third phase of implementation of Sarbox rules, warned Patricia Teufel, consulting actuary and principal for KPMG in Hartford. Both experts presented their views at the spring meeting of the American Academy of Actuaries here earlier this month.

Ms. Teufel was referring to Section 404, which requires company managements to report annually on the effectiveness of internal controls over financial reporting, and auditors to separately test and opine on the controls. To meet these requirements, companies must design, document and test controls and then remediate any that are found deficient, she said.

While many of her insurer clients have started the work involved with 404 compliance, “the difficulty I see is that most companies are saving the hardest processes for the end,” she said, referring specifically to the loss reserving process. By postponing the hard part, she said, “what you risk is that you, the company, or your external auditors find a problem [that you don't have time to fix before] the rubber hits the road on Dec. 31,” she said, referring to the deadline for most insurers.

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

Explaining why she expects insurers to find problems that will need fixing, she said internal controls to the reserving process don't simply mean checking the completeness of data underlying actuarial processes against data that's reported in the accounting general ledger. In addition, judgments need to be tested.

“The process that is supposed to be documented in 404 is the process by which management arrives at its recorded reserves,” she said. What if management overrides a loss reserve estimate produced by a qualified actuary? “How do you effectively test professional judgment?” she asked.

Ms. Teufel and other audit firm representatives went on to debate the likelihood of companies actually receiving qualified opinions on processes such as loss reserve estimation. Some audience participants suggested that with loss reserves being the biggest liability on an insurer's balance sheet, insurers don't just risk qualified opinions on the reserve process but risk adverse opinions on internal controls generally.

Others said pressures on both sides would make both qualified and adverse opinions unlikely with firms accelerating their timetables because they fear unfavorable investor reactions to qualified opinions, and auditors moving to issue clean opinions given the fact that they've never uncovered material weaknesses in the past.

More generally, Ms. Geiger, who counsels clients on regulatory and legislative issues, 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, have passed a bill out of the House Financial Services Committee, “and it's not to retract provisions of Sarbanes-Oxle it is to push it forward,” she said. Among other things, the bill would substantially increase penalties for corporate wrongdoing by eliminating the ability “to hide behind state Homestead laws in bankruptcy.” In other words, white-collar criminals wouldn't be able to keep their homes if they file for bankruptcy, she explained.

While Ms. Geiger noted that the amendments actually face a “very uphill battle” to get passed, “there's more coming,” she predicted. “If it doesn't come from Congress, it will come from prosecutors and the judiciary,” she said, reasoning that these parties “want to see enforcement of Sarbanes-Oxley happen and happen now.”

Last year Congress allocated enough money to the Securities and Exchange Commission to hire 800 new people, and 188 of them are devoted 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 serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Insurers May Come Up Short On Sarbox Demands

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